SMART MONEY: Resilient Hope, A U.S. Perspective On Digital Assets

The mounting pressure to regulate the use of digital assets in capital raising transactions is partly due to reforms in other countries that explicitly provide legal structures for digital asset offerings. Because the U.S. has enacted no such measures, both domestic and international entities have been left without a clear roadmap for compliant digital asset fundraising in America. U.S. regulators have instead continued to apply decades-old regulations and case law to these emerging technologies. Paths to raise capital legally in the U.S. with digital assets do exist through either registered or exempt traditional securities offerings. However, the lack of a digital asset-specific U.S. regulatory framework has meant that regulation continues to occur principally through enforcement activity. It seems unlikely this situation will change any time soon, but several developments provide hope for a solution that could allow the U.S. to remain competitive in the digital asset fundraising space.

Compliant Fundraising & Enforcement under Current Law

Regulation A

Amended Regulation A of the Securities Act of 1933 (“Reg. A+”) provides a two-tiered exemption scheme under which offerings can be “qualified” as exempt from the U.S. securities laws. Tier 2 of the Reg. A+ exemption allows an issuer to raise up to $50 million per year from both accredited and non-accredited investors.   In July 2019, the SEC qualified the first digital asset offering under Reg. A+ for Blockstack PBC (“Blockstack”), which conducted a $28 million offering to fund the growth and functionality of its network. Blockstack stated that it decided to conduct the offering under existing U.S. law because it “wanted to open our token offering to the general public… without excluding the U.S.”, in hopes of “maturing the broader crypto industry.” The day after qualifying the Blockstack offering, the SEC qualified video-streaming platform YouNow’s Reg. A+ issuance of 178 million “Props” Tokens that would be used to reward application users and content creators.

Compliance requirements for Reg. A+ issuers approximate those demanded of public companies, and the offering process can be costly and slow. However, Blockstack and YouNow have demonstrated that compliant digital asset fundraising is possible.

Significant Enforcement Actions

Reg. A+ provides an important option for compliant digital asset offerings in the United States, but most would-be issuers seek to raise more than Reg. A+’s $50 million threshold (or the $75 million it will increase to later in 2021). And while the SEC contends that its application of the securities laws to digital assets has been coherent and definitive, many in the digital asset community believe the agency’s approach has left no clear and easily-utilized fundraising options.

Despite this uncertain environment, digital asset issuers have continued to raise funds, resulting in a flurry of enforcement activity. Most notably, the SEC sued messaging platform Telegram Group Inc. (“Telegram”) in September 2019 to stop its $1.7 billion offering of digital assets called Grams. The SEC alleged that Telegram’s offering, structured as a two-part transaction known as a Simple Agreement for Future Tokens (“SAFT”  ), was actually one integrated and unregistered securities offering. The U.S. District Court for the Southern District of New York (“SDNY”) accepted the SEC’s argument that the offering was a scheme to unlawfully distribute Grams to the secondary public market, and issued an order prohibiting sale or distribution of Grams, and ordering Telegram to disgorge $1.2 billion raised in the offering and pay an $18.5 million civil penalty.

The agency filed a similar suit against Kik Interactive, Inc. (“Kik”) for what it claimed was an illegal issuance of “Kin” digital assets in a $100 million offering. The SDNY again agreed with the SEC’s claim that Kik sold digital assets to investors without registering their offer and sale as required by the U.S. securities laws. The court permanently enjoined Kik from publicly offering Kin, ordering it to notify the agency before any future issuance or sale of digital assets and to pay a $5 million penalty.  Both Telegram and Kik filed a Form D with the SEC that claimed a Rule 506(c) exemption  from registering their offering of rights to receive future tokens. But in both cases the SDNY looked to the “economic realities” of the transactions, and accepted the SEC’s argument that the two transactions should be viewed as one integrated offering to which the exemption could not apply.  These results have furthered the market perception that U.S. regulators are hostile toward digital assets.

Reasons For Hope

Recent events provide some cause for optimism that the U.S. could be on the cusp of a new era for digital asset fundraising. While SAFT transactions were rejected in both the Telegram and Kik cases, Protocol Labs’ Filecoin offering, the first project ever to utilize the SAFT structure, recently completed its SAFT’s digital asset offering step in October 2020 and has so far avoided SEC scrutiny. There is hope that the presumed success of Filecoin’s SAFT can be a roadmap for other issuers, though the substantial period (more than three years) between investors’ initial outlay of cash and their receipt of digital assets could make it a less attractive option. Whether the SEC remains indifferent to the offering is also a critical question. But apart from any developments regarding Filecoin, SEC guidance released in late 2020 may soften the legal regime around SAFT offerings by providing new exemptions that allow related offerings to avoid integration under some circumstances.

Hope also comes from regulatory reforms championed by the most digital-asset-friendly SEC Commissioner, so-called “Crypto Mom” Hester Peirce. She has proposed a “safe harbour” for crypto start-ups, whereby digital asset projects enjoy a three-year grace period after a digital asset issuance during which they are exempt from the securities laws. While it remains uncertain whether Cmr. Peirce’s proposal will ever become law,  in the near term, her suggestions have ignited debate in the crypto community and the transition to new SEC leadership could be an opportunity for them to gain traction.

Looking Ahead

While new U.S. regulation similar to that implemented in Germany and contemplated in the U.K. would provide certainty for both private parties and the government, hope alone cannot make it a reality and it rests with the branches of government to chart such a course.

U.S. President-elect Biden will reportedly name former CFTC chairman Gary Genseler to head the SEC. Genseler is a leader with both a history of successfully imposing regulation on unregulated spaces and good familiarity with digital assets. Recently departed SEC Chairman Jay Clayton ably oversaw the agency’s initial response to digital assets, but his measured approach to the instruments was viewed as hostile by sectors of the crypto / digital asset community. Some of President-Elect Biden’s most prominent advisors on financial policy have backgrounds that suggest they would be more welcoming – even enthusiastic – about the technology. And legislators have already begun efforts to fill the regulatory void with proposed reforms governing the digital asset space. Two complementary bills, the Securities Clarity Act and the Digital Commodity Exchange Act, were recently introduced in the U.S. Congress, and seek to clarify the legal status of digital assets and their trading platforms. While the precise regulatory environment that will prevail remains unknown, the multiplicity of potential avenues for reform is a positive development.

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