HIGHLIGHTS:

  • Issuing an initial coin offering (ICO) is a new and innovative way for companies to infuse capital into their enterprise. However, several regulatory agencies have increased their scrutiny of ICOs, including the U.S. Securities and Exchange Commission (SEC).
  • While ICOs represent an exciting new possibility for capital raises, much uncertainty remains with respect to ongoing regulation and therefore compliance with applicable securities laws is needed to ensure a smooth offering. Failure to comply with applicable securities registration and offering requirements can have severe consequences for the issuer and those involved in the offering and may provide investors with a right of rescission.
  • This client alert provides a high-level overview of certain offering exemptions available to a company intending to conduct an ICO pursuant to Regulation D, Regulation A-Plus, Regulation CF or Regulation S.

Issuing an initial coin offering (ICO) is a new and innovative way for companies to infuse capital into their enterprise. One survey recently estimated that the average ICO issued in 2017 raised $12.7 million for each issuing company and current data indicates that ICOs issued in 2018 have already surpassed the total amount of funds raised last year. However, several regulatory agencies have increased their scrutiny of ICOs, including the U.S. Securities and Exchange Commission (SEC). According to recent statements by the SEC, most "tokens" or "coins" issued through an ICO are securities and companies issuing ICOs must consider how these offerings implicate the securities registration requirements of the federal securities laws.

Companies may find relief from the securities registration requirements through one or more of the exempt offering options provided under federal securities laws. This client alert provides a high-level overview of certain offering exemptions available to a company intending to conduct an ICO pursuant to Regulation D, Regulation A-Plus, Regulation CF or Regulation S.

Exemption

Pros

Cons

Reg D 506(b)

  • No capital fundraising limit
  • Relatively limited filing requirements
  • Cannot solicit/advertise to the public
  • Generally must limit to accredited investors (self-certified); 35 nonaccredited
  • Resale limitations
  • State law requirements

Reg D 506(c)

  • No capital fundraising limit
  • Relatively limited filing requirements
  • Can solicit/advertise to the public
  • Must limit to only accredited investors (reasonably verified)
  • Resale limitations
  • State law requirements

Reg A-Plus (Tier 1)

  • $20 million capital fundraising limit in a 12-month period
  • No limits on type of investors (can be offered to general public)
  • No limits on resale
  • Qualification by the SEC and the respective states required

Reg A-Plus (Tier 2)

  • $50 million capital fundraising limit in a 12-month period
  • No limits on type of investors (can be offered to general public)
  • Initial offering exempt from state registration
  • SEC qualification only
  • Ongoing disclosure requirements
  • State qualification may be required for resales

Reg CF

  • No limits on type of investors (can be offered to general public)
  • Low capital fundraising limit and limited amount per investor
  • Increased reporting obligations
  • Resale limitations

Reg S

  • No capital fundraising limit
  • Increased monitoring to ensure all investors are non-U.S. persons
  • May be subject to restriction and registration in foreign jurisdictions
  • Resale limitations

Regulation D

Regulation D provides for two exemptions under Rule 506(b) and Rule 506(c).

Under Rule 506(b), a company conducting an ICO is not subject to any limitation on the amount of money it can raise pursuant to this offering exemption. However, a company may not use general solicitation or advertising to market the offering and must generally limit its sales to financially sophisticated or accredited investors (or up to 35 nonaccredited investors, provided such investors receive certain additional disclosures). Because of the prohibition on solicitation, the company must generally know that such investors are qualified as accredited investors and may rely on the investors' certification of their status to do so.

Under Rule 506(c), a company conducting an ICO is also not subject to any limitations on the amount of money it can raise. Moreover, under this exemption, a company is permitted to broadly solicit and advertise the ICO, provided that all of the investors are accredited investors. Accordingly, the company may not rely solely on such investors' representations, but must take reasonable steps to verify their status as such.

Both Rule 506(b) and Rule 506(c) require companies to file a notice on Form D that includes the names of the company's executive officers and directors and some limited information about the offering. State regulators also have Form D filing requirements. Finally, under both rules, the tokens or coins issued through the ICO would be restricted securities, which cannot be freely resold in a public marketplace for six months or a year.

Takeaway: A Regulation D exempt offering may be enticing for companies planning on issuing an ICO as it affords no limitation on the amount of capital that may be raised and the regulatory filing requirements are relatively minimal. However, companies that are contemplating an ICO through this exemption are limited by the type of investors who may invest in such offering. To this point, the company should consider the feasibility of sourcing sufficient accredited investors as well as the operational burden of ensuring that investors are accredited and adhering to limitations applicable to nonaccredited investors.

