Legal aspects of Security Token Offering (STO)

Alt.Estate
Feb 22 · 4 min read

Legal Disclaimer:

This article does not constitute legal guidance or legal opinion of the author or any entity associated with the author. This article is published to serve as a summary guide of the information currently available to the public.

As we have mentioned in our previous post, the major limitation of blockchain adoption is the lack of a relevant regulatory framework. As such, tokenization will not fit within most of the legal systems posing multiple legal risks for the token issuer. However, as soon as the token is officially identified as “security”, the tokenization process will fall under the regulations that are traditionally applied for IPOs or private placements. Security tokens can represent any type of tokenized (digital) security such as shares, bonds, notes etc. Compared to IPO, security token offering (STO) opens up a wider geography of investors and brings a whole new range of real assets to the market.

Public Offering
In case of public STO, the issuer will be a subject to investment prospectus requirements, pretty much as if he was preparing for an IPO. Investment prospectus is a legal document that provides detailed information about the offering and its financials. Before being handed out to potential investors, the prospectus must be approved by the financial regulator. This process aims to protect unsophisticated investors from fraud. Talking about two largest securities market , EU and USA, their requirements are outlined in Prospectus Directive (Directive 2003/71/EC) and Regulation C respectively.
No restrictions on resale are generally applied in this case.

Registration Exemptions
However, almost every jurisdiction provides exemptions from the obligation to publish a prospectus that is very costly and time-consuming. Let’s look at the US and EU regulations.
In the US to obviate the need to prepare the prospectus and to file the registration statement with the Securities and Exchange Commission (SEC) the funding can be processed through the exemption instruments promoted and sold by the company, the broker-dealer or by both. STO can utilize the SEC regulatory frameworks, such as,

- Rule 506(c) — exemption with public solicitation, where only accredited investors may purchase security tokens and each investor has to pass KYC;
- Rule 506(b) — private placement exemption without general solicitation, where no more than 35 non-accredited investors may purchase tokens;
- Regulation Crowdfunding — exemption for small offerings up to USD 1.07 million during a 12-month period with the limitation of the amount each individual investor can invest;
- Limited offering under Rule 504 for eligible companies, where up to USD 5 million in a 12-month period can be raised, and the issuer has to comply with state securities laws (blue sky laws);
- Regulation A, where two tiers can be applied: tier 1 for offerings up to USD 20 million in a 12-month period and tier 2 for offerings up to USD 50 million in a 12-month period with certain more complicated requirements.
Some exemptions have restrictions on resale.
In contrast, the European legislation, reflected in the Prospectus Directive (Directive 2003/71/EC), states that the obligation to publish a prospectus shall not apply to the following types of offer:
- an offer addressed solely to qualified investors;
- an offer addressed to fewer than 150 persons per EU member state, other than qualified investors;
- an offer addressed to investors who acquire securities for a total consideration of at least EUR 100 000 per investor;
- an offer whose denomination per unit amounts to at least EUR 100 000;
- an offer with a total consideration in the EU of less than EUR 100 000 per 12 months.
In addition, laws of some EU countries provide the prospectus exemptions for crowdfunding — raising small amounts from the public. For example, in Germany domestic offers of up to EUR 2.5 million do not require the prospectus (§ 2a of Law on Investments — Vermögensanlagengesetz). Similar provisions contained in the laws of other EU countries: in Finland, the domestic threshold is set at EUR 5 million, in Spain — at EUR 2 million per the EU, etc.
As a general rule, any resale of exempted securities shall be made in the same manner as the initial offer.

Where to Tokenize Real Estate

As follows from the regulations above, the location of the property does not entail necessary legal consequences, the location of the SPV incorporation, on the contrary, is what matters the most. The selection of the “right” SPV jurisdiction will depend on tokenization structure, type of the investors involved, the possibility to resale tokens etc. Another important aspect is the type of asset that is being tokenized — real estate or real estate investment trust (REIT), for example, will have different laws that apply for tokenization.
Legal jurisdictions that we see as best for the STOs are USA, Canada, some European countries like Malta, Luxembourg, Lichtenstein, Estonia, etc. All those countries are preparing crypto regulations and are welcoming wider blockchain adoption. Also, several established stock exchanges as Swiss SIX Exchange, Gibraltar Stock Exchange, London Stock Exchange, Australian Securities Exchange have announced the development of their digital assets platforms designed specifically for security-token trading.

Alt.Estate legal team and experienced advisors have a global network of investment and securities market professionals. We are partnering with the stock exchanges implementing blockchain technology to provide high-end tokenization services. By making fully compliant STOs in connection with real estate tokenization, Alt.Estate platform will be among pioneers of the STO market.

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