tag:blogger.com,1999:blog-3061303081732380342024-03-14T03:06:10.116-04:00Business Law PostArina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.comBlogger247125tag:blogger.com,1999:blog-306130308173238034.post-47560252855401799532020-12-07T07:59:00.004-05:002020-12-07T08:55:26.027-05:00Startup Cap Table 101: Reflecting a New Equity Financing<p>In the first blog post about cap tables, we talked about setting up equity compensation pools. In this blog post, let's learn how to add a new equity investment to the cap table. Let's assume that our startup has 2,000,000 founder shares outstanding, a 500,000 equity compensation pool, and a pre-money valuation of $1 million. The investor is investing $200,000.</p><p>So, the cap table pre-financing looks like this:</p><div style="text-align: left;"> <u>Type of shares<span> </span></u><span><u> # of shares<span> </span></u><span><u> % fully diluted</u><br /></span></span>Founder Common<span> </span><span> </span><span> </span><span> 1,000,000<span> </span><span> </span><span> <br /></span></span>Founder Common<span> </span><span> </span><span> </span><span> 1,000,000<br /></span>Pool Common<span> </span><span> </span><span> </span><span> 500,000<br /></span>Total 2,500,000<span> </span><span> </span><span> 100%</span></div><div style="text-align: left;"><br /></div><div style="text-align: left;">To get the price per share that the investor will pay, we use the following formula:<br />pre-money valuation / # of shares outstanding, which in our case will be $1 million / 2.5 million shares = $0.40 per share.</div><div style="text-align: left;"><br /></div><div style="text-align: left;">Investor will own 16.7% of the company following its investment. We get there by using the following formula: Investment amount / post-money valuation = % ownership, which in our case is $200,000 / $1,200,000 = 16.7% (BTW, post-money valuation equals pre-money + the amount of investment).</div><p>To find out the number of shares that the investor will get, we need to divide the investment amount by the price per share, which is $200,000 / $0.40 = 500,000 shares.</p><p>So, our new post-investment cap table looks like this:</p><div style="text-align: left;"><span> </span><span> </span><span> </span><span> </span><span> </span><span> </span><span> </span><u>Type of shares # of shares % fully diluted</u></div><p></p><div style="text-align: left;">Founder Common 1,000,000 33.3%</div>Founder Common 1,000,000<span> </span><span> </span><span> 33.3%</span><div>Investor<span> </span><span> </span><span> </span><span> Preferred<span> </span><span> </span><span> </span><span> <span>500,000</span><span> </span><span> </span><span> </span><span> <span> </span>16.7%</span></span></span><br />Pool Common 500,000<span> </span><span> </span><span> </span><span> 16.7%</span><br /><div style="text-align: left;">Total 3,000,000 100%<span style="white-space: pre;"> </span><span style="white-space: pre;"> </span></div><div style="text-align: left;"><br /></div><div style="text-align: left;">We can get the same results by using different formulas. Imagine that, as in the previous example, all you know is the following: (i) number of outstanding shares pre-financing, (ii) the startup pre-money valuation, and (iii) the amount of financing. </div><div style="text-align: left;"><br /></div><div style="text-align: left;"> <u>Type of shares # of shares % fully diluted</u></div><p></p><div>Founder Common 1,000,000 IV</div>Founder Common 1,000,000 IV<div>Investor Preferred II<span> </span><span> </span><span> </span> 16.7%<br />Pool Common 500,000 III<br /><div>Total I<span> </span><span> </span><span> </span><span> </span> 100%<span style="white-space: pre;"> </span></div></div><p>Using the known information, we can fill in the missing amounts. We know that the investor will own 16.7% post financing by dividing $200,000 / $1.2 million post-money valuation. </p><p>Let's solve for I: We know that III+IV = 83.7%. We also know that 83.7% equals 2,500,000 shares. This means that I equals 3,000,000 shares (2,500,000 / 0.837). </p><p>Let's solve for II: If 100% equals 3,000,000 shares, then 16.7% will equal 500,000 shares. Therefore, investor will receive 500,000 shares. </p><p>Let's solve for III: We can calculate III by dividing 500,000 shares by the total 3,000,000 shares. </p><p>Let's solve for IV: With the pool and investor shares taking 16.7% each, we have 66.6% left, split equally, to the two founders holding 2,000,000 shares. This gives us 33.3% ownership for each founder. </p><p>Since we know that a $200,000 investment buys 500,000 shares, then the price per share will be $0.40.</p><p>Although some numbers may be somewhat off due to rounding errors, the formulas should work. </p><p>Next, time, let's see how to reflect the conversion of convertible notes at the time of the financing.</p><p><i>This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>.</i></p></div>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-3258030227442643022020-12-02T12:23:00.001-05:002020-12-07T08:00:51.901-05:00Startup Cap Table 101: Introducing an Equity Compensation Pool <p> I have to admit: cap table calculations are not easy and not all startup lawyers enjoy this part of their jobs. However, no matter how hard it can get, being able to make sense of the cap table is an essential skill for startup lawyers. Since I have just finished teaching this to students at Fordham Law's Entrepreneurial Law class, I thought I would share some of the calculations here with you. </p><p>Let's start with your basic cap table:</p><div style="text-align: left;"><span><u> </u></span><u><span> </span><span> </span><span> </span><span> </span><span> </span><span> Stock Type<span> </span><span> Shares<span> </span><span> Fully Diluted Stock %<br /></span></span></span></u>Founder A<span> </span><span> </span><span> Common<span> </span><span> 1,000,000<span> </span><span> 50%<br /></span></span></span>Founder B<span> </span><span> </span><span> Common<span> </span><span> 1,000,000<span> </span><span> 50%<br /></span></span></span><span><span><span><span>Totals:<span> </span><span> </span><span> </span><span> </span><span> </span><span> </span><span> </span><span> </span><span> </span><span> </span><span> 2,000,000<span> </span><span> 100%</span></span> </span></span></span></span></div><p>This example shows that the startup has two founders, each holding 50% of the issued and outstanding stock. BTW, this startup has authorized 5,000,000 shares of common stock, $0.00001 par value.</p><p>The Board of Directors has just approved the issuance of an equity compensation pool of 20%. The stockholders of the company (ie, both founders) have also unanimously approved the pool. Now, let's reflect it in the cap table:</p><p>First, let's find out how many shares will be allocated to the pool. To get there, we use the following formula: </p><p>Total New Shares Outstanding = Existing shares outstanding / 1 - options pool %, which means: 2,000,000 shares / 0.8 = 2,500,000 shares. So, with the pool, the startup will have 2,500,000, which means that the pool will have 500,000 shares of common stock allocated to it. Our cap table now looks like this:</p><div style="text-align: left;"><u> </u><u> Stock Type Shares Fully Diluted Stock %<br /></u>Founder A Common 1,000,000 40%<br />Founder B Common 1,000,000 40%<br />Pool<span> </span><span> </span><span> </span><span> </span><span> </span><span> Common<span> </span><span> 500,000<span> </span><span> </span><span> 20%<br /></span></span></span>Totals: 2,500,000 100% </div><p>As you can see, the creation of the pool diluted both founders. Obviously, if the pool were to be created after an equity financing event, it would dilute both the investors and the founders. That's why investors always want the pool shares to be created on a pre-money basis, diluting the founders alone. </p><p>In the next blog post, let's look at how to add a Series A financing to this cap table.</p><p><i>This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>.</i></p>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-33279904953600538062020-11-29T08:14:00.001-05:002020-11-30T15:51:10.046-05:00The SEC Modernizes US Securities Laws – Part I – Amendments to the “Accredited Investor” Definition<p>This Fall 2020 has seen an unprecedented number of rulemaking by the Securities and Exchange Commission (the “SEC”) that will be remembered for years to come. I will attempt to summarize the changes for you in a series of blog posts. Altogether, the changes will have lasting ramifications for the U.S. capital markets, enabling (I predict) an even greater flow of capital to the private markets. The changes come at an important time when, due to the pandemic, many have lost jobs and may be launching their own ventures.