Lessons Learned Bitcoin and ICOs Kim Lowe and
Lessons Learned: Bitcoin and ICOs Kim Lowe and Brian Edstrom Avisen Legal, P. A. 901 Marquette Ave. S. Suite 1675 Minneapolis, MN 55402
This presentation provides general information only. Nothing in this presentation, and nothing the presenters say during this presentation or at this event, is offered as legal advice. Raising money from investors likely requires you to comply with federal and state securities regulations, which are highly complex. This presentation does not cover all aspects of these, or other potentially applicable, regulations. You should consult an attorney prior to raising money from investors.
Blockchain Technology – What is It? A distributed public database that keeps a permanent record of digital transactions. • Each “block” is a record of a specific transaction, which are linked together and secured in a “chain” using cryptography • “Transparent” and decentralized • Resistant to modification • Not only used for cryptocurrencies
Cryptocurrencies – What are They? A proposed medium of exchange that is created and stored electronically in the blockchain. • • • Use cryptography to record and control transactions No physical form Cannot always be exchanged for other commodities No inherent value Not insured Not controlled by a central bank or other authority
Cryptocurrencies - Examples • • • Bitcoin 2 GIVE Ethereum Litecoin Monero Ripple Dogercoin Sia NZT ZCASH
ICOs – What are They? Initial Coin Offering: The sale of cryptocurrency “tokens” to raise money for a business venture or (usually blockchain-related) project. • “Tokens” can represent different things, not always equity in company • Investors may be able to invest using US$ or other cryptocurrencies • Different from Initial Public Offerings (IPOs), which involve sale of stock in the company
ICOs – 2018 Examples • • • Cypherium Rentberry Loci Trippki Right. Mesh Experty NAU Coinlancer Fans. Unite Giftz Source: https: //www. inc. com/bill-carmody/top-10 -initial-coin-offerings-icos-to-watch-heading-into 2018. html
Bounty Programs – What are They? A referral program where people get “paid” in coins or tokens for spreading the word about an ICO offering. • In a securities law context, these types of people are referred to as “finders” • May be subject to broker registration requirements • Both the issuer of the ICO and the “bounty hunter” may be liable for utilizing unregistered broker to promote a securities offering
Celebrity Promoters
What do Regulators Say? SEC Chairman Jay Clayton: I have instructed the SEC staff to be on high alert for approaches to ICOs that may be contrary to the spirit of our securities laws and the professional obligations of the U. S. securities bar. Source: https: //www. sec. gov/news/speech-clayton-012218 I believe every ICO I’ve seen is a security. Source: Comments in a 2/6/2018 US Senate hearing
What do Regulators Say? Financial Industry Regulatory Authority (FINRA): Where [cryptocurrencies] are securities or where an ICO involves the offer and sale of securities, FINRA may review the mechanisms—for example, supervisory, compliance and operational infrastructure— firms have put in place to ensure compliance with relevant federal securities laws and regulations and FINRA rules. Source: https: //www. finra. org/sites/default/files/2018 -regulatory-and-examination-priorities-letter. pdf
What do Regulators Say? North American Securities Administrators Association (NASAA): The recent wild price fluctuations and speculation in cryptocurrency-related investments can easily tempt unsuspecting investors to rush into an investment they may not fully understand. Cryptocurrencies and investments tied to them are high-risk products with an unproven track record and high price volatility. Combined with a high risk of fraud, investing in cryptocurrencies is not for the faint of heart. Source: http: //www. nasaa. org/44073/nasaa-reminds-investors-approach-cryptocurrencies-initial-coinofferings-cryptocurrency-related-investment-products-caution/
What do Regulators Say? Minnesota Department of Commerce: The Minnesota Department of Commerce is urging Minnesotans to proceed with caution and understand the potential risks of any investment or transaction involving a virtual currency such as Bitcoin. Source: https: //mn. gov/commerce/media/news/? id=81448
SEC Actions Involving ICOs • REcoin Group Foundation and DRC World– Fraud Charges/ Asset freeze (9/29/2017) • Plex. Corps – Fraud Charges/Asset freeze (12/4/2017) • Munchee Inc. – Cease and Desist Order (12/11/2017) • Arise. Bank – Asset Freeze (1/30/2018) • Cherubim Interests, Inc. – Trading Suspension (2/16/2018) • PDX Partners Inc. – Trading Suspension (2/16/2018) • Victura Construction Group, Inc. – Trading Suspension (2/16/2018) • Centra Tech – Fraud Charges/ Injunction/ Penalties (4/2/2018) Source: https: //www. sec. gov/news
SEC Actions Involving ICOs • NYTimes: Subpoenas Signal S. E. C. Crackdown on Initial Coin Offerings (2/28/2018) • CNBC: SEC Subpoenas Tech. Crunch Founder’s Cryptofund Amid Broader Investigation into Digital Coins (3/2/2018) • EBIT News: SEC Issues 80 Subpoenas to Cryptocurrency Funds (3/5/2018)
Thinking of Raising Money Through an ICO? Three Initial Questions: 1. Is it a security? 2. If a security, must it be registered with the SEC? 3. If a security, must it be registered with state regulators? *Tip: All securities offerings, whether or not requiring registration, are subject to federal and state anti-fraud provisions.
