“I believe every ICO I’ve seen is a security.”
With those nine words in a hearing before the U.S. Senate Banking Committee in February 2018, the chairman of the U.S. Securities and Exchange Commission (SEC) confirmed the worst fears of many blockchain startups—that their ICOs, also known as token sales, would be regulated as securities in the United States, subject to cumbersome registration and prospectus requirements.
Those fears have led many blockchain startups to conduct token sales exclusively outside of the United States, foregoing the advantages of appealing to U.S.-based investors in the belief that doing so could avoid government regulation.
But that strategy rests on two mistaken beliefs about securities laws around the world: First, that it is impossible to conduct a token sale in the United States without undergoing the expensive process of registering with the SEC and preparing a prospectus; and, second, that securities regulation in the United States is uniquely burdensome.
In reality, as the following discussion shows, U.S. law provides significant exemptions from the registration and prospectus requirements, and it is far from the only country regulating token sales. Regardless of where a token sale is to occur, blockchain startups must investigate and comply with securities laws in every nation where their token is offered.
Securities Laws in the United States: Registration and Exemptions
In the United States, the SEC has held that virtual tokens may be securities under existing federal law. Securities generally cannot be offered or sold unless a registration statement has been filed with the SEC and the offering is accompanied by a detailed prospectus. Both registration and preparing a prospectus are costly and time-consuming processes.
However, U.S. law provides several exemptions from these requirements. For example, under Rule 506(c) of Regulation D of the Securities Act of 1933, a company can legally structure a sale of security tokens to U.S. accredited investors without having to register the securities offering with the SEC.
The process of preparation of Regulation D offering materials usually takes 2-4 weeks. Some of features of Regulation D (506(c)) offering include:
- Unlimited amount funds can be raised;
- No restrictions on advertising;
- Only U.S. accredited investors can participate in the offering; and
- Certain restrictions on transfer of tokens.
And, although qualifying for an exemption to sell security tokens in the U.S. requires the guidance of a knowledgeable securities lawyer in the United States, that process is often less expensive, time-consuming, and difficult than many blockchain startups believe.
Securities Laws Around the World
In contrast to the SEC’s explicit statements regarding token sales in the United States, regulators in many other countries have remained silent or provided unclear statements about how their own local laws will apply to virtual tokens.
However, as summarized below, many of those countries have laws similar to those of the United States, and blockchain startups must be as mindful of those laws when conducting a token sale as of U.S. laws.
Asia
China and South Korea. In early September 2017, the People’s Bank of China, in a joint statement with other Chinese regulators, declared token sales illegal in that country. Later that month, South Korea’s Financial Services Commission did the same for sales in South Korea.
Hong Kong. Hong Kong has taken a different approach to token sales than has mainland China. Rather than banning them entirely, it has simply noted that they may involve the offer and sale of securities. If so, registration, prospectus, or authorization requirements may apply, although some exemptions from those requirements are available.
Singapore. In November 2017, the Monetary Authority of Singapore (MAS) issued a series of guidelines for token sales. The MAS recognized that virtual tokens can be “capital markets products” (CMPs) under Singapore law, a category that includes, but is not limited to, securities.
Any CMP must be registered with the MAS and accompanied by a prospectus that complies with the requirements of the Securities and Futures Act. However, an offer involving a CMP may be exempt from the registration and prospectus requirements if it satisfies certain criteria.
Europe
European Union. According to the European Securities and Markets Authority, token sales may be subject to several distinct E.U. regulations when undertaken in any member state. These regulations include the Prospectus Directive, which generally requires the publication and approval of a detailed prospectus before transferable securities may be offered or sold.
France. In France, the Financial Markets Authority (AMF) has said that, while some token sales may be governed by existing French securities laws, most are not. However, the AMF is currently considering three proposals for how best to regulate such sales, including by extending existing securities laws to cover them or developing new, token-specific legislation.
Germany. In November 2017, Germany’s Federal Financial Supervisory Authority (BaFin) issued a warning to consumers concerning token sales. In its warning, BaFin stated that it would determine on a case-by-case basis whether a token sale is governed by any of a series of existing German laws, including Germany’s Securities Prospectus Act, which implements the E.U. Prospectus Directive.
Russia. Russia is currently considering new token-specific legislation. Earlier reports suggested that the country would regulate token sales in similar fashion to traditional initial public offerings. As in other countries, such offerings are subject to various registration, approval, and prospectus requirements.
Switzerland. Although Switzerland is often viewed as more token-friendly than other countries, FINMA, which regulates the country’s financial markets, has stated that token sales may need to comply with existing Swiss laws governing anti-money laundering, banking, securities trading, and collective investment schemes.
FINMA considers each token sale on a case-by-case basis, and is currently investigating several blockchain startups for potentially violating Swiss law.
United Kingdom. The United Kingdom’s Financial Conduct Authority (FCA) believes that most token sales are not subject to its jurisdiction. However, whether a sale is regulated depends on a case-by-case analysis. A token may be a transferable security under U.K. law, in which case its offering must be accompanied by a prospectus approved by the FCA, unless an exemption applies.
Middle East
Israel. The Israeli Securities Authority (ISA) formed a committee in August 2017 to study the applicability of existing Israeli securities laws to token sales. If they do apply, and if token sales involve the sale of securities, then the virtual token may not be offered to the public except by a prospectus approved by the ISA, unless an exemption applies.
United Arab Emirates. In the U.A.E., regulatory authority over securities is divided among several different bodies. The Dubai International Financial Services Authority (DFSA) governs securities in the Dubai International Financial Centre, and the Abu Dhabi Global Market’s Financial Services Regulatory Authority (FSRA) governs securities in Abu Dhabi.
These two regulators have taken different approaches in formally commenting on token sales. In September 2017, the DFSA stated that it does not currently regulate token sales and does not license firms to undertake them.
The following month, the FSRA announced that token sales may involve securities under relevant Abu Dhabi regulations, and that that determination must be made on a case-by-case basis. If a token sale involves a security, then it must generally be accompanied by a prospectus, unless an exemption applies.
North America
Canada. Canadian securities laws are similar to U.S. law. In fact, the test to determine what is a security in Canada is virtually identical to the Howey test followed under U.S. law. If a token sale is a security under Canadian law, then it must generally be registered with a securities regulatory authority and accompanied by a prospectus, unless the offering can qualify for an exemption.
Conclusion
Token sales remain a relatively new form of capitalization, and not every nation has explicitly addressed how they will be regulated. However, it is a potentially fatal mistake to interpret the silence of some countries to mean that token sales are completely unregulated there.
Similarly, it is also a mistake to believe that the SEC’s statements on token sales means that it is impossible to offer new virtual tokens in the United States without undue expense. As with most other countries, the U.S. provides substantial exemptions from the registration and other requirements under its securities laws.
Taking advantage of those exemptions is key. For help in doing so with U.S. securities laws, blockchain startups should contact the blockchain and securities attorneys of Dilendorf & Khurdayan in New York City.
DISCLAIMER: This article is not intended to be, and may not be relied on as, legal advice. The information provided is for general information purposes only. Companies and others wishing to understand how the laws of any state or nation apply to them or a proposed transaction should seek personalized legal advice from qualified local counsel.
