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Looking to the future, the marriage of financial securities and blockchain technology provides a myriad of benefits to traditional investors and cryptocurrency investors alike. Blockchain provides traditional investors with greater liquidity, the ability to custody their own assets, and a transparent market while simultaneously providing cryptocurrency investors with access to greater protections in a regulated market. This union of burgeoning and legacy financial instruments is the logical next step for both industries and is gaining wider adoption and traction as blockchain technologies and regulations develop.
United States securities law is laid out in part in the Securities Exchange Act of 1934, the Securities Act of 1933, and case precedents. At the time of writing, no blockchain- or cryptocurrency-specific legislation exists in the U.S.A. at a federal level, though existing securities legislation still applies to the market. Since 2017, many projects have launched what they believed were compliant security token offerings and — to the knowledge of Pink Sky Group — few have been pursued by the SEC.
As the cryptocurrency market shifts into the tokenization of real-world assets and as digital securities start to represent traditional financial products, regulators are taking an increased interest in how companies structure their offerings. This is especially true for companies looking to crowdfund or raise through non-accredited investors. As such, we at Pink Sky thought it prudent to look at the different regulations in closer detail.
Regulations and Compliance
Under the Securities Act of 1933, the offer and sale of securities must be registered unless an exemption from registration is available. The Securities Act provides a number of exemptions, allowing some companies to compliantly offer and sell securities without having to register the offering with the SEC.
Title III of the Jumpstart Our Business Act (JOBS Act) added Securities Act Section IV which provides an exemption from registration for certain crowdfunding transactions. In 2015, the Commission adopted Regulation Crowdfunding to implement the requirements of Title III.
Both Title III and Title IV help entrepreneurs crowdfund capital investments from non-accredited and accredited investors alike. The differences between these regulations are related to the limitations imposed on investors, the amount of capital companies are attempting to raise, and the different disclosure and reporting requirements.
Pink Sky Group notes that a large number of compliant security token offerings are structured pursuant to Regulation D and Regulation S exemptions and that for reasons that are debatable, Regulation A+ offerings are not likely to meet the approval of the Securities and Exchange Commission.
Regulation A+
Regulation A+ (Reg. A+, also known as Title IV of the JOBS Act) allows companies to raise up to US$50 million from both accredited and non-accredited investors. This regulation is similar to a traditional initial public offering (IPO). However, in a Reg. A+ offering, a company soliciting investments from the general public will remain private. Additionally, Reg. A+ offerings allow companies to raise capital faster and less expensively than in an IPO. There are two tiers to Reg. A+ offerings that a company may raise under depending on how much capital is being raised. This table demonstrates some of the key differences between the two tiers:
Regulation A+ offerings are available to companies that are incorporated in the United States and Canada, primarily conduct their business in the United States and Canada, and are seeking to raise a minimum of US$2 million. Lastly, it is important to note that Reg. A+ offerings incur significantly higher accounting and legal costs, have more stringent qualifications with SEC, and have ongoing disclosure requirements for investors and the public.
Regulation CF
Title III of the JOBS Act, also known Regulation Crowdfunding (Reg. CF), was adopted in 2016 as a way to reduce regulatory restrictions for small companies and startups, making it easier to raise capital from both accredited and non-accredited investors. This means that companies who seek to raise up to US$1.07 million are now able to do so through crowdfunding portals like StartEngine should they meet the necessary requirements.
Regulation D
Regulation D (Reg. D) offerings are advantageous to any private company because they allow an entity to obtain funding faster and avoid the costs associated with a public offering. Additionally, Title II does not impose capital raise limitations. Regulation D may allow offerings to be openly solicited to prospective investors in a network, though the company raising capital still needs to provide disclosure documentation and ensure that their investors are accredited. However, these requirements are significantly less than what is required in a public offering. Companies must still electronically file a Form D with the SEC, which includes names and addresses of their executives and directors and some details regarding their offering.
Among the other requirements of Title II, the issuer of the securities must provide disclosures of any prior “bad actor” events in advance of the sale. If such information is not provided, the issuer can prove they are not at fault if they establish that they were not aware nor could have become aware of the undisclosed information.
