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Token Presale Agreements and the ConsenSys Automated Convertible Note
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Latham & Watkins has collaborated with ConsenSys to launch the Automated Convertible
Note to help startups raise capital using a traditional financing instrument with an eye
toward a future distribution of tokens.
In recent years, token presale agreements, including the Simple Agreement for Future Tokens (the
SAFT),2 have become a popular type of financing instrument among startups in the blockchain and
cryptocurrency sector. These agreements typically provide startups with non-dilutive financing to fund the
development of their blockchain-based network or platform and are often used as an alternative to
traditional startup financing instruments (such as convertible promissory notes and preferred stock). While
these agreements seek to solve certain securities law issues applicable to sales of prefunctional tokens,
they raise significant additional concerns with regard to US securities and commodities laws.3 In light of
such concerns, Latham & Watkins has collaborated with ConsenSys to launch the Automated Convertible
Note to help startups raise capital using a traditional financing instrument with an eye toward a future
distribution of tokens. This analysis surveys the regulatory issues raised by existing token presale
agreements and introduces the ConsenSys Automated Convertible Note as a potential solution for capital
formation that also addresses future token sales in a manner compliant with US securities and
commodities regulations. To access the complimentary online tool, please visit the ConsenSys website.
US SECURITIES LAW ISSUES
While token presale agreements often acknowledge that issuances of the underlying tokens could be
securities transactions, the agreements continue to subject issuers and purchasers to significant risks by
potentially increasing the likelihood that the underlying tokens will be deemed securities. First, such
agreements are regularly marketed as an investment opportunity and securities offering. Of course, this
works well for the sale of the instrument, but it also implicitly markets the investment value of the
underlying token. For example, such instruments have been and continue to be marketed to purchasers
with investment intent, such as hedge funds, venture capital funds, and others. Second, the proceeds
from token presale agreements are typically used for the development of the issuerâ€™s network or platform,
which creates a strong correlation between the sale of the tokens and development, and further supports
a finding that US federal securities laws should apply to the offer and sale of such tokens under the
Howey test.4 Third, the settlement of these instruments often contemplates delivery of the tokens at
network launch,5 coinciding with the delivery of tokens for consumptive use. This contemplation would
seem to make arguing in favor of the proposition that a token launch is not a securities offering more
difficult, as the delivery of tokens in settlement of these instruments is not directed solely to consumers.6
The consequence of deeming as securities any consumer tokens underlying a token presale agreement
could be dire for the issuer and token-based network that depends upon the free transfer of tokens on
such network. As US securities laws often require the existence and registration of an intermediary in
securities transactions (i.e., the transfer of tokens deemed to be securities), an issuer or any token-based
platform for which the underlying tokens have been deemed to be securities may be required to register
as a broker-dealer or exchange (or alternative trading system)7 to permit the functioning of such token-
based network.8 In many cases, such registration requirement would render token-based networks
unusable. Although statements by the Securities and Exchange Commission indicate an acceptance of
the notion that a digital asset originally issued as a security could subsequently cease to be a security
once the network is sufficiently decentralized,9 the uncertainty that remains regarding the viability and
timing of the consumer token sale raises challenges for appropriate disclosures to investors and potential
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liability for issuers. For cases in which the entire investment decision is based on the availability and
functionality of the underlying token, it would seem to be challenging to craft sufficient disclosure if the
entire investment proposition is subject to such a high level of uncertainty.
US COMMODITIES LAW ISSUES
Beyond the securities law concerns, token presale agreements also raise commodities law concerns.
Because cryptocurrencies are commodities,10 a presale of tokens through an instrument that provides the
purchaser with a right to receive tokens in the future, or confers such purchaser with the right to exchange
or convert such instrument into tokens, may be a forward contract for the sale of a commodity or a
commodity option, and subject to regulation by the US Commodity Futures Trading Commission (the
CFTC) as a swap, if an exemption is not available.
