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Raising Capital with Regulation D – 506c

Posted on by Allomerlaw

An STO, or Security Token Offering uses blockchains distributed encrypted ledger in the sale and transfer of a company’s stock or membership units in an LLC.

Because this token is a security under U.S. law, the rules and regulations must be followed. There could be civil or criminal liability for individuals that do not deal properly with securities. Blockchain does not provide a work-around to U.S. securities or tax laws.

There are several exemptions from Securities Act registration that make it more practical and affordable to raise funds.

In 1982, the SEC combined the exemptions for private placements and small offerings into a set of rules known as “Regulation D”. These rules give guidance on when an offering will qualify for the §4(a)(2) private placement exemption (Rule 506) and create another exemption for smaller offerings as authorized by §3(b)(1) and more recently §28 (Rule 504, amended in 2020).

With Rule 506, there is a 506(b) or 506(c) option. 506(b) will be discussed in another article.

The Rule 506(c) exemption to Securities Act Registration used to fundraise.

It is a private placement that allows an unlimited amount of funds to be raised from accredited investors. A company may advertise to everyone with 506(c), so long as equity is only sold to accredited investors.

“Rule 506(c) permits issuers to broadly solicit and generally advertise an offering, provided that:

  • all purchasers in the offering are accredited investors
  • the issuer takes reasonable steps to verify purchasers’ accredited investor status and
  • certain other conditions in Regulation D are satisfied

Purchasers in a Rule 506(c) offering receive “restricted securities.” A company is required to file a notice with the Commission on Form D within 15 days after the first sale of securities in the offering. Although the Securities Act provides a federal preemption from state registration and qualification under Rule 506(c), the states still have authority to require notice filings and collect state fees.” (See https://www.sec.gov/education/smallbusiness/exemptofferings/rule506c)

What are restricted securities?

According to the SEC – “Restricted securities” are previously-issued securities held by security holders that are not freely tradable. Securities Act Rule 144(a)(3) identifies what offerings produce restricted securities. After such a transaction, the security holders can only resell the securities into the market by using an effective registration statement under the Securities Act or a valid exemption from registration for the resale, such as Rule 144.

Rule 144 is a “safe harbor” under Section 4(a)(1) providing objective standards that a security holder can rely on to meet the requirements of that exemption. Rule 144 permits the resale of restricted securities if a number of conditions are met, including holding the securities for six months or one year, depending on whether the issuer has been filing reports under the Exchange Act. Rule 144 may limit the amount of securities that can be sold at one time and may restrict the manner of sale, depending on whether the security holder is an affiliate. An affiliate of a company is a person that, directly, or indirectly through one or more intermediaries controls, or is controlled by, or is under common control with, the company.

How can an investor resell non-restricted securities?

An investor that is not affiliated with the issuer and wishes to sell securities that are not restricted must either register the transaction or have an exemption for the transaction. An exemption commonly relied upon for the resale of the securities is Section 4(a)(1) of the Securities Act which is available to any person other than an issuer, underwriter or dealer.  Please be aware that several exemptions, including the exemptions under Regulation D, are only available for offers and sales by an issuer of securities to initial purchasers and are not available to any affiliate of the issuer or to any person for resales of the securities.” (See https://www.sec.gov/education/smallbusiness/exemptofferings/faq?auHash=rh5WfJi9h3wRzP6X2anOmgYLdhPHNuo-3Vw0YNZyR_M#faq4)

Built in compliance options. We program a companies security token for the restricted security. 

To comply with a Rule 144 safe harbor,  a buy/sell lockup period is programmed into a Regulation D security token to enforce the restriction.

Regulation D 506(c) offerings are are subject “bad actor” disqualification provisions. It is reccomended clients hire a third-party service to execute bad actor checks.  https://www.sec.gov/info/smallbus/secg/bad-actor-small-entity-compliance-guide

Note; “…an offering is disqualified from relying on Rule 506(b) and 506(c) of Regulation D if the issuer or any other person covered by Rule 506(d) has a relevant criminal conviction, regulatory or court order or other disqualifying event that occurred on or after September 23, 2013, the effective date of the rule amendments.  Under Rule 506(e), for disqualifying events that occurred before September 23, 2013, issuers may still rely on Rule 506, but will have to comply with the disclosure provisions of Rule 506(e).”

…

Under the final rule, disqualifying events include:

  • Certain criminal convictions
  • Certain court injunctions and restraining orders
  • Final orders of certain state and federal regulators
  • Certain SEC disciplinary orders
  • Certain SEC cease-and-desist orders
  • SEC stop orders and orders suspending the Regulation A exemption
  • Suspension or expulsion from membership in a self-regulatory organization (SRO), such as FINRA, or from association with an SRO member
  • U.S. Postal Service false representation orders

Many disqualifying events include a look-back period (for example, a court injunction that was issued within the last five years or a regulatory order that was issued within the last ten years).  The look-back period is measured from the date of the disqualifying event—in the example, the issuance of the injunction or regulatory order—and not the date of the underlying conduct that led to the disqualifying event.” (See https://www.sec.gov/info/smallbus/secg/bad-actor-small-entity-compliance-guide#part3)

Schedule an appointment to have an attorney begin the Security Token Offering process utilizing Regulation D / rule 506(c).

SEC Sends Cease and Desist – Orders Bloom Protocol to Register BLT Token as a Security

Posted on by Allomerlaw

The Securities and Exchange Commission (“SEC”) sent a cease and desist letter to Bloom Protocol, demanding it register the token as a security or face up to 31 Million in fines. Bloom quickly agreed to register and take other remedial actions.

