Most companies considering an Initial Coin Offering to U.S. purchasers have resigned themselves to the fact that their proposed token or coin offering is likely to be considered an offering of securities by the Securities and Exchange Commission (“SEC”) and must be made in compliance with U.S. securities laws. The logical next question then becomes – “what are my options?”
A traditional initial public offering (“IPO”) of equity securities usually requires extensive meetings with underwriters, accountants and lawyers, the preparation of audited financial statements and the filing of voluminous and detailed documents with the SEC. In addition, once a company has completed an initial public offering, it must comply with extensive ongoing SEC disclosure requirements.
Reg. D Private Placements
The sale of securities (including securities tokens) may also be conducted as a private placement under Regulation D of the Securities Act, particularly Rules 506(b) and (c). Rules 506(b) and (c) of Regulation D allow issuers to raise an unlimited amount of funds from “accredited” investors.
Issuers conducting their offering under Rule 506(b) may allow, in addition to the accredited investors, up to 35 sophisticated but non-accredited investors to participate in their offering, but there are heightened disclosure requirements that apply; there are no exceptions for Rule 506(c) offerings, which may be made only to accredited investors.
Aside from the unlimited offering potential, one other big advantage for many issuers using the Rule 506 exemptions is that the securities issued do not have to be registered with the SEC and therefore there is no SEC review process. Aside from a short Form D that must be filed with the SEC within 15 days of the first sale of securities with basic details of the offering (i.e., maximum dollar amount of securities being offered, number of investors, industry group, etc.), there are no other SEC filing requirements and no ongoing disclosure requirements.
Issuers using one of the Rule 506 exemptions will typically provide prospective investors with offering documents such as a private placement memorandum (which is subject to antifraud liability), but the costs, both financial and timewise, associated with Rule 506 offerings are significantly less than a traditional public offering. Of course, there also are drawbacks to conducting an offering under Rule 506. For example, we mention above that under Rule 506, securities may only be sold to accredited investors (barring the limited exception provided under Rule 506(b)). But perhaps the most significant drawback of Rule 506 offerings is that the securities offered and sold in a Rule 506 offering are deemed to be “restricted” securities under U.S. securities laws and must generally be held by the purchaser for one year before they may be resold. In addition, while Rule 506(c) offerings permit general solicitation and advertising, issuers conducting 506(b) offerings may not participate in any general solicitation or advertising.
Reg A+ Offerings
There is an alternative path that has been gaining a lot of attention in crypto circles recently, and that is the exemption provided by Regulation A+ of the Securities Act, deemed by some the “mini-IPO.”
Regulation A+ was passed under the JOBS Act as an improvement to the predecessor Regulation A exemption and provides for a more streamlined process than the typical IPO. Like an IPO, Regulation A+ permits eligible issuers to offer securities to the general public, not just to accredited investors. Issuers relying on Regulation A+ are required to file a Form 1-A with the SEC, which is subject to SEC review and approval (unlike Regulation D offerings, which are not reviewed and issuers do not need to wait for approval prior to issuance).
The crux of the Form 1-A is the offering circular, which must contain financial statements and other information similar to but less extensive than what would be required in a registration statement (albeit significantly more extensive than what is typically included in an ICO white paper).
Aside from the ability of the issuer to offer securities to the general public under Regulation A+ (subject to the non-accredited investor caps imposed by Tier 2), one of the most significant advantages of Regulation A+, as compared to Regulation D, is that securities issued in a Regulation A+ offering are not “restricted” securities and are freely tradable. However, we note that the potential for a trading market actually developing, and the potential for real liquidity, particularly for tokens and coins, should be evaluated. Another benefit to Regulation A+ is that it allows issuers to “test the waters” or solicit interest in a potential offering either before or after the filing of the Form 1-A, subject to certain conditions. However, Regulation A+ offerings are subject to offering caps, unlike Rule 506 offerings, as described below.
Regulation A+ consists of two offering categories – Tier 1 for offerings up to $20 million and Tier 2 for offerings up to $50 million. Aside from the price differential, the other significant differences between the two offering tiers are that Tier 2 offerings require audited financial statements, ongoing SEC disclosure requirements (albeit to a lesser extent than those required in connection with an IPO) and an investment cap for non-accredited investors. Tier 2 offerings, but not Tier 1 offerings, also preempt state securities regulatory review (similar to Rule 506 offerings), a significant improvement over the predecessor Regulation A.
So, is Regulation A+ the answer for crypto companies? Maybe, maybe not. To date, only six issuers have filed a publicly available Form 1-A for a token offering, and none of these filings has been qualified by the SEC.
As noted above, perhaps the most significant advantage to Regulation A+ is that investors receive unrestricted securities that are freely tradable. But how soon will a truly robust secondary trading market develop for the tokens and coins being offered by most crypto companies? And why would a crypto company subject itself to the filing requirements and ongoing disclosure requirements of a Regulation A+ offering, when it could instead offer unlimited securities (albeit to accredited investors only) under Rule 506 with limited filing requirements, not to mention no SEC review, and no ongoing SEC reporting obligations? The best alternative will, of course, be issuer specific, which is why it is critical for issuers to weigh the pros and cons with experienced legal counsel.
 An “accredited investor,” in the context of a natural person, includes anyone who: (i) earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year; or (ii) has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence. Entities such as banks, partnerships, corporations, nonprofits and trusts with total assets in excess of $5 million also qualify as accredited investors.