Presenting a live 90-minute webinar with interactive Q&A Digital Coin Offerings: New SEC Guidance on Registration of Blockchain Tokens as Securities TUESDAY, OCTOBER 3, 2017 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Jay G. Baris, Partner, Morrison & Foerster , New York Alfredo B. D. Silva, Partner, Morrison & Foerster , San Francisco Joshua Ashley Klayman, Of Counsel, Finance + Projects & Co-Chair , Blockchain + Smart Contracts, Morrison & Foerster , New York Daniel R. Kahan, Morrison & Foerster , McLean, Va. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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DIGITAL COIN OFFERINGS: NEW SEC GUIDANCE ON REGISTRATION OF BLOCKCHAIN TOKENS AS SECURITIES STRAFFORD RAFFORD LIVE WEBINAR NAR OC OCTOBER BER 3, 2017
Overview • Background • What Is a Blockchain? • Blockchain Use Cases • Cryptocurrencies • Application- Specific Tokens (“Apptokens”) • Market Practice • Recent Securities Law Developments • SEC Report of Investigation • Other Applicable Jurisdictions • Legal Framework • Analyzing the Token • Conducting a Compliant Offering • Other Legal Issues 6
Background
What Is a Blockchain? • An immutable, decentralized ledger • Key characteristics that differentiate a blockchain from traditional distributed databases: • Transactions authenticated and tracked via nodes on network • Cryptographic techniques prevent tampering or manipulating transactions • Can be public (anyone can participate) or permissioned (only authorized participants) • Application-agnostic (not limited to digital currencies) • Popular blockchains today include the payment network Bitcoin and the smart contracts platform Ethereum, which create and track transactions in bitcoin and ether 8
Blockchain Use Cases • Store of value • Asset tracking/supply chain management • Securities ledgers • Voting systems/prediction markets • B2B transactions using smart contracts 9
Cryptocurrencies • Popular focus is on the use of blockchain technology as store of value , often referred to as digital currencies , virtual currencies , or cryptocurrencies • Value of tokens built on these blockchains has rapidly increased over the past year Source: Coinbase, 9/8/2017 10
Utility Tokens • Developers are now building application-specific tokens, also referred to as appcoins or utility tokens, which practitioners argue should not be considered securities • Key distinction between utility tokens and other tokens (such as digital currency or a debt or equity interest denominated in tokens) is that the former have non-incidental utility with respect to the platform or system issuing the token • As outlined by Debevoise & Plimpton, such utility may include: • Rights to program, develop or create features for the system or to “mine” things that are embedded in the system • Rights to access or license the system • Rights to charge a toll for such access or license • Rights to contribute labor or effort to the system • Rights to use the system and its outputs • Rights to sell the products of the system • Rights to vote on additions to or deletions from the system in terms of features 11 and functionality
Security Tokens • On the other hand, issuers are in some cases simply moving traditional securities to blockchain distributed ledgers • What is more common – and more complicated – is that developers are building application-specific tokens that, in addition to non-incidental utility, also have features similar to equity, debt and other investment contracts, which cause them to be treated as securities • These tokens may, for example: • Be redeemed at specified times for a portion of net revenues in a given year • Grant holders a pro rata portion of a percentage of revenues from contracts entered into on the platform • Bear a coupon • Grant holder a right to participate in other investment opportunities 12
Market Practice • More than $1.8 billion has been raised in token sales in 2017, compared to less than $240 million for all of 2016 • These tokens are offered in exchange for fiat currency or other tokens (typically bitcoin or ether) • Tokens are often pre-sold privately to select investors prior to the public offering, often referred to as the “initial coin offering,” or ICO, and increasingly referred to as the “token generation event,” or TGE • Issuers may also use SAFTs (simple agreements for future tokens) or convertible promissory notes, in each case convertible into preferred stock of the issuer and/or tokens upon the TGE • Tokens also often issued as compensation to service providers and employees 13
Recent Securities Law Developments
The DAO Report: Background on the DAO • The Decentralized Autonomous Organization (or “The DAO”) began as an effort to create a crowdfunding smart contract • Supporters sent ether to The DAO in exchange for DAO Tokens, which would permit the supporter to vote on which projects The DAO would fund and would entitle the supporter to “rewards” if those projects later succeeded • At the time the DAO Token offering closed, the total ether raised by the DAO was valued at approximately $150 million • One of The DAO’s founders described the model as similar to “buying shares in a company and getting . . . dividends” • The project’s organizers and supporters were geographically dispersed • There were no restrictions on the resale of DAO Tokens • Security vulnerabilities in The DAO ultimately caused a “hard fork” of the Ethereum Blockchain to restore funds stolen from The DAO 15
The DAO Report: Legal Analysis • Status of DAO Tokens as “securities” • Analysis of the definition of the term “investment contract” under 1933 Act, as interpreted by SEC v. W.J. Howey Co. , 328 U.S. 293 (1946), and its progeny • Status of DAO Platforms as “exchanges” • Analysis of Section 3(a)(1) of the 1934 Act and related exemptions • Status of The DAO as an “investment company” • No analysis , but would have been under Section 3(a) of Investment Company Act of 1940 (ICA) 16
Other Applicable Jurisdictions • U.S. states haven’t commented, but… • Most follow Howey • Some also apply family resemblance test • Others, including California, also apply risk capital test • Foreign jurisdictions are following suit • Taking the SEC’s lead: Singapore, Canada, Hong Kong, Malaysia • China: moratorium on ICOs, mandatory repayment of proceeds from completed offerings 17
Legal Framework
Key Implications • Three key questions to consider (as to laws of each applicable jurisdiction): • Is this token a “security”? • Is this platform an “exchange”? • Is this project an “investment company”? • Structure token accordingly • Structure offering accordingly 19
Analyzing the Token • Apply Howey • Investment of money • Common enterprise (horizontal or vertical) • Expectation of profits • Efforts of others • Conduct risk assessment 20
Securities Offering • Conducting the TGE: • Register with the SEC or • Rely on exemptions (e.g., Regulation D, Regulation S, Rule 701 and Section 4(a)(2)) and verify purchasers • Resale Issues: • Rule 144 compliance (12-month holding period, information requirement) • Section 12(g) – and Rule 12g3-2(b) 21
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