Commodity Forward Contracts
Forward sales of commodities fall within the Commodity Exchange Actâ€™s (as amended, the CEAâ€™s) broad
definition of â€œswap,â€ which encompasses numerous types of derivatives, and are subject to regulation by
the CFTC absent an applicable exclusion.11 Notably, the sale of a non-financial commodity for deferred
shipment or delivery is excluded from the swap definition, so long as it is intended to be physically
delivered,12 but provided such forward contract also qualifies as a commercial merchandising transaction
(Non-Financial Forward Contract Exclusion).13 If such instruments are purchased by investors or
speculators, they will not satisfy the requirement of the Non-Financial Forward Contract Exclusion
because the purchasers are not â€œcommercial market participants.â€14 The CFTC has expressly stated that
hedge funds, acting in their capacity as investors, are not commercial market participants.15 Token
presale agreements that include the agreement of the parties on a price or percentage discount on the
token to be delivered at a later date are effectively prepaid forward contracts of commodities. Moreover, if
these token presale agreements are largely marketed to investors and not commercial market
participants,16 such investors will not be eligible for the Non-Financial Forward Contract Exclusion.
More recent versions of presale instruments have included token sale-related rights, which provide
investors or issuers with a token call or put right, as applicable, upon the consummation of a token sale at
an agreed price or discount. Such rights constitute a commodity option that would be subject to CFTC
regulation as a swap,17 unless an exemption applies. Trade options are one such possible exemption, as
they are generally exempt from regulation by the CFTC, other than for certain large trader reporting
requirements and the CFTCâ€™s general anti-fraud and anti-manipulation enforcement authority (the Trade
Option Exemption).18 In order to qualify as a trade option and benefit from the Trade Option Exemption,19
the commodity option in question must be:
ï‚· Intended to be physically settled if exercised;
ï‚· Entered into with an offeror who is either an eligible contract participant (â€œECPâ€)20 or a producer,
processor or commercial user of, or merchant handling, the commodity (or products or by-products
thereof) that is the subject of the option, and such offeror is offering to enter into such option solely for
the purposes related to its business as such; and
ï‚· Entered into with an offeree who is a producer, processor or commercial user of, or merchant
handling, the commodity (or products or by-products thereof) that is the subject of the option, and
such offeree is entering into such option solely for the purposes related to its business as such.
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The Trade Option Exemption was developed to afford commercial market participants with an exemption
from trading in commodities that are physically delivered. The availability of the exemption for commercial
market participants is not currently foreclosed to participants solely by virtue of their also being investors.
As a result, an option to purchase tokens held by investors who are also network participants as part of
their business may be eligible for the Trade Option Exemption if the conditions are met.
Nevertheless, presale agreements are still heavily marketed to investors that are not commercial market
participants. As a result, the Trade Option Exemption will not be available in many instances.
Hybrid Instrument Exemption
The Hybrid Instrument Exemption (defined below) may be another avenue for exemption from
commodities law regulations applicable to commodity forward contracts and/or commodity options. Under
CFTC Rule 34.2(a), a â€œhybrid instrumentâ€ is defined to include an equity or debt security with â€œone or more
commodity-dependent components that have payment features similar to commodity futures or
commodity options contracts or combinations thereof.â€21 Under Section 2(f) of the CEA, a hybrid
instrument that is â€œpredominantly a securityâ€ is exempt from the provisions of the CEA if, among other
things, the instrument is (i) not marketed as a contract of sale of a commodity for future delivery (or option
on such a contract) subject to the CEA (the Marketing Condition), and (ii) the purchaser is not required to
make additional payments in addition to the purchase price (the Purchaser Payment Condition) (such
exemption being the Hybrid Instrument Exemption).22
While token presale instruments may, in theory, be capable of qualifying for the Hybrid Instrument
Exemption, because they are often primarily marketed to investors who themselves are solely or in large
part motivated to purchase such instrument in order to receive the underlying commodity (i.e., the token),
such instruments will often fail to satisfy the requirements of the Marketing Condition of the Hybrid
Coupled with the securities law issues discussed above, these commodities law issues compound the
regulatory concerns surrounding the SAFT and similar presale instruments.
