Babbitt Column | Apocalypse of STO compliance issues under Reg A+

According to the author: Blockstack has a series of compliance problems in STO under Reg A+. The related issues may not be the unique personality problems of the project, nor the common problems of blockchain enterprises that intend to carry out STO according to Reg A+. It is a common problem faced by all blockchain companies that intend to issue securities tokens. Regardless of whether Blockstack can be successfully issued, this case will have a reference for the practical and theoretical circles to understand how US securities rules are applicable in virtual currency issuance.

As a kind of application for SMEs, the revised Regulation A (Reg A+) can be exempted from securities registration and can be publicly publicized. The investors are not limited to qualified investors and the number of investors is not limited. The maximum amount of funds raised is higher. Unrestricted sales, release requirements, time and cost are lower than traditional IPOs. In recent years, they have been widely concerned and discussed in the blockchain circle, but today they are recognized by the US Securities and Exchange Exchange (SEC). The issue of securities tokens (STO) under Reg A+ is still extremely rare .

In mid-April this year, Blockstack Token LLC, a blockchain software company based in New York, announced that it had formally submitted Form 1-A to the US Securities and Exchange Commission (SEC), which is intended to be issued and sold under Reg A+ no more than 2.95. Billion tokens STX, financing $50 million.

This is not Blockstack's first token sale. According to its disclosure, between 2017 and 2018, Blockstack has adopted the Simple Agreement for Future Tokens (SAFT) in accordance with Regulation D, Regulation S, and Conducted multiple non-public offerings and sales involving STX.

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The author notes that this is a special case , not only because it is a rare STO project that is currently under Reg A+, but also because the nature of STX securities is variable (in some cases, non-securities) And the function of STX is not purely financing or commercial use, but a currency with both financing and commercial functions. These characteristics of the case directly touched on a series of unavoidable compliance issues under the US law for the issuance of virtual tokens.

In response to some of these issues, the issuer made a more detailed explanation and explanation, and believed that its business operations and this issuance are in compliance with relevant regulations, but at the same time further stated that in some cases its compliance conclusions may not It must be so certain.

In my opinion, some of the problems in this case may not be the unique personality problem of Blockstack, nor the common problem of blockchain enterprises that intend to conduct STO according to Reg A+, but all the blocks that are intended to sell securities tokens. The common problems faced by chain companies. Regardless of whether Blockstack can be successfully distributed, this case will have a reference for the practical and theoretical circles to understand how US securities rules are applicable in the field of virtual currency issuance.

Based on the information publicly disclosed by Blockstack, the author draws some compliance issues from the project and shares some observations and understandings with the authors .

I. Compliance issues in this case

1. Does the token constitute a security

According to Blockstack's release notes , in a nutshell, the answer to the question: yes, no, and variable .

(1) The token issued this time is a security

The issuer believes that the STX issued this time constitutes a securities under the US securities law system, but neither belongs to equity securities (investors do not enjoy dividends, distribution or voting rights similar to equity), nor do they belong to debt securities ( The investor does not enjoy the principal of the debt, the right to return interest, but the investment contract.

(2) The token held by the issuer is not a security

When it is determined whether the issuer constitutes an investment company to be registered, the issuer believes that the token it holds does not constitute a security.

According to the US Investment Companies Act, in general, if more than 40% of the company’s non-cash assets are securities, the company will constitute an investment company and must be registered in accordance with the provisions of the Act, and the company may not engage in the issuer’s current work. Blockchain related business.

The issuer believes that although the value of the token it holds may exceed 40% of its non-cash assets, it does not meet the Howe test because it does not depend on the efforts of others but on its own efforts. Howey test) is a test standard that constitutes an "investment contract". Therefore, the token held by the issuer does not constitute a securities, and the issuer should not apply the provisions of the Investment Company Law. However, the SEC may disagree with these views.

(3) The token held by the miner is a security

There is a mining mechanism in the Blockstack project, which will be launched in 2019 or 2020. The issuer believes that, in view of the current issue of STX constitutes securities, the tokens received by miners for mining in the foreseeable future will also constitute securities, and unless they meet the exemption conditions, they must apply in federal and state states in accordance with US securities laws. Securities registration.

According to the issuer's instructions, it may be difficult to comply with current securities exemption registration conditions (eg, under Reg A+, one of the conditions for exemption from registration is that the total amount issued per currency must not exceed $50 million, and the issuer expects to mine in it Under the mechanism, the total amount of tokens awarded to the miners each year will exceed the limit; if other exemption registration rules, there will be restrictions on the number of miners, and the number of miners is not commercially reasonable for the issuer, so the future may It is necessary to apply for securities registration in the federal and state before the start of the mining mechanism.

(4) Use not securities in the issuer platform

The issuer believes that the use of tokens in the Blockstack platform (including transfers between users) does not constitute securities and does not require registration for securities registration or exemption from registration.

