Thought Leaders
HODL Your Hoopla Over SEC Changes For Exempt Offerings – Thought Leaders
Last week the The U.S. Securities and Exchange Commission released a proposal – that has yet to become regulation – to simplify how exempt offerings are done. Shortly thereafter, a flurry of articles and newsletters made their way through the digital asset industry – many of which suggested their platforms were already being modified to fit the new rules. While the SEC has proposed changes, time will tell whether the proposal is adopted – and if so, whether there will be changes to the final draft that will be published to the Federal Register.
The US exempt offering framework includes tools such as Reg D, Reg A, crowdfunding (a.k.a. Reg CF) – essentially everything that is not a public or retail offering. This framework has seen little in the way of changes or modernization since the Securities Exchange Act of 1934. There has been significant public criticism of the current rules for exempt offerings, largely because they reserve access for only the wealthiest Americans to invest in private funds, companies, and other offerings.
If passed, the proposed changes could allow for the average person to invest in earlier stage deals – such as Uber or WeWork – before they reach their lofty valuations and dumped into the public markets. Enabling SPV (special purpose vehicles) and harmonized reporting (ie combing Reg D and Reg CF into one, not two reports), and increasing the total amount that can be raised would help streamline compliance for issuing firms. Additionally, the changes could also enable crowdfunding to become a viable capital formation tool for investing in such asset classes as real estate.
Currently, US offering exemptions such as Regulation CF (crowdfunding) are quite restrictive, limiting the total amount you can raise to $1.07M USD per 12 month period and includes significant restrictions per investor. The US SEC appears to be following the lead of other jurisdictions such as Canada where regulators proposed similar changes, or Europe where regulations were updated last year, increasing the limits for the EGP (European Growth Prospectus) to €8M EUR, a little over $9M USD. According to the new proposal, companies would be able to raise up to $5M USD. While $5M is still a relatively small amount of capital, it does allow early stage companies to build their tribe with a broader investor base.
The SEC proposed similar changes to Reg A, increasing the upper limit to $75M USD. This could make Reg A viable for many later stage companies where larger Series B, C, or even D rounds demand more capital than what is currently available in Reg A.. This also opens up these investment opportunities to the retail investor, previously these deals were only available to the wealthiest corporate venture firms, private equity shops, and high net worth individuals.
Further changes include allowing accredited investors to participate in crowdfunding. Previously, if you used a crowdfunding exemption, you could not accept funds from accredited investors and would actually have to use another exemption, such as Reg D, simultaneously. This typically forces companies into more paperwork, legal fees, and an increased risk of getting something wrong – which could result in regulatory or civil actions. The proposed changes would enable companies to combine accredited and retail investors into one offering.
Aside from accredited investors, the changes also open the doors to institutional and corporate investors, including the SPV (Special Purpose Vehicle).
An SPV is a corporate entity created for a specific purpose – usually for reasons such as limiting liability, tax efficiency, investment, or capital formation. For example: In order to tokenize a piece of real estate, you might form an SPV, and transfer the deed to the real estate into this company. The purpose of that company/vehicle is to hold the deed of this real estate and maintain a accurate record of who the owners are, SPVs are commonly used for investment funds as well.
Combined, SPVs, corporate investors, accredited investors, and major institutional investors can move large amounts of capital. However, they weren’t able to invest in crowdfunding offerings in the US. This created an interesting paradox for companies raising capital, if you could get the big fish interested, you would avoid the crowd – but, if your offering didn’t look good enough for professional investors, your last resort may be crowdfunding. The crowdfunding industry as a whole has faced a lot of criticism from professional investors for low returns and low deal quality, this is likely to change when retail investors have access to the same deals as larger institutions.
Finally, the new crowdfunding regulations propose several major changes to how much each investor can put into any one offering. Currently, investors who do not meet the accreditation thresholds were limited on how much they could invest based on the lower of their income or net worth. The new regulations would change this to the greater of those two. These changes are expected to not only fuel innovation, they are likely to bring in a lot of smart money as well.
For example, an investor with a net worth of $750,000 and an income of $150,000 couldn’t qualify as an accredited investor. This person has a Phd in bioscience and finds a startup with a revolutionary innovation in the field of bioscience – they are not qualified as an accredited investor and barred from investing. Ironically, they can be an advisor to any institutional investor on why this particular startup is so hot – but under the current rules, they are not qualified to risk their own money.
