Babbitt column | Another example of STO application under Reg A+, what is the difference this time?

Author's note: In the article published in this April, the author analyzed a case Blockstack in which the Reg A+ rule is applied for STO. In mid-June, another case, YouNow, was proposed to be released using Reg A+. What is the main difference between this case and the previous case?

On April 11, 2019, a blockchain software company in the United States, Blockstack Token LLC ("Blockstack"), published its issuance specification ("Model 411") [1], indicating that it had submitted Form 1- to the SEC. A. It is proposed to issue and sell no more than 295 million tokens in accordance with Reg A+, raising $50 million. On May 15, 2019, Blockstack updated its release specification ("Model 515") [2].

Two months later, on June 19th, YouNow, Inc. ("YouNow"), a US-based company that aims to build a blockchain-based decentralized digital media network, also published its release specification [3] [, indicating that The company will jointly issue a total of 178 million tokens in accordance with Reg A+, together with one of its wholly-owned subsidiaries, but the issuer does not involve raising funds in this offering.

The two cases are also intended to be STO based on Reg A+. The issuer also explained and explained a lot of compliance issues involved in the issue (including all aspects of token generation, use, circulation, and various participants). However, compared to Blockstack (for the case study of Blockstack, please refer to the author's "Babet Column | A Revelation on STO Compliance under Reg A+" published on April 30, 2019, YouNow case still has its worth The particularity of a look: for example, the STO is not necessarily a fundraising tool, and the STO that does not raise funds also needs to be compliant; the identification of the nature and type of the token is more flexible; attempts to solve the problem exist in the Blockstack case. Whether the "investment contract" can be regarded as "eligible securities" and the issue of Reg A+ is applicable.

The following is a brief introduction and analysis of the specificity of the YouNow case based on the relevant public information, for the reference of interested parties.

First, several characteristics

1.STO is not necessarily a fundraising tool

In most of the current cases, regardless of which rule (Reg D, Reg S, Reg CF, or Reg A+) is issued, STO is a fundraising tool. It can be said that STO was originally a financing tool invented to collect funds from investors in compliance. It seems that STO and fundraising are accompanied by each other, no fundraising, no STO.

However, in the YouNow case, STO is not a fundraising tool. The issuer did not raise funds (including legal currency and BTC, ETH and other digital currencies) in the token issuance process. Participants who want to get the tokens that YouNow publishes in STO need to be involved in the ecosystem of the platform as content creators, developers, verifiers or other users, based on the support of the project participants and their projects. In the case of contribution, the corresponding token is issued as a reward. In this regard, there is no necessary connection between STO and fundraising.

Even if the STO does not raise funds, because YouNow's tokens have the functions used in the YouNow platform ecosystem, they will be traded on the exchanges in the future and have investment value. Therefore, these tokens have securities attributes. The issuance of such tokens is subject to the rules of the securities issue (or application for securities registration or application for exemption from registration). In other words, once the issuance of securities is involved, whether or not funds are raised, the supervision of the securities law is required.

2. More flexible identification of the nature and type of tokens

Compared to Blockstack's description of the nature and type of tokens issued in the 411 manual, YouNow has both a place and a more flexibility in terms of Blockstack.

(1) Consistency: In terms of whether a token constitutes a “securities”, a distinction is made between different situations:

In terms of the nature of the tokens issued this time, according to the “analytical framework for whether digital assets constitute an investment contract” [4] and the Howell test standard issued earlier this year by the SEC, the issuer believes that the tokens of this issue are “Investment contract” is therefore a “securities”.

However, when it is determined that the issuer constitutes an investment company that needs to be registered under the US Investment Corporation Act, the issuer believes that since the future return of the token is not dependent on others, it depends on its own efforts. Therefore, the token held by the issuer does not constitute an “investment contract” and thus does not belong to “securities”, and the issuer does not need to be registered as an investment company.

(2) More flexibility: In the case where the token constitutes “securities”, the specific securities type of the token can be flexibly identified:

(a) Tokens are “investment contracts”: As mentioned above, based on the SEC-issued analytical framework and the Howe test standard, the tokens that YouNow issued this time are one of the securities – the “investment contract”.

(b) For the purposes of Reg A+, the token is “debt security” or “equity security”: in conjunction with “equity securities” and “debt securities” appearing and using in relevant regulations The context, the legislative purpose of Reg A+ and the time of introduction, etc., the issuer believes that for the purpose of Reg A+, the token is “debt securities” or “equity securities”.

(c) For the purposes of section 12(g) of the Securities Exchange Act of 1934, the token is not an "equity security" and thus does not require a securities registration, and the issuer therefore does not constitute a "reporting company".

In the 411 version of Blockstack's specification, the issuer stated that the token it issued was an "investment contract" (and thus a "securities"), but not an "equity securities" or a "debt securities." These statements are contrary to the statements in the YouNow issue specification.

The author understands that YouNow, in the case of classifying its tokens as “securities”, makes a more flexible and non-exclusive division of the types of securities, mainly to solve the problem of whether the “investment contract” can be issued according to Reg A+. (See below for a detailed analysis of the issue).

