On September 27th, in partnership with Geektime, we held an hour long conference call with four thought leaders on SEC complaint ICOs. The speakers were Mike Jones, CEO of Science, Emma Channing, General Counsel of Argon Group, Lee Schneider, Counsel at Debevoise & Plimpton, and Tom Kineshanko, Co-Founder of Protos Cryptocurrency Asset Management
Each speaker shared their perspective on the process of, and the risks involved in, executing and investing in SEC complaint ICOs. After the speakers shared their prepared remarks, the call was opened for questions from the audience. A video replay of the call is below (only the last speaker had slides).
The big take away from the call for me was how much uncertainty and risk there remains in trying to execute an SEC compliant ICO. That said, there were lots of thoughtful insights shared on the call. The chart below, which identifies the three types of tokens, and their attributes, can be a helpful reference given the discussions on the call.
For purposes of this post, we’ll use the term Security Token instead of Crypto-Securities, as that was the term used on the call.
Below are what I believe to be the seven most important thoughts shared on the call:
- The SEC DAO Report was a remarkable gift to the ICO industry. Emma was emphatic about the incredible amount of detail and guidance the SEC gave in the report, without it being an enforcement action. Emma stated that the SEC has a very sophisticated team looking at ICOs, and that the ICO community should take advantage of the fact that the SEC is happy to take emails or phone calls with ICO related questions.
- There’s been no guidance on how long a White Paper for an SEC Compliant Utility token should be, or what should be in it. Emma says she looks to S-1s for guidance on Security Token White Papers, but there is no similar reference for a Utility Token. Is 20–30 pages sufficient, or should it be 70–80 pages long like offering memorandums? Should the Utility Token White Paper include risk factors, use cases, or use of proceeds? Should it have audited financials or management financials? Emma believes we don’t have answers to ANY of these questions. So there is risk that a regulator in five years could say that a certain piece of information that wasn’t in the White Paper was material, and sue an issuer on the basis of contract fraud misstatement.
- Lee Believes That the Use of Proceeds Section is the Most Important Part of a White Paper. Lee said there is a range of acceptable ways to codify the use of proceeds. The Use of Proceeds can be given in great detail or at a higher level. The use of proceeds can be linked to milestones, with amounts targeted to spend once those milestones are reached. While there is no “right” way to explain the use of proceeds, it’s critical to be thoughtful. In addition, issuers should have contingency plans in case they raise more money than expected.
- Solving For The SEC/U.S. Regulators Does Not Solve For The Rest of the World. Lee pointed out that all developed countries have securities laws and regulations that should be considered. ICO issuers then have to decide in which countries they’ll be regulatory compliant, as they can’t be compliant everywhere due to cost and time constraints. Generally issuers care about the countries where they can sell the most tokens, and take a risk in other countries. Emma said she’s often asked why the industry can’t just evolve away from regulation. She explains that there are laws that apply when you cross the road, let alone when you issue ICOs. So while some people say she’s scaring people, she believes she’s educating people.
- SEC Compliant ICOs Are More Complicated and Costly Than Traditional Fund Raising. Mike stated that issuing ICOs has been more complicated than his past raises where his LPs were U.S. investors. Opening a crowd sale for people outside the U.S. and working within the legal constraints of different countries, is not only more complicated, it’s about twice the price of a traditional raise. In addition, in a traditional raise, the movement of shares is controlled. But in a token sale, where the tokens can move around the world, there are new things to think about like information control and how information is distributed. Designing the token economy adds another layer of complexity. For Mike, the Science Blockchain ICO has been a four month process. .
- Mike Jones now looks at everything through a Decentralization lens, and sees opportunities everywhere. Before Science, Mike worked at News Corp and was tasked with seeing if they could leverage MySpace to better battle Facebook. During that period, Mike spent a lot of time with people from MySpace and Facebook. There was a moment when Zuckerberg clearly articulated the value of social as it related to software. Once Mike got his mind around that, every piece of software he looked at, he looked at thru the social lens, and saw how the software could be more powerful. Mike said the moment he got the concept of decentralized software, everything he sees now, is through that Decentralization lens, and he sees opportunity everywhere.
- A Major Advantage of a Tokenized Hedge Fund Is A More Stable Pool of Capital Due to the Elimination of Redemptions. Tom pointed out that traditional hedge funds may take a shorter term view on their investments than might otherwise be optimal, because of the risk of redemptions. Traditional funds can sometimes have 15 or 30 day redemptions (when investors ask for their money back). Redemptions can force the fund to sell assets to meet the redemption. Sometimes redemptions can cascade, as forced asset sales can happen at sub optimal prices, which can cause further redemptions, or cascading redemptions, resulting in the demise of a fund (see 2008). In a tokenized fund, investors who want out simply sell their tokens to other investors, leaving the pool of capital stable, and leaving the Token Fund manager able to take a longer term view.
There were numerous other things mentioned on the call that were quite meaningful. Emma suggested that every ICO should be taking addresses and checking IDs for KYC purposes. Emma also mentioned Argon’s new ATS (Alternative Trading System) venture with Overstock and RenGen. Lee talked about the importance of communications post ICO. Mike talked about the structure of his Science Blockchain incubator and how some exits will lead to tokens being burned. It was an hour well spent.
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