</p><p>Below are the notable changes:</p><p>1.<span style="white-space: pre;"> </span>A revised definition of “accredited investor”;</p><p>2.<span style="white-space: pre;"> </span>Introducing two exemptions for finders;</p><p>3.<span style="white-space: pre;"> </span>Proposing changes to Rule 701 enabling to issue equity to the participants in the gig economy;</p><p>4.<span style="white-space: pre;"> </span>Adopting sweeping changes to Regulation CF; and</p><p>5.<span style="white-space: pre;"> </span>Rule amendments to Regulation A+, integration, and other rules.</p><p>Today, I will focus on the amendments to the “accredited investor” definition. Subsequent blogs will cover the remaining rulemaking. </p><p>On August 26, 2020, the SEC published its <a href="https://www.sec.gov/rules/final/2020/33-10824.pdf" target="_blank">final rules</a> amending the “accredited investor” definition. These rules become effective on December 8, 2020. The definition of accredited investor is the cornerstone of private placements made pursuant to Regulation D and has not been substantially amended since its adoption in 1982 (except for the 2011 amendment excluding the value of the primary residence from the net worth test). Regulation D is the most relied upon exemption from registration requirements of the Securities Act for private placements of securities in the United States. According to the final rules, in 2019, out of $3.9 trillion raised by companies in the United States, Regulation D private placements accounted for $1.56 trillion. </p><p>Regulation D consists of Rule 504 (not frequently used) and Rules 506(b) and 506(c). Rule 506(b) allows issuers to offer and sell securities to an unlimited number of accredited investors and up to 35 non-accredited but financially sophisticated investors (although from 2009 to 2019, only between 3.4% and 6.9% of all Rule 506(b) offerings included non-accredited investors). Another popular rule within Regulation D, Rule 506(c), allows sales only to accredited investors. Therefore, being an accredited investor is essential for being able to participate in the private placements of securities by startups, which could at times be extremely lucrative. </p><p>Prior to the changes, the status of accredited investor, as applied to individuals, was determined based on such person’s wealth, with wealth being the only proxy for financial sophistication. The SEC estimates that approximately 13% of the U.S. households currently meet the wealth-based accredited investor tests. The final rules expand the definition by adding to the list of accredited investors those who hold certain professional degrees and are in good standing: the Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82). This list is subject to ongoing revision by the SEC based on the nonexclusive list of attributes that the SEC will consider in determining additional qualifying professional certifications. Although there are over 700,000 individuals who are currently Registered Securities Representatives and State Registered Investment Adviser Representatives, it is unlikely that the universe of qualifying investors will increase by that same number, given that some of these individuals may already qualify under the wealth tests. Even though this change will not have a significant effect on the number of qualifying individuals, it signals a change in the overall approach towards defining who accredited investors are.</p><p>Another new category of individuals who are now accredited investors are the “knowledgeable employees” of “private funds” (private equity or hedge funds that are investment companies but qualify for Section 3(c)(1) or 3(c)(7) exemptions). The term “knowledgeable employees” is already defined in Rule 3c-5(a)(4) under the Investment Company Act. Starting on December 8, 2020, such employees can participate in the private fund’s investments as limited partners. Making such individuals be accredited investors for the purpose of investing in the private fund for which they work (or are affiliated with) is reasonable and helps align their interests with the interests of the other limited partners. </p><p>The SEC has also added several categories of entities to the list of accredited investors:</p><p>•<span style="white-space: pre;"> </span>any investment adviser registered under federal or state law (and Exempt Reporting Advisers relying on Section 203(m) or 203(l) of the Investment Advisers Act of 1940) – this also applies to sole proprietorships;</p><p>•<span style="white-space: pre;"> </span>any rural business investment company (RBIC);</p><p>•<span style="white-space: pre;"> </span>any entity that owns investments in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;</p><p>•<span style="white-space: pre;"> </span>any family office with at least $5 million in assets under management and that was not formed for the specific purpose of acquiring the securities offered, and whose investment is directed by a person capable of evaluating the merits and risks of the prospective investment; and</p><p>•<span style="white-space: pre;"> </span>any family client of a family office described above whose prospective investment is directed by that family office.</p><p>The SEC also clarified that limited liability companies with $5 million in assets and not formed for the specific purpose of acquiring the securities offered qualify as accredited investors.</p><p>Lastly, the SEC allowed natural persons to include joint income and net worth from spousal equivalents when calculating the wealth-based tests. “Spousal equivalent” is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse. </p><p>Here is a helpful <a href="https://www.pillsburylaw.com/images/content/1/3/139417/NEW-Redline-501-a.pdf" target="_blank">blackline</a> prepared by Pillsbury that shows the changes to the definition of accredited investor.</p><p>In conclusion, the amendments to the definition of accredited investor will significantly increase the pool of qualifying investors, although mostly among entities rather than individual investors.</p><div><i>This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, <a href="https://www.msk.com/attorneys-Arina_Shulga">Arina Shulga</a>.</i></div>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-86340565209071811962020-05-05T09:49:00.002-04:002020-05-05T09:49:36.541-04:00Temporary Rules Make Crowdfunding EasierYesterday, on May 4th, the Securities and Exchange Commission (the "SEC") adopted <a href="https://www.sec.gov/rules/interim/2020/33-10781.pdf" target="_blank">temporary rules</a> (through the end of August) making it easier for smaller companies affected by COVID-19 to raise capital through a Regulation Crowdfunding offering. To rely on these temporary rules, the issuers will need to disclose to the investors that they are specifically relying on them as well as meet certain enhanced eligibility requirements, one of which is that the company has been in existence for over 6 months. The SEC <a href="https://www.sec.gov/news/press-release/2020-101" target="_blank">press release</a> provides a good overview of the temporary rules.<br />
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In particular, the rules allow companies to initially omit financial statements, which is an important amendment. In our experience, preparing financial statements often delays the campaigns. The companies can now accept investment commitments without having to wait until the closing, so long as their offering statement includes the financials. For smaller campaigns (not exceeding $250,000), the financial statements do not have to be reviewed by a CPA but can be certified by the principal executive officer. Sales are permitted as soon as the issuer has received binding investment commitments covering the targeted amount (no need to wait 21 days, which is the minimum offering length). Investment commitments become binding 48 hours after they are given, and cannot be canceled after that unless there is a material change in the offering. Early closing is permitted as soon as binding commitments reaching the target amount are received.<br />
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These measures will simplify and, what is most important, will expedite the crowdfunding campaigns, allowing the smaller companies to raise much-needed funds.<br />
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<i>This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, <a href="https://www.msk.com/attorneys-Arina_Shulga">Arina Shulga</a>.</i><br />
