Here are some key points in response to your questions about ICOs and compliance:
- Financial statements and audits can help provide transparency about a project's finances and use of funds. However, there are currently no uniform accounting or auditing standards for ICOs.
- For a 506(c) private placement, issuers are responsible for taking reasonable steps to verify accredited investor status, such as reviewing documentation. Engaging a broker-dealer may help mitigate some legal risks but does not eliminate the issuer's obligations.
- Restrictions under Reg A and Reg CF apply to all participants in a US offering, regardless of location. However, these rules do not prevent non-US persons from participating in offerings that do
2. Agenda
• Agenda & Introductions
• Present State of Blockchain & ICO
• ICO In-depth
• Types of Coins
• SAFT
• Post SAFT
• Safe Harbor
• Governance/Use of Funds
• International View
• Validation & Storage
• Cybersecurity
• Secondary Markets
• Trading
• Importance of ICO’s
• Role in Finance
3. Attendees:
• Alan Koz Kostrinsky: Principal Advisor & Co-Founder Macola Management
• Sheri Kaiserman: Principal Advisor & Co-Founder Macola Management
• Lilya Tessler: Partner, McDermott, Will & Emery
• Marco Santori: Partner, Cooley LLP
• Bart Mallon: Partner, Cole-Frieman & Mallon LLP
• Dror Futter: Partner, Rimon Law
• Lana Reeve: Counsel to Macola Management
• Edward Jacobson: Partner, Jacobson, Segal & Associates
• Ara Yavruyan: CEO ChainVault
4. Present State of Blockchain & ICO
• Implementation of production blockchain systems at Utilities, Banks and Broker Dealers
in 2018
• Internal systems
• Client Facing
• Consortiums
• Crowdfunding + Blockchain Technology = ICO
• ICO Market expanded at the rate of 25x quarter over quarter in 2017
• Acceleration of Initial Coin Offerings in 2017
• Est $5.0 Billion invested in 2017 (WSJ 12/13/17)
• Over 550 ICO sales in 2017
7. Cryptocurrencies, utility tokens and tokenized securities
• Cryptocurrencies
• These are digital currencies like Bitcoin in which encryption techniques are used to regulate the
generation of units of currency and verify the transfer of funds. They are operating independently of a
central bank.
• Utility tokens
• The utility tokens are services or units of services that can be purchased. These tokens can be
compared to API keys, used to access the service.
• They are a way to fund projects of shared infrastructure that couldn’t be funded before. To enable
such ecosystems to be built some tokens can be “pre-mined” in addition to be sold in “crowd-sales”
during tokens launches.
• Tokenized securities:
• Tokens are representing shares of a business. In addition, considering the SEC announcement any
token that can’t pass the Howey test should be considered as a security and fall under the 1934
Security Exchange Act.
8. Howey Test
• The Supreme Court in Howey set forth the test for determining when an
arrangement constitutes an “investment contract” under the Securities Act and the
Securities Exchange Act
• The Test: An investment of money in a common enterprise with an expectation of
profits solely from the efforts of others
• A blockchain token is a digital representation of an asset, information or other
item
• Therefore, in evaluating a token under Howey, the facts and circumstances are
important, including the functions and features of the token
9. The SAFT Project: Toward a compliant token
sale framework
• A self-regulatory reaction to pre-functional utility token sales
• An alternative to the “ICO”
• SAFT= Simple Agreement for Future Tokens
• A forward contract that is also a security (it passes the Howey Test)
• Investors pay money to developers and get a SAFT in exchange
• SAFT obligates developers to deliver tokens once the network is functional
• SAFT Framework uses the investor protection laws when enterprise risk is
highest, consumer protection laws once product risks predominate
10. The SAFT Project: Toward a compliant token
sale framework
EnterpriseRisk
ProductRisk
FUNCTIONALITY
Investor protection laws
do most good with least harm
Consumer protection laws
do most good with least harm
11. The SAFT Project: Toward a compliant token
sale framework
• Step 1: Developers have no working product, so they sell a SAFT to investors
pursuant to a registration exemption. Investors pay money to developers
• Step 2: Developers use the money to develop the network and build a working
token. Investor takes on enterprise risks
• Step 3: Once network is functional, developers deliver the tokens to the Investors.