POTENTIAL SOLUTIONS: CONSENSYS AUTOMATED CONVERTIBLE NOTE
Traditional early-stage financing structures, such as preferred stock and convertible promissory notes,23
are well-known structures that generally feature the necessary flexibility to address the needs of early
stage companies/token issuers and token platforms. The Automated Convertible Note, which runs on
OpenLaw, provides investors with greater protections with respect to their investments in token issuers
while simultaneously addressing investor demand for exposure to consumer tokens in a manner
compliant with applicable securities and commodities laws.
First, due to the inherent and significant value of the unissued consumer tokens and corresponding
network protocols of any creator or developer of such technologies, the Automated Convertible Note
provides noteholders with certain voting rights with respect to the creation and distribution of tokens.24
Eventually, as the pathway for consumer token sales becomes more clear, these voting rights may be
more narrowly tailored to apply only when such sales do not meet certain specifications, including
regulatory compliance. In addition, noteholders may seek additional protections to prevent potential uses
of the issuerâ€™s token-based network that circumvent their consumer token-related economic and
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Second, the ConsenSys Automated Convertible Note replaces the conversion and exchange rights
featured in other token presale instruments with appropriately limited rights to participate in the future
token sale of the issuer (the Token Purchase Option) as well as certain additional economic rights that
reduce the securities law-related regulatory risks associated with consumer token sales discussed above.
In particular, the Token Purchase Option included in the Automated Convertible Note does not represent
a conversion or exchange of the convertible note (which is itself a security), but is a supplemental right
provided alongside the other traditional rights granted to the noteholders. The exercise of such Token
Purchase Option also provides the parties with flexibility to structure the subsequent sales or distributions
of any consumer tokens that could be deemed securities, including by enabling the parties to delay the
issuance and sale of such tokens until a time when the relevant token-based network has achieved
sufficient decentralization.25 The Token Purchase Option can be further limited at the time of purchase to
require that any noteholderâ€™s purchase of tokens be for an actual use or to limit the total number of
consumer tokens reserved for distribution or sale to investors, thereby ensuring that any distributions or
sales thereof occur in a manner that supports the broader consumer token-based network. The Token
Purchase Option included in the Automated Convertible Note is coupled with a â€œmost favored nationâ€
(MFN) pricing provision, which guarantees noteholders the best token sale and distribution terms offered
by the issuer to any third party.
The Token Purchase Option is supplemented with certain token economic rights that are triggered upon
consummation of a token sale by the issuer. In particular, in such event the Automated Convertible Note
enables the noteholder to elect for such convertible note to either be repaid a pre-negotiated multiple of
the convertible noteâ€™s aggregate principal amount or converted into preferred stock of the issuer. While
the Automated Convertible Note does not dictate the terms of such preferred stock, the parties could
agree to modify customary preferred stock rights to provide economic benefits to the holders of such
stock upon consummation of future token sales, including through the inclusion of token-based dividend
and/or redemption rights. The careful balancing of the Token Purchase Option and these additional
economic rights should enable issuers to provide investors access to consumer tokens while protecting
development of the underlying network and consumer tokens from the application of the securities law.
Finally, the Automated Convertible Note is preferable to other token presale agreements from a
commodities law perspective for several reasons. First, conferring future participation rights on an
investor to participate in a token sale (i.e., the Token Purchase Option), or conferring economic rights to
an investor in respect of future distributions, is not clearly a swap under the CEA and subject to CFTC
regulation. There is no set strike price or final price differential that creates market risk that the CFTC
would necessarily be incentivized to regulate in the commodity options market. While no regulatory
certainty currently exists as to the treatment of the Token Purchase Option as a swap (or not) subject to
CFTC jurisdiction, the Token Purchase Option seeks to reduce economic risk and loss attributable to
other token presale agreements and simply affords the investor an MFN pricing provision to purchase the
token at spot, which is likely to drastically reduce economic risk of loss for an investor. In addition, a
noteholder cannot be said to have provided anything of value in exchange for the Token Purchase
Option, as such noteholder is under no obligation to purchase tokens in any token sale and may elect to
have the entire principal amount of the convertible note repaid upon consummation of such token sale in
the same manner as though the issuer had completed a change of control.