The letters summary states;

“1. Bloom, a technology start up, was founded in August 2017 by three students and
another individual, all of whom were living in the United States. At its founding, Bloom’s
purported goal was to “revolutionize” the credit scoring industry by moving identity attestations
and credit scoring to a blockchain.

2. From November 14, 2017 to January 2, 2018, Bloom continuously offered and sold
crypto assets known as Bloom Tokens (“BLT”), which were issued on a blockchain or distributed
ledger. Bloom raised approximately $30.9 million from 7,358 worldwide investors, including U.S.
investors, through this initial coin offering (“ICO”). Bloom did not register the offering with the
Commission, nor did it qualify for an exemption to the registration requirements.

3. Based on the facts and circumstances set forth below, BLT were offered and sold as
investment contracts, and therefore securities, pursuant to SEC v. W J. Howey Co., 328 U.S. 293
(1946) and its progeny, including the cases referenced by the Commission in its Report of
Investigation Pursuant to Section 21(a) of The Securities Exchange Act of 1934: The DAO
(Exchange Act Rel. No. 81207) (July 25, 2017) (the “DAO Report”). A purchaser in the offering
of BLT would have had a reasonable expectation of obtaining a future profit based upon Bloom’s
efforts in using the proceeds from the offering to create an online identity attestation system that
would increase the token’s value on crypto asset trading platforms. Bloom violated Sections 5(a)
and 5(c) of the Securities Act by offering and selling BLT without having a registration statement
filed or in effect with the Commission or qualifying for an exemption from registration with the
Commission”

Consult an attorney that understands blockchain and securities law to help avoid issues like this.

How the Infrastructure Bill Impacts Crypto Investors.

Posted on by Allomerlaw

Source : https://www.cnbc.com/2021/11/09/how-bipartisan-infrastructure-bill-will-impact-crypto-investors.html

President Biden has signed the infrastructure bill into law. CNBC’s linked article dated November 9th states the potential impact to be:

“1. Overstated 1099-Bs

One provision would require each “broker,” which will mainly be exchanges, to report their cryptocurrency gains in a type of 1099 form. “Brokers” will also have to disclose the names and addresses of their customers.

Critics worry that as written, the provision’s definition of a “broker” is too broad. Cryptocurrency advocates are concerned that the current language could potentially target those without customers who wouldn’t have access to the information needed to comply. In response to these fears, the U.S. Treasury Department said in August that it will not target non-brokers, such as miners, hardware developers and others.

However, this provision will still impact cryptocurrency investors, says Shehan Chandrasekera, certified public accountant and head of tax strategy at cryptocurrency portfolio tracker and tax calculator CoinTracker.

A “broker” or exchange must send a Form 1099-B to both the Internal Revenue Service (IRS) and their customer. The customer uses information from the 1099-B to calculate their preliminary gains and losses, which is reported on their own tax return.

However, “these 1099s are going to be inaccurate for the most part, because these exchanges don’t have visibility into what you have in your self-custody wallet or what you’re doing in decentralized finance, or DeFi, applications,” Chandrasekera says. With a self-custody wallet, investors own their private keys and cryptocurrency holdings, rather than using a third party, such as an exchange. Things could get tricky if an investor has both self-custody wallets and exchange wallets.

If an investor were to send $100,000 worth of bitcoin from their self-custody wallet to their Coinbase wallet and sell the funds, Coinbase would be required to issue a 1099 saying that the investor sold $100,000. But Coinbase will not know how much the investor initially paid for the bitcoin because it didn’t happen on the exchange.

As a result, Coinbase will not know the investor’s cost basis, which may lead to an overstated 1099, Chandrasekera says.

Investors will need to sort out these inaccuracies themselves. They’re “going to get these 1099s and they’re going to panic, like, ‘Why do I have so much in gains?’” Chandrasekera says. “They will have to talk to an accountant or use a tool to reconcile it and report the right amount.”

2. Privacy and surveillance

Another provision expands a section of the U.S. tax code called 6050I to include digital assets.

Section 6050I requires that people who receive more than $10,000 in cash and equivalents file a report with the IRS. The report includes details about who paid them, including names and Social Security numbers. Any failure to report details about those sending payments is considered a felony offense.

The infrastructure bill provision would require similar from businesses and exchanges when they receive more than $10,000 in cryptocurrency.

While “it doesn’t have any direct burden on the end taxpayer,” Chandrasekera says, it will impact their privacy.

“Say you buy a Tesla with one bitcoin valued at $60,000. The car seller — the business — has to collect your personal information, like your name, address, Social Security number, etc., so they can report that to the IRS,” he says.

This surveillance rule has been called “unworkable and arguably unconstitutional” by cryptocurrency lobbyists like non-profit CoinCenter.

“Crypto people are privacy conscious. Why would they want to give all their information to these businesses? Some of these businesses may not even have a good way to protect that private information. That could lead to other second- and third-order consequences,” Chandrasekera says.

Provisions will not take effect until January 2024

The provisions will not take effect until January 2024, and in the meantime, lobbyists within the cryptocurrency industry plan to push for amendments and standalone bills to adjust the provisions.

Prior to establishing the law, the Treasury plans to take time to undergo research to understand who might be asked to comply and verify whether they’d be capable of doing so, a Treasury official previously told CNBC Make It. This process could take years.

The provisions in this bill are more to establish intent, rather than lay out specific rules.

“It’s up to the Treasury Department to decide who is subject to the provisions,” Ivory Johnson, certified financial planner, chartered financial consultant and founder of Delancey Wealth Management, says. “Similar to the ‘broker’ definition, the Treasury Department will have to provide guidance.”