SAFT terminates
• Step 4 (Optional): Developers and investors may sell functional tokens directly to
the public. Public takes on product risks
12. The SAFT Project: Toward a compliant token
sale framework
Misconceptions
• A security somehow “transforms” into a nonsecurity
• The SAFT requires a “bright line” rule of functionality
• The “timing” of efforts matters in the SAFT framework
• The terms of the SAFT document don’t adequately protect investors
13. The SAFT Project: Toward a compliant token
sale framework
Limitations
• Preserves inequities of the current system
• Causes self-censorship
• Not all token sales are appropriate for the SAFT Framework
• SAFT Project can over-enable
More available at saftproject.com
14. Current Avenues to Raise Capital
S-1 Registration Regulation D 506(b) Regulation D 506(c) Regulation A Crowdfunding
• General Solicitation
• Sales to general public (not
limited to accredited
investors)
• No limit on dollars raised
• No limit on dollars from
particular investors
• No limit on number of
investors
• Other: full registration
statement; state filings,
ongoing reporting
requirements
• No General Solicitation
• Accredited investors & up to
35 non-accredited investors
• No limit on dollars raised
• No limit on dollars from
particular investors
• 2,000 investor limit pursuant
to Section 12(g) of the 34 Act
• Other: offering
memorandum, Form D, state
blue sky filings
• General Solicitation
• Only accredited investors;
status must be verified
• No limit on dollars raised
• No limit on dollars from
particular investors
• 2,000 investor limit pursuant
to Section 12(g) of the 34 Act
• Other: offering
memorandum, Form D, state
blue sky filings, reporting
requirements
• General Solicitation
• Sales to general public (not
limited to accredited
investors)
• Can raise either $20M (Tier
1) or $50M limit (Tier 2)
• None for Tier 1; limits for
Tier 2 for certain investors
• Tier 1 subject to 2,000
investor limit pursuant to
Section 12(g) of the 34 Act;
Tier 2 not subject in certain
cases
• Other: offering
memorandum, state filings &
potential coordination,
reporting requirements
depending on tier
• Advertising on Crowdfunding
platform only
• Sales to general public (not
limited to accredited
investors)
• Limit to $1M raised over 12
month period
• Limit on investment amount
based on investor annual
income and net worth
• 2,000 investor limit pursuant
to Section 12(g) of the 34
Act, subject to conditional
exemption
• Other: offering
memorandum, Form C,
reporting requirements, Bad
Actor Disqualification, FINRA
involvement
SEC involvement: high SEC involvement: minimal/none SEC involvement: minimal/none SEC involvement: medium SEC involvement: minimal/none
15. Present Avenues to Raise Capital
• Concurrent raises (may be able to utilize more than one)
• Transfers after issuance (transfer restrictions & secondary markets)
• Legislation versus rulemaking (Dodd-Frank Act)
• SEC involvement v. SRO involvement
• How to create network effects?
• Other items addressed in current avenues:
• Accredited Investor Qualification
• AML / Bad Actor
• “Custody” of the securities
16. Goal: Create immediate zone of regulatory certainty
Goal of Utility Token Safe Harbor: Define criteria which if met would assure that a token
would not be classified as a security. Criteria could address promotion, sale, use and/or
transferability of tokens and include disclosure requirements
Non-Exclusive: Tokens could still be issued outside the Safe Harbor and would be subject
to a conventional securities analysis. Does not preclude additional, broader regulations as
market experience increases
Grandfathering: Existing ICOs could be given a period of time to retroactively qualify for
the Safe Harbor
Safe Harbor
17. Governance/ Use of Funds
Securities Tokens & SAFT investment contracts (Securities Laws)
• Legal Status of Token & Token Investment Contract Holders
• Need for Clarification
• Rights of Securities Token Holders
• No Right of Recourse for non-delivery/non-performance of underlying technology/good/project (other than token itself)
• Need for an Investment/Sale Contract setting forth rights of token investor.