While these changes are welcomed by most market participants, they are not a sure thing. This proposal for a new exempt offering framework is not yet regulation, it still has to make it’s way through the government and be entered into the Federal Register. Looking back at the proposals for crowdfunding in the US we can see how different a proposal can be from the regulation – and there are still a lot of lobbying dollars that want to see the status quo maintained. It is important to not make important business decisions based on this proposal – rather, look at these changes as a larger trend among securities regulators globally.
We’re seeing securities regulators trying to make easier for distributed capital formation. Crowdsales and crowdfunding are actually becoming something that the regulators across around the world are working together to harmonize their frameworks. By combining the crowdfunding regulations from jurisdictions around the world, early stage companies would be able to access global capital and build a global investor base, without being forced to break the rules like most of the ICO and STO issuers are doing today.
Perhaps the most exciting thing about the SEC’s proposed changes is how they demonstrate a very coordinated effort among securities commissions globally. As this new era of capital formation emerges, businesses will be able to combine and leverage the regulatory frameworks of multiple countries. That being said, for US based offerings, we still have to wait for the new regulations before knowing what they will look like, or their impact on the digital securities industry.
Halifax & Associates – A Repeat Offender
A pair of Canadian regulatory bodies have now issued warnings to investors, regarding foreign companies selling illegal securities within the nation.
The first instance occurred in late March, when the Manitoba Securities Commission (MSC), brought the issue to light. In their statement at the time, the MSC named Denmark based, Halifax & Associates, as defrauding Canadian investors.
Fast forward a mere two weeks, and the Nova Scotia Securities Commission (NSSC), has had to contend with the same issues. Again, this prompted the regulatory body to issue warnings to prospective investors, as Halifax & Associates is not registered to offer securities within the province.
Money Lost
While the total number of investors – and the sums of money lost – is unknown, we do know that this is not an isolated occurrence.
The MSC specifically notes that a rural resident of the province was bilked out of more than $8000, while the NSSC notes that multiple investors were taken advantage of.
Proceed with Caution
Unfortunately, despite continued adoption among legitimate companies and investors, there continue to be select bad actors which utilize cryptocurrencies, such as Bitcoin.
In these particular scenarios, investors were advised to fund trading accounts with Bitcoin. From here, Halifax & Associates would provide them with access to services subject to securities laws – something that the company is not registered to offer in the provinces.
The MSC provides the following points for investors to adhere, and proceed with cation.
- promises of high returns with low risk,
- pressure to invest quickly / limited time offers
- secret or sans-serif”>‘insider’ information / exclusive offers
- offers from complete strangers
- unregistered salespeople and companies
- inconsistent details / avoiding questions / no paper trail
Commentary
In their statement warning investors, Stephanie Atkinson, Acting Director of Enforcement at the NSSC, had the following to say.
“The internet can be a dangerous place to shop for investments…Always take the time to check registration and understand the risks and costs associated with your investments. Further, never give out personal information without verification of the legitimacy of operations. This is particularly important where the entity or individual is unknown. Becoming an informed investor is your best protection from falling victim to scams.”
In Other News
There will always be those that try and circumvent regulations. We cannot paint the blockchain sector with a broad brush however, as there are many which adhere to rules and regulations.
In Canada, there are various regulatory bodies which do their best to provide safety to investors, while facilitating start-ups through exemptions. With avenues existing which allow for potential exemptions, there is no valid reason to be offering unregistered securities.
For instance, a promising Canadian company has recently been awarded an exemption status, as they look to develop and grow. The following article touches on an example of this.
DigiMax Designated ‘Exempt Market Dealer’ by OSC
Accelerating
To date, various nations have not only noted the potential need for a CBDC in the future, but have actually embarked on pilot programs to develop them. The most recent nation to accelerate this process, delving in to a pilot program, is South Korea.
In this recent announcement by The Bank of Korea (also the nation’s central bank), they begin by stating, ‘The need for the introduction of the central bank digital currency (CBDC) by the Bank of Korea will increase.’ It is this recognition that has clearly prompted them to look at the logistics surrounding the creation, dispersion, and usage of such a CBDC.
What Will it Look Like?
While the BOK states that they are looking into the feasibility of utilizing blockchain to underpin a CBDC, usage of this technology is not a given.
Furthermore, the pilot program is expected to look at more than simply the technical requirements behind such a feat. This extended look includes possible legal hurdles, expected cooperation between other central banks, custody solutions, and more.
The pilot program is said to be structured as a 22 month process, with the following breakdown.