<br />Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-18115932298749496922020-05-04T16:59:00.000-04:002020-05-04T16:59:06.093-04:00Открытие Бизнеса в США: Практические Советы<span style="background-color: white; color: #1d2129; font-family: system-ui, -apple-system, system-ui, ".SFNSText-Regular", sans-serif; font-size: 14px;">Мы организуем бесплатный вебинар на тему открытия бизнеса в США. Вебинар покроет не только юридические вопросы но и налоговые. Присоединяйтесь 14 мая в 17:00 по МСК!</span><br />
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<br />Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-74938543527754068902020-01-29T09:48:00.000-05:002020-01-29T09:48:48.679-05:00LEGAL PERSPECTIVE ON RUNNING A SUCCESSFUL CROWDFUNDING CAMPAIGNAlthough <a href="https://www.sec.gov/rules/final/2015/33-9974.pdf">Regulation Crowdfunding</a> (or Reg CF in short) is a great way to get funding for companies that otherwise would have been overlooked by angel or VC investors, running a successful and compliant Reg CF campaign is not an easy undertaking. Based on experience working with Reg CF issuers, in this blog I describe and discuss three key legal challenges that all Reg CF issuers should know about: restriction on advertising, hiring promoters, and putting together a complete and accurate Form C.<br /><br />First, the issuer cannot generally solicit and advertise its Reg CF offering. All communications must be done through the portal. According to <a href="https://www.law.cornell.edu/cfr/text/17/227.204">Rule 204 of Reg CF</a>, the issuer can make factual statements and then direct potential investors to its page on the portal. Such factual statements are limited to the following information: the fact that the issuer is conducting a Reg CF offering; the terms of the offering (amount, nature of securities, price, and closing date), and factual business information about the issuer. While the first two categories are straight forward, issues can arise when talking about the factual business information. Such information cannot include predictions or opinions and must be limited only to facts, such as name, address, website of the issuer and a brief factual description of its business.<br /><br />Second, <a href="https://www.law.cornell.edu/cfr/text/17/227.205">Rule 205 of Reg CF</a> allows issuers to hire promoters for their offerings as long as the promoters work within the portal page and the issuer takes reasonable steps to ensure that the promoter discloses the fact that they are compensated. Outside of the portal, the promoters are restricted to providing the same factual statements that are described above. Again, the issuer must take reasonable steps to ensure that the promoters disclose that they are being paid by the company. As a separate issue, companies should not pay promoters a commission or a success-based fee. Such transaction-based compensation is a red flag to the SEC that the promoters are acting as unregistered broker-dealers, which may invalidate the entire offering. Compensation should be in the form of a flat fixed fee, rather than be tied to the success of the sales efforts.<br /><br />Third, prior to launching a Reg CF offering, the issuer must file a disclosure document called <a href="https://www.law.cornell.edu/cfr/text/17/227.203">Form C</a> with the SEC. Even though its disclosure requirements are less extensive than for other offerings (such as Regulation A or an IPO), Form C must still be taken seriously. Form C requires the company to provide a description of its business and the anticipated business plan, the team bios, use of proceeds, and the risk factors that describe in depth the risks of investing in the company as well as the risks related to the company’s operations. Further, Form C asks for disclosures related to the ownership and capital structure of the company and rights of all securities that have been issued by the company prior to the offering. The company must list all of its other securities offerings for the past three years. This has often proven to be a challenge for some younger companies that may not realize that they were conducting securities offerings when, for example, they sold a SAFE to a neighbor or a couple of convertible notes to unaccredited friends, fail to file Form Ds for prior offerings, or comply with the offering exemption requirements. When preparing Form C, issuers should remember that under <a href="https://www.law.cornell.edu/cfr/text/17/240.10b-5">Rule 10b-5</a> of the Securities Act they have liability for any material misstatements or omissions in their Form Cs.<br /><br />Additionally, even the younger companies must include US GAAP financial statements. For offerings of $107,000 or less, the financial statements must be certified by the principal executive officer of the issuer; for offerings between $107,000 and $535,000, they must be reviewed by a public accountant independent of the issuer; and for the offerings over $535,000, the financial statements must be audited (although the first-time issuers could provide reviewed financials instead).<br /><br />Consequences for violating these rules can be severe. Regulation CF is a safe harbor exemption from the general requirement that a company must register its securities with the SEC. If violated, the offering may be deemed to be void, and all investors in the offering could receive recession rights (i.e., the right to get their money back). Additionally, the SEC may impose sanctions and shareholders may file civil lawsuits against the company. Further, the company itself may be deemed to be a “bad actor” and be prevented from conducting private placements of its securities in the future.<br /><br />In conclusion, running a successful and compliant crowdfunding campaign is not a simple task. The key to success often lies in finding the right advisers: a funding portal that would be willing and able to support its issuers throughout the entire crowdfunding campaign, and an expert legal adviser that can prepare Form C, ensure that the company’s legal records and corporate governance documents are in order, and guide the company through the maze of legal rules and forms of Regulation Crowdfunding.<br /><br /><i>This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, <a href="https://www.msk.com/attorneys-Arina_Shulga">Arina Shulga</a>. </i>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-57601486264838687492020-01-18T10:57:00.000-05:002020-01-18T10:57:13.568-05:00Amending the Definition of "Accredited Investor"The definition of an “accredited investor” is the cornerstone of Regulation D that provides a safe harbor exemption for private placements of securities by startups and more mature companies. Only in 2018, $1.7 trillion was invested into the startup sector by means of Regulation D offerings, out of which $228 billion was raised by companies rather than investment funds. Nearly all of the investors in such offerings were accredited. Now, the definition of an accredited investor may be changing to include new categories of people. This will open the extremely risky but yet extremely lucrative startup investment opportunities to more participants.<br /><br />This blog focuses on certain proposed changes to the definition as it relates to natural persons.<br /><br />The definition of “accredited investor” came about in 1982 together with the adoption of Regulation D (although the concept of an “accredited person” was first introduced by Rule 242 in 1980). The following categories of natural persons are deemed to be accredited:<div>
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<li>Any natural person who had individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;</li>
<li>Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1 million (excluding the value of primary residence); and</li>
<li>Directors, executive officers, and general partners of the issuer or of the general partner of the issuer.</li>
</ul>
