Regulation of token sales internationally. ICO business models and tokens.
Legal framework in the USA. "I believe that every ICO that I encounter will provide certainty," the chairman of the US Securities and Exchange Commission (SEC) began his presentation to the US Senate Banking Oversight Committee in February 2018 with these words. In doing so, he confirmed the great fears of many blockchain startups - that their ICOs, based on the public offering of online bonds called "tokens" (the latter legislated as securities in the United States), are subject to cumbersome registration requirements.
These fears have led numerous emerging companies in the IT industry to launch their ICOs exclusively outside of the United States, ignoring the advantages of attracting U.S.-based investors in the belief that they can thus avoid certain sluggish government regulations.
This "strategy" is based on two misconceptions about the laws governing securities trading around the world. First, it is impossible to conduct a token sale in the US without going through the particularly expensive administrative procedure of registering the ICO with the US Securities and Exchange Commission (SEC), accompanied by the preparation of a project description. Second, the legal framework and procedures for securities regulation in the United States is uniquely burdensome.
On the other hand, U.S. law provides significant exemptions from registration and description requirements (the legal term is "prospectus"), and it is worth noting here that the United States is far from the only country regulating the sale of tokens. Regardless of where the initial token offering is to take place, blockchain firms must research and comply with the securities laws in each country where their tokens are offered.
Securities Laws in the United States. Registration regime and exemptions.
The U.S. Securities and Exchange Commission(SEC) takes the regulatory view that virtual tokens may be securities under existing federal law. Generally, securities may not be offered or sold unless an application for registration of the holder has been filed with the SEC, and the holder's offer must be accompanied by a detailed prospectus. Registration and preparation of the prospectus are expensive and time consuming.
However, U.S. law provides several exceptions to these requirements. For example, under Section 506(c) of Regulation D of the Securities Act of 1933, a company may lawfully structure a sale of security tokens to accredited U.S. investors without the need to register the offering with the SEC.
The document preparation process outlined in Regulation D typically takes 2-4 weeks. Some of the Regulation D (506(c)) rules offer the following legal constructs:
An unlimited amount of funds may be contributed to an ICO company;
No restrictions on advertising;
Only U.S. accredited investors may participate in the pubic offering as entities; and
There are some restrictions on the transfer of tokens.
Companies must decide what information to give to accredited investors, as long as they do not violate antifraud prohibitions implemented in federal securities laws. This means that any information a company provides to investors must not contain false or misleading statements. Also, a company must not exclude any information for the purpose of misleading investors. Companies must provide non-accredited investors with disclosure documents for public offerings of toll roads, including financial statements, which in some cases may need to be certified or audited by an accountant. If a company provides information to accredited investors, it must also provide that information to non-accredited investors.
The company must be able to answer questions from potential buyers.
All of these legal instruments enshrined in US law, in my opinion, guarantee transparency in token transactions and serve to safeguard the interest of investors, so that they do not invest in projects that are speculative or unrealistic from a financial point of view.
Securities laws and the regulation of token trading internationally.
In contrast to statements made by the U.S. Securities and Exchange Commission (SEC) regarding token sales in the United States, regulators in many other countries have remained silent or provided vague statements about how their own local laws would apply to virtual currencies, or tokens.
However, as summarized below, many of these countries have laws similar to those in the United States, and blockchain start-ups should exercise appropriate concern and research relevant legislation in order to properly conduct a public offering of tokens in a co-territory.
Asia
China and South Korea. In early September 2017, the People's Bank of China, in a joint statement with other Chinese financial and banking regulators, declared the sale of tokens illegal in that country. Later, in January 2108, South Korea's Financial Services Commission also banned the public offering of tokens in South Korea.
Hong Kong. Hong Kong has taken a different approach to token sales than mainland China. Instead of banning them entirely, the local financial administration noted that they public token offerings could be credited as offering and selling securities. In such a case, registration, prospectus or permit requirements may apply, although there are some exceptions to these requirements.
Singapore. In November 2017, the Monetary Authority of Singapore (MAS) issued a series of guidelines for token sales. In a statement, the MAS stated that virtual tokens may be considered "capital markets products" ("CMPs" from the English "capital markets products") under Singapore law, a category that includes, but is not limited to, securities.
