STO Registration Procedures in the USA

Mr. Nathan Mubasher holds blockchain certificates from Oxford and the University of Nicosia. He earned a CORe Credential from Harvard Business School, a post-doctorate LL.M. in International Financial Transactions with emphasis on Anti-Money Laundering and Compliance at Thomas Jefferson School of Law, a J.D. at American College of Law, and his B.A. at University of California, Riverside. He is a member of the State Bar of California and is admitted to practice before all state and federal courts in California. In addition to his litigation and cryptocurrency practice, he has performed over 1,000 mediations and has Alternative Dispute Resolution (ADR) training from the United Nations Institute for Training and Research (UNITAR).

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

In the United States, many companies thought they could get away with launching an ICO if they simply labelled their token a “utility” with future value. The SEC’s recent actions against such ICOs have shown that the SEC won’t be buying that distinction in many cases.

From the SEC: “ICOs, or more specifically tokens, can be called a variety of names, but merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.”

Whether you’re launching an STO or ICO, you’ll need all your paperwork in order. Proper business registration, audited financials, and other legal documents to establish your business in the US. Most ICOs (and all STOs) will be scrutinized by the SEC and found to be securities if things continue the way they’ve been going at the SEC. As such, you’ll need to either register your security with the SEC or claim an exemption to SEC regulation.

Registering a security for a public sale is an initial public offering (IPO). The challenges of operating an IPO are massive, as is the compliance burden of getting approval and reporting on the results of the IPO. It requires underwriters and deep pockets to take a company public. As such, most STOs will opt for an exemption to securities rules under SEC regulations. Regulations A, D, and CF are exemptions to the SEC’s security filing rules.

What are the main reasons for a project team to choose Reg D, Reg CF, Reg A+, etc.?

Regulation D is what you would typically think of as a standard private capital raise. There is no upper limit to the amount you can raise if filing under Rule 506. However, the investors must be accredited (high-net-worth individuals, banks, brokers, etc.) So, Regulation D is a good option if you have connections to investors and don’t intend to offer your token publicly. Nevertheless, you’ll be responsible for reviewing documentation from investors and ensuring they’re accredited.

Regulation A received an upgrade in 2012, so many have come to call it Regulation A+. A+ is a mini-IPO. It allows companies to raise money from unaccredited investors up to $20 million in Tier I and $50 million in Tier II. However, both Regulation D and A apply to equity raises where investors typically own shares of the company. You’ll need to speak to a lawyer to see if your token offering qualifies. While Regulation A doesn’t require verification of accredited investor status, it does involve other compliance reporting requirements.

Regulation CF stands for “crowdfunding.” If your company needs seed money, this might be a good route. CF raises have a limit of $1.07 million per 12 months and the transactions themselves must take place through a registered crowdfunding platform. This is by far the easiest option, but the upper limit does make it too small of an option for most STOs.

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

Several companies have applied to offer securities under Regulation A+. However, it’s currently difficult to say whether they’ll be successful. Working with the SEC takes a lot of time and back and forth. This is what delayed the KodakCoin ICO last year; for instance, waiting for accredited investors to be validated under Regulation D.

Other projects, like Knowbella and devFreight, are trying to operate compliant STOs, but we have yet to see a project operate an ICO fully under Regulation A+. Working with the SEC simply takes too long and places high hurdles in front of young startups.

On the other hand, you’re also seeing STO exchanges like Open Finance and Sharepost (which also exchanges stock), along with issuance platforms like Desico and SPICE push forward with a build as you go approach. Some, like Abra, have recently just jumped straight in with a platform that allows you to buy stock with cryptocurrency directly.

Big players are slowed down by attempting to comply perfectly while smaller players are rushing ahead, but at the biggest risk of being shut down entirely if they overstep their bounds.

What are the recommended legal arrangements (legal structure) for pre-sale (private sale) investment deals?

This will vary based on your offering and your investors, so I can’t give a general rule here. What I can say is that Simple Agreements for Future Tokens (SAFTs) have grown dramatically in popularity since they were first introduced.

Kodak, the company doing everything by the book, decided to offer their tokens as a SAFT to investors. Once the Kodak One platform is built then Kodak will give the coins to investors. Until then, the funds from the sale of SAFTs provides the startup capital needed to build the platform.

SAFTs typically introduce income requirements, essentially limiting them to high-wealth individuals that could be accredited investors under Regulation D.

Another option we’re seeing with increasing frequency is companies dividing tokens into a utility offering and a security offering. The idea is to limit the security token to qualified investors while allowing anyone to purchase the utility token. This scheme has yet to officially come under the scrutiny of the SEC, but I expect it’s a thinly veiled attempt at circumvention and is unreliable as a legal structure.

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

An STO team has obligations to investors and to regulators. Depending on the way you structure the offering, those obligations vary. However, at a minimum, the team is responsible for keeping clear and open communication to investors and regulators. They also must provide public reporting on the status of the fundraiser in most cases.

Maintaining investor privacy, successfully executing all funding agreements, and keeping proper records of the company’s actions before, during, and after the token sale are critical. More importantly, though, be honest with investors and regulators. The companies that have been audited and taken to court by the SEC first are the ones clearly defrauding or misleading investors.

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

This is also difficult to say and will vary on a case-by-case basis. If you’re an established company like Kodak with years of audited financials and a proven track record, the process will be quicker. But even Kodak had to delay their offering because the SEC took longer than expected.