Other than expanding the income test to include a joint income component in 1988 and excluding the value of one’s primary residence from the net worth calculation as part of the Dodd-Frank Act in 2011, the SEC has not revised the definition since 1982.<br /><br />On December 18, 2019, the SEC issued <a href="https://www.sec.gov/rules/proposed/2019/33-10734.pdf">proposed rules</a> to amend the accredited investor definition. The rules are currently in the 60-day comment process, so anyone who cares deeply about the outcome is encouraged to submit a comment to the SEC.<br /><br />The main premise of the proposed rules is the fact that the SEC no longer believes wealth to be a proxy for financial sophistication, and I fully support this conclusion. There should be other criteria for establishing financial sophistication. Hence, the SEC is proposing to add the following new categories of natural persons to the category of accredited investors: (i) those who hold certain professional “certifications, designations or other credentials recognized by the Commission” and (ii) “knowledgeable employees” of a private fund who are investing in that fund. Since I fully agree with adding “knowledgeable employees” to the accredited investor definition list, I will focus my discussion on the persons with professional certifications.<br /><br />With respect to the professional degrees, the SEC has proposed an initial list of accepted certifications, to be revised and amended from time to time. The initial list includes:</div>
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<ul>
<li>A Licensed General Securities Representative (Series 7);</li>
<li>A Licensed Investment Adviser Representative (Series 65); and</li>
<li>A Licensed Private Securities Offerings Representative (Series 82).</li>
</ul>
As currently proposed, the list of acceptable professional certifications is narrow and substantially limits eligible persons to those professionals working for broker-dealers (most of whom may already be accredited by other means). These individuals must be sponsored by a FINRA member firm to be allowed to take the Series 7 or 82 exam and first pass an introductory-level Securities Industry Essentials examination. There are no similar requirements for the Series 65 exam. As previously mentioned, taking a Series 7 or 82 exam assumes that such an individual is employed by a FINRA member firm. My view is that those individuals who are not working for a FINRA member firm should also be allowed to take the examinations, and if they pass, become “accredited investors.” In a sense, these exams, if stripped of the sponsorship requirement, should become tests for the minimum expertise necessary to be deemed to be an accredited investor. There should also be annual re-certification to ensure that these individuals keep abreast of all relevant developments in the financial and legal markets. Allowing everyone to take these exams, whether or not affiliated with a FINRA member firm, would render it unnecessary to consider other professional degrees such as a Ph.D. in finance or a Master’s degree in a similar field. All persons, regardless of the professional or educational background, should be able to take the tests and qualify to be an accredited investor. It could make sense, however, to impose investment limitations on those investors who qualify to be accredited solely based on the professional certifications criteria.<br /><br />Additionally, harmonization of the various definitions that are currently used in different securities laws would go a long way towards simplifying and streamlining the compliance process. Currently, in addition to the definition of an “accredited investor” found in Rule 501(a) of Regulation D under the Securities Act, we have the definition of a “qualified purchaser” under the Investment Company Act of 1940, a “qualified client” under the Investment Advisers Act of 1940, and a “qualified institutional buyer” in Rule 144A under the Securities Act. All of these definitions generally refer to wealthy entities and individuals but vary somewhat with respect to the thresholds and scope.<br /><br />In conclusion, the proposed rules are a big step forward towards democratizing the definition of “accredited investor.” Having more accredited investors willing and interested to invest in startups will fuel the growth of the startup economy and should result in producing more jobs.<br /><br /><i>This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, <a href="https://www.msk.com/attorneys-Arina_Shulga">Arina Shulga</a>. </i></div>
Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-90306258183341145682019-11-30T12:04:00.001-05:002019-12-02T09:39:58.548-05:00Corporate Formalities for Delaware StartupsYou have just formed your very first Delaware corporation. Congratulations! Although as a busy founder you may not have time to take care of ongoing corporate maintenance, there are some minimum corporate formalities that you should strive to maintain. Below is my list and the reasons why.<br />
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<br />
One of the main benefits that is afforded by corporate structure is the limited liability protection for its owners. This means that the corporation and its stockholders are treated as separate legal entities. The corporation enters into its own contracts, and therefore, it is only the corporation’s assets, and not the assets of its individual stockholders, that are available to pay for judgments and claims of creditors. <br />
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There are, however, circumstances when a creditor of a corporation can “pierce the corporate veil” to hold the corporation’s stockholders liable for the corporation’s debts and other obligations. When deciding whether to pierce the corporate veil and hold stockholders personally liable, courts consider, among other factors, whether: <br />
<ul>
<li>the corporate formalities have been disregarded;</li>
<li>the corporation is a mere façade of its owners; </li>
<li>the corporation is inadequately capitalized; </li>
<li>the owners use the corporation’s assets and property as their own; </li>
<li>the corporation makes undocumented “loans” to the owners or extends credit not on market terms; or </li>
<li>the owners simply take money out of the corporation; </li>
</ul>
The following best practices with respect to corporate governance and external appearance of the corporation may strengthen the argument that the corporation exists as a separate legal entity: <br />
<br />
<u>Stockholder and Board of Directors Meetings</u>. The corporation should hold both annual stockholder and Board meetings (or at least prepare unanimous written consents). In addition, the Board should consider and approve all significant actions of the corporation (such as taking out loans, hiring executive officers, selling securities, entering into any other transaction that is out of the ordinary for such corporation). A majority of disinterested directors or the stockholders should approve all transactions between directors, officers, and the corporation. <br />
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<u>Delaware Annual Report and Franchise Tax</u>. In order to maintain good standing in Delaware, the corporation has to file an online annual report with the Delaware Division of Corporations and pay the Delaware franchise tax no later than March 1st of each year. <br />
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<u>Delaware Registered Agent</u>. It is important to renew the services of the mandatory Delaware Registered Agent every year. The fee is about $50/year.<br />
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<u>Qualifying to Do Business in the Other States</u>. If the corporation is conducting business in another state, it must register there as a foreign corporation and pay tax on the income derived from that state. The definition of “conducting business” varies state by state. So, please reach out to your accountant or lawyer for assistance with this question. <br />
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<u>Separate Bank Account</u>. The corporation must have its own corporate bank account. All expenses must be paid from that account and all revenue be deposited there. If the founders paid for incorporation expenses personally, they should submit an expense report and be reimbursed by the corporation from the corporate bank account. One of the “red flags” for the “piercing of the corporate veil” argument is the co-mingling of funds between the corporation and its owners. <br />
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<u>Hiring Employees</u>. The hiring process is complicated and involves setting up payroll, preparing pay notices, registering with appropriate state authorities, complying with federal immigration laws, and obtaining the mandatory insurance policies. Failure to comply with these requirements may result in hefty fines. <br />
<br />
<u>Debt Guarantees</u>. Stockholders should be careful not to personally guarantee and pay debts of the corporation (at least not on the recurrent basis). Otherwise, the courts may decide that the owners act as “alter egos” of the corporation and the corporation has lost its separate entity status. Board resolutions should be adopted allowing guarantees for specified purposes only. <br />
