By: Steve Masur
A lot of people have been asking us what may happen with regards to regulation of ICOs in the United States. The U.S. Securities and Exchange Commission’s regulatory action against Munchee, Inc.’s ICO, coupled with the recent U.S. Senate Committee on Banking, Housing, and Urban Affairs hearing on cryptocurrencies, set off a massive regulatory change. By the end of 2018, many ICOs made available in the US market may need to be qualified as securities offerings, and complying with the U.S. securities laws may not be too burdensome or difficult, though it could affect the marketability of token offerings.
So What Happened?
On February 6, 2018, Securities and Exchange Commission (SEC) chairman Jay Clayton and Commodity Futures Trading Commission (CFTC) chairman J. Christopher Giancarlo testified in front of the Senate Banking Committee in a hearing entitled “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” and spectators have come away with four key things from the hearing:
- Clayton and Giancarlo used personal anecdotes to demonstrate that they don’t want to shut down coin offerings and cryptocurrencies in the United States. They acknowledged that the stock market feels inaccessible to main street investors and indicated they understand the role that cryptocurrency offerings can play in giving people the opportunity to gain access to early-stage investment opportunities, as well as the attractiveness of early liquidity.
- They are unsure of exactly how to deal with scams and fraudulent activity in the crypto space without creating too much of a chilling effect on activity. They are mindful that if they scare all of the ICOs offshore, they could scare a lot of innovation offshore and, with it, potential economic growth for the United States.
- They each see regulating cryptocurrency as partially within the SEC’s jurisdiction, partially within the CFTC’s jurisdiction, and partially within a grey zone in between. They understand that this creates the opportunity for them to expand their agencies’ jurisdictions and get more federal funding, as well as to surgically paint themselves out of responsibility of policing the more problematic areas in cryptocurrency regulation and push them to other agencies. They understand the need to collaborate on enforcement.
- They were crystal clear that an opinion letter from a law firm does not exempt a utility token offering from consideration as a securities offering under U.S. law.
What Might This Mean for Utility Token Offerings in the US?
First, it will likely be much more difficult to get a U.S. law firm to write an opinion letter stating that your token offering is not a securities offering. Second, there may be many fewer utility token offerings in the United States because of the regulatory requirements. Third, token offerings accessible to U.S. investors need to comply with U.S. securities laws, i.e., either be registered as a public offering or be exempt from registration. Fourth, since there are many countries that do not classify ICOs as securities offerings, many companies may choose to launch their ICOs offshore and geofence U.S. investors out of the offering, or at a minimum, subject them to Anti-Money Laundering (AML) and Know Your Customer (KYC) review and qualification. Finally, companies that believe they can conduct their ICO offshore may find they have not actually escaped U.S. enforcement jurisdiction if their business maintains sufficient contacts within the United States.
What Can You Do?
You might not need to scrap your plans to conduct a token offering in the United States and immediately move offshore, and may actually comply with U.S. securities laws without too much expense with strategic legal guidance. The SEC has set out rules for conducting a complaint securities offering, including Regulations D, A, A+, and CF, and the SEC made clear in the Munchee action that they will “scrutinize the market vigilantly for improper offerings that seek to sell securities to the general public without the required registration or exemption.” That said, in declining to impose a penalty, the SEC was sympathetic to Munchee’s efforts to comply by immediately stopping the ICO and refunding investors’ money before issuing any tokens.
With all of this said, the biggest problem that offerings qualified as securities under U.S. law face is decreased marketability. Long lockups and other limitations on trading mean that securities-tokens are not nearly as interesting to the whales during a presale, or to the general market afterwards. As a result, right now, the reputable cryptocurrency exchanges are unlikely to list new security tokens and tokens that are already listed, which are later defined as security tokens, are likely to be de-listed. So while security tokens may very likely have a bright future, at the moment, they are less marketable because of the uncertainty in how they will be practically regulated. The continued ability to list on the best known and most reputable exchanges is why so many companies planning to launch utility token ICOs are forum shopping for jurisdictions outside the U.S., signing SAFTS with accredited presale investors, and exploring foundations, and other corporate models that will allow their tokens to continue to avoid being considered securities.
While the law in the area is still unclear, law firms experienced in securities offerings and ICOs can evaluate compliance obligations for specific scenarios and offer valuable guidance in structuring a token offering that is both mindful of business objectives and conscious of risk.