The benefits of Reg. D are only available to the issuer of the securities, not to affiliates of the issuer or to any other individual for resale of the securities. Exemptions offered under Title II only apply to the transactions, not to the securities themselves.
Rule 506
For decades, companies wishing to sell private securities had to rely on friends, family, or their own networks because securities laws did not allow for general solicitation. However, this changed when Title II of the JOBS Act came into effect in September 2013. The Rule 506 exemption was split into two: 506(b) represents the old approach and 506(c) — in keeping with the age of transparency and sharing of information — allows general solicitation or advertising to the public.
Companies selling securities under Rule 506(b) can — but do not usually — sell securities to accredited investors and up to 35 non-accredited, but sophisticated investors. Determining what constitutes a “sophisticated investor” is sometimes debated between issuers and the SEC. Under Rule 506(c), companies are required to sell only to accredited investors.
Regulation S
Regulation S (Reg. S) was adopted by the SEC in 1990 and provides that offers and sales of securities that occur outside of the United States are exempt from the registration requirements of Section V of the Securities Act of 1933. Regulation S is generally intended to facilitate two capital-raising scenarios: either a U.S. company that issues securities only to foreigners, or a U.S. investor who enters a foreign market to buy foreign securities. In essence, Reg. S permits these types of transactions, among others, to occur without SEC registration and imposes a 40-day lockup period on the trading of securities issued under the exemption.
The Fixing America’s Surface Transportation Act
In 2015, the Fixing America’s Surface Transportation Act (FAST Act) was signed into law. While the FAST Act primarily provides long-term funding for surface transportation, it also makes several changes to the Securities Act of 1933. While not an offering exemption, the FAST Act adds Sections 4(a)(1½) and 4(a)(7), providing exemptions for the exchange of privately issued sales.
Section 4(a)(1½). Like Rule 506, Section 4(a)(1½) operates as a safe harbor for privately issued sales under Section 4(a)(2), providing an exemption for the private sale of securities by unaffiliated securities holders. This exemption permits the resale of a privately issued security to qualified institutional buyers, subject to limitations.
Section 4(a)(7). Section 4(a)(7) created a new safe harbor for private resales 90 days after the initial sale, which can be considered exempt under certain conditions. However, securities acquired under Section 4(a)(7) cannot be further transferred until they are registered and any state blue sky restrictions become inapplicable.
Summary
As traditional, accredited, non-accredited, and even first-time investors turn to the burgeoning and accessible STO market to seek profit, the Securities and Exchange Commission’s goal of investor protection becomes more compelling than ever. As new technology companies enter into the world of securities exchanges, and as traditional financial instruments are converted into digital securities, there is an even greater need for sound market regulation.
Securities can easily lose value. The only means by which investors can protect the money they put into securities is to perform research and understand as much as they can about how the company or industry they are investing in is evolving. Whether one is looking to launch their own security token or invest in an STO, it is essential to understand these regulations and securities compliance at large. We hope that this article highlighted these regulations and the difference in exemptions in a useful fashion.
Important Disclaimer:
Information is Opinion and Provided “AS IS.” The information provided herein is the opinion of Pink Sky Group. Certain information has been provided to Pink Sky Group by other third parties. Pink Sky Group has relied on information provided to it by such parties that it has not independently verified. Pink Sky Group cannot guarantee the accuracy of any such information and does not represent that such information is accurate or complete.
All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. Pink Sky Group is under no obligation to revise or update any statements herein for any reason or to notify you of any such change, revision or update.
Information does not Constitute Investment, Tax, Estate Planning or other Professional Advice. Information on this page should not be construed as investment, tax, estate planning or other professional advice. Pink Sky Group is not acting as an investment or other professional adviser or otherwise making any recommendation as to any investor’s decision to invest in any security, industry, strategy or other financial instrument. Users should consult their own professional advisers regarding their own specific investment, legal or tax situation before making any investment, engaging in any tax or estate planning strategy or otherwise acting on any information provided herein.
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