Whitepaper: Conducting a Token Offering Under Regulation A1
This white paper discusses considerations related to conducting a token offering under Regulation A under the Securities Act of 1933 (the "Securities Act"). The benefit of this strategy is that it can allow broad distributions of freely tradable tokens to their intended users. In July of 2019, two companies – Blockstack PBC ("Blockstack") and YouNow, Inc. ("YouNow") – successfully launched the first two token offerings under Regulation A, working in collaboration with Wilson Sonsini Goodrich & Rosati ("WSGR"). Below, we describe why Regulation A is a good option for many token issuers, the qualification process, and how token issuers should prepare for that process.
The Business Opportunity: Distribution of Freely Transferable Tokens to a Wide Audience
For many (if not all) companies developing blockchain-based technologies that involve digital assets ("tokens"), success is dependent on two critical issues: (1) the ability of a project sponsor (the "token issuer") to distribute tokens broadly to its targeted users, often as rewards for contributing to a project's development, and (2) free transferability of the tokens, without which the tokens are of limited use or value. These two elements together can encourage use and development of a new platform, which in turn can allow it to then achieve visibility and market saturation. In contrast, without these two features, it is unlikely that a token-based platform will be able to fully develop, much less achieve success.
Throughout much of 2017 and 2018, many companies developing blockchain-based technologies (and their counsel) steadfastly took the position that tokens were not securities and that, as a result, the federal securities laws did not apply to limit a developer's ability to distribute freely transferrable tokens broadly.
This ultimately did not serve the developer's interests. The now well-known speech given by William Hinman, Director of the Securities and Exchange Commission's ("SEC") Division of Corporation Finance, in June 2018, confirmed that the SEC viewed virtually all tokens besides Bitcoin and Ether to be securities. Recently, the SEC has issued two no-action letters (the "token NALs"), to TurnKey Jet, Inc. and Pocketful of Quarters, Inc., that suggest that tokens under significantly constrained circumstances could also not be securities.
As described in these token NALs, for a developer to rely on the SEC's relief, proceeds from the developer's token sales cannot be used to build the platform, the tokens need to be immediately functional upon sale, transfers can only be allowed to wallets on the platform, tokens can only be sold at a fixed price, repurchases could only be at a discount to the fixed price, and the token cannot be marketed in a manner to suggest potential increases in market value.
If your token is not Bitcoin, Ether, or subject to the extensive restrictions described in the token NALs, there is a high likelihood it's a security. There are thousands of outstanding tokens, and at least to date, the SEC has determined that exactly four can be treated as something other than a security. The federal courts that have considered whether a token is a security have generally agreed with the SEC.
Because most tokens are considered securities under the federal securities laws and the token NALs suggest most tokens will remain securities, token issuers cannot engage in broad distributions of freely transferable tokens without complying with those laws. Under the federal securities laws, any offering and sale of a security must be either registered with the SEC or comply with an exemption from registration. Most frequently, token issuers rely on exemptions for private offerings made only to "accredited investors" (generally, individuals with at least $1 million in net worth or annual income of $200,000, $300,000 with a spouse, or entities with $5 million in assets) or only to non-U.S. persons. This has meant that many intended users of a platform cannot receive the tokens. In addition, because securities offered in reliance on these exemptions are not tradable for at least a year and a day after their distribution, tokens distributed in this manner are not freely transferable. Even after the yearlong holding period, token issuers cannot receive the tokens and re-distribute them without complying with the same restrictions.
We commonly hear a number of questions from developers who feel confident that their token is one of the special, few non-security tokens: "But wait! My platform is really decentralized. My tokens aren't securities, are they?" and "I'm creating a stable coin...that's not a security, is it?" The answers to all of these questions can be found in SEC v. W.J. Howey Company (1946), in which the Supreme Court found that an instrument meets the definition of an "investment contract" under the Securities Act if it involves "an investment of money in a common enterprise with profits to come solely from the efforts of others." The fact that tokens involve new or different technologies does not mean that Howey is inapplicable. The new or different is precisely what Howey is designed to address. Remember that Howey involved orange groves, and the SEC has used the Howey analysis to take the position that interests involving concert tickets, golf club memberships, and ferrets can be securities. The Howey definition is far-reaching.
1. This paper was written by Robert H. Rosenblum, Amy Caiazza, and Taylor Evenson in WSGR's Blockchain and Cryptocurrency group, which is part of our Securities Regulatory and Complex Transactions group1. This paper was written by Robert H. Rosenblum, Amy Caiazza, and Taylor Evenson in WSGR's Blockchain and Cryptocurrency group, which is part of our Securities Regulatory and Complex Transactions group
To view full Article, please click here .
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.