• Ongoing information rights
• Enforcement of sold investment project plan
• Diversion of funds– specified limitations on use of funds
• Management compensation/distributions
• Distribution of profits/allocations
• Intellectual Property rights
• Ownership of code
• Modifications to code/rights to offshoot trees- technologies
• Licensing
• Maintenance
• Other traditional investment protections
• Purchaser of Token without strong Investment/Sale Contract may have very limited or no rights
18. Governance/ Use of Funds
Utility Tokens (Consumer Protection Laws - US)
• Legal Status of Utility Token Holder
• Consumer
• Rights of Utility Token Holders
• Recourse for non-delivery of good/service
• Fraud & Unfair Business Practices protections
• Misrepresentation protection
• Information rights as to Product only generally
• No Intellectual Property ownership rights
• No rights to percentage of profits
19. International View
• China: Blanket ban on commercial transactions involving Crypto-currencies,
prohibition on fund-raising through ICO’s. Mining is also a prohibited activity.
• Hong Kong: SFC has issued Cautionary guidance that tokens may be securities,
and if so would be regulated under HK Securities laws.
• South Korea: ICO’s are prohibited. Although trading in Crypto-currencies is legal,
recent announcements indicating a possible outright ban on trading have been
issued (and revoked).
• Russia: ICO’s are not banned, and will be regulated under still evolving securities
laws. Mining is allowed, regulated and even encouraged.
• Gibraltar: Recently announced launching regulatory framework as looking to
draw in business as a friendly State
20. International View
• Singapore: Rather closely follows US law. If a token is a Security, it will be
regulated by the MAS under Singapore Securities laws. Utility tokens (if in fact
not securities) will not be banned. Crypto-currencies treated as currency.
• Japan: ICO’s in Japan are not banned. A token that constitutes an investment will
be regulated. Crypto-currencies are not banned and may be received as
payments.
• Switzerland: ICO’s are not prohibited, but may be regulated. Crypto-currencies
may be subject to AML requirements, but otherwise are allowed.
• Estonia: ICO’s are not banned, and will be regulated under still evolving securities
laws. Crypto-currencies are not regulated.
• India: ICO’s are prohibited. Crypto-currencies are highly regulated.
21. Validation/Storage and more
• Smart contract ICO token secure storage by accredited SEC service providers
• Validating token architecture with financial model by independent third party or SEC technical team
• Track record and credibility of an token issuer - Rating model
• Duration and expiration of the token
• Utility Token API framework and architecture
• Access to offerings Open vs Exclusive API
• Standardizing smart contracts templates application
• Audit smart contracts based on a standard framework
• Naming Symbol and supply standardization
• Block size planningaudit procedures based on financial model
• Token features and functions standardization
Acceptable methods of reserve to be determined
• Cryptographic proof of reserves
• Independently audited reserve accounts
• Segregated accounts
• Funds held in trust by third parties
22. Cyber Security
• Cyber audit of the token application
• Create cybersecurity framework/architecture for issuers
• Cybersecurity protocols to avoid manipulation or hacking
• Standardize emergency stop procedures and techniques
• Standardize emergency stop process by SEC “Stop API”
24. Current State of the Crypto Market
Domestic crypto platforms are regulated as:
• Licensed money transmitter platform by state
• Licensed as a money services business by the Financial Crimes Enforcement Network
• OCC proposal for a special purpose federal charter that New York State Department of Financial
Supervision has filed a complaint
Mainstream Exchanges:
• CBOE: First to launch Bitcoin Future product on 12/10/17
• CME: Launched their Bitcoin Future product on 12/18/17
• Both are a cash based settlement product
• Limited coverage by banks and broker dealers