- Defining CBDC design and functionality
- 5 months
- Technological requirements
- 5 months
- Business process analysis through external consultation
- 4 months
- CBDC construction and testing in controlled environment
- 12 months
The BOK, notably, refers to Sweden and their CBDC, the e-Krona, with regards to the structuring of their pilot program.
CBDC
The acronym ‘CBDC’, refers to a ‘Central Bank Digital Currency’. These currencies are digital representations of previously established FIAT – meaning government issued currency.
While their structuring may vary, most believe that CBDCs will be structured as blockchain based tokens; Primarily due to the technologies ability to encode fungibility, while providing easy and cost efficient value transfer.
While digital, because CBDCs are issued by government regulated entities, they would be subject to the same, or very similar, regulations and scrutiny as traditional paper currencies.
Similar Approach
If this approach being taken by The Bank of Korea sounds familiar, perhaps that it because The Bank of Canada has recently announced similar intentions.
The Bank of Canada Could Issue a Digital Currency in the Future
While there is no firm timetable for the launch of a potential digital dollar, development is in the works. As the adage goes, ‘an ounce of prevention is worth a pound of cure’. Clearly, this is a stance adopted by each of these central banks, as they look to be prepared for the eventual need of a CBDC. When the time comes, and a cure is needed for ailing paper currencies, preventative measures will be ready on the sidelines.
The Bank of Korea (BOK)
The Bank of Korea acts as the central bank for South Korea. Operations are situated in the capital, Seoul.
In operation since 1950, The Bank of Korea is currently spearheaded by Governor, Lee Ju-yeol
In Other News
Recently, we took a brief look at a few ways that COVID-19 is affecting blockchain based endeavours, to date. One of these revolves around issues which plague paper currency, and the need to go digital. Make sure to read the following article to learn more about the perks brought forth by CBDCs.
Japanese regulators officially launched their STO market via amendments to the country’s current securities regulations this week. The new crypto exchange-specific amendments add clarity to the market and introduce a number of important customer protections. As such, analysts predict that the Japanese crypto sector is about to experience rapid expansion.
According to new reports, the amendments will go into effect on May 1. Importantly the changes directly alter the Payment Services Act and the Financial Instruments and Exchange Act. The amendments introduced a variety of new measures ranging from new banking regulations and cold wallet requirements, all the way to, new legal terminology.
Storage Upgrades – STO Regulations
Specifically, the new amendments put new requirements on exchanges. For one, all exchanges must now keep in cold storage an amount equal or greater than the number of users’ funds held online. This regulation ensures that exchanges rely on cold storage whenever possible. Along the same line of thought, exchanges are no longer allowed to keep users’ funds and their funds together. Importantly, this regulation extends across both crypto and fiat reserves.
Financial Services Act via Wikipedia – STO Regulations
ICO and STO Amendments
Another important amendment added to the regulations is the legal definitions of initial coin offerings (ICOs) and security token offerings (STOs). For years, blockchain firms struggled to get regulators to clarify the exact differences in terms of regulations. Now, regulators have a clear cut understanding of what type of fundraising campaign is underway, and how to classify it.
Fighting Fake News – STO Regulations
Interestingly, the new amendments go after all forms of market manipulation. There are now stricter fines and punishments in place for spreading rumors or making false statements. This is an important addition as market manipulation is a real concern internationally. Japanese officials hope they can curb these nefarious actors and weed out bad sources of information.
As part of the new enforcement policies, the new regulations place cryptocurrency asset derivatives transactions under the FSA’s jurisdiction. Additionally, there are some terminology changes. Moving forward, cryptoassets and not “cryptocurrencies” is the terminology regulators agreed on.
Importantly, a group of Japan’s top securities firms has been patiently waiting for these regulations to become official. The group includes Monex Group, Rakuten, and one of the largest financial institutions in the country, SBI. In March, the group publicly revealed plans to create a regulated security token exchange.
COVID-19 Delays
The group’s wish could have come sooner if the world wasn’t in the middle of the COVID-19 pandemic. Unfortunately, the virus has wreaked havoc on the markets and caused multiple delays for regulators. Notably, Japan was even forced to postpone the 2020 Olympics.
Japan STO Market is Here
Despite the dreary state of the international markets, Japan seeks to be the blockchain capital of the region. This determination, coupled with regulators forward-looking stance, is sure to give the country an advantage over the competition. For now, you can expect to see progress as the Japanese STO market is officially active.