2018: The Detailed Guide About STO Regulations

2018: The Detailed Guide About STO Regulations

As I begin to craft this post, I am reminded of an adage by Laurent Baheux that says, rules of the wildlife are simple and clear, but that’s never the case for men.

A lot of lawyers and financial specialists are cashing in on various security token projects simply because the laws affecting securities are quite stringent and, to some extent, unclear.

Security tokens are a very interesting digital asset, and they are also quite lucrative and affordable to issue.

According to Tatiana Koffman, founder of Fourblocks Ventures, the issuance of security tokens is much cheaper compared to other forms of securities due to the fact that they are operated on decentralized markets. This also means that they attract lower legal and accountancy fees, among other costs. To better understand how security tokens operate, a video of her interview is available through this YouTube link.

It’s taken time for crypto products to be operated under the laws and we all know how chaotic things get when there are no formal rules for undertaking an investment activity.

Cryptocurrency activities are now starting to operate according to some set regulations that are meant to make the online trade much safer and more lucrative to new and existing investors.

The initial idea behind cryptos was to allow the trade to be conducted with minimal to zero rules, but as time went by, various stakeholders are beginning to come to terms with the fact that we may, after all, need some form of formal structures to guide certain aspects of crypto projects.

Despite STO regulations not being new to the investment space, securities to do with crypto assets are.

In this article, we’ll focus on the regulatory framework of STOs in relation to the cryptocurrency space.  It is important to note that there are a lot of misguiding pieces of literature on the internet regarding the regulations affecting STOs. Let’s begin by debunking those.

Confusion Surrounding STO Regulations

security token offering regulations
Source of the image: https://stock.adobe.com/

Indeed, there has been a lot of confusion surrounding the cryptocurrency regulations; various states including the US authorities have been trying to rope in crypto into their regulatory framework to tap in on the technology. Some financial moguls, on the other hand, have been quoted on a number of occasions adopting the narrative of “Blockchain and not Bitcoin” to ensure that the talk revolves around all digital assets.

All the back and forth flow of information have brought about more confusion.

The stakes are high for all the stakeholders and this has resulted in some players concluding that some authorities are out to scrap the very existence of crypto assets from the digital space.

In actual sense, regulators are only looking out for the general public and trying not to hinder the innovation taking root in the various sectors of the economy. This is why it is vital for these regulators to keep a keen eye on crypto activities to be able to monitor its progress and impact.

And we tend to agree with these regulators – whether you’re an opportunist, a maximalist, or a speculator – regulating the crypto ecosystem as it continues to grow is very important.

Amidst all the speculations, it is easy to lose track of the true meaning of regulating the sector, one of the obvious reasons being to enhance the safety of all the parties involved. Imagine a trading environment where you wouldn’t have to worry about transacting with an anonymous person who is continents away. Further, imagine how easy it would be to woo investors who are  hesitant about taking part in crypto projects due to the fact that it still remains largely unregulated.

Rules relating to security tokens are mainly geared towards cushioning small businesses against any dangers that may deter them from raising capital for their businesses.

The State of STO Regulations

The CFTC considers digital assets such as Bitcoin as a commodity, while the IRS considers cryptocurrencies to be some form of property.

SEC, on the other hand, defines digital projects such ICOs as some form of security.

Commodity vs. Security

The law provides that it isn’t mandatory for a platform offering a spot market for currencies or commodities to be issued with a license. Securities, however, need to be listed on a national exchange or Alternative Trading System, as well as to be registered as an exchange.

At times, some of these regulations can be expensive, intrusive and time-consuming, which explains why many crypto stakeholders are a bit reluctant when it comes to embracing some of the provided/proposed regulations.

This has seen SEC face a lot of resistance from the crypto community regarding the move by the state body to categorize certain cryptos and ICO tokens as securities which makes them fall squarely under the radar of the state.

Additionally, companies operating in the financial assets industry are also required under the law to comply with the financial services and consumer protection laws including the US Patriot Act and the Bank Secrecy Act.

Security Tokens

Given the keenness of the SEC, a large number of the ICOs currently being issued will be categorized as securities; this, therefore, subjects them to the same laws as other conventional securities of the real-world companies. That said, let us be reminded of these two defining moments in the history of security tokens:

Sometime in July 2017, SEC announced that it would henceforth consider the Decentralized Autonomous Organization (DAO) token as a security. In the report, the regulators claimed that they had arrived at the decision due to the fact that the token satisfied all four parameters of the Howey Test.

The Howey Test is a formulation by the Supreme Court in a case involving Howey Co vs. SEC. The decision by the court sought to clear the air on whether certain transactions qualify as investment contracts, which forms part of a security.

In June 2017, about a month earlier, the SEC Corporate Finance Director made an announcement that the regulator would not categorize the offers and sales of Ether as securities. A copy of the full report can be viewed here.

So then you may ask, why do these announcements matter so much?

They matter because they give so much hope to the advocates of utility tokens and also clear the air on matters to do with the issuance of ICOs as seen below:

  • Tokens are highly “fluid”. This means that at the time of their issuance, they can be taken as a security but transform into another form of asset in future.
  • Whenever a token is issued using an Initial Coin Offering, it would be prudent to assume that the resultant token is a security. This, therefore, means that such an issue should be compliant with the laws governing securities. As a result of the SEC statement on Ether’s case, it means that tokens can fulfill the requirements for becoming a utility despite being launched as a security.

Some Key Definitions Relating to the STO Regulations

If you’ve interacted with one or two regulations regarding STOs, then you might have come across one or more of these phrases.

General Solicitation

General solicitation, as the phrase suggests, is a mode of raising capital from the general public through openly advertising using the available media sources, calling on potential investors to invest in a certain company.

However, general solicitation doesn’t include:

  • Demonstration time: This will only be exempted if the details of the security were not discussed including the price.
  • Stating facts about a company: Discussing details pertaining to the financial climate, business environment, products or services without a direct prediction in relation to the security at hand does not amount to general solicitation.
  • Pre-existing business associations: When existing stakeholders discuss with their associates the details about a security and they opt to invest in it, that doesn’t amount to general solicitation.

Restricted Securities

These are securities that cannot be traded freely as they have certain limitations. For these securities to be traded on an open market, they have to meet certain conditions:

  • They need to have a holding period of between 6 – 12 months.
  • The details regarding the security need to be made available to anyone with an interest in them. These include the nature of the issuing company, the team behind it including the directors and the top management, its updated financial statement, among other things.
  • The trading formula needs to be: <1% of the outstanding shares.
  • Must provide Ordinary Brokerage Transactions
  • Must file a notice of proposed sale with the Securities and Exchange Commission

Preemption

Some of the exemptions and conditions discussed above “preempt” what is contained in the SEC laws.

Essentially, companies wishing to issue their securities are required to comply with state laws as well as federal laws. In addition, such issuers may need to comply with additional laws relating to the particular state they wish to sell their securities.

In case a preemption of an offering occurs, such a security won’t necessarily need to register with a state regulator in order for them to comply with the related laws.

Conclusion

We hope this article puts to rest a number of issues relating to STO regulations including the perceived ambiguity in the way STOs are regulated and so on. As you’ve seen, the US continues to put in place clearer laws pertaining to the way crypto security tokens are traded and how they are treated under different circumstances.

Ultimately, we hope the regulators can provide more structured guidelines relating to security tokens as the market continues to warm up to the idea of cryptocurrencies.

What do you think about the STO regulatory framework? Do you think the regulators have done enough in terms of regulating trade?

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