3. “Investment Contract” securities may be issued using Reg A+

In the article "Revelation", the author has questioned whether the "investment contract" securities can be issued according to Reg A+. According to Reg A+, only "eligible securities" can be issued in accordance with the rules; and Reg A+'s Rule 261 (c) defines "eligible securities", including only "equity securities", "debt securities" or Securities that can be converted or converted into equity interests do not include other types of securities such as “investment contracts”. So, can the "investment contract" be issued under Reg A+? This problem is not explained in Blockstack's 411 manual.

In the YouNow case, the issuer also identified the token it issued as an “investment contract”, but this time, the SEC was concerned about this issue and asked the issuer to make a question about whether the “investment contract” could apply Reg A+ issue. Interpretation and analysis.

As mentioned above, in the YouNow case, the issuer believes that the token it issued belongs to the “investment contract” and constitutes the “Eligible Securities” under Reg A+ – the “debt securities” under Reg A+, or Reg A+ Under the "equity securities", it can be applied to the Reg A+ issue.

In addition, the author notes that in his updated 515 version of the specification, Blockstack modified the relevant paragraph of the 414 version about the token property – deleting the token it issued "is an investment contract, not an equity or debt securities "The description, and the modification of the token issued by it" is an investment contract; for the purpose of Reg A+, it can also be a debt securities or equity securities. This is basically consistent with YouNow's interpretation of the type of its securities token.

4. Ordinary investors participating in STO are not subject to the amount of investment

According to Reg A+, the second level (Tier 2) issuance of securities can be open to qualified investors and non-qualified investors. The regulations have no restrictions on the amount of investment for qualified investors, and there are restrictive requirements for the investment amount of non-qualified investors: that the amount of funds invested by non-qualified investors on a certain project each year shall not exceed their annual income or net assets. 10%.

Reg A+ limits the amount of capital invested by non-qualified investors, mainly to protect the interests of ordinary investors, but objectively leads to restrictions on the amount of tokens that ordinary investors can obtain in participating in token issuance, and thus may Affect the enthusiasm of ordinary investors.

In the YouNow case, according to the issuer's instructions, since the issuer did not raise funds in the STO, the participants as users, developers, etc. invested in non-cash considerations such as content and attention, so their participants are not applicable under Reg A+. The amount of investment set for non-qualified investors.

Under the above circumstances, a large number of ordinary investors can ignore the problems of their own economic conditions and capital investment restrictions, and in STO, they have a large number of tokens issued by the issuer that have both practical functions and investment value. It will help the project side to gain more investors' attention and participation, develop and prosper its ecosystem, and thus increase the value of the tokens it issues.

Second, some questions and thoughts

1. The same token can be divided into different natures and types.

Driven by various innovation practices of market players, the US SEC has publicly issued official framework guidelines or documents on the conditions under which tokens constitute “investment contracts” (and thus securities) and the characteristics of usable securities. Whether the nature of the token issued by the issuer is whether it is a securities or a non-securities, gradually forms the standard and basis for judgment.

However, whether the nature of the token issued by the issuer can be characterized as an “investment contract” (and thus a security), and in certain circumstances (such as when it is determined whether the issuer constitutes an investment company), it constitutes an “investment contract” ( So not a security)?

Further, in the case where the issued token constitutes the type of "investment contract", whether the token can be classified as "debt securities" or "equity securities" for the purpose of applying the relevant rules (such as Reg A+) At the same time, in order not to apply the specific rules (such as Article 12(g) of the Securities Exchange Act of 1934), it also denies that the token constitutes "equity securities"?

There are no clear answers to these questions. In both cases, the issuer has made an attempt to explain the issue in order to be able to issue the project smoothly and reduce compliance risks. But for the issuer's understanding, it remains to be seen whether the SEC holds the same view.

2. Who will adopt Reg A+ rules and conduct STO without raising funds?

The STO based on Reg A+ rules, but not the way to raise funds, may be more suitable for those projects that are “not bad money” but require a large number of users to participate in ecological construction and prosperity.

The early funds required for project development can be raised according to the rules of Reg D, Reg CF, Reg S, etc., and a large number of ecological participants such as users and developers can be attracted by issuing tokens with securities attributes. Since the project is issued under Reg A+ and does not involve fundraising, even ordinary investors who are not qualified investors can participate and the participants are not subject to the investment amount.

The reduction of the threshold of investors, coupled with the use of tokens and the use of investment attributes, will help attract more users and other stakeholders in the ecological construction to participate in the platform to jointly create and share value.

3. Reg A+, non-funded STO may be easier to get released

Although the compliance cost of STO according to Reg A+ is relatively high and takes a long time, if the project issuance itself does not involve fundraising, the project party has a relatively low risk of issuing air currency and fraudulently running. In this regard, These projects may be more easily recognized by the regulatory authorities than large-funded projects.

References: [1] Blockstack 411 version of the manual: https://www.disclosurequest.com/form/blockstack-token-llc/0001104659-19-020748/offering-circular

[2] Blockstack 515 version of the manual: https://www.disclosurequest.com/form/blockstack-token-llc/0001104659-19-029828/offering-circular?returnURL=

[3] YouNow Release Notes: https://www.disclosurequest.com/form/younow-inc./0001628279-19-000230/offering-circular?returnURL=

[4] Framework for "Investment Contract" Analysis of Digital Assets, https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets

Author: Zhang Ling, a partner at law firm Han

Disclaimer: This article only represents the author's personal opinion and does not represent the opinions of the organization. The contents of this article do not constitute legal advice and investment advice. If you need to reprint or quote any of the content of this article, please specify the author's name