• ICE: Announce March 2018 launch of high speed data feed for top crypto currencies
• NASDAQ: Announced to list a Futures Product in Q2 of 2018
25. Trading Platforms: Not Exchanges in the Traditional Space
• Securities Tokens & SAFT Investment Contracts
• Limited Trading Pre- IPO Trading, described above
• Heavily Regulated Post-IPO Trading
• Utility Tokens & Other Goods and Services:
• Multiple trading platforms across the globe in various spaces
• Coinbase (US)
• BitFlyer (Japan)
• EToro (EU)
• BitOasis (Dubai)
• Platform examples in physical goods space
• Ebay
• Cragslist
• Platform examples in event ticket space
• Ticketmaster
• Stub Hub
26. Why The Innovation of ICOs Is Important
• The main purpose of the JOBS act was to encourage the funding of startups and small
businesses in the US and allow individuals to become investors
• Cryptocurrencies like Bitcoin, which are powered by blockchain technology, give the
37mm unbanked people in the US access to the financial system
• Cryptocurrencies represent equity in emerging blockchain technologies
• Crowdfunding + blockchain technology = ICO
• ICO’s are paving the path toward the democratization of finance
27. The Democratization Of Finance
• Investing in startups has been exclusive to elite venture investors
• Crowdfunding gives access to individuals to invest but the investment is illiquid.
• Additionally, a bank account is needed to participate
• ICOs provides anyone the opportunity to invest, become a user/customer to help
• Support the company, and decide whether to continue to hold or sell their investment
easily through an exchange
• Users will now be able to partake in broad wealth creation from the companies whose
products and services they support
29. Contributors
Agraria Technologies Inc. Blockstream
Dell EMC RT LLC
Coin Center OTCXN
Science Blockchain Silvergate Bank
Sheppard Mullin Everledger
Start Engine Circle
Distributed Network Advisors Dervee & XBTO
Goodwin Proctor Skuchain
Civic Coincircle
Snap Interactive iComply Investor Services Inc.
3GC Group NuID
Thetaray Evercoin Crypto Exchange
BuildCoin BitFlyer
Libra Tech World Bank
Greenwich Associates Top Ledger Consulting
DBOT
Tradewind Markets
30. Industry Questions: ICO
Master Category Sub Category Question
ICO Accounting Are there financial statements? If so, are they audited and by whom?
ICO Compliance
If for the sake of of extreme caution, {ENTITY} were to undertake an ICO in full compliance with Reg. D, Rule 506 safe-harbor provisions for
private placement, would the legal burden for ascertaining that all investors met accredited investor status fall solely on us? What
measures would we be expected to undertake to fulfill our diligence requirement for ascertaining investor status--meaning, is self-
certification not sufficient and do we have to conduct our own "investigation" of every investor to ascertain status? What if we were to
engage a registered broker/dealer to conduct the placement--would that liability no longer rest with {ENTITY}?
ICO Compliance
If {ENTITY} were to undertake the normal crowdfunding ICO but in compliance with Reg A, Rule CF provisions, would the restrictions under
the regs apply only to US participants in the offering or to all?
ICO Compliance Retail clients in APAC, what would be a best efforts with regards to a US ICO their investing?
ICO Compliance Is the product legal? Is it subject to regulation, including rules designed to protect investors? Does the product comply with those rules?
ICO Compliance Is the offering legal? Are those offering the product licensed to do so?
ICO Compliance Any SEC & Congress collaboration on Crypto Currencies and ICO’s?
ICO Contractual
If an ICO token is determined to be a security and a rescission is required what procedures would they follow? What if part of a transaction
is voided?
ICO Contractual
Will any liability attach if an underlying platform is not built? What actions will need to be taken to preclude this, or is this a risk of
purchase?
ICO Contractual I would like clarification and/or examples of when a token sale is not an investment contract (i.e. is not a security)?