On average, probably plan for a year of regulatory approvals before you can launch A+ or D fundraising. CF fundraising don’t require the same approvals because the limit is so low.

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

Assuming you’re applying for an exemption under Regulation A, you’ll need to submit an offering statement via Form 1-A. That form requests verification of:

● Issuer’s identity, industry, number of employees, financial statements, capital structure, as well as contact information

● Jurisdiction(s) in which the securities will be offered

● Disclosure about unregistered issuances or sales of securities within the last year

● Balance sheets and related financial statements for the two previous fiscal year ends (or for such shorter time that they have been in existence)

● Exhibits for consideration — Underwriting agreement; charter, and bylaws; instrument defining the rights of securityholders; subscription agreement; voting trust agreement; material contracts; plan of acquisition, reorganization, arrangement, liquidation, or succession; escrow agreements; consents; opinion regarding legality; “testing the waters” materials; appointment of agent for service of process; materials related to non-public submissions; and any additional exhibits the issuer may wish to file

After successful approval, issuers also need to file annual and semi-annual reports to the SEC.

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

As long as your STO is registered with the SEC, the general rules of fair marketing apply. Marketing for STOs must not mislead consumers. Keep your public communications relevant and don’t promise big returns or make false statements.

In general, advertisements in the US are regulated under the FTC’s (Federal Trade Commission) rules. Additionally, financial services and implements may need approval from the Financial Industry Regulatory Agency (FINRA).

That said, individual platforms have a lot of leeway over the advertisements they run. Whether or not STOs will be allowed to advertise on Twitter, Facebook, Google, and other platforms that have banned cryptocurrency advertisements is still an open question.

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?

Once your token offering is approved by the SEC, you can accept US dollars from US investors. Bank transfers are feasible. As a compliant STO, you’ll need to collect identity information about your investors.

Polymath is probably the most well-known and respected platform for issuing security tokens at present. It includes built-in legal and application layers for various needs. You can issue tokens and then pay distributions to investors directly on the Ethereum blockchain. Securitize is another potential good option for issuing a security token. Where Polymath is more customizable, Securitize bills itself as the one that offers end-to-end solutions.

Of course, compliance and reporting will still ultimately be the issuer’s responsibility. No platform can take away that liability.

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?

Yes, there are several reports you’ll need to submit to the SEC on an ongoing basis. The reporting requirements are different for Tier I (<$20 million) vs. Tier II (<$50 million) of Regulation A. The requirements vary even more for Regulations D and CF.

Tier I offerings require an exit report within 30 days of the completion of your STO. In contrast, Tier II offerings need to file an annual and semi-annual report with the SEC as well as current reports when there are major changes in the business.

The cost of ongoing compliance is much less than the up-front cost of getting approved. That said, companies should keep meticulous records of all transactions. If your accounting becomes disorganized, the cost of compliance or an audit could be quite high.

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

The company must be registered in the US. The nationality of the founders does not matter.

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

Yes, the regulations of whatever country you’re raising funds from. You’ll likely need to go through a similar process in every country where you want to issue a security. Receiving approval from the SEC is only for a US company to issue securities to US investors.

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

There are certainly other jurisdictions in the world that are more friendly to STOs than the United States. For a long time, ICOs were scared to sell their tokens to US investors for fear the SEC would come after them. The SEC remains one of the more difficult regulatory bodies in the world to get approval from.

However, if you’re approved, you get access to some of the wealthiest investors in the world. Also, there is a “gold standard” that is applied to projects that are SEC approved which can generate a massive influx of capital. The challenge is there, but the reward is great for companies that get approval.

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

In terms of regulations, the SEC has federal-level oversight of the entire nation. In addition, certain states in the US may impose further regulations on STOs.

One potential “haven” is Puerto Rico, where tax law works very competitively while still remaining a US territory.

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

That depends on the state and the structure of the startup. Filing for an LLC or a corporation is a fairly straightforward process. However, each state in the US has different requirements, so you’ll need to consult with the Secretary of State office you intend to base your company in.

What is the legal status of cryptocurrencies in your country?

Are cryptocurrencies an asset, currency, security, or all of the above and maybe even more?

It is legal to own cryptocurrencies in the United States. However, they are not recognized as “money” by the US government except when it comes to money transmission licenses if you’re a custodial seller. Instead, most are securities if they represent interest in a company and can be traded.

Nevertheless, some major currencies, like Bitcoin and Ethereum, have received acceptance by the SEC. Neither of those is considered a security. Instead, they’re simply digital assets according to US law and are treated like other forms of property. This suggests that the view of what cryptocurrencies really are continues to evolve.

We’ll see the definition of a security token evolve as well. Is it a security token in and of itself, or rather, a utility token of a security?

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

Cryptocurrency transactions are subject to capital gains taxes. Any sale of cryptocurrency for a profit is considered an investment dividend. For most investors, this means that 15–20% of all investment gains goes to taxes.

Capital losses can be subtracted from capital gains, but only up to $3,000 per year. If your losses exceed $3,000, you can carry over those losses to the next year.

Questions asked by Kirill Shilov

Entrepreneur, the product guy at Geekforge. Has answered over 10k questions on digital marketing and is now in the process of asking 10k experts about the way to technical singularity at formula.geekforge.io