<br />
<u>Acting on Behalf of the Corporation</u>. All documents signed on behalf of the corporation must indicate the signing officer’s name and title. For example: <br />
<br />
XYZ Inc. <br />
<br />
________________ <br />
Name: John Smith <br />
Title: CEO <br />
<br />
Further, all contracts should be in the name of the corporation, and the insurance policies should name the corporation as the insured. The full corporate name should appear on the website, business cards, letterhead, and checks of the corporation. </div>
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In conclusion, although this list seems long, it actually doesn't take much effort to comply with if the proper procedures have already been set up. Your accounting and legal team should work with you on ensuring that your startup follows all corporate formalities.</div>
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<div>
<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i></div>
Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-45637465890373640532019-08-22T09:56:00.000-04:002019-08-22T09:57:02.895-04:00SEC Complaint Against a VC Exempt Reporting AdviserOn August 13, 2019, the SEC filed a <a href="https://www.sec.gov/litigation/complaints/2019/comp24560.pdf" target="_blank">complaint</a> against Stuart Frost and Frost Management Company, LLC for violating the antifraud
provisions of <a href="https://40act.com/laws-rules/investment-advisers-act-of-1940-statute/section-206-prohibited-transactions-by-investment-advisers/" target="_blank">Sections 206(1)-(2) and 206(4) of the Investment Advisers Act</a>. This case is a reminder that certain provisions of the Advisers Act apply to all investment fund managers, regardless of whether they are registered, non-registered, or exempt (exempt reporting advisers are referred to as "ERAs"). Also, this case highlights once more the importance of proper disclosure of management fees and expenses (and that they have to be reasonable and market).<br />
<br />
Mr. Frost, through his investment management firm, managed five venture capital funds that raised about $63 million. These funds were invested into start-ups incubated by Frost Data Capital, LLC ("FDC"), an entity wholly-owned by Mr. Frost. Start-ups paid incubator fees to FDC. The SEC complaint alleges that these incubator fees were not properly disclosed to the investors and, in fact, were exorbitant. As stated in the <a href="https://www.sec.gov/litigation/litreleases/2019/lr24560.htm" target="_blank">SEC press release</a>, the fees were used to finance Mr. Frost's "extravagant personal expenses" and "lavish lifestyle", and when he ran out of money, he would create and fund new start-ups in order to obtain more incubator fees.<br />
<br />
<i>Section 206 of the Advisers Act Applies to All Fund Managers</i><br />
<br />
The anti-fraud provisions of the Advisers Act apply to <a href="https://www.sec.gov/divisions/investment/iaregulation/memoia.htm" target="_blank">ALL investment advisers</a>, regardless of their status with the SEC or state authorities, or the absence thereof. In particular, Section 206 of the Advisers Act states:<br />
<br />
"It shall be unlawful for <b>any</b> investment adviser by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly—<br />
<br />
(1) to employ any device, scheme, or artifice to defraud any client or prospective client;<br />
<br />
(2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client; ...<br />
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<br /></div>
<div>
(4) to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative."</div>
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<br /></div>
<div>
Further, all investment advisers owe a fiduciary duty to their clients of undivided loyalty and may not engage in any activity that conflicts with the interests of their clients without their prior consent. As held by the Supreme Court in <a href="https://supreme.justia.com/cases/federal/us/375/180/" target="_blank">SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963)</a>, the advisers owe to their clients a duty of good faith and full and fair disclosure of all material facts and a duty to avoid misleading them.<br />
<br />
According to the complaint, FDC (wholly-owned by Mr. Frost) was financially dependent on the incubator fees paid by portfolio companies. FDC charged the portfolio companies $21.69 million in incubator fees. None of that money went to the investors. In the fund disclosure materials, Frost and his management company either completely omitted the existence of such incubator fees or misled the investors by saying that FDC would charge incubator fees on a case-by-case basis and at below-market rates. In reality, every portfolio company was charged with such fees, which were $30,000 - $40,000 per month per portfolio company. The fees had to be paid even if the portfolio company moved out of FDC's offices. The service contracts could be canceled only upon a 180-day notice, which meant that the startups had to pay for an additional six month period. Unsurprisingly, these ongoing payments reduced the chance of the startups to succeed, as they were quickly running out of cash. Overall, there were 24 portfolio companies. As of 2018, only several remained active.</div>
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<br /></div>
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<i>ERAs Must File with the SEC</i> </div>
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According to <a href="https://www.law.cornell.edu/uscode/text/15/80b-2" target="_blank">Section 202(a)(11) of the Advisers Act</a>, an "investment adviser" is any person that (1) for compensation (2) is engaged in the business of (3) providing advice (4) as to the value of securities or advisability of investing in, purchasing, or selling securities. The Advisers Act mandates that all investment advisers must register with the SEC, unless exempt or prohibited to do so. </div>
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<br /></div>
<div>
A fund adviser may be exempt from registering with the SEC if it is an adviser solely to private funds with total AUM under $150 million and that are (i) venture capital funds (<a href="https://www.law.cornell.edu/cfr/text/17/275.203(l)-1" target="_blank">Section 203(l) of the Advisers Act</a>) or private funds relying on Section 3(c)(1) or 3(c)(7) exemption under the Investment Company Act (<a href="https://www.law.cornell.edu/cfr/text/17/275.203(m)-1" target="_blank">Section 203(m) of the Advisers Act</a>). Such fund managers must still file Form ADV with the SEC, but a shorter version.<br />
<br />
There is also a duty to file annual updates of the Form ADV. Frost Management Company failed to renew its <a href="https://adviserinfo.sec.gov/Firm/165847" target="_blank">ERA filing</a> in 2018 and onwards.<br />
<br />
In conclusion, this case reminds us that the SEC has jurisdiction over all investment advisers, including the ERAs and the unregistered advisers. Being an investment adviser, registered or not, big or small, carries the fiduciary duty of good faith and full and fair disclosure that should not be taken lightly. </div>
<div>
<br />
<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i></div>
Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-75319535856563528022019-08-02T15:16:00.000-04:002019-08-02T15:16:24.837-04:00How Using the Word "MAY" Instead of "WAS" Can Cost You $100 MillionOn July 24, 2019, the SEC <a href="https://www.sec.gov/news/press-release/2019-140" target="_blank">charged</a> Facebook Inc. $100 million for inaccurately disclosing the risk of misuse of user data. Facebook agreed to pay, without admitting or denying any wrongdoing. So, what happened?<br />
<br />
According to the <a href="https://www.sec.gov/litigation/complaints/2019/comp-pr2019-140.pdf" target="_blank">SEC complaint</a>, the Facebook public filings (such as the annual reports on Form 10-K or the quarterly reports on Form 10-Q, etc.) informed the public that "our users' data MAY be improperly accessed, used or disclosed" (emphasis added), but in fact, at that time Facebook already knew that it was true. It all goes back to the infamous Cambridge Analytica scandal (CA paid an academic to collect and transfer from Facebook certain data in violation of the Facebook policies). Later, CA used such data for clients' political campaigns. According to the SEC complaint, Facebook discovered the misuse by December 2015 but failed to correct its public company disclosure until May 2018.<br />
<br />
