Initial coin offerings ("ICOs") are facing increased regulatory scrutiny, and are likely to be seen as securities by agencies. We've written before about the securities exemptions ICOs may use to comply with the Securities and Exchange Commission (the "SEC"): Reg D, Reg CF and Reg A+.
Reg A+ (Tier 2, in particular) has started to get attention in the cryptocurrency world because it offers advantages over the others that make the most sense for digital assets.
Well, there's good regulatory news (...which seems uncommon right now for most of crypto).
The US House of Representatives has passed the "Regulation A+ Improvement Act" (the "Reg A+ Act") that increases the cap on investments under Reg A+.
Increased Reg A+ Caps
Reg A+ is divided into Tier 1 and Tier 2. If you issue an exempt security offering under Tier 1, you can raise up to $20m in a 12-month period. If you issue the offering under Tier 2, you can raise up to $50m in a 12-month period.
The new Reg A+ Act would increase the investment cap by 50% ($30m for Tier 1, $75m for Tier 2).
ICOs & Reg A+
Several ICOs have already used Reg A+: Gab, RideCoin and WeDemand. So Reg A+ has been shown to work in practice for crypto offerings. And with an increase in capital raising potential, it will likely increase.
There are still a few key limits on using Reg A+:
The cryptocurrency market is a prime targets for broker-dealer regulation.
Brokers and dealers are people or businesses that are in the business of buying and selling securities. The formal definitions are below, but, in essence, a broker is an entity like E*Trade that acts as an intermediary between buyers and sellers. You want to buy, say, Tesla stock, so you go on E*Trade, place an order, and E*Trade finds someone selling it. This is the most traditional instance of a broker-dealer.
The "less" traditional type of broker-dealer happens when a company is selling its own securities. If it's not an IPO, the company will want to promote the fact it's selling it's securities. It could hire a third party marketing agency that would go out and promote . . . but that would make the marketing agency "in the business" of buying/selling securities, even if it's not doing any buying or selling. It's still making those transactions happens, so the marketing agency would be a broker-dealer. So anyone a company has promote its securities would count as a broker-dealer.
As a general rule, brokers and dealers are required to register with the SEC and joint a self-regulatory organization (“SRO”). The main US SRO is the Financial Industry Regulatory Authority (“FINRA”). There may also be state registration requirements, depending on your state.
If you act as a broker-dealer without properly registering, the SEC or state securities regulators can seek significant monetary penalties and/or criminal sanctions. Also, they may require rescission (basically, an undoing of the investment).
Why Broker-Dealer Laws Matter for Crypto
Given Chairman Jay Clayton of the Securities & Exchange Commission’s (“SEC”) recent aggressive view that “every ICO I’ve seen is a security,” these broker-dealer laws (“B-D laws”) will apply to most cryptocurrencies, whether utility or not.
Remember how a marketing agency that promotes a securities issuing would be a broker-dealer?
Replace "securities issuing" with ICO.
Now think of all the ads, tweets, emails, shills, etc. you have received and seen promoting ICOs.
*cough* John McAfee *cough*
Yeah . . . kind of a potentially big problem for crypto.
First off, remember that the SEC is viewing most crypto as securities. So when you see the word “security,” it would apply to a crypto or ICO that's being shilled.
The Securities Exchange Act defines “broker” as any person:
Dealer is defined as any person:
The key difference is that brokers buy and sell securities for others, while dealers do so for themselves.
Note that these definitions are really broad. You don’t have to be involved in the actual purchase or sale of a security, you just have be involved somehow. This can mean you promoted the security (read: ICO) or introduced the issuer to an investor.
The “Finder” Exception
The most cited exception to B-D registration is for a "finder," which is someone that finds investors or makes referrals. However, this is a very narrow exception. If a person has helped effect any securities (again, read: ICO) transaction more than once, this exception probably won't apply.
The main factors in determining if someone is a “finder” or “broker-dealer” are:
The determination is made on a case-by-case basis, and if any of the factors weigh in favor of being a broker . . . you’re probably a broker. Again, circumventing B-D laws is not easy; these laws are meant to apply to a lot of situations.
There are a few other exclusions from this requirement to register. The most relevant for crypto are:
The most common way to be compliant with B-D laws is to hire someone as an employee, and pay them on a fixed, regular basis. That way they'll fit in the "associated persons of the issuer" exemption from registration.
Often, these employment arrangements include bonuses. Whether this is transaction-based compensation that would trigger B-D registration depends on the circumstances, but it generally should not be tied to how much “business” an ICO promoter brings in. Key features include:
But Seriously, Consult Legal Counsel
B-D activities have serious repercussions if handled incorrectly, and the exceptions are narrow. This is an area of law where anyone that does any investing-related activities should talk to a lawyer.
Want To Learn More?
This Time Is Not Different: A Brief History of Private Money & Crypto
Initial Coin Offering (ICO) Security Exemptions
Bitcoin Dip Frequency
Reginald Young is a licensed attorney in San Francisco, California, where he works with private investment funds and startups in the crypto industry. You can connect with him here.