Category: Securities (Page 1 of 5)

Federal Securities Laws applied to ICO’s – Initial Coin Offerings

BITCOINNew “coins” or tokens and their platforms are all the rage.  Bitcoin, Bitcoin Cash, Ethereum, Litecoin, Zcash, Dash, Ripple, Monero, the list goes on and on and new ones keep popping up.  The new coins are either entirely their own platform or they are derivations, i.e. spin-offs of one of the existing virtual currency platforms.

The IRS took the position in 2014 that Bitcoin and coins like it were property, and not currency.  Interestingly, it did this as it referred to Bitcoin and other coins as “virtual currency.”  The classification of Bitcoin as property has certain effects on its treatment with respect to tax issues. The IRS has a decent FAQ on this here.

It was only a matter of time until the SEC weighed in.  Especially because the promoters of these new coins started calling the birth of new coin platforms as ICO’s (“Initial Coin Offerings”), and heavily advertising them to the public, such as Floyd Mayweather’s promotion of the Stox ICO on social media platforms, from which ICO he said he was going to make a “sh*t ton of money”.  That’s the type of situation and language that gets the SEC up in the morning.

Now under the federal securities laws (which I have described with respect to virtual world items in the past), an offering of “securities” must be done only after registration of such securities or pursuant to an exemption from registration.   The main issue present with these ICOs is whether the virtual currency is a “security” or not.   This would bring up the “Howey Test”, from SEC v. Howey Co., 328 U.S. 293 (1946), which can be summarized as whether the individual investing the funds into a common enterprise expects profits to come solely from the efforts of others (there are some other factors used in the test as well, but that’s it in a nutshell).  Usually the people pumping money into these ICOs are not the ones working on the platform (usually blockchain type information exchange platforms), and without that involvement it may come down to the investor’s expectation – are they expecting the money they invest to go towards the growth of the platform which would increase the popularity and hence value of the platform’s coin?  If so that may be an issue. What a coin (or sometimes called a “token”) is still has not been fully defined, and the characteristics of each coin or token vary by platform and change over time.

The SEC issued an Investor Bulletin that said that some ICOs depending on the circumstances “may” involve sale of securities.  It should be taken as a warning. While the application of the securities laws to coins and ICOs is a gray area, there is a line somewhere and the first very public ICO to cross it without registration or use of an exemption (which is doubtful if public advertising is used and investment is taken from anyone, regardless of circumstances), the SEC may come after.  Watch out Floyd, you may not be too worried about Conor McGregor but you should be of the SEC.

U.S. DOL’s Final Rule on Fiduciary Duties owed in connection with Retirement Plan Advice

USDOL_Seal_circa_2015_svgOn April 6, 2016, the United States Department of Labor issued a Final Rule with respect to the fiduciary duty owed by any individual or entity providing recommendations with respect to a retirement plan.  It takes effect in April of 2017.

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Best Practices for Issuing Stock Options to Startup Employees @ Paper this Deal

stock-optionsHere is a quick list a company can refer to prior to issuing stock options to its employees.  I’ve covered the basics of stock options in a previous post, as well as a more in depth pricing item related to stock options, but wanted this post to give the broad overview to founders.

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Funding Portal Rules for Regulation Crowdfunding a/k/a Equity Crowdfunding

Geefunding_crowdfundingThe JOBS Act from way back in 2012, set forth the Crowdfunding exemption to the securities laws, and required that any Funding Portal that engaged in Crowdfunding registered with the SEC and became a member of FINRA.  In late 2015, the SEC came out with the Regulation Crowdfunding Final Rules and forms to permit companies to offer and sell securities through Crowdfunding and to regulate the intermediaries which can sell the crowdfunded securities.  The latest Funding Portal rules have been finalized by the SEC and FINRA.

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Crowdfunding Investor Alert from SEC

On February 16, 2016, the Securities and Exchange Commission issued an investor bulletin addressing the new crowdfunding opportunities that will be available to investors starting as of May 2016.  The SEC issues these alerts so that investors will be knowledgeable about such offerings, especially the risks inherent in same.

The full bulletin can be found here – SEC Crowdfunding Investor Alert.

The alert does a good job breaking down the ways investors calculate their net worth and how much can be invested in any twelve month period. It also cautions investors on the risks of crowdfunding investing and the structure of how such offering can be conducted through portals.

Equity Crowdfunding a/k/a Regulation Crowdfunding Coming Soon (May 16, 2016) to a Startup Near You

crowdfunding imageThe SEC’s Final Rules for Regulation Crowdfunding were published on October 31, 2015, and are  considered effective 180 days after such publication.  Meaning that on May 16, 2016, Regulation Crowdfunding will be a go.