Overview of Securities Laws Federal Laws at Play: • Securities Act of 1933 • Securities Exchange Act of 1934 • Investment Company Act of 1940 Enforced by: • SEC • FINRA State Laws at Play: • Minnesota Securities Act • Other States’ Laws Enforced by: • MN Dept. of Commerce • State securities regulators • Attorneys General (? )
What do securities regulations do? • Require registration of securities offerings, unless exempt • Limit who can sell securities • Limit how securities are sold • Impose reporting requirements • Impose anti-fraud provisions *Tip: Its all about disclosure; say what you do, do what you say
Is it a Security? “Security” is defined broadly in federal (and state) statutes: Securities Act: The term “security” means any note, stock, treasury stock, security future, securitybased swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. *Tip: When in doubt, assume it’s a security.
Is it a Security? SEC v. Howey, 328 U. S. 293 (1946) Establishes 4 -part test for defining “investment contract” 1. A person invests money 2. In a common enterprise 3. Is led to expect profits 4. Solely from the efforts of others
Its Not a Security, it’s a “Utility Token!” Ask yourself: • How is the token marketed? • What do investors hope to get out of the token? • Are investors only motivated by “utility” use, or also by hope of making money? • Has SEC taken action against similar “utility” tokens? “Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction. ” – 7/25/2017 SEC Press Release
Planning to say its not a Security? Minnesota Securities Act, Section 80 A. 70; EVIDENTIARY BURDEN. (a) Civil. In a civil action or administrative proceeding under this chapter, a person claiming an exemption, exception, preemption, or exclusion has the burden to prove the applicability of the claim. (b) Criminal. In a criminal proceeding under this chapter, a person claiming an exemption, exception, preemption, or exclusion has the burden of going forward with evidence of the claim. *Tip: Do your homework first, not after you receive a subpoena
Must it be registered with the SEC? Securities Act Sec. 2: Unless a registration statement is in effect, it is unlawful to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell a security. But… several exemptions apply. *Tip: Before applying for registration, always consider whether an exemption applies
Must it be registered with states? Minnesota Securities Act: It is unlawful for a person to offer or sell a security in Minnesota unless: - The security is a federal covered security; - The security, transaction or offer is exempted from registration - The security is registered with the Minnesota Department of Commerce Other states have similar requirements *Tip: Review registration/exemption requirements in every state where offers occur
Finding an Exemption 1. 2. 3. 4. 5. ? How much money do you need? Do you want non-accredited investors? Do you want to advertise? Where (in which states) do you want to raise money? How much money can you afford to spend? ? ? ?
Common Exemptions This chart identifies common exemptions from federal securities law requirements, and state (Minnesota) exemptions/requirements commonly paired with those federal exemptions. Federal Exemptions State (MN) Exemptions Rule 506(b) of Regulation D+ [federal preemption applies] + Rule 506(c) of Regulation D+ [federal preemption applies] + Rule 504 of Regulation D+ SCOR (Minn. Stat. 80 A. 50(b))* Regulation A Tier 2* [federal preemption applies] Regulation A Tier 1* Must register with state(s)* Regulation Crowdfunding (Reg CF) + [federal preemption applies] Section 3(a)(11) and Rule 147 A MNvest (Minn. Stat. 80 A. 461) + + Requires a notice filing * This “exemption” is actually a simplified registration requirement.
