Initial coin offerings are all the craze, and for good reason. According to CoinSchedule, over $3 billion has been raised in the first 10 months of October. The Securities Exchange Commission released an investigative report concluding that DAO tokens were securities, and that scared people for maybe a few days. And then…the ICO craze continued. Some still issued illegal tokens. Some just avoided the US entirely. Many chose to comply with US laws. Filecoin, for example, conducted a Rule 506(c) offering under US securities laws and became the biggest ICO, raising $257 million, most of it within an hour.
Compliance is Achievable
For ICOs that involve securities (and some argue that all ICOs should be treated as securities offerings), US issuers or those selling to US persons will need to take heed of US securities laws. Luckily, the most common securities exemptions for ICOs under US law aren’t really that difficult to comply with. Read this prior article for an outline of the various securities exemptions that are useful for ICOs; for newbies, it’ll help you understand this article better. Many ICOs have already been conducted under Rule 506(c), and a crop of ICOs being conducted under Reg A+ will soon hit the market. Relatively few ICOs have relied on Reg S so far, but that trend should change. This article explains how concurrent Rule 506(c) and Reg S offerings can be a powerful combination for securities ICOs.
Rule 506(c) & Reg S
We assume that the ideal ICO is marketed globally through general solicitation and advertising. In the US, it is illegal to sell securities that are not registered or exempt. Rule 506(c) exempts offerings that are sold to investors who have been verified as accredited investors. Reg S exempts offerings that are made to non-US persons. If an ICO only uses Rule 506(c), then it must verify every investor as an accredited investor to US standards, including foreign investors. If an ICO only uses Reg S, then it cannot sell to any US person. Running two simultaneous side-by-side offerings with one relying on Rule 506(c) and the other relying on Reg S can therefore provide a winning combination for ICO securities compliance.
Keeping it Separate
The key is to treat each offering as a separate offering and carefully respect the separate nature of each offering. Every aspect of the 506(c) offering, including verification of its investors, must fulfill the 506(c) requirements, and every aspect of the Reg S offering, including qualification of its investors, must fulfill the Reg S requirements. A properly run structured Rule 506(c)/Reg S offering will clearly delineate between US and foreign investors. ICOs are generally marketed online, and it is critical to understand how websites should handle concurrent Rule 506(c) and Reg S offerings.
The SEC provided guidance regarding the use of websites to offer securities offshores. Specifically, they noted that they would not view those “that implement measures that are reasonably designed to guard against sales or the provision of services to U.S. persons to have targeted persons in the United States with their Internet offers”. Essentially, for a legally compliant Reg S offering, efforts must be taken to screen out US Persons from being targeted in the capital raise. For US issuers, the SEC imposes even more stringent requirements due to the increased risk that US issuers might target US persons.
It’s also important to note that the resale restrictions exist for both Rule 506(c) and Reg S securities, and they differ. This means that purchasers of tokens offered under Rule 506(c) might have different restrictions on how they can exchange those tokens from purchasers of tokens offered under Reg S. Both ICO issuers and purchasers of tokens must comply with the transfer restrictions so that neither allows for an illegal exchange of the tokens.
Is Reg S Worth It?
There are many complexities to properly executing concurrent Rule 506(c) and Reg S offerings, and it is strongly advisable to seek a competent attorney with extensive experience working on these transactions. The complexities are significant enough that issuers, especially those raising smaller dollar amounts, should strongly consider just relying on the Rule 506(c) exemption for both domestic and foreign investors, even if it means that foreign investors will need to be verified. Quite a number of very successful ICOs had no trouble raising large amounts of money from foreign investors that were required to go through the accredited investor verification process.
But the States Have a Say
It’s important to note that while Rule 506(c) is a federal exemption, states are preempted from substantively regulating the registration of such offerings under state securities laws. States may still require the issuer to make a notice filing and collect a filing fee, but they are otherwise prohibited from requiring registration at the state level. Reg S, however, enjoys no such benefit. So an offering that relies upon Reg S to exempt federal registration requirements must also find a state exemption if the offering is regulated at the state level. Some states, such as California, might not have any clear state exemption for a publicly solicited and advertised Reg S offering. In these states, ICO issuers may wish to consult with their attorneys to determine whether a Reg S offering makes sense for their ICO.
by Jor Law, a co-founder of Homeier Law PC