ICO Contractual Who exactly am I contracting with?
ICO Contractual
Who is issuing and sponsoring the product, what are their backgrounds, and have they provided a full and complete description of the
product
ICO Contractual Do they have a clear written business plan that I understand?
ICO Contractual Who is promoting or marketing the product, what are their backgrounds, and are they licensed to sell the product?
ICO Contractual Where is the enterprise located?
ICO Cyber Security Are there substantial risks of theft or loss, including from hacking?
31. Industry Questions: ICO
Master Category Sub Category Question
ICO Howey
Will the SEC apply the Howey test in a strictly textual way or in a more substantive way? E.g., if {ENTITY} were to issue a utility token--
meaning a token giving the holder access to trading privileges on our network through discounted but prepaid pricing--then the holder
could be construed as meeting only the first two Howey criteria (investing money in a common enterprise) but not the latter two (for the
purpose of deriving a profit largely through the efforts of others), ergo technically not a security. But what if the holders acquired the token
in the belief that the value and price of {ENTITY} trading access would appreciate, and therefore allow the opportunity to profit from re-
selling the token to others in the future? Does this market perception then make our token substantively a security? (I would argue not,
for the same reason that Led Zeppelin reunion tickets are not, even though those tickets get scalped for multiples of their purchase price.)
ICO Howey Will Howey be the only test applied to determine securities law applicability (or Tcherepin), or will a bright line test be developed?
ICO Howey
Does the knowledge that the token may be traded satisfy the "expectation of profits" portion of the Howey test (assuming the token
otherwise meets all requirements of Howey to be considered a security)?
ICO Legal What specific rights come with my investment?
ICO Legal
Has the offering been structured to comply with the securities laws and, if not, what implications will that have for the stability of the
enterprise and the value of my investment?
ICO Legal
What legal protections may or may not be available in the event of fraud, a hack, malware, or a downturn in business prospects? Who will
be responsible for refunding my investment if something goes wrong?
ICO Legal If I do have legal rights, can I effectively enforce them and will there be adequate funds to compensate me if my rights are violated?
ICO Listing We need more clarity around when a utility token is not a security?
ICO Listing
With any regulated coin or token, how will online theft/ hacking be treated? Is a new replacement issuance considered a new regulated
transaction? Stolen coins are difficult to void.
ICO Marketing Will the sites and publications used to inform individuals of a sale be considered promoters or other regulated actor?
ICO Regulation Have they been paid to promote the product?
ICO Regulation Does the SEC agree with the SAFT framework?
32. Industry Questions: ICO
Master Category Sub Category Question
ICO Regulation
How the SEC will work with the CFTC and other regulatory bodies where there is potential jurisdiction among multiple agencies that may
claim regulatory ability?
ICO Regulation
Does the SEC expect Congress to act on these new asset classes to expand SEC or other agency authority, given that SEC is constrained in its
enforcement abilities and tokens don't neatly fit within SEC (or other regulatory agency) zone of authority in many cases?
ICO Regulation It would be great to know if Ethereum was funding today, would Ether be a security?
ICO Regulation
What about a game company which creates and pre-sells their in-game currency to fund the development of the game. What if a game
company creates and pre-sells in-game creature tokens instead of a currency?
ICO Regulation Is a SAFT legal?
ICO Regulation
Is the SEC going to create a framework of what an acceptable structure for an ICO would look like, underlining the important investor
protections that are insured by the key aspects of the structure as they see them?
ICO Regulation
What coordination is taking place between SEC and CFTC in terms of drawing regulatory borders between their respective jurisdictions re:
crypto tokens?
ICO Regulation Is Ethereum a security, we need clarity around this?
ICO Regulation Clarify a utility VS security ICO?
ICO Safe Harbor How will currency and securities regulations be integrated? Can a coin or token be deemed both, or will one determination govern?