How much money do you need? Unlimited (Rule 506(b) or (c)) • As much as possible • Up to $50 million • Up to $20 million • Up to $5 million • Up to $2 million • Up to $1 million $50 million (Reg A Tier 2) $20 million (Reg A Tier 1) $5 million (Rule 504/SCOR) $2 million (MNVest) $1 million (Reg CF)
Do you want non-accredited investors? Accredited investors include individuals who: • for the past two years, have made at least $200, 000 per year (or $300, 000 if joint with a spouse’s income) • have a net worth of at least $1 million, not including the value of the individual’s home. Most people (over 90% of the U. S. population) do not meet these thresholds, making them non-accredited investors
Do you want non-accredited investors? Allows sales to nonaccredited investors, subject to limitations Rule 506(b) Allows unlimited sales to Prohibits sales to nonnon-accredited investors Reg A Tier 2 Rule 504/SCOR (subject to state requirements) MNvest Reg CF Reg A Tier 1 Rule 506(c)
Do you want to advertise? • Some securities regulations prohibit general advertising or solicitation. • General advertising and solicitation occurs when you share information about the offering with someone with whom you do not have a preexisting, substantial relationship. This could include: • Social media posts • TV/newspaper interviews • Verbal conversations with strangers
Advertising Violation? “A University of Minnesota professor is hoping to raise money to research the parasite that's devastating Minnesota's moose population. […] While researchers also plan to apply for research grants, Wolf said the $6, 000 funding goal at the university's crowdfunding site is a good way for members of the public to help the research along. So far about half of the goal has been raised. ”
Advertising Violation? What if this was a securities offering? A metaphor: Don't celebrate your sea salt for being "formed by the primal sea more than 250 million years ago" without also disclosing it expires next year. Source: https: //i. redd. it/3 ent 6 tkrz 4 c 01. jpg
Do you want to advertise? Allows general advertising and solicitation Rule 506(c) Allows limited advertising and solicitation MNvest Reg A Tier 2 Reg CF Reg A Tier 1 Rule 504/SCOR (subject to state requirements) Prohibits general advertising and solicitation Rule 506(b)
Where do you want to raise money? • All securities offerings must comply with both federal and state securities laws. • To avoid registering the offering, you will need to comply with an exemption in each state where securities are offered or sold. • Some federal regulations (e. g. , Rule 506(b) & (c), Reg CF) preempt state regulations, though you may still need to file notice of the offering with state(s).
Where do you want to raise money? Allows sales in all states Allows sales in only some states Allows sales in MN only Rule 506(c) Reg A Tier 1 MNvest Rule 506(b) Rule 504/SCOR Reg A Tier 2 Reg CF
How much can you afford to spend? • Each of the options discussed here involve some form of regulatory filing. • Some require lengthy disclosure documents. • Some require audited/reviewed financial statements. • Some require ongoing reporting. • Legal, accounting, and filing fees can be expensive
How much can you afford to spend? Highest Costs Medium Costs Lowest Costs Reg A Tier 2 Rule 504/SCOR Rule 506(b) Reg A Tier 1 MNvest Rule 506(c) Reg CF
Common Exemption Options Question Regulation CF MNvest Rule 504/ SCOR + Reg A Tier 1 Reg A Tier 2 How much money do you need? Up to $1 million allowed Up to $2 million allowed Up to $5 million allowed Up to $20 million allowed Up to $50 million allowed Do you want nonaccredited investors? Non-accredited allowed, but investment limits apply Non-accredited allowed, but allowed, subject to investment limits state law apply requirements Advertising Do you want to Only limited allowed, but only advertise? * advertising allowed in states where registered Sales permitted in Do you want to raise all states where money from Sales permitted in state law investors in multiple all states MN only requirements are states? also met How important is it to you to minimize legal & accounting fees? ** Highest Costs Medium Costs Non-accredited allowed Advertising allowed Rule 506(b) Rule 506(c) Unlimited amount allowed Up to 35 non. Non-accredited allowed, but Non-accredited not allowed, so long as investment limits allowed they are apply “sophisticated” Advertising allowed Advertising not allowed Advertising allowed Sales permitted in only those states Sales permitted in where the offering all states is qualified Highest Costs Lowest Costs This chart contains limited information only and is not provided as legal advice. This chart does not address “bad actor” restrictions, integration issues, anti-fraud provisions, regulations applicable to finders, agents, broker-dealers or investment advisers, reporting requirements, or other regulations that may apply to a company conducting a securities offering. Companies planning to engage in equity crowdfunding should consult an attorney and an accountant before commencing the offering.
Examples ICOs attempting to comply with securities laws • Protocol Labs, Inc. (File. Coin) – raised $257 mm from accredited investors via two 506(c) offerings (8/7/2017 and 8/25/2017) • Wenn Digital Inc. (Kodak. Coin) - raised $6. 75 mm from accredited investors via 506(c) offering (1/16/2018) • Telegram Group Inc. – raised $1. 7 billion(!) from accredited investors via two 506(c) offerings (2/13/2018 and 3/29/2018)
Other Issues • Registration requirements for cryptocurrency exchanges • Bad Actor disqualifications • Integration • Anti-fraud provisions • Agents, finders • Ongoing reporting requirements
Questions? ? Kim Lowe 612 -584 -3403 klowe@avisenlegal. com ? ? ? Brian Edstrom 612 -584 -3407 bedstrom@avisenlegal. com ? ? ? ?
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