(5) The nature of the token may be converted

The issuer believes that STX may not constitute securities in the future, especially after its platform has been completely decentralized. However, whether the nature of the token securities issued this time can be transformed, when it can be transformed, and how it is transformed, the issuer is not sure at present.

2. Is it applicable to Reg A+ release?

According to Reg A, only eligible eligible securities can be issued in accordance with Reg A+. The stipulated defined securities include only equity, claims or securities convertible or convertible into equity, and do not include other types of securities such as investment contracts. [ Rule 261 (§ 230.261) of Regulation A ]

As mentioned above, the tokens issued by Blockstack belong to investment contracts, not equity or debt securities. Whether this type of securities can be issued under Reg A+, the issuer does not explain this, but also how the SEC understands.

3. Whether the miner needs to be registered as a broker (broker-dealer)

Under the US Securities Exchange Act of 1934, brokers provide services for the securities transactions of others. The SEC staff has stated that one of the decisive factors in determining whether an entity constitutes a broker is whether the entity is charged. Commission or compensation related to securities trading.

For the miner’s income from the addition of new blocks and record transactions in the Blockstack blockchain, the issuer believes that since the tokens are not based on the payment of securities transactions (but based on pre-set algorithms, And whether the transaction recorded by the miner is not related to the securities transaction, the miner is not engaged in broker-type activities, therefore, the miner does not constitute a broker. However, whether the SEC agrees with the issuer's point of view is not guaranteed by the issuer.

4. Whether the issuer, miner and the blockchain constitute a transfer agent (Transfer Agent)

According to the US Securities Exchange Act of 1934, “transfer agent” refers to activities such as signing, supervising the issuance of such securities, registering securities transfers, securities exchange or conversion, and recording ownership transfer of securities through bookkeeping systems when issuing registered securities. People (where "person" refers to natural persons, companies, governments, etc.). According to the Act, the transfer agent is required to register with the SEC.

The issuer believes that although the issuer, miner and the blockchain will assist in the transfer of tokens, the related activities may be similar to those of the transfer agent, but the issuer’s tokens are not registered securities under the Act; The activities of the issuer, the miners and the operation of the blockchain are not actually the activities of the transfer agent as defined by the regulations; and the relevant actions are automatically completed on the blockchain, and the blockchain is not the person defined by the law. Therefore, the issuer, miner and the blockchain need not be registered as transfer agents. However, the SEC may have different opinions on this.

5. Whether the issuer, miner and the blockchain constitute a clearing agent (Clearing Agent)

According to the US Securities Exchange Act of 1934, the “clearing agent” mainly refers to the intermediary in the payment or delivery of securities related transactions, or the comparison of settlement data involving securities transactions, the reduction of the number of settlement of securities transactions or the settlement of securities. A person who provides facilities and facilities such as distribution ("person" means a natural person, company, government, etc.). According to the law, the clearing agent is required to register with the SEC.

The issuer believes that although the issuer, miner and the blockchain will participate in assisting the transfer of tokens, the related activities may be similar to the activities of the clearing agent, but the behavior of the entities and the operation of the blockchain are not defined by the regulations. The activities of the clearing agent; and the related actions are automatically run on the blockchain, and the blockchain is not defined by the law. Therefore, the issuer, the miner and the blockchain need not be registered as clearing agents. However, the SEC may have different views on this.

6. Does the platform constitute an exchange or alternative trading system (ATS)

Under US law, in general, providing and maintaining markets and facilities for securities trading, a platform that aggregates a large number of buyers and sellers and matches securities trading orders will constitute an exchange or ATS subject to the SEC and the US Financial Industry Regulatory Authority ( FINRA) is regulated (except for one seller only, even if the buyer is numerous).

The issuer believes that the Blockstack platform does not aggregate and match securities trading orders, and that as a token issuer, when it distributes tokens on the blockchain, only one of them actually sells tokens; The payment of fees incurred by the platform to provide services, because it is not a securities transaction, does not involve securities orders (these payment is the payment for the user to use the distributed application (DApp) on it or purchase goods or services through internal procedures) ) Therefore, the platform should not be considered to constitute an exchange or ATS. However, the SEC does not necessarily agree with the issuer's opinion.

7. Whether the transfer at the time of token destruction is applicable to the M regulations

According to the US Securities Exchange Act of 1934, in order to prevent price manipulation, issuers are not allowed to buy or sell securities at the same time. In some cases, the issuer may sell the STX to the user while the user burns the STX.

The issuer believes that while the STX is being sold to users, the user destroys the STX. Instead of transferring the securities to the issuer, the user transfers them to a "black hole" that is not accessible to everyone, including the issuer. In the (blackhole) address, the issuer did not receive the token. However, whether the regulatory authorities will hold the same opinion is another issue.

Second, the enlightenment and impact of the case

1. The nature of the token or the specific situation can be analyzed

In this case, the nature of the token is not static, but needs to be based on the specific circumstances (in terms of the nature of the token issued, or whether the issuer constitutes the investment company to be registered), the identity of the holder (is the investor, miner or issuer), the use of the token (whether it is used in the platform), and the stage (which is currently or after the platform has been developed in the future).