The ConsenSys Automated Convertible Note also provides built-in protections for token purchasers who
will also participate on the network as part of their business and intend to benefit from the Trade Option
Exemption. If such Trade Option Exemption is not otherwise available, it will direct the user to confer with
counsel as to whether such instrument should be regulated as a swap and if the noteholder and issuer
meet the requirements to be eligible to enter into the swap. In order to trade over-the-counter, swaps
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must be entered into between ECPs. While some investors (and certain token issuers) may qualify as
ECPs, token issuers who are early-stage companies that do not have at least US$10 million gross assets
would not satisfy the ECP test. A swap entered into by parties who are not ECPs would be in violation of
the CEA and CFTC regulation, and both parties could face penalties and sanctions for such actions.
Separately and importantly, swaps are also subject to trade reporting obligations. As a result, if the Token
Purchase Option does not otherwise qualify for the Trade Option Exemption, issuers and investors will
want to carefully consider the swap analysis with regard to their respective Token Purchase Option.
Importantly, the ConsenSys Automated Convertible Note does not qualify for the Hybrid Instrument
Exemption because, as a threshold matter, the Purchaser Payment Condition is not satisfied. However, it
is this element â€” i.e., no payment or price risk taken on by the purchaser â€” of the Token Purchase
Option that arguably places it outside the definition of swap as discussed above. Of course, while each
instrument would need to be analyzed on its own merits, and while regulatory certainty does not yet exist
with respect to the application of CFTC regulation to the Token Purchase Option, this alternate structure
represented by the ConsenSys Automated Convertible Note at a minimum significantly mitigates the
regulatory risks of the SAFT and other similar presale structures, and at best may offer a clear path to
avoid characterization as a swap subject to CFTC jurisdiction.
The ConsenSys Automated Convertible Note is preferable from a securities law perspective for many
similar reasons: the investor is receiving a more traditional security, the various rights they are purchasing
are far less ambiguous, and appropriate disclosures regarding the material aspects of the investment are
more easily crafted.
If you have questions about this article, please contact one of the authors listed below or the Latham
lawyer with whom you normally consult:
David L. Concannon firstname.lastname@example.org +1.212.906.1389 New York Stephen P. Wink email@example.com +1.212.906.1229 New York
Yvette D. Valdez firstname.lastname@example.org +1.212.906.1797 New York Miles P. Jennings email@example.com +1.650.463.3063 Silicon Valley
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Latham & Watkins Token Presale Agreements | Page 1
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1 The following discussion assumes readers are familiar with the US securities law and commodities law frameworks applicable to
sales of tokens in the United States. For a further discussion of such frameworks, see our article, The Yellow Brick Road to
Consumer Tokens: The Path to SEC and CFTC Compliance. In addition, the following discussion seeks to address only
fundraising instruments utilized for pure consumer token issuances and not instruments utilized for pure security token
issuances, which often have similar terms. We note that the presale of a token designed to be a security is a far easier analysis,
as each of the instruments should be offered and sold in compliance with securities law requirements and ordinary corporate
2 See, e.g., Juan Batiz-Benet, Jesse Clayburgh & Marco Santori, The SAFT Project: Toward a Compliant Token Sale Framework
(Oct. 2, 2017), [hereinafter SAFT Whitepaper].
3 In addition to the securities law issues and commodities law issues discussed below, the SAFT and similar token presale
agreements can raise tax concerns in light of the uncertainty regarding their treatment for US federal income tax purposes. It is
possible that an issuer could be subject to US federal income tax on proceeds from SAFT sales on a current basis, particularly if
the underlying tokens are consumer tokens.