This was a material risk, and in Facebook's case, it became a reality. However, the company did not move it from the category of "possible risks" to the category of "real events". <a href="https://www.law.cornell.edu/cfr/text/17/240.10b-5" target="_blank">Rule 10b-5</a> under the Securities Exchange Act (like <a href="https://www.law.cornell.edu/uscode/text/15/77q" target="_blank">Section 17(a)(2)</a> of the Securities Act which is near identical) prohibits companies to make "any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading...". Most securities lawyers know this phrase verbatim. Perhaps, there was a question of whether such information was "material" to Facebook's stockholders (there are ongoing debates about the materiality standard, although in this case misusing data of 30 million Facebook users does sound "material"). Perhaps, Facebook management did not actually know about what was happening or was in disbelief. Perhaps, some people knew but failed to communicate it to others with the disclosure-making responsibilities. Whatever the explanation is, the fact remains that after Facebook finally publically announced that it knew about the data breach, its share price dropped, underscoring the importance of this information. Well, this turned out to be a costly misuse of the three letters MAY. <br />
<br />
Drafting disclosure documents is not creative writing. This skill is rooted in the deep understanding of the legal standards, the industry, the company, and the specific risks the company faces. It is also based on the information that is being made available to the drafter.<br />
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<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-76425086848819837972019-07-30T09:13:00.001-04:002019-07-30T09:13:57.080-04:00Utility Tokens ExistOn July 25, 2019, the SEC issued its <a href="https://www.sec.gov/corpfin/pocketful-quarters-inc-072519-2a1" target="_blank">second no action letter</a> 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 <a href="https://www.sec.gov/divisions/corpfin/cf-noaction/2019/turnkey-jet-040219-2a1.htm" target="_blank">no action letter</a> to TurnKey Jet, Inc.<br />
<br />
Below are my observations regarding this no action letter and token issuance in general:<br />
<ul>
<li>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. </li>
<li>If previously the SEC had only shown us the instruments that <u>cannot</u> 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 <u>can be and are</u> utility tokens. This is incredibly useful guidance when advising clients on how to structure their tokens.</li>
<li>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 <u>after</u> the platform development has been completed. Again, this approach (issuing two types of tokens) can be used by others when conducting their token offerings. </li>
<li>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.</li>
<li>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.</li>
<li>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.</li>
<li>Quarters will be sold only for the gamers' personal use within the gaming platform. </li>
<li>Quarters will not be marketed to the public as an investment, and PoQ will make corresponding disclosures in its marketing literature.</li>
</ul>
As described in the thorough and well-written <a href="https://www.sec.gov/divisions/corpfin/cf-noaction/2019/pocketful-of-quarters-inc-072519-2a1-incoming.pdf" target="_blank">incoming letter</a>, 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.<br />
<br />
<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-32630729330793362802019-07-21T11:24:00.000-04:002019-07-21T11:24:15.008-04:00Blockstack: First Reg A+ Token OfferingOn 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.<br />
<br />
It was Blockstack that, after a 10-month wait, was approved for the $28 million offering. According to Blockstack's <a href="https://www.sec.gov/Archives/edgar/data/1693656/000110465919039476/a18-15736_1partiiandiii.htm" target="_blank">offering circular</a>, 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, <a href="http://www.stackstoken.com/">www.stackstoken.com</a>, 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. <br />
<br />
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 <a href="https://www.wsj.com/articles/sec-clears-blockstack-to-hold-first-regulated-token-offering-11562794848" target="_blank">WSJ article</a> 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.<br />
<br />
<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i><br />
<br />
<br />Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-24769928486449339152019-07-20T14:41:00.003-04:002019-07-21T10:30:53.058-04:00What'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.<br />
<br />
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 <a href="https://www.wsj.com/articles/exchanges-shy-away-from-mini-ipos-after-fraud-concerns-11560177205?mod=article_inline" target="_blank">WSJ</a> 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.<br />
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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 <a href="https://www.sec.gov/news/press-release/2018-61" target="_blank">accused</a> Longfin of violating securities laws because its chief executives and associates sold shares after the stock price increased. The <a href="https://www.sec.gov/litigation/complaints/2018/comp-pr2018-61.pdf" target="_blank">complaint</a> was accompanied by a preliminary injunction freezing more than $27 million in trading proceeds. On June 5, 2019, the SEC added <a href="https://www.sec.gov/litigation/litreleases/2019/lr24492.htm" target="_blank">fraud charges</a> 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.<br />
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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 <a href="https://www.sec.gov/rules/sro/nasdaq/2019/34-86314.pdf" target="_blank">approved</a> the new NASDAQ initial listing standards related to the minimum liquidity needed to list on any NASDAQ tier. You can read about it <a href="https://cooleypubco.com/2019/07/09/nasdaq-liquidity-proposal-approved/" target="_blank">here</a>. One of the <a href="http://nasdaq.cchwallstreet.com/NASDAQ/pdf/nasdaq-filings/2019/SR-NASDAQ-2019-017_Resubmission.pdf?mod=article_inline" target="_blank">changes</a> 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. <br />
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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.<br />
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<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-7818859863206019622019-06-30T11:35:00.002-04:002019-06-30T12:17:43.949-04:00Are Undeveloped Lots Securities?As we recently found out from the CA Court of Appeals decision in <a href="https://www.leagle.com/decision/incaco20180207046" target="_blank">People v. Dunham</a>, undeveloped lots of land may be "investment contracts" and therefore, "securities".<br />
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A brief summary of the facts of this case are as follows: Ronald Duane Dunham convinced several elderly persons in 2004 through 2007 to invest over a million dollars into the purchase of undeveloped lots of land in Cherokee Village, Arkansas and/or support his real estate development efforts. There was no fund created. Purchases were made individually. According to the court opinion, Dunham told the investors that "he would increase land values through the marketing and development of a retirement community." There were many misstatements in Dunham's promises, which coupled with other misdeeds by Dunham, resulted in a criminal and civil lawsuits being filed against him. In 2014, a jury convicted Dunham of 20 counts of grand theft, elder theft, and securities fraud. Although the Court of Appeals reversed six out of 20 counts relating to grand theft (because it was a lesser included offense of elder theft), it affirmed the other convictions, including the securities fraud counts.<br />