Regulation A-Plus

Like Regulation D, a Regulation A (now known as Regulation A-Plus because of the amendments promulgated by the JOBS Act in 2015) may be available through two options. These options are generally available to U.S. or Canadian issuers not currently subject to reporting requirements of the federal securities laws or subject to a "bad actor" disqualification. In both cases, the offering may be made to the general public and, unlike Regulation D, the coins or tokens so issued are not restricted securities.

The first option, a Tier 1 offering, allows a company to raise up to $20 million in any 12-month period. A company conducting an ICO under this exemption must provide investors with an offering circular which must be filed with, and is subject to review and qualification by, the SEC as well as state regulators where the ICO is being conducted. The offering circular should include information about the ICO, describe the use of proceeds and the risks of the ICO and describe selling shareholders, the company's business, management, performance, plans and financial statements. However, after the offering circular has been filed with the SEC and any applicable state regulators, the company has no other ongoing reporting obligations.

The second option, a Tier 2 offering, allows a company to raise up to $50 million in any 12-month period. Like Tier 1 offerings, companies must give investors access to an offering circular and file with the SEC for review and qualification. However, the company does not need to file with any state securities regulator. Unlike Tier 1 offerings, companies offering under Tier 2 are subject to ongoing reporting requirements and must regularly disclose their financial results and file reports with the SEC. Moreover, Tier 2 limits how much individual investors can invest depending on such investors' net worth, which they may self-certify, provided the company has no knowledge that an investor has exceeded such limit. Additionally, while tokens or coins issued under either tier of Regulation A-Plus are not restricted securities, qualification by state regulators (Blue Sky Laws) may be required for secondary trades in Tier 2 issues.

Takeaway: Regulation A-Plus may be attractive for smaller companies issuing an ICO that are looking to raise capital through the offering of tokens or coins while avoiding some of the more burdensome disclosure requirements. Companies can raise a large amount of capital and, unlike under Regulation D, are not limited to certain types of investors. While a company issuing an ICO under this exemption has some initial (and potentially ongoing) reporting obligations, these requirements are not as burdensome as they would be under a public offering regime.

Regulation CF

Under Regulation CF, a company can raise $1.07 million over a 12-month period. Certain companies are not eligible to use this offering exemption, such as non-U.S. companies, Exchange Act reporting companies, certain investment companies and others. Further, Regulation CF limits how much individuals can invest depending on their net worth. The entire Regulation CF offering must be conducted through an online intermediary registered with the SEC as a funding portal or broker-dealer. The company may not advertise the terms of the offering, except in a limited notice directing potential investors to the registered online intermediary. However, the company can, through the registered online intermediary, communicate with investors regarding the terms of the ICO. Finally, tokens or coins issued in an ICO cannot be resold in public markets within a one-year period.

A company conducting a Regulation CF offering must file an Offering Statement Disclosure via Form C with the SEC, which discloses certain information about the company and its business. Furthermore, a company that offers securities through Regulation CF has a continued reporting obligation and must provide an annual report that contains certain information about the company.

Takeaway: Regulation CF provides for the lowest capital amount and imposes heightened reporting obligations on a company issuing an ICO. Furthermore, while there are no restrictions on the type of investors, these investors are more limited in how much they can invest compared to the limits established in Regulation A-Plus.Nevertheless, this exemption does provide a fundraising avenue to many small companies that may have previously turned exclusively to friends and family or utilized bank loans.

Regulation S

Another potential avenue for companies is to engage in a purely offshore offering to non-U.S. persons pursuant to Regulation S. It should be noted however, that companies relying upon this offering exemption must take several steps to ensure that potential investors are indeed non-U.S. persons and take steps to ensure that securities are not offered into the U.S. without registration. Moreover, companies need to be aware of the offering restrictions and registration requirements of the various countries in which their investors reside, thus creating a complex task for an issuer seeking to take advantage of this exemption. In addition, similar to the other offering exemptions, resales using the public markets in the U.S. are not permitted unless a seller uses another applicable offering exemption.

Takeaway: In addition to enforcing restrictions on sales to U.S. persons, a company seeking to conduct an ICO through Regulation S must ensure that it is knowledgeable about the offering restrictions in the countries in which non-U.S. investors reside to avoid adverse regulatory action and/or rescission by such investors.

Conclusion

While ICOs represent an exciting new possibility for capital raises, much uncertainty remains with respect to ongoing regulation and therefore compliance with applicable securities laws is needed to ensure a smooth offering. Depending on a company's goals and tolerance for associated regulatory burdens, the company may have a strong preference for a certain form of exempt offering. These offering exemptions provide a "middle ground" for a company looking to raise capital when compared to other capital raising initiatives, such as offerings to private equity firms, venture capital firms and public offerings under the federal securities laws.