WASHINGTON/NEW YORK – Tech start-ups that issue digital tokens to raise funds are falling in line with U.S. securities laws or seeking legal ways to skirt them after the Securities and Exchange Commission (SEC) said it planned to regulate the market.
The issuers are increasingly filing their ‘initial coin offerings (ICOs)’ with the SEC, adding customer checks, barring U.S. investors or halting fundraising after the regulator said it will hold most token offerings to the same standards as share sales, more than a dozen ICO lawyers and executives told Reuters.
“It’s better to pay the cost upfront than to have the SEC come after you and shut you down,” said Armin Ebrahimi, CEO of Silicon Valley-based ShoCard which is preparing for an ICO in May.
Until recently, hundreds of start-ups raised billions of dollars with few investor protections or customer checks. Backed in many cases by formal legal opinions, those companies believed that as issuers of “tokens” they did not fall within the SEC’s remit. However, SEC chair Jay Clayton said in February he believed most digital coins were effectively securities and should be regulated as such.
The SEC has also launched multiple probes, saying many coin issuers, their lawyers and advisors may have breached its rules.
Spooked U.S. law firms are now advising digital coin clients to be much more cautious, according to several lawyers and executives.
“Most credible law firms will not give an opinion that the token is not a security,” said Richard Levin, chair of the fintech and regulation team at law firm Polsinelli.
No digital coin issuer has yet launched a public offering akin to a stock exchange listing, but many are now structuring their deals like traditional private share placements.
North Carolina-based energy settlement platform Causam eXchange is one of many companies offering tokens under the SEC’s ‘Reg D’ rule which allows firms to sell securities to accredited investors subject to know-your-customer checks and a holding period.
Causam CEO Joe Forbes told Reuters he had chosen the structure so as “not to go to jail.”
Cryptocurrency firms are also starting to raise money under the SEC’s crowdfunding rules, which allow companies to solicit funds more broadly subject to a $50 million cap and additional disclosures, said Nimish Patel, partner at Mitchell Silberberg & Knupp.
“That’s the middle ground that people are going for now.”
The value of funds raised globally by digital coin offerings in January and February fell 43 percent to $726 million compared with November and December when bitcoin, the best known cryptocurrency, hit an all-time high just below $20,000, according to data from research firm Novum Insights.
Silicon Valley-based start-up Stream decided last month to shelve its planned ICO due to regulatory uncertainty, Simar Mangat, Stream’s chief executive, told Reuters.
“If the SEC were to rule all tokens as securities, it’d be a huge blow to innovation in the crypto ecosystem here in the U.S,” he added.
Some companies are shunning U.S. investors altogether in order to avoid U.S. securities law, which generally focuses on where investors are from rather than where the company is based.
Executives at Estonia-based iOlite, Scotland-based CaskCoin, UK-based Celsius Network, and Auctus, told Reuters they were barring U.S. citizens to steer clear of the SEC.
“Auctus will not sell tokens to the residents of the U.S. due to various regulatory issues,” said Daniel Duarte, the Brazil-based co-founder of Auctus, which is launching its ICO this month.
iOlite believes its token is not a security, but decided to bar U.S. investors after recent discussions with U.S. legal counsel, said CEO Alfred Shaffir.
“We prefer to be on the safe side,” he added.
Likewise, Celsius will block U.S. persons from its upcoming token crowdsale, said CEO Alex Mashinsky, adding there was confusion globally over the United States’ position.
“The lawyers themselves don’t know what they are talking about because things are changing.”
Even some U.S-based issuers, such as portfolio platform CoinSeed, are barring home investors “as a preventative measure of caution,” its documents note.
However, such a disclaimer does not necessarily put start-ups in the clear. Coin issuers still need to actively screen-out U.S. persons to fully comply with U.S. law, said Eric Kintner, partner at law firm Snell & Wilmer.
“Per the SEC guidance, it is doubtful that a simple ‘check the box’ would be sufficient to establish that the buyer is not a U.S.-person,” he said in an email.
iOlite, Celsius, ShoCard and Auctus will require investors to show their passports. iOlite and Celsius told Reuters they would also be blocking U.S. IP addresses
But not everyone has been so diligent. U.S.-headquartered transaction laundering detection firm EverCompliant analyzed a sample of ICOs and found 30 percent asked the registrant to check a box saying they were not a U.S. citizen, but only 11 percent of these asked buyers to prove this.
And as other jurisdictions start to tighten-up their ICO rules, focusing on investors outside the United States will become riskier, said Kintner.
“Companies that seek to avoid U.S. securities laws by only selling outside the U.S. may be jumping out of the pot and into the fire.”