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This case illustrates the ever more resilient nature of the Howey test that can put just about any investment scheme into the realm of securities laws. As a way of background (just in case you haven't heard enough about it yet), the US Supreme Court ruled in <a href="https://supreme.justia.com/cases/federal/us/328/293/" target="_blank">SEC v. </a><a href="https://supreme.justia.com/cases/federal/us/328/293/" target="_blank">W.J. Howey Co., 328 U.S. 293</a> (1946) that an investment contract can be a security if it represents investment of money (or other consideration) in a common enterprise with an expectation of profits to be derived solely from the efforts of the promoter or a third party. Hundreds of pages of legal analysis have been written since then about the <i>Howey Test</i>. The test has been applied to find receipts for <a href="https://casetext.com/case/securities-exch-comn-v-haffenden-rimar-2" target="_blank">Scotch whiskey barrels</a>, <a href="https://www.casemine.com/judgement/us/59149691add7b049345e39c2" target="_blank">pairs of mating chinchillas</a>, and the <a href="https://casetext.com/case/continental-mktg-corp-v-sec-exch-comn" target="_blank">sale of beavers</a> raised at a ranch all to be investment contracts. More recently, the <i>Howey Test</i> has been applied to the initial coin offerings to find that digital tokens that investors received in exchange for their money were securities. <br />
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Similarly here, the court looked at the <i>Howey Test</i> to determine whether the undeveloped lots were securities. As the court noted:<br />
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"Here, like in Howey, Dunham offered investors an opportunity to contribute money and to share in the profits of a Cherokee Village retirement community, which would be managed, sold, and partly owned by Dunham. The lots represented the victims' "shares in [the] enterprise." (Howey, supra,328 U.S. at p. 300.) None of the California victims had any ability to develop homes in Arkansas, and they expected "Dunham and company" to sell their lots for them. The victims were relying on Dunham to bring professional management, homebuilding, and financing experience to the project."<br />
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They all expected a return on their investment. Even though there was no investment fund or other syndication company created, and there was no management contract between Dunham and the victims, it was clear from the presentations, seminars, and marketing materials that the victims placed their trust in Dunham to develop the lots in order to increase their value. <br />
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This case reminds us once again to disregard form for substance and focus on the economic reality when analyzing whether any investment is an "investment contract" and therefore is a "security". Even undeveloped land can be such. What else?<br />
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<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i><br />
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<br />Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-65476903223731026332019-06-25T12:39:00.001-04:002019-06-25T13:03:37.042-04:00Regulation Crowdfunding Study - June 2019On June 18, 2019, the staff of the SEC issued a <a href="https://www.sec.gov/files/regulation-crowdfunding-2019_0.pdf" target="_blank">report</a> on Regulation Crowdfunding (in short, Regulation CF). The report presents a summary of the status of crowdfunding as of now, three years after the SEC <a href="https://www.sec.gov/rules/final/2015/33-9974.pdf" target="_blank">final rules</a> for Regulation CF became effective. Although a great initiative, Regulation CF is too complex and costly to be the main securities law exemption behind capital raising in the U.S.<br />
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As a way of background, Title III of the JOBS Act added <a href="https://www.law.cornell.edu/uscode/text/15/77d" target="_blank">Section 4(a)(6)</a> to the Securities Act, providing for a new exemption from registration for private placements conducted through an online platform. Regulation CF provides the regulations that put Section 4(a)(6) into practice. According to Section 4(a)(6) and Regulation CF, a domestic issuer may raise up to $1.07 million in a 12-month period from unaccredited investors provided the issuer prepares certain disclosures, the investors invest only up to a certain maximum based on the investor's income or net worth, and the offering is conducted through a broker-dealer or a registered funding portal.<br />
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In summary, Regulation CF did not prove to be as popular as once anticipated. According to the report, only 1,351 offerings relying on Regulation CF were initiated in 2.5 years between May 16, 2016 and December 31, 2018, and only 519 offerings were reported as completed. The average amount reported raised per offering was approximately $107,367 for a total of $108.2 million. In comparison, in 2016 alone, companies in the United Kingdom and China raised $335 million and $460 million, respectively, under similar crowdfunding exemptions.<br />
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Most issuers were early in their lifecycle: an average issuer was formed within two years prior to the offering and employed about three people. Just over half of the offerings were done by issuers with no revenues. Only about 10% of the issuers became profitable in the most recent fiscal year prior to the offering. About one-third of the issuers were from California, followed by New York (about 11%) and Texas (about 7%).<br />
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The average offering lasted about four months. About one-half of the issuers offered equity, 27% - debt, and the remaining issuers offered SAFE or another type of investment structure.<br />
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Although the $1.07 million limit in Regulation CF offerings was initially much criticized, a typical offering amount was small: the average target amounts ranged between $25,000 and $500,000. Only 29 offerings reported raising at least $1.07 million during the three-year study period. Therefore, the low offering limit seems to be appropriate, although one can argue that many potential issuers avoid Regulation CF because of such low limits. <br />
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The SEC staff noted in the report some issuers' lack of compliance with the ongoing filing obligations. Issuers have to file an annual report on Form C-AR and the final progress update on Form C-U. Many survey respondents cited the complexity of regulations and Form C as well as high costs associated with Form C and financial statement preparation as the reasons behind such a lack of compliance.<br />
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Overall, the report is full of data that should be analyzed with the view of amending Regulation CF. Then, those issuers that stay away from conducting a Regulation CF campaign due to the low limits, complex and onerous disclosure requirements, necessary audited financials for larger offerings, and ongoing reporting obligations will rely on the Regulation CF in their capital raising efforts and will allow more unaccredited investors to participate in the startup ecosystem.<br />
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<i style="font-family: times; text-align: justify;">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 <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i> <br />
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<br />Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-92019666902241147312019-06-11T23:14:00.000-04:002019-06-11T23:29:10.435-04:00SEC vs. Kik Interactive Inc. - Another Test for the Howey TestOn June 4, 2019, the SEC filed a <a href="https://www.sec.gov/litigation/complaints/2019/comp-pr2019-87.pdf" target="_blank">complaint </a>in SDNY against Kik Interactive Inc. ("Kik"), a Canadian company, for failing to register the offering and sale of its digital tokens called Kin pursuant to Section 5 of the Securities Act of 1933 (the "Securities Act").<br />
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The complaint reiterates the SEC's long-standing position since it first issued the <a href="https://www.sec.gov/litigation/investreport/34-81207.pdf" target="_blank">DAO Report</a> in July 2017 that digital tokens may be securities and that the U.S. federal securities laws would apply regardless of whether the consideration paid was virtual currency or whether the securities were issued through a distributed ledger technology instead of in the certificated form. According to the complaint, the Kik executives knew of the risk that the Kin tokens could be securities under the Securities Act but failed to sell them to the U.S. investors in a legally compliant way. This complaint did not come as a surprise to the company or the larger blockchain community. <br />