4 The Howey test determines whether an asset constitutes an â€œinvestment contact,â€ one of the enumerated types of instruments
defined in the securities law (15 U.S.C. Â§Â§ 77b(a)(1), 78c(a)(10)). The test states that an investment contract involves: (i) an
investment of money, (ii) in a common enterprise, (iii) in which the investor is led to expect profits, (iv) derived from the
entrepreneurial or managerial efforts of one or more third parties. If the test is satisfied, it is immaterial whether the enterprise is
speculative or non-speculative, or whether there is a sale of property with or without intrinsic value. See SEC v. W.J. Howey
Co., 328 U.S. 293 (1946).
5 Defined in the SAFT as â€œa bona fide transaction or series of transactions, pursuant to which the [issuer] will sell the Tokens to
the general public in a publicized product launch.â€ Simple Agreement for Future Token (last visited May 10, 2019).
6 We note that some practitioners have proposed that if the network launch occurs more than six months after the SAFT sale,
they should constitute two distinct plans of financing and thus would not be integrated in accordance with the safe harbor of
Rule 502 under the Securities Act of 1933. In this regard, we would consider the concurrent settlement to negate this
proposition. Similarly, the SAFT itself may constitute an offering of the underlying token that is continuous until delivery. In any
event, we would expect that the tokens received by SAFT investors would nevertheless constitute securities on the date of
delivery given the nature of the SAFT offering and the delivery of tokens to investors, unless the network has become
sufficiently decentralized in the interim such that the â€œeffortsâ€ prong of the Howey test was no longer satisfied.
7 It is worth noting that the US House of Representatives has passed several bills aimed at improving capital formation for smaller
companies. For example, the Main Street Growth Act would amend the Securities Exchange Act of 1934, as amended, to allow
registration of venture exchanges that would provide trading venues tailored for smaller companies, such as blockchain-based
startups, whose securities are considered less liquid than those of larger companies. Main Street Growth Act, H.R. 5877, 115th
Congress (as passed by the House, July 10, 2018); see Tom Zanki, House Passes Bill to Allow Venture Exchanges, LAW360
(July 11, 2018).
8 See 15 U.S.C. Â§ 78c(a)(4)(A) (defining â€œbrokerâ€ as â€œany person engaged in the business of effecting transactions in securities for
the account of othersâ€); 15 U.S.C. Â§ 78c(a) (5)(A) (defining â€œdealerâ€ as â€œany person engaged in the business of buying and
selling securities ... for such personâ€™s own accountâ€); 15 U.S.C. Â§ 78c(a)(1) (defining â€œexchangeâ€ as â€œany organization,
association or group of persons, whether incorporated or unincorporated, which constitutes, maintains or provides a
marketplace or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to
securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market
place and the market facilities maintained by such exchange.â€).
9 See William Hinman, Dir., Div. Corp. Fin., Sec. & Exch. Commâ€™n, Digital Asset Transactions: When Howey Met Gary (Plastic)
(June 14, 2018), https://www.sec.gov/news/speech/speech-hinman-061418 [hereinafter Hinman Speech].
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10 Timothy Massad, Chairman, Commodity Futures Trading Commâ€™n, Testimony of Chairman Timothy Massad before the US
Senate Committee on Agriculture, Nutrition & Forestry (Dec. 10, 2014) [hereinafter 2014 Massad Senate Testimony].