ICO Safe Harbor
There is some confusion over whether particular platforms and tokens/coins operating in those platforms’ dApps are somehow “exempt”
from regulation (brought up with respect to NEO in particular), please clarify.
ICO Storage Will prior ICOs be grandfathered in, or will the resultant tokens (and coins) be subject to new scrutiny (assuming still in use)?
ICO Use of Funds
If a particular transaction or coin is determined to be a security, what exemptions apply (eg, can they offer only in state? What if fewer than
500 hold coins (see NXT sale) Can they become exempt from reporting obligations? Etc).
ICO Use of Funds If a digital wallet is involved, what happens if I lose the key? Will I still have access to my investment?
ICO Use of Funds Is there truly a “safe” way for a public company to do an ICO that is non-dilutive Capital
ICO Validation Is the SEC working on a better way for non-accredited users to fund seed-stage (non-utility) coins?
33. Industry Questions: Secondary Markets
Master Category Sub Category Question
Secondary
Markets
Compliance Where is my money going and what will be it be used for? Is my money going to be used to “cash out” others?
Secondary
Markets
Compliance
Due to how recent blockchain technology is, would the SEC revise procurement practices to allow for adoption of emerging blockchain
software for regulation, investigation, and enforcement?
Secondary
Markets
Compliance
Would the regulator consider integrating systems like EDGAR with decentralized platforms and protocols that use blockchain to
programmatically publish corporate disclosures, reporting, and communications?
Secondary
Markets
Compliance
Would the SEC consider using a decentralized ledger technology to manage LEI with a zero knowledge proof of identity integration into
CAT?
Secondary
Markets
Cyber Security
If a blockchain is used, is the blockchain open and public? Has the code been published, and has there been an independent cybersecurity
audit?
Secondary
Markets
Data Because someone else will always run the platform, how important is passivity?
Secondary
Markets
Legal How will market manipulation be prevented pursuant to 12(a)(1) or 10(b)(5) actions?
Secondary
Markets
Regulation Is there trading data? If so, is there some way to verify it?
Secondary
Markets
Regulation To what extent (if any) will platforms be liable for token/coin liability?
Secondary
Markets
Regulation If a company has tokens of monetary value in the public market and wants to go IPO, how will that be regulated?
Secondary
Markets
Regulation When are they going to shut down the exchanges that are trading securities disguised as utility tokens?
34. Industry Questions: Clearance & Settlement
Master Category Sub Category Question
Secondary
Markets
Clearance &
Settlement
How will blockchain “settlement” be implemented and acknowledged by an independent third party on contractual settlement date?
Secondary
Markets
Clearance &
Settlement
How will a party not part of the blockchain receive notice of settlement in release of currency/value?
Secondary
Markets
Clearance &
Settlement
When will buy/sell settlement change ownership? Will it be simultaneously?
Secondary
Markets
Clearance &
Settlement
What are the market settlement cycles today? Same-day, T+1, etc.?
Secondary
Markets
Clearance &
Settlement
What are the risks and who bears them and when?
Secondary
Markets
Clearance &
Settlement
How will positions be audited? Can they be audited or accounted for?
Secondary
Markets
Clearance &
Settlement
What is the impact when the govt. rules all positions must be disclosed to tax authorities?
Secondary
Markets
Clearance &
Settlement
What safeguards will be in place for money laundering, if any?
35. Presenter Contact Details
Alan Kostrinsky - Koz Macola Management Partner & Co-Founder koz@maco.la
Sheri Kaiserman Macola Management Partner & Co-Founder sheri@maco.la
Lana Reeve Macola Management Counsel to Macola lana@maco.la
Ara Yavruyan ChainVault CEO ayavruyan@chainvault.org
Lilya Tessler McDermott, Will &Emery Partner ltessler@mwe.com
Marco Santori Cooley LLP Partner msantori@cooley.com
Dror Futter Rimon Law Partner dror.futter@rimonlaw.com
Bart Mallon Freiman Cole & Mallon Partner bmallon@colefrieman.com