STO Registration Procedures in Germany

Lutz Auffenberg, LL.M. (London)

Lutz is German attorney at law and founder of the Frankfurt-based boutique law firm FIN LAW, a firm with a strong focus on the regulation of cryptocurrencies, STOs and ICOs, as well as other blockchain-related projects. Lutz has been working in blockchain law since 2012. Prior to his founding of FIN LAW he was in charge of the banking and capital markets department at a midsize law firm in Frankfurt before becoming a salary partner at one on Germany’s top twenty law firms. Lutz is renowned in the German blockchain community due to the prominent blockchain projects he consulted on along with several scientific publications regarding the regulation of cryptocurrencies. https://fin-law.de

What are the main regulations that exist in your region if you’d like to launch an STO/ICO?

Lutz: Businesses planning to procure funds through an ICO in Germany will at first have to determine how exactly the token to be issued can be classified from a regulatory point of view. For example, so-called “utility tokens” granting access to a specific service of the issuer or alike will be classified differently from investment tokens, equity tokens, or security tokens. Depending on the concrete features of the token it may be that the issuer needs to draft a prospectus prior to the initial offering or obtain a license from the competent supervision authority BaFin for offering their services. In case the tokens to be issued qualify as securities, further regulations must be complied with, such as the German Securities Trading Act (WpHG), the European Markets in Financial Instruments Regulation (MiFIR), and the European Market Abuse Regulation (MAR). As the possibilities to design tokens are numerous, a definite answer on the regulations applicable can only be given after a sound assessment of the ICO project on a case-by-case basis.

In a nutshell, ICOs and STOs in Germany are legally possible as long as the issuer complies with the regulations.

For Germany: What are the main reasons for a project team to choose a certain type of regulation? (type of project, softcap/hardcap, marketing strategy, product specifics).

Lutz: The regulatory framework in Germany differs from the one in the US. In general, the issuer is not in the position to choose a regulation. However, it may be possible to draft the ICO-project in a way which entails lower regulatory obligations, e.g. utility token instead of security token, security token offering only to professional investors or a private placement instead of a public offering.

Are there any examples of ICO/STO projects that have already complied with regulations? Do you consider their pick to be appropriate or not?

Lutz: There have been several ICOs in Germany, some of them coordinated with BaFin, some without professional legal advisory. Since BaFin officially stated in early 2018 that ICO projects conducted in Germany may be subject to the capital markets regulations, a thorough drafting of the ICO documentation and coordination with BaFin is absolutely necessary in order to not get in trouble with regulators or investors. For example, according to German private law, issuers are liable for all funds invested in case they did not draft and have approved a prospectus prior to the ICO if such prospectus would have been required for the offering.

German ICOs so far have been utility token offerings, which did not have to meet very complex regulations. The first real security token offering under German law, fully coordinated with BaFin, has not yet be conducted, but I assume that we will see several projects in 2019.

What are the recommended legal arrangements (legal structure) for pre-sale (private sale) investment deals (ST buyout, SAFT, options, etc.)?

Lutz: That depends on what exactly the issuer wants. In the first place, the product itself has to be drafted, namely the terms of the rights associated with the tokens. In the second step, the conditions of the private sale follows, where it is of the utmost importance that the offering is really private and not public. If so, it can be possible to offer some tokens to specific investors without having to draft and have approved a prospectus for the offer. It is important to keep in mind the specific laws and regulations of the country where the ICO shall take place. The SAFT Agreement, for example, is not explicitly drafted in accordance with German law but rather American law. Therefore, I always strongly advise to draft a new tailor-made document that meets the peculiarities of German private and regulatory law rather than using a SAFT template or something similar. Such a document may be drafted as a SAFT-like agreement or an option agreement as long as the agreement complies with German laws.

What are the main liabilities of an STO team to the ST holders and who is in control over the fulfilment of this obligation?

Lutz: Again, the liabilities arising from an STO depend on the individual project. Usually, it is not the team itself issuing the security tokens but a legal entity (GmbH or AG). However, the STO team will have to act carefully and meet all regulations and obligations. According to German regulatory law, if a prospectus is required for an STO, valid and complete information about the company, the business plan, the risks and tax situation along with profound information on the shareholders of the issuer, its directors, and the most important employees of the issuer has to be set out in the document. If any information in the prospectus turns out not to be true or complete and the team or a member of it has made untrue or misleading representations, under specific conditions they or he/she may be fully liable to the investors to the extent of the investments made.