11 See 7 U.S.C. Â§ 1a(47)(A)(ii) (â€œthe term â€˜swapâ€™ means any agreement, contract, or transaction ... that provides for any purchase,
sale, payment, or delivery ... that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or
contingency associated with a potential financial, economic, or commercial consequence.â€). Swap contracts are subject to a
myriad of CFTC regulations under the CEA, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act
of 2010 (the Dodd-Frank Act), including the requirement that over-the-counter (OTC) swap counterparties be â€œeligible contract
participants.â€ Id. Â§ 1a(18) (defining eligible contract participants (ECPs)). An individual can only qualify as an ECP if such person
has amounts invested on a discretionary basis, the aggregate of which is in excess of US$10 million; or US$5 million and enters
into swaps in order to manage the risk associated with an asset owned or liability incurred (or reasonably likely to be owned or
incurred) by such person. Id. Â§ 1a(18)(A)(xi). If one or both of the parties to a swap transaction are non-ECPs, the swap must be
executed on a CFTC-registered designated contract market. Id. Â§ 2(e).
12 Both the CEA and CFTC regulations thereunder have long recognized a forward contract exclusion from futures contracts. See
7 U.S.C. Â§ 1a(27) (â€œThe term â€˜future deliveryâ€™ does not include any sale of any cash commodity for deferred shipment or
delivery.â€). Following enactment of the Dodd-Frank Act, the sale of a non-financial commodity for deferred shipment or delivery
was also excluded from the definition of â€œswapâ€ in Section 1a(47) of the CEA under the Non-Financial Forward Contract
Exclusion. Id. Â§ 1a(47)(B)(ii).
13 See Further Definition of â€œSwap,â€ â€œSecurity-Based Swap,â€ and â€œSecurity-Based Swap Agreementâ€; Mixed Swaps; Security-
Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48208, 48228 (Aug. 13, 2012) [hereinafter Products Release].
14 As the CFTC has noted, â€œthe underlying postulate of the [forward] exclusion is that the [CEAâ€™s] regulatory scheme for futures
trading simply should not apply to private commercial merchandising transactions which create enforceable obligations to
deliver but in which delivery is deferred for reasons of commercial convenience or necessity.â€ Id. at 48228.
15 The CFTC drew a clear distinction between commercial market participants and investors in the Products Release, stating that
â€œ[a] hedge fundâ€™s investment activity is not commercial activity within the CFTCâ€™s longstanding view of the Brent Interpretation.â€
Id. at 48229. The Brent Interpretation refers to the CFTCâ€™s 1990 interpretation of the application of the forward contract
exclusion from the definition of â€œfuture deliveryâ€ in the context of â€œbook-outsâ€ transactions, which the CFTC extended in the
Products Release to apply to the forward contract exclusion from the swap definition for non- financial commodities. Statutory
Interpretation Concerning Forward Transactions, 55 Fed. Reg. 39188 (Sept. 25, 1990).
Moreover, the CFTC continued to elaborate on its discerning view of â€œcommercialâ€ in the Products Release, stating that â€œan
investment vehicle taking delivery of gold as part of its investment strategy would not be engaging in a commercial activity within
the meaning of the Brent Interpretation.â€ Products Release at 48229. However, if the investment vehicle were to own a chain of
jewelry stores and would purchase gold on a forward basis to provide raw materials for the jewelry store, the CFTC would
consider such activity to fall within the forward contract exclusion under the Brent Interpretation. Id. Notably, the CFTC stated in
the Products Release that, for purposes of the â€œswapâ€ definition, the Non-Financial Forward Contract Exclusion will be
interpreted in a manner consistent with the CFTCâ€™s historical interpretation of the existing forward exclusion with respect to
futures. As a result, the Brent Interpretation analysis is applicable for purposes of evaluating the Non-Financial Forward Contract
Exclusion as it pertains to the â€œswapâ€ definition. Id. at 48227-48228.
16 See Id.
17 7 U.S.C. Â§ 1a(47)(A)(i) (â€œthe term â€˜swapâ€™ means any agreement, contract, or transaction ... that is a put, call, cap, floor, collar, or
similar option of any kind that is for the purchase or sale, or based on the value, of 1 or more ... commoditiesâ€).
18 See 17 C.F.R. Â§ 32.3(a).
19 See 17 C.F.R. Â§ 32.3(c).
20 See supra text accompanying note 12.
21 17 C.F.R. Â§ 34.3(a).
