Utility Tokens Exist

On July 25, 2019, the SEC issued its second no action letter that enables a company to generate and sell digital tokens that are not "securities" within the meaning of the US securities laws.  This no-action letter provides a no action relief to Pocketful of Quarters, Inc. ("PoQ") that intends to sell Quarters (its native digital tokens) to gamers for use in connection with playing games of the participating developers on their platform.  Just in April of this year, the SEC issued a similar no action letter to TurnKey Jet, Inc.

Below are my observations regarding this no action letter and token issuance in general:

• This second no action letter helps us delineate the universe of utility tokens.  They are not just a concept that was abused and misused in the 2017-2018 ICOs.  Utility tokens can legally exist within the legal framework of the US laws.    
• If previously the SEC had only shown us the instruments that cannot be utility tokens (through its cease and desist orders and various enforcement actions), then now, for the second time, we are shown examples of tokens that can be and are utility tokens.  This is incredibly useful guidance when advising clients on how to structure their tokens.
• PoQ financed the development of its gaming platform through the issuance and sale of Q2 TOkens that were treated as "securities".  The Quarters that are subject to this no action letter are being issued after the platform development has been completed.  Again, this approach (issuing two types of tokens) can be used by others when conducting their token offerings.  
• Quarters are not redeemable by gamers.  Once purchased, Quarters can only be used within the platform to play games, purchase upgrades, and participate in tournaments.  The only persons who can redeem the Quarters are the participating pre-approved developers and influencers who can earn the tokens by developing games and marketing them to the gamers.
• Quarters will be sold at a fixed price, and there will be an unlimited supply of them.  This means that there will be no price speculation and no shortage that could affect the price.
• Quarters cannot be transferred to other gamers, and therefore Quarters cannot be, and will not be, traded on secondary markets.  This means that gamers would not be purchasing the tokens with an expectation to make a profit.
• Quarters will be sold only for the gamers' personal use within the gaming platform.  
• Quarters will not be marketed to the public as an investment, and PoQ will make corresponding disclosures in its marketing literature.

As described in the thorough and well-written incoming letter, the Quarters present an example of true utility tokens that others may be tempted to replicate.  However, it is important to remember that only the recipient of the no action letter can legally rely on it.  Other tokens will have different features that may or may not support the legal outcome that these tokens are not "securities".  But still, the PoQ no action letter presents a good model of how to structure an offering of utility tokens that should be studied by the future token issuers.

This article is not legal advice and was written for general informational purposes only.  It does not express anyone else's views except for the author's.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author Arina Shulga.  

Blockstack: First Reg A+ Token Offering

On July 10, 2019, the SEC qualified the first digital token Regulation A+ offering.  This is an important event that could open the gates for other Regulation A+ token offerings that have been patiently waiting for their turn.

It was Blockstack that, after a 10-month wait, was approved for the $28 million offering.  According to Blockstack's offering circular, purchasers of the tokens will not be buying anything that resembles securities in a traditional sense.  Instead, they will receive utility tokens usable on the Blockstack network that consists of a Blockchain platform for developers to build applications.  Tokens are being sold to three groups of people: (i) to the existing holders of certain vouchers, at a discount; (ii) to the general public; and (iii) to app developers and reviewers as rewards.   The offering is being conducted directly by the company through its own website, www.stackstoken.com, where qualifying prospective purchasers can sign an online subscription agreement and transfer the money (at least $100) either in US dollars, Ether or Bitcoin. The tokens will not be sold to the residents of Arizona, Nebraska, North Dakota or Texas.  Union Square Ventures, already a 15% equity holder in Blockstack, has indicated interest to purchase $1 million worth of tokens.  Blockstack expects to issue the tokens 30 days after the close of the cash offering, at which time all proceeds raised in the offering will be released from escrow.  Although the tokens will be unrestricted securities under federal securities law, initially, tokens will not trade on any exchange and will be "time locked", which means that purchasers will not be able to use (or "burn") the tokens on the Blockstack platform.  About 1/24th of tokens will be released from the time lock every month.  Concurrently, Blockstack is selling its tokens in Regulation S private offering to non-US investors.  These tokens will be restricted securities. 

It is still uncertain that the Blockstack qualification would, in fact, lead to other Regulation A+ token offerings.  After all, they paid $2 million in legal fees to get the SEC approval, according to the WSJ article and, according to the company's offering circular, their overall expenses related to the offering amounted to $2.8 million.  This is a hefty price tag for a "registered ICO" that others may not afford.

This article is not legal advice and was written for general informational purposes only.  It does not express anyone else's views except for the author's.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author Arina Shulga.  

What's next after a Reg A+ offering?

Conducting a Regulation A+ offering may not be enough to provide for the liquidity of a company's shares.

It turns out that companies that undergo a Regulation A+ offering are not likely to list their securities on NASDAQ or NYSE.  Out of 157 Reg A+ offerings that took place from 2015 to 2018, according to WSJ and Manhattan Street Capital, only 11 companies listed on NASDAQ or NYSE.  Out of these 11, 10 are trading at below their initial offering price.

There are also fraud concerns.  Just last month the SEC filed additional charges against Longfin Corp., a company that used Reg A+ to list on NASDAQ.  Longfin listed on NASDAQ in December 2017.  Its shares rose 13 times upon the news that the company was about to acquire a cryptocurrency business.  On April 4, 2018, the SEC accused Longfin of violating securities laws because its chief executives and associates sold shares after the stock price increased.  The complaint was accompanied by a preliminary injunction freezing more than $27 million in trading proceeds.  On June 5, 2019, the SEC added fraud charges for falsifying the company's revenue and fraudulently obtaining a Reg A+ qualification and a NASDAQ listing.   The SEC's civil lawsuits against the company are currently ongoing.

Concerns over fraud and securities law violations, fueled by the Longfin case, prompted NASDAQ and NYSE to revise their listing rules to make it more difficult for smaller companies to list following a Regulation A+ offering.  On July 5, 2019, the SEC approved the new NASDAQ initial listing standards related to the minimum liquidity needed to list on any NASDAQ tier.  You can read about it here.  One of the changes requested by NASDAQ in April, that the company have a minimum operating history of two years prior to listing, was in direct response to Longfin. 

In conclusion, it seems that there will be little or no shortcuts for companies intending to trade their securities on NASDAQ or NYSE, regardless of their size, due to poor liquidity and concerns over fraudulent actions.

This article is not legal advice and was written for general informational purposes only.  It does not express anyone else's views except for the author's.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author Arina Shulga.