This shows that security token offerings should be conducted by reliable and diligent teams. STOs are very complex projects that require a professional team as well as professional legal advisory.

What is the timeframe when going through the registration process (by stages)?

Lutz: The stage of planning and drafting the essential documentation (Terms of Security, Terms of Token Sale) can easily take two months or even more as the legal framework will have to be thoroughly coordinated with the technical details of the smart contract for the token generating event (TGE) as well as with all marketing activities and the conditions during the offering. The timeframe also depends on the STO team and their ability to quickly decide and compile the required information.

In case a prospectus is required for the offering as for most STOs, the STO team should calculate an approval procedure with BaFin, which may easily take at least three months or more. Since there have not been approvals for security token offering prospectuses so far, such projects are pioneer projects. Therefore, BaFin eventually needs rather more time to understand the specifics of the technical details of the STO and to check if all regulatory requirements are met in the document.

What are the documents that need to be prepared for the registration process?

Lutz: All documentation and contracts the offering will be based on needs to be drafted before entering into cooperation with BaFin in order to enable the authority to assess the project. The essential document — if required according to capital markets regulations — is the prospectus for the offering. Depending on the type of offering, the team will have to prepare further documents, such as the Terms of the Token , how investor rights will be associated with the tokens, the Terms of the Token Sale, if necessary for the description of the business model of the company a valid and sustainable business plan, cooperation contracts with relevant cooperation partners of the issuer, etc.

What are the advertising limitations for the STO marketing campaign in comparison with one for an ICO?

Lutz: In case any license for the business model of the issuer from BaFin or an approval from BaFin for a prospectus for the security token offering is required, marketing may not start before such license or approval is obtained. If issuers do not comply with these rules, BaFin is able to stop all marketing activities, close a non-licensed business, freeze and seize business accounts, etc. Furthermore, conducting business without a required license from BaFin is a criminal offense with a prison term up to five years, even if the team has acted negligently.

From a practical standpoint, what are the legal payment methods (to transfer the investments)? Are there any special, legally qualified platforms that provide such a service?

Lutz: From a regulatory perspective there are no limitations in regard to payment methods. The issuer is generally free to choose. We have some banks in Germany being less reluctant than others to open a bank account for an ICO/STO. It is, of course, also possible to offer payment in cryptocurrencies. Currently, some platforms for ICO/STO-payment processing are forming in Germany. For example, the stock exchange in Stuttgart is planning to offer such a service through one of their subsidiaries. However, to the best of my knowledge, none of them is already legally qualified in terms of proof-of-concept and regulatory licensing.

Are there any periodic reports required to be filed once registration has been accepted (regular audits, etc.)> How much does it cost to keep up with the regulatory filings?

Lutz: We must differentiate here. In case the issuer conducts financial services or banking activities it is possible that he/she needs a prior license from BaFin to do so. In these cases, the issuer will be subject to ongoing supervision by BaFin and periodic reports about the business of the issuer will be necessary.

Apart from that, if a prospectus for an STO has been drafted and approved, the issuer must keep that prospectus up to date as long as the offering is in place. They will then be required to have approved amendments to the prospectus every time there are relevant changes to the information provided in the prospectus.

For both the ongoing supervision and amendments to a prospectus BaFin demands fees. The costs depend on the individual business or STO, the extent, and revenues. In addition to that, costs for legal advisory and auditing are incurred.

Who will have regulatory control over exempt securities that cannot be traded within a given time?

Lutz: The issuer is responsible for all tokens issued through his TGE. If the hardcap is not met and the tokens are generated, the legal documentation, especially the Terms of Token Sale should foresee provisions as to how the issuer will handle them.

What is the cost structure of the STO registration process?

Lutz: All in all, STO issuers should calculate with costs in the range of 20k to 100k euros (plus VAT, if applicable) of BaFin fees and legal advisory fees for an STO project. The concrete costs again will depend on the project as the issuance of utility tokens will probably be less complex than conducting a security token offering. Certain STO projects may meet legal exemptions and, for instance, not require a fully approved BaFin prospectus. A reliable quote on the costs for legally compliant STO preparation can only be made with reference to a specific project. A general cost estimate in this context would rather be unsound.

