On June 13, 2018, the five SEC commissioners and selected staff visited the campus of Georgia State University (College of Law) Atlanta for an interactive event with the public outside of the Beltway. The SEC event, one of several held and planned in 2018 is in keeping with the SEC’s recent efforts to be more engaging and open to the public, especially on topics of cutting edge interest.
The event began with a town hall-style discussion, which included all five commissioners and addressed several topics. Following the town hall, each Commissioner and various staff headed smaller breakout groups. Interestingly (if not altogether surprisingly) the most heavily attended session was the blockchain and ICO session.
The ICO panel consisted of SEC Commissioner Kara M. Stein and SEC staff members Valerie Szczepanik (informally dubbed the ‘crypto czar’), Amy Starr, and Josh Dickman. Quickly addressing the general public sentiment hoping for new regulation in the ICO space, the panelists reiterated the SEC’s stance, to date, on using the existing framework of securities laws to guide how crypto is treated. As previously stated by the SEC, issuing tokens on the basis of some future promise—including future utility on a future platform—is a security.
With the reiteration of this general presumption, the panelists discussed how issuers might work within existing registration and exemption frameworks, in order to manage compliant digital coin offerings. One of the more interesting discussion points was around the possible use of Reg. A+ in such contexts, whereby digital coin offerings can, in theory, be allowed to proceed, subject to the required SEC review and approval before the offering commences. While Reg. A+ is arguably the most flexible option to do an ICO, given its benefits, it would, by the very nature of its use, mean that any digital coin offering commenced thereunder would be ‘a security’ for regulatory purposes. Although the SEC has yet to approve a Reg. A+ offering in the ICO context, the panelists stated that this does not mean that they will never approve a Reg. A+ offering, or that they are not actively reviewing such offerings submitted to them. Accordingly, the session gave the impression that the door is open to such qualification, if/when the right use case is presented.
With respect to uses of Regulation S in the digital coin offering context, the SEC raised concerns over the issue of ‘flowbacks’. Along with a Regulation D exempt offering, many ICO issuers are simultaneously using Reg S in order to offer and sell digital coins to non-US residents, as Reg S provides a safe harbor from registration under the Securities Act for offerings made outside the US. However, Reg S participants are under certain resale restrictions, which includes directly selling to anyone in the US prior to the expiration of a lock-up period of 12 months.
Flowbacks are said to occur when foreign investors in a US offering, which is otherwise exempt under Reg S, sell their shares to people living inside the US. In a nutshell, the problem is that crypto assets exist in a distributed/global environment and there is a robust secondary trading market for these tokens which has developed in several places. Unfortunately, other than raising flowbacks as a concern, there was no additional guidance on best practices to avoid or handle this problem that was communicated by the SEC during the session. Accordingly, ICO issuers are advised to be aware of such SEC concerns and structure their Reg S offerings to put lock-up safeguards in place.
Despite the promise of an intimate and less formal gathering, the SEC generally shied away from commenting on specific projects and tokens, or providing concrete industry guidance. Nevertheless, an impression was given that the SEC is continuing to ramp up its competency and focus in the ICO space, and was forceful in its recommendation that issuers are counsel contact the agency with questions, concerns, comments and suggestions in this evolving market.
Commentary by Stan Sater & Jeffrey Bekiares, Esq. Jeff is a securities lawyer with over 8+ years of experience, and is co-founder at both Founders Legal and SparkMarket. He can be reached at [email protected]