On that date, a company will be able to raise money under the new rules and file Form C (which still does not appear on the SEC’s Form Page).

To get a head start prior to the final rules allowing sales, and to catch up to broker-dealers who can also act as intermediaries and sell securities through the Regulation Crowdfunding final rules, Funding Portals were allowed to begin registering with the SEC on January 29, 2016, by filing the Form Funding Portal, among other things.

I’ve blogged on this before (here and here) and will be doing a number of posts solely on Regulation Crowdfunding in the near future to make sure that the basics are covered and will dig into some advanced topics.

Anyone company looking to take advantage of the new rules should start getting its house in order, by preparing its financials, its legal structure and investigating which intermediary it wishes to use for the sale of its shares, whether a broker-dealer or a funding portal.

After a further review of the new Regulation Crowdfunding rules I think they exemption provided may best serve companies looking to raise smaller amounts, such as below $500,000 (to avoid the audited financial requirement), or who are raising equity capital for the first time.  There is a huge need for smaller companies to get access to capital.   The Regulation Crowdfunding rules may allow investments to happen which otherwise wouldn’t, which is what Congress intended by passing the JOBS Act to modernize the antiquated securities laws.  Companies that can attract accredited investors will likely continue to rely on the private placement exemption under Rule 506(b) due to its relative simplicity compared to other offerings. But again, I do think the Regulation Crowdfunding rules have a specific subset of issuers that can benefit from them.

SEC’s Final Rules on Regulation Crowdfunding (Finally) @ Paper This Deal

So on October 30, 2015, the SEC adopted final rules which will, after the comment period is done (60) days and they are adopted, allow crowdfunding a/k/a Regulation Crowdfunding a/k/a Equity Crowdfunding in the United States.

At first glance the final rules appear similar to the previously issued versions, with individuals only authorized to invest a portion of their annual salary or net worth through crowdfunding each year.  See the press release here.

Portals which will offer the securities of companies offering same through Regulation Crowdfunding will be effective January 29, 2016 so hopefully a decent number of platforms will be available to start the party in early 2016.

The final rules will be effective 180 days after they are published in the Federal Register. The below is a brief summary in FAQ form covering the Regulation Crowdfunding rules.

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New York Qualified Emerging Technology Company (QETC) Incentives @ Paper This Deal

If your company operates in New York and meets the definition of a “qualified emerging technology company” (a “QETC”) it is eligible for New York tax credits.  Additionally if you are a New York State taxpayer and interested in investing in a QETC you may be eligible to claim a credit as well.

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Strip Rights @ Paper This Deal

In addition to the other ways we’ve discussed here (stock options, phantom stock, stock appreciation rights), another way to compensate individuals working for a startup is to give them a cash payment upon a change in control of the company, called in the industry a “strip right”.

For example if a startup company has four founders each owning 25% of the shares, and they bring on another but don’t grant him or her shares, the initial founders can agree to pay the new individual a percentage of the “net proceeds” received from a “change in control” of the corporation.   “Net proceeds” is usually defined as the gross proceeds received minus transaction costs and brokers commissions as well as some other items.   A “change in control” is defined as it normally is in these agreements, and covers if the company merges with another or sells substantially all of the company’s assets.  In such a case, the shareholders would receive cash (or assets it can sell for cash, like tradeable shares of the acquirer).  The strip right agreement would require the shareholders that granted it to pay to the holder of the strip right, either a percentage or flat fee before they received their cash for the change of control.

In the example, if the four founders grant a 10% strip right, and a couple years down the road the company is sold for one million dollars, with transaction fees of $100,000, the holder of the strip right would receive $90,000 (net proceeds of $900,000 x ten percent).    The shareholders would split the rest of the $810,000 and each receive $202,500.

One of the benefits of the granting of the strip right is that it is not taxable to the recipient.  The downside, at least to the recipient is that they are not a shareholder of the corporation and they may never receive a cent if there is never a change in control.  Due to its tenuous nature, the strip right is usually granted in connection with other compensation awards.

 

SEC Adopts Final Rules Amending Regulation A @ Paper This Deal

On March 25, 2015, the SEC adopted final rules amending Regulation A, referred to now as Regulation A+. These amendments were required by Congress via Title IV of the JOBS Act which was passed some time ago. (we are all still waiting for the Regulation Crowdfunding rules to be finalized).

The general rule is that when a company offers or sells a security, the security must either be registered or an exemption from registration must be relied upon.  Regulation A has been on the books for a long long time and has been relied on very little.

Now the SEC has a tough job, its tasked with allowing companies to raise money via offerings of securities but on the other hand it needs to ensure that fraud does not run rampant. These two goals don’t have to be mutually exclusive, but the SEC has generally focused on the latter of the two at the expense of the first. 

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