The issuer's view of the nature of the token's identification needs to be analyzed in detail with SEC Chairman Jay Clayton's view. Jay Clayton said in an open letter in March this year that a digital asset may be issued or sold as a security because it meets the definition of an investment contract, but in subsequent transactions the digital asset may no longer meet the investment contract. Definitions, whose nature will change (for example, the purchaser of a digital asset no longer expects a third party to carry out critical management or operational efforts, then the digital asset does not constitute an investment contract under the Howe test).

In addition, when the issuer stated that its token does not constitute an investment contract (and thus does not belong to securities, and therefore does not constitute an investment company to be registered), it also refers to whether the SEC issued an investment contract in April this year. The analytical framework considers that the key question in determining whether the tokens it holds is a security is whether the return on the income of the tokens depends on the efforts of the third party.

Generally speaking, the issuer's determination of the nature of its token has certain rationality and theoretical origin. However, there is no clear legal basis and precedent for whether the nature of the token can be transformed, when it is transformed, and how the SEC can accept it. In addition, it still needs to wait for practical tests. In addition, whether the identity of the holder will affect the nature of the token and thus affect whether the issuer belongs to the investment company is a new issue, and it depends on how the SEC looks.

2. The dual function of financing and commercialization of one currency may no longer be a problem.

At present, most of the STO issues in the practice are typical securities-type tokens, and such tokens usually do not have commercial functions. In order to realize the two functions of financing and commercial use, and in order to avoid the legal restrictions and risks of securities tokens in terms of issuance and circulation, some projects have adopted the financing function of securities-based tokens and commercial functions of functional tokens. A clear dual currency structure (such as MintHealth, EpigenCare; for questions and analysis about the structure of the dual currency, please see the author's previous article " Babbit column | one coin or two coins, this is a problem ."

In this case, the nature of the token can be explained according to the specific situation, and can also be transformed. The issuer can realize the dual functions of financing and commercial use by adopting a one-coin structure. If the SEC can accept the publisher's design and interpretation, this is of great significance to blockchain companies that need to finance and have a token commercial function scenario—the ability to implement a currency structure under a compliance framework The dual functions of financing and commercialization are naturally the “most blockchain”, the simplest, most efficient and cost-effective way to design a business model.

3. The dilemma of the choice of securities token types

In this case, the issuer determines the type of token it issues as a type of security – an investment contract. Under this circumstance, the issuer can try to "require that the token held by the issuer does not constitute a security on the grounds that the return of the proceeds of the token does not depend on others, but depends on its own efforts", so there is no need to register an investment company. However, in this case, there may be doubts about whether the securities can be applied to the Reg A+ issue, because the investment contract is not literally a Regisable securities under Reg A+ (including equity, claims and equity convertible securities). ), mainly need to see how the SEC understands.

If the token property is equity or debt securities, the application of Reg A+ is not theoretically controversial; however, in this case, the issuer may constitute an investment company that needs to be registered with the SEC (because it is In the judgment of whether the token constitutes a securities, only when the token is an investment contract (not an equity or other type), the judgment standard includes whether the return of the token depends on the third-party effort. The equity or creditor tokens it holds do not constitute securities and therefore do not constitute an investment company).

It can be seen that if the project party intends to carry out STO according to Reg A+, and its holding value of the token may be higher (more than 40% of its non-cash assets), how to choose the type of securities to which the token belongs (is equity) , investment contract or other) may be a problem, and it is a dilemma, and this issue will directly affect whether the issuer can smoothly issue according to Reg A+ or meet the compliance requirements.

4. How high is the compliance requirement issued by Reg A+

As we all know, the compliance requirements for STO in accordance with Reg A+ are relatively high, but to what extent, the SEC did not issue official opinions. There was no precedent to fully demonstrate it. This time Blockstack came on stage to provide a sample for the market.

In this case, the issuer comprehensively elaborated various compliance issues and risks related to the various aspects involved in the definition of tokens and their production, use, destruction, transfer and circulation. If the miner constitutes a broker, whether the issuer constitutes an investment company, whether the issuer, miner and blockchain constitute a transfer agent or clearing agent, whether the platform constitutes an exchange or ATS, etc.

The project's comprehensive elaboration of various compliance issues, on the one hand, shows its emphasis on project compliance and helps to gain recognition from the SEC; on the other hand, it is also unclear in terms of compliance. The problem was thrown at the SEC and indirectly sought the advice of the SEC.

Regardless of whether the project will eventually be released smoothly, how much the relevant process and results will reduce some of the compliance confusion for the latecomers. The SEC's views on these issues are not only useful for the projects that intend to carry out STO according to Reg A+, but also for the theoretical and practical sessions to understand how securities rules are applicable in the field of virtual currency issuance (including applicable objects, scope of application, and application). Degree) has a reference meaning.

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. To reprint or cite any of the content in this article, please include the author's name.

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