The ABC's of Crypto Compliance
Feb 20, 2019
So who can actually buy an ICO? If you're a US citizen, you may be surprised to see private placements of many initial coin offerings exclude you. This is due to the confusion over US regulation and the classification of tokens. Arguably, the cryptocurrency space has spent the first part of the year in a bear market because of the cloud of regulatory uncertainty. I realize 6 months is a lifetime in the crypto space, but in the world of regulation and compliance, it’s a matter of course. It’s been argued that the US will be less competitive and is stifling innovation in the cryptocurrency industry. However, the regulators are doing a good job of patiently trying to understand the technology and how it affects markets while fulfilling their mandate of protecting investors, maintaining fair, orderly, and efficient markets, and helping facilitate capital formation.
The Commodity Futures Trading Commission (CFTC) has claimed cryptos as a commodity (more precisely BTC), and has generally been a proponent of the promise and innovation of crypto assets. Arguably the CFTC has been at the forefront because commodity exchanges needed permission to roll out Bitcoin future contracts. The Securities Exchange Commission (SEC), in the meantime, has recently gotten more active in issuing multiple subpoenas. While this may sound ominous, keep in mind that the SEC has said ICOs fall under the Howey test (what makes something a security) and the subpoenas are a way for the SEC to gather information and put bad actors on notice.
Given where the regulatory regime currently sits, let’s look at what rules already apply to investors.
- Regulation A: this exemption is for up to 10mm and no more than 500 shareholders. In 2015, this was updated through the jobs act to include tiered exemptions, which is essentially Reg A+.
- Regulation D — This is essentially an exemption with the SEC, but requires an electronic filing of “Form D” after the securities have first been sold. Solicitation is allowed to investors for an offering if they meet the requirements of Section 506c, which requires verification that the investors are accredited. and the information provided during the solicitation must be “free from false or misleading statements.”
- Regulation A+ — This is also an exemption that allows an issuer to offer a security qualified with the SEC to non-accredited investors through general solicitation for up to a total of $50,000,000 in investment. Due to the requirement to register the security, Regulation A+ issuance can take longer compared to other options. This regulation came directly from the jobs act as a way to even the playing field for smaller firms in investment management.
- Regulation S — This is when an offering of securities is deemed to be executed in a country other than the US and therefore not subjected to the registration requirement under section 5 of the 1933 Act. Issuers of the security are still required to abide by the security regulations in each country where they offer their security.
Where Are We Headed?
Michael Piwowar, a U.S. Securities and Exchange Commissioner, recently stated that there are 3 buckets of securities:
- Bucket One: In this bucket are registered public offerings, or initial public offerings (IPOs).
- Bucket Two: In this bucket are exempt offerings, and these include ICOs.
- Bucket Three: In this bucket are basically all the other offerings, which tend to be illegal. Piwowar noted about bucket three that if the offering does not fall into the first two buckets, the SEC has said “we’re coming after you."
Certainly regulation is much deeper and more complex than I have mentioned here, but regulators have made clear distinctions between BTC, ETH and the altcoins coming from ICOs. The point is that regulators are pointing to the existing rules while acknowledging that there is a new and important technology emerging in finance. I believe they have essentially said we will work with you, not by sitting in the sandbox with developers, but by standing on the beach making sure investors don't get swept away with the tide.
For more information on this topic, check out the SEC post here.