Co-founder of Activision & co-founder and CEO of StartEngine
It is now clear that U.S. based companies who issued utility tokens in 2017 and 2018 will need to do some clean up in order to move forward safely and not endanger their company, the officers of the company and their investors. There are many great blockchain projects and great entrepreneurs who are at risk of being afoul with the law and, you guessed it, the SEC.
So what are those entrepreneurs supposed to do? After all, many of them got sound legal advice from lawyers who confirmed the tokens being issued were utility tokens. These entrepreneurs then took this advice to heart and sold them to users. Those users are now investors, and those tokens are now securities. This may be confusing to many, but in reality the remedies are not difficult and manageable in most cases.
The good news is this: you can fix it (and you must fix it). The SEC has already sent a large number of subpoenas to companies, and this I can assure you is not fun. But volunteering a fix is a realistic solution compared to years of litigation with the SEC. The blockchain marketplace works in dog years and does not have the time to focus on litigation or government intrusion in their business. The fix is the right way to move forward.
A new buzz word has emerged in the ICO world, and it is called the rescission. Yes, this is an old trick to solve a securities deal gone bad. When a broker dealer sells securities to customers, and they turn out to have issues, such as false disclosures or missing key information, then the broker simply makes a rescission offer to its investors. Investors then have 30 days to either accept the offer and keep the securities or get their money back with interest. Guess what, Google did this! A company can successfully make a rescission offer.
Let’s go into more detail as to what this all means. The utility tokens were not sold as securities, and the investors probably did not go through an anti-money laundering review and the checks required per the Bank Secrecy Act and the USA Patriot Act.
Also, those investors did not get qualified to either be non-accredited or wealthy accredited investors. The remedy is to make a rescission offer to all of the investors who can either accept the offer and keep their newly minted security tokens or reject it and get their BTC/ETH back with interest (usually 6%).
The problem is that because some of those investors are non-accredited, simply sending the right paperwork to sign is not going to work. Why? Because in order to sell securities to a non-accredited investor, a company must use an exemption to SEC registration.
Great news: there are two exemptions that work VERY well. The first one is Regulation Crowdfunding, which is part of the JOBS ACT, and will allow the company to offer security tokens to ANY investors, for a total sale up to $1.07M per year. However, some of the investors will be accredited and can be offered the security tokens under rule 506(c) of Regulation D and the non-accredited can invest under Regulation Crowdfunding. This means that companies can raise more than $1.07M per year if accredited investors are involved (which they likely will be), more great news.
The other good news is that it takes only a couple of weeks to set up the Regulation Crowdfunding offering on a funding portal (which is required). To find out who offers funding portals, just go to the SEC list. However it’s also worth noting that both Regulation D 506(c) and Regulation CF will restrict the investors to a one-year trading lock.
The other solution is to prepare a Regulation A+ offering and get it qualified by the SEC. This process can take 3 to 4 months, but it will raise the capital limit to $50M per year, which is enough for most ICOs. The security tokens issued are now freely tradable right away, which is more appealing to investors and can help companies raise more capital. Another piece of good news.
However, to do it right, companies need a good securities attorney and a platform they can rely on to make this rescission work. These are really requirements. The do-it-yourself (DIY) option is no longer feasible. Some of the investors will want their money back with interest, and many more want to continue as investors because they believe in the project and want to invest.
The Great Rescission is upon us, and we need to embrace it so we can move forward and build a great blockchain industry that will fix the Internet and usher us into the next era of trusted computing.
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