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Although we cannot foretell how the case will turn out (and this may go on to become a full-blown jury trial), there are several interesting observations about the Kik story, including some lessons for future token issuers. Please note that the observations are based on the facts as they were presented in the SEC complaint. These facts may be disputed by Kik in the process of litigation.<br />
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1. There were no allegations of fraud made against Kik. This case is solely about the violation of the registration provisions of the Securities Act. There have been prior SEC enforcement actions against ICO issuers that did not involve allegations of fraud but they all were settled with the SEC (<a href="https://www.sec.gov/litigation/admin/2018/33-10574.pdf" target="_blank">In re Matter of Paragon Coin, Inc.</a>, where the issuer raised $12,066,000, settled with the SEC on November 16, 2018, paid a $250,000 penalty, offered rescission rights to investors, and agreed to register tokens with the SEC; <a href="https://www.sec.gov/litigation/admin/2018/33-10575.pdf" target="_blank">In the Matter of Carrierreq, Inc.,</a> d/b/a Airfox, where the issuer raised approximately $15 million, and settled with the SEC on the same day and with the same consequences; and <a href="https://www.sec.gov/litigation/admin/2017/33-10445.pdf" target="_blank">In re Matter of Munchee Inc.</a>, where the issuer raised about $60,000 in the one day ICO, refunded all money, and settled on December 11, 2017 without penalty).<br />
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2. Kik raised approximately $100 million from more than 10,000 investors, about half of whom were U.S. investors. This was a large offering that was bound to attract the attention of the regulators.<br />
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3. Kik actually conducted two Kin offerings that became integrated. The first offer and sale took place from early July to September 11, 2017, whereby Kik received approximately $49.5 million from about 50 investors, including 21 U.S. investors. This was a private offering of SAFTs (Simple Agreements for Future Tokens) only to accredited investors. The company provided a PPM to the investors and filed a Form D, treating SAFTs as securities. The SAFT contracts obligated Kik to generate and distribute half of the tokens at the time of the public sale that had to take place before the September 30, 2017 deadline or return to the investors 70% of the funds. Since the company was running out of money, it had no choice but to conduct the public sale of tokens that took place between September 12-26, 2017, including distributing Kin tokens to the early investors, prior to the deadline. The offerings were integrated in part because of (i) the proximity in time between the SAFT offering and the public sale (the last SAFT was sold on September 11, 2017, one day before the launch of the public sale), (ii) the fact that the tokens issued in the public sale and the tokens underlying the SAFT had the same characteristics, and (iii) the fact that the company failed to distinguish between the funds received through SAFTs and the funds received from the general public.<br />
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4. Kik did not offer the Kin tokens to the Canadian investors in its public sale made to the retail investors from September 12 to September 26, 2017. Interestingly, based on the advice of its Canadian counsel and after engaging into discussions with the Ontario Securities Commission, Kik excluded Canadian investors from the public sale because, based on a Canadian test that is similar to the Howey test, the Kin tokens were determined to be securities under Canadian law. However, Kik did not reach out to the SEC and did not restrict U.S. investors from purchasing the tokens. In fact, only the residents of Canada, Cuba, China and North Korea (and residents of New York and Washington states) were excluded from the offering. <br />
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5. Kik failed to treat the underlying Kin tokens as securities when it offered and sold them through the SAFTs. The company knew at the time of offering and selling the SAFTs that it would not be able to build the "Kin Ecosystem" before the token distribution date, which, according to the SAFT contracts, had to take place before the September 30th deadline. This tight deadline allowed only for a window of several months (and in the case of the SAFT sold on September 11th, only a 20-day window) to do so, which was clearly insufficient time to build a fully functioning platform for the Kin tokens with all the features promised by Kik. Therefore, it was not reasonably possible for the Kin tokens to exist as "utility tokens" on the "Kin Ecosystem" and they had to be treated as securities. The fact that they did gain some utility later should be irrelevant to the analysis of the initial distribution of the Kin tokens back in September 2017.<br />
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6. The public sale was conducted several months after the SEC issued its DAO Report, warning issuers that tokens could be securities. However, Kik did not heed the SEC guidance.<br />
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7. In its <a href="https://www.prnewswire.com/news-releases/kik-responds-to-sec-complaint-300862114.html" target="_blank">press release</a> issued on June 4, 2019, Kik referred to its Kin tokens as a currency and alleged that the SEC stretched the Howey test "well beyond its definition". It is a question of fact whether Kin is now more like a currency rather than a security. It is a different question of fact whether Kin was more like a security than a currency at the time of its initial issuance in 2017. It should be noted that at the time Kin tokens were issued, the company was still building its "Kin Ecosystem" where Kin tokens could be used for payments, and therefore, unlike Ether, was not decentralized and depended on the efforts of Kik's developers. As the SEC noted in paragraph 126 of the complaint, "There was, simply, nothing to purchase with Kin at the times Kik sold the tokens through September 26, 2017...". <br />
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It will be up to the courts to decide whether Kin tokens were securities at the time of their issuance. Since the SEC's complaint is in line with its prior enforcement actions and interpretive releases on the subject, the outcome of the Kik case may either reaffirm once again the SEC's position or, if Kik were to prevail, return the Wild West of 2017 ICOs.<br />
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Perhaps, instead of applying and perhaps "stretching" the old Howey test one more time, it is time to adopt a new legal regime suitable for digital asset offerings (as it is being done in multiple jurisdictions across the globe)? But then remember, the courts are not legislative bodies and are bound to apply the law as currently written.<br />
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<i style="font-family: times; text-align: justify;">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 <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i><br />
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Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-35391536262134848202019-05-15T11:56:00.000-04:002019-06-10T18:03:14.031-04:00What to expect from your STO legal adviserI have <a href="http://www.businesslawpost.com/2019/05/getting-started-with-your-security.html" target="_blank">previously written</a> about the steps to prepare for a security token offering ("STO") and now would like to zero in on one of them: selecting the team.<br />
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The choice of the STO legal adviser can render your offering a success or failure. Don't select merely based on price. It is important to look at the prior experience with this type of offerings and the overall qualifications. Get references. Remember that you are hiring a legal team whose core members are experts in securities and corporate law, and its other members cover tax and other relevant subject areas.<br />
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Below is a summary of the services that (in my opinion) you should expect from your legal team: <br />
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<li>Advising on the choice of jurisdiction, both from the corporate and tax perspective, depending on the physical location of an asset/interest to be tokenized, targeted investors, availability of banking services, and relevant securities regulations and other applicable laws;</li>
<li>Choosing the right