What tax residency is allowed for project founders? (Do you need to be a German citizen if you want to raise money in Germany?)

Lutz: As soon as an STO issuer wants to address German investors, the German regulatory framework is applicable. Therefore, it is also possible that an issuer from the US needs to comply with the German rules if he or she also focuses on German token purchasers. A German tax residency of the issuer is not a condition for conducting an STO in Germany.

Are there any additional regulations that must be complied with if a project raises capital from non-German investors?

Lutz: The German capital markets regulations have to be met whenever an STO team wants to raise funds in Germany or from German investors. In this regard, it does not make any difference if the issuer has their seat in Germany or abroad. As soon as an STO shall not be limited to the German market, I advise the STO team to involve a colleague specializing in capital markets regulation and blockchain-related legal advisory from the country he/she wants to additionally address. We at FIN LAW have a broad network of qualified international lawyers who can be of assistance when it comes to international projects. Such an expert will be able to identify if and to what extent regulations apply on STOs in a given country.

What are the main advantages of the STO regulations within Germany when compared to other jurisdictions?

Lutz: From my perspective, the main advantage is that, in Germany, the regulatory body BaFin has already stated their view on STOs and ICOs as well as the regulatory qualification of blockchain units and blockchain tokens. We are, therefore, able to clearly identify the applicable laws and regulations for the STO or ICO project and can draft the legal documentation accordingly. In comparison to other jurisdictions, this provides legal certainty and reliability to STOs made in Germany. Another important aspect is that Germany is a prosperous country where potentially a lot of funds can be raised, which is why it is interesting for STO issuers.

At the end of the day, due to the regulatory situation in Germany for STOs, issuers cannot choose whether or not to comply with the German rules in case they want to raise funds from German investors. Therefore, any STO team wanting to conduct an STO or ICO in Germany should definitely clarify which provisions and regulations must be followed in order to mitigate regulatory risks.

Is there any special territory in your country that is a tax haven or has other beneficial regulations for cryptocurrencies and blockchain startups?

Lutz: No. The regulations apply to all territories of the FRG and BaFin is the competent authority for all STO or ICO projects.

What will be the cost of all registration procedures for a startup to incorporate in your jurisdiction? Will it differ for a foreign startup?

Lutz: The incorporation costs are equal for German and foreign startups and depend on the legal entity form the founders chose. For the most common legal entity, GmbH (the German equivalent to a Limited Liability Company), a share capital of at least 25,000 euros is required, of which at least 12,500 euros have to be paid directly in the beginning. In addition to that, costs for the notary, which must be involved, and costs for the registration in the commercial register will be incurred. The founders will decide whether they need personnel or any further infrastructure at the beginning, which may of course bring further costs.

What is legal status of cryptocurrencies in your country?

Lutz: From a banking and capital markets regulatory perspective, BaFin qualifies Bitcoins and comparable clones (Bitcoin Cash or Litecoin, etc.) as financial instruments in the sense of the German Banking Act. Other cryptocurrencies that are associated to further rights such as participation rights, AirDrops, or alike may be qualified as securities or other investments. Certain blockchain units, which are not comparable to Bitcoin and do not provide any financial rights to investors (e.g. some utility tokens) may be qualified as simple vouchers and not as any financial instrument. A universal legal status for cryptocurrencies does not exist in Germany.

Can you describe general/special taxation schemes for cryptocurrency owners and token issuers?

Lutz: The taxation of gains from cryptocurrencies is not definitively clear for now. For the time being, the tax authorities handle gains from cryptocurrencies such as Bitcoin and comparable units as gains from private sales, which results in a taxation of the gains with the personal tax rate of the investor if the cryptocurrency is sold in less than a year. For longer holding periods a tax exemption may apply and no taxes have to be paid. This is only applicable to private investors and not to professional trading. Apart from that, gains from coins or tokens which can be qualified as securities will most likely be treated as securities from a tax perspective as well, which means a flat rate taxation of 25% of the gains currently.

Do you have anything further to say about the legal nuances of cryptocurrency/token regulation?

Lutz: It is important to keep in mind that blockchain technology and blockchain units or tokens from smart contracts are a new technology. This new technology can be used as a vehicle for various projects. Regulation, therefore, does not aim at the technology itself but rather at the specific project the issuer wants to realize. If funds shall be raised, the German regulator will handle that project as what it is — an issuance of investment products.

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