When I first saw the announcement from the SEC’s Enforcement Division about an emergency action to halt an unregistered ICO, I brushed it off as a takedown of yet another fraudulent “crypto” company. But a column from Bloomberg’s Matt Levine points out that this one is different.
In Matt’s words, the company here was doing the “best-practices-y thing” that had been blessed by several law firms. Its offering was structured as a “Simple Agreement for Future Tokens” – as John wrote last year, that’s an approach – based on the popular “SAFE” template for startup financing – that was starting to take off for Reg D token deals. Matt’s explanation of how it works:
1. Sell something—call it a “pre-token”—to accredited investors (institutions, venture capitalists, etc.) to raise money to build your platform. Concede that the pre-token is a security.
2. When the platform is built, it will run on a token, a cryptocurrency that can be used for transactions on the platform and that is not a security.
3. At some point — at or after the launch of the platform — the pre-token (the security) flips into the token (the non-security), and all the people who bought pre-tokens to finance the platform now have tokens to use on it. (Or to sell to people who will use them.)
This seems to honor the intention of securities law—you’re not selling speculative investments to retail investors to fund the development of a new business—while also honoring the intention of the ICO: Your platform is financed (indirectly, eventually) by the people who use it; the people putting up the money do so not in exchange for a share of the profits but for the ability to participate in the platform itself. In this model the pre-token will be called something like a “Token Purchase Agreement” or “Simple Agreement for Future Tokens”: It’s a security wrapper for the eventual utility token.
Unfortunately, the SEC’s complaint took issue with the fact that when the “pre-tokens” here were scheduled to flip into tokens, there would be no established ecosystem for them to trade as currency. Which would seem to be an obvious side-effect of financing a new form of cryptocurrency?
We’re not really sure what to make of this yet – there were some reports that early investors in this offering were flipping their tokens right away, which would be a problem in the SEC’s view. Matt also suggests that maybe the SEC would be more amenable if the pre-tokens didn’t flip until the ecosystem is running robustly. But probably not. John blogged recently on “The Mentor Blog” about how to do a Reg A token offering. So perhaps anyone considering an ICO should take a look at that…
-Liz Dunshee, TheCorporateCounsel.net October 28, 2019
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