Issuers who offer and sell securities in the U.S. must (a) comply with the U.S. federal securities laws, including the requirement to register with the U.S. Securities and Exchange Commission (the “SEC”) or (b) qualify for an exemption from the registration requirements of the U.S. federal securities laws.
Registration requirements apply to those who offer and sell securities in the U.S. regardless of whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless of whether those securities are purchased using U.S. dollars or virtual currencies, and regardless of whether they are distributed in certificated form or through a blockchain or other distributed ledger technology.
Registration under U.S. federal securities laws requires a statutory prospectus containing information necessary to enable prospective purchasers to make an informed investment decision, a proper offering process and disclosure requirements. Such information must not make untrue statements of material fact or omit to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. Similarly, the offering must not operate as a fraud or deceit upon the purchaser. To date, no token sales have been registered with the SEC.
There are several exemptions to registration, each of which is subject to certain conditions. Common exemptions (including some of their conditions) that could apply to token sales are:
Several token sales have been conducted under the above exemptions. Recent token sales have also implemented the newly proposed SAFT framework, which is an attempt at a legally compliant framework to conduct token sales. In the SAFT framework, the issuer makes an offering of securities under an exemption, which is then followed by a token sale of non-securities once the tokens are functional. However, the SAFT framework has been met with criticism and is not guaranteed to be compliant with U.S. federal securities laws as the SEC has not provided comment on this proposed framework.
On July 25, 2017, the SEC issued its first action on a token sale in its Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, where it applied U.S. federal securities law principles to demonstrate that a particular token constituted an investment contract and therefore was a security that should have been registered with the SEC or otherwise exempt. Specifically, based on the fact and circumstances, the SEC concluded that the token offering was a securities offering because it represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.
Since this action, the SEC has issued enforcement actions against the following token sales: REcoin Group Foundation and DRC World, PlexCorps and Munchee Inc. Each of these actions related to fraudulent and/or unregistered offerings and sales of securities and were brought by the SEC’s new Cyber Unit. The unit was created in September 2017 to focus on misconduct involving distributed ledger technology and initial coin offerings, the spread of false information through electronic and social media, hacking and threats to trading platforms.
The SEC’s Office of Investor Education and Advocacy, the SEC’s Division of Enforcement and the SEC’s Office of Compliance Inspections and Examinations have also issued the following investor alerts, bulletins and statements since the DAO action: Initial Coin Offerings, Public Companies Making ICO-Related Claims, Unlawful Promotion of Initial Coin Offerings and Other Investments by Celebrities and Others.
Each state in the U.S., including New York, has its own securities act, known as “blue sky laws”, which regulates both the offer and sale of securities. Therefore, in addition to following U.S. federal securities laws, issuers must also comply with New York’s securities laws.
Many types of securities, and many transactions in securities, are exempt from these blue sky laws if they comply with federal securities laws. In New York, pursuant to the National Securities Markets Improvement Act, securities offered under Rule 506(b) and (c) qualify as “covered securities” under Section 18(b)(4) of the Securities Act and are excluded from New York’s blue sky laws. Similarly, securities offered under Regulation A+ Tier 2 are also excluded. However, New York can ask the issuers of securities to make notice filings and pay filing fees with respect to offerings if any of the investors are New York residents.
The Investor Protection Bureau is charged with enforcing the New York State securities law, commonly known as the Martin Act. The Martin Act gives the Attorney General broad law-enforcement powers to conduct investigations of suspected fraud in the offer, sale or purchase of securities and bring both civil and criminal enforcement actions. Companies issuing tokens or listing tokens on exchanges that are securities are required to take the below actions:
Persons selling securities must be aware of the strict securities fraud laws in New York. With the passing of the Martin Act, the New York securities fraud laws provide the state’s attorney general with extraordinary powers for fighting financial fraud. This power far exceeds that of any other attorney general in the United States. New York securities fraud laws provide the state’s attorney general with the power to investigate and sue any person, partnership, or corporation that employs any device or scheme to defraud or to obtain money or property by means of any false pretense, representation, or promise.
More information on the Martin Act and New York Securities Laws can be found here.
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