Every capital market product in Singapore must be registered with MAS and be accompanied by a prospectus that complies with the requirements of the Securities and Futures Act. Note - a financial public offering involving CMPs involving tokens may be exempt from the registration and prospectus requirements if it meets certain statutory criteria.
Europe
European Union. According to the European Securities and Markets Authority, public offerings of tokens may be subject to several different European regulations that have been adopted in the relevant EU Member State. These regulations include most notably Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus to be published when securities are offered to the public or admitted to trading. The Directive, which is also part of the Bulgarian legislation (the prospectus as such is regulated in Article 81 et seq. of the Public Offering of Securities Act), requires the publication and approval of a detailed prospectus before transferable securities may be offered or sold.
France. In France, the Autorité des marchés financiers ("AMF" from the Financial Markets Authority) has stated that although some public token sales may be regulated by existing French securities laws, most are not. However, the AMF is currently considering three proposals to improve the means of regulating such public offerings of electronic notes, including by extending existing securities laws to cover them by developing new specific legislation specifically along the lines described.
Germany. In November 2017, the German Federal Financial Supervisory Authority (BaFin) issued a consumer alert on the sale of tokens. In its warning, BaFin stated that it would determine on a case-by-case basis whether the sale of tokens is governed by any of a number of existing German laws, including Germany's Securities Prospectus Act, which was created to implement Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus into German law.
Russia. Russia is currently considering new legislation aimed specifically at tokens. Reports pointing to surveys of legislative attitudes suggest that the country will regulate the sale of tokens similarly to traditional initial public offerings of securities. As in other countries, however, such offerings would be subject to different registration, approval and prospectus requirements.
Switzerland. Although Switzerland is often perceived as more welcoming than other countries, FINMA, which regulates the country's financial markets, has said that token sales may be in compliance with existing Swiss laws governing anti-money laundering, banking, securities trading and collective investment schemes.
FINMA considers each token sale as a separate case and is currently investigating several blockchain companies located on its territory for potential violations of Swiss law. One of the largest crypto communities at the same time is "Cryprto Valley" in Zug, indicating increased liberalism and the creation of a hub of blockchain companies, literally in the heart of Europe.
The UK's Financial Conduct Authority (FCA) believes that most token sales do not fall under its jurisdiction. However, whether their sale is regulated depends on a case-by-case analysis. A token may be a transferable security under UK law, in which case its offering must be accompanied by a prospectus approved by the FCA unless an exemption applies.
Middle East
Israel. The Israeli Securities Authority (ISA) established a committee in August 2017 to examine the applicability of existing Israeli securities laws to the sale of tokens. If they do apply, and if token sales involve the sale of securities, virtual tokens should not be offered to the public except by prospectus approved by the ISA and if any statutory exemptions do not apply.
United Arab Emirates. In the UAE, the securities regulatory authority is divided among several different authorities. The Dubai Financial Services Authority (DFSA) manages securities in the Dubai International Financial Centre and the Financial Services Regulatory Authority of Abu Dhabi (FSRA) manages securities in Abu Dhabi.
These two regulators have adopted different approaches in officially commenting on token sales. In September 2017, the DFSA stated that it does not currently regulate token sales or license firms to undertake them.
The following month, the FSRA announced that token sales may involve securities under relevant Abu Dhabi regulations and that the legal status of transactions must be determined on a case-by-case basis. If a token sale involves a security, it must normally be accompanied by a prospectus unless an exception applies.
North America
Canada. Canadian securities laws are similar to U.S. law. In fact, the test for determining security in such transactions in Canada is almost identical to the "Howey test" which is based on U.S. law. If a token sale is guaranteed as a security, then under Canadian law it must generally be registered with a securities regulatory authority and accompanied by a prospectus, unless the offering qualifies for an exemption.
Token sales remain a relatively new form of capitalization, which is why not every country in the world has established legislation governing these transactions. However, I think it is a misconception that the legislative 'silence' of some countries means that token sales are completely unregulated there.
Author: Mr.Atanas Kostov – attorney at law
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