Enough Is Enough, Says Jay Clayton SEC Chairman: ICOs Are Securities

It is amazing to witness the clash of the SEC against an entire marketplace dedicated to raising capital for companies using ICOs. On January 22nd, Jay Clayton, the chairman of the SEC, addressed the industry one more time and said in no uncertain terms that every participant in ICOs has an obligation to follow the securities laws and protect investors.

His tone and message are those of someone who is exasperated and offering a last chance to lawyers, accountants, promoters and entrepreneurs to clean up their act: register your ICO with the SEC or use one of the permitted exemptions. Or else. Or else what?

So far the SEC has been very gentle and kind to the ICO marketplace. This is very unusual for regulators who generally like to make big examples with strong enforcement on a few key players in order to induce others to fall in line and not break securities laws. However, this time is different: the SEC chose not to meddle with what they see as an innovative industry with disruptive technology. After all, America’s leadership in the blockchain and cryptocurrencies is key to its future. So how does the SEC manage such a delicate task, where enforcement is key to regulation but greater allowances to entrepreneurs help them pursue their mission?

It is not hard to predict that most companies who raise money through an ICO will fail. After all, close to 90% of startups fail within 2 years after being founded. Most of the time, they either run out of money, lack a product-market fit, or end up fighting between their founders. Failure is good because it means someone was willing to take a chance. The more companies that try, the more likely you will see a big winner such as a Facebook, Uber or Snap. Our economy depends on the success of these soon-to-be-mega companies which create the high quality jobs our economy really needs.

The SEC has a difficult and critical task to play in the ICO marketplace. They need to regulate and make sure investors are protected while companies are able to raise the capital they need to build amazing businesses. It is clear the SEC is frustrated and will act soon. How hard the enforcement will be is not exactly clear yet, but it will happen.

So what should crypto entrepreneurs do? The SEC has made it clear they should either register or use an approved exemption. Registration is not realistic in 99.9% of cases because the costs of registration with blue sky laws and the cost of maintaining a reporting company are prohibitive. However, using an approved exemption is no big deal. What?

The JOBS ACT, which was voted into law in 2012, provides all of the necessary tools for crypto entrepreneurs to raise capital while meeting SEC regulations. This route is safe for the entrepreneur, the attorney, the accountant, and, more importantly, the investor. So why not just raise capital with a regulated ICO? It is clear that greed has taken over the better judgment of everyone who launches ICOs as utility tokens. Greed is sometimes good, but when someone is breaking securities laws, greed becomes criminal.

ICOs need to use one of the following permitted exemptions and save a ton of money on lawyer fees:

• Rule 506(c) of Regulation D. An ICO can raise an unlimited amount of money from accredited investors. This means investors who are wealthy with $1M in crypto assets or cash sitting in a real bank. The company can choose one of two structures: SAFT, which is a simple agreement for future tokens, or RATE, which is a real agreement for tokens and equity. Costs? Not much. They need an experienced securities attorney and a platform to help meet all of these keywords: AML, KYC, IV (Investor Verification). One caveat: investors need to hold their investment for 1 year before it can be legally re-sold under rule 144.
• Regulation A+. This is probably the best exemption available for ICO entrepreneurs. Under this rule, a U.S. company can raise up to $50M per year, and the investors can be the general public. The tokens they purchase are immediately liquid and can be resold. The costs are higher than with Reg D, but are not a real big deal, usually $100K to $200K, which includes the attorney and audits by CPAs.
• Regulation Crowdfunding. I left the best for the last. This rule allows a company to raise up to $1,070,000 per year with very little costs. How much? Thousands of dollars and a very short time from start to finish. Companies can raise capital from the general public; however, these new investors need to hold their investment for 1 year.
• Regulation S. This one permits companies to raise money from non-US residents with no limits but requires a one year holding restriction on reselling the tokens. The problem is that this is hard to manage because no US persons or residents can see the offering (IP blocking), and in most cases, the company also needs to comply with international securities rules in other countries: ouch. Really expensive to do it right.

A company can structure their ICO using these rules for a successful ICO. For example:

• Pre-sale: Regulation Crowdfunding + Regulation D 506(c) to raise $1M from consumers and $9M from whales
• General sale: Regulation A+ and Regulation D 506(c) to raise $50M from consumers and $100M from whales

This is the modern way to raise money for an ICO. Utility tokens are just not legal in most cases, and entrepreneurs who have a long career of success in front of them better not jeopardize their reputation working with these utility token promoters and professionals. There is just too much to lose. Investors are quickly going to realize they have been played and will be crying directly to the SEC. What happens next is the classic riches to rags to jail story. Not fun for anyone. Jay Clayton has spoken, and hopefully the marketplace, this time, has listened.

StartEngine does not endorse or highlight any individual companies on our website. We prepare a company interview for all new companies our website. Readers should not consider statements made in this post as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:http://startenginebetadev.s3.amazonaws.com/production/pdfs/Disclaimer.p