22 Under Section 2(f) of the CEA, a hybrid instrument is â€œpredominantly a securityâ€ and exempt from the provisions of the CEA if:
â€”the hybrid instrument issuer receives payment in full of the hybrid instrumentâ€™s purchase price, substantially
contemporaneously with delivery of the hybrid instrument;
â€”the hybrid instrument purchaser/holder is not required to make any payment to the issuer in addition to the purchase price
described above, whether as margin, settlement payment or otherwise, during the life of the hybrid instrument or at maturity;
â€”the hybrid instrument issuer is not subject by the instrumentâ€™s terms to mark-to- market margining requirements; and
â€”the hybrid instrument is not marketed as a contract of sale of a commodity for future delivery (or option on such a contract)
subject to the CEA.
7 U.S.C. Â§ 2(f)(2).
23 Such securities offerings are almost exclusively accomplished through the use of an exemption from registration, such as in a
private placement that is limited to participants who are â€œaccredited investors,â€ as defined in 17 C.F.R. Â§ 230.501, either under
the more traditional style private placement of Regulation D, Rule 506(b), or the crowdfunding compatible, Regulation D, Rule
506(c). Issuers may also consider utilizing Regulation CF or Regulation A, which permit sales to non-accredited investors after
making certain filings with the SEC. For additional information, see Latham & Watkins, SEC Adopts Final Crowdfunding Rules,
Latham & Watkins Token Presale Agreements | Page 3
Client Alert No. 1893 (Nov. 10, 2015); Stephen P. Wink and Brett M. Ackerman, Crowdfunding Under the SECâ€™s New Rules, 49
REV. OF SEC. & COMMODITIES REG. 267 (Dec. 21, 2016).
24 While issuers should be cautious when granting such rights, generally the enterprise and its investors are best served when
their interests align. In consumer token sales, the parties share a direct interest in ensuring the offering or distribution complies
with applicable securities and commodities laws. In addition, all participants should share a similar interest in the maturing of the
market for token presales, as in the traditional venture capital space, to attract capital from investors that have yet to approach
the sector due to regulatory risks.
25 Two of the most widely held and well-known digital assets â€” Bitcoin and Ether â€” provide good examples of digital assets that
the SEC has indicated no longer constitute securities, primarily due to the decentralized nature of their use. See Hinman
Speech. The â€œefforts of othersâ€ prong of the Howey Test requires that such efforts must be â€œundeniably significant ones, those
essential managerial efforts which affect the failure or success of the enterprise.â€ See SEC v. Glenn W. Turner Enterprises Inc.,
474 F.2d 476, 482 (9th Cir. 1973) (â€œ[T]he fact that the investors here were required to exert some efforts if a return were to be
achieved should not automatically preclude a finding that the Plan or Adventure is an investment contract. To do so would not
serve the purpose of the legislation. Rather we adopt a more realistic test, whether the efforts made by those other than the
investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the
enterprise.â€); see United Housing Found., Inc. v. Forman, 421 U.S. 837, 855 (1975) (the â€œefforts of othersâ€ prong of the Howey
Test requires that investors have a reasonable expectation of profi t derived from the efforts of others). Two seminal cases
provide guidance on this prong for instruments traded in well-developed markets such as Bitcoin and Ether. In both Noa v. Key
Futures (Noa v. Key Futures, Inc., 638 F.2d. 77 (9th Cir. 1980).) and SEC v. Belmont Reid & Co. (SEC v. Belmont Reid & Co,
794 F.2d 1388 (9th Cir. 1986)), the Ninth Circuit applied the Howey Test to the sale of precious metals, finding that the Howey
Test is not satisfied if the expectation of economic return is based on market forces, and not on the efforts of a promoter. Thus,
the applicability of these cases to the analysis of Bitcoin and Ether within this prong of the Howey Test (and therefore the
analysis of whether either Bitcoin or Ether is a security) depends on the existence of an established, decentralized market where
the spot price is determined by ordinary market forces.