Laying Down the Law: Protecting Against Regulatory Enforcement
So you wrote a whitepaper, and raised funds from investors to launch your blockchain project. Chances are you probably entered into some simple agreements for future tokens (SAFTs) and/or sold tokens to be used on your platform, regardless of whether the platform was finished or yet-to-be developed. If the latter holds true — which tends to be the case with many fundraising blockchain companies — the SAFTs executed and any tokens you sold more than likely than not fell under the definition of a security. Unless you registered the securities with the Securities and Exchange Commission (SEC) or qualified for an exemption under the 1933 Securities Act, there is a good chance you might be hearing from the SEC.
This all leads to a question that you should be asking yourself: Do the SAFTs and/or tokens I sold constitute securities? The answer resonates with what the SEC encouraged companies to do in its November 16 press release on digital asset securities issuance and trading: hire legal experts to examine the facts and circumstances of your SAFTs and/or tokens to determine whether they constitute securities under the Securities Act. If your SAFTs and/or tokens are indeed securities, you need to get them registered with the SEC right now or file for an exemption through a Form D.
I would, however, take it a notch further, and strongly encourage anyone who has raised funds for a blockchain project through the sale of SAFTs and/or tokens not just to bring on counsel — but to bring on competent counsel. That said, there are many blockchain companies that appear to be under the impression they have found some way around the federal securities laws. Here is why obfuscation is not a winning long-term cryptocurrency strategy.
SEC ups the ante on cryptocurrency enforcement
SEC Chairman Jay Clayton stated in February that he had yet to see an initial coin offering (ICO) in which the tokens offered were not securities, and that the SEC indeed intended on enforcing the federal securities laws in connection with ICOs. With the recent SEC actions against Paragon Coin and Airfox as well as against boxer Floyd Mayweather Jr. and music mogul DJ Khaled, the SEC has made clear it intends on making good on Clayton’s promise. Notwithstanding, with the enforcements against Paragon and Airfox, the SEC made clear that there is a path toward compliance even for firms deemed to have been selling illegal securities: get them registered or file for the exemption ASAP and keep up to date with the required periodic reporting. You should then present your investors with all the material disclosures — that is, the risks your business faces — as required under the Securities Act, and leave your investors with the option of being refunded in full. Paragon and Airfox were also forced to pay fines. Yet the SEC was otherwise silent on whether companies who voluntarily register its tokens as securities or file for an exemption from the registration requirement will be forced to pay civil fines.
When it comes to unregistered securities, criminal penalties are not out of the realm of possibility. If the SEC decides that an ICO was a fraudulent scheme, the people behind it could be facing criminal charges and prison time, as well as having to return funds and pay additional civil fines. On that note, the SEC may bring charges against even if the violation was without “scienter,” which is a term interchangeably used with “intent.” In other words, you may still be charged even if you did not knowingly violate the Securities Act.
How ICOs can remain compliant with SEC regulations
For any company that has not raised funds but is looking to raise funds through a SAFT and/or a token sale, there are a couple of things to consider to avoid any enforcement issues with the SEC. First off, my number-one recommendation: hire competent counsel. Second, in working with your counsel, please bear in mind that the spirit of the federal securities laws is compliance, not avoidance. Federal securities laws were passed after the Great Depression to instill confidence in investors to invest in our markets. When contemplating whether to disclose a certain aspect of your business such as risks to a potential investor whether verbally or through any offering document, imagine that you are the investor. Would that aspect dissuade you from investing? If so, disclose it.
To that end, I always advise clients to overdisclose and underpromise. It is like that good old saying that will almost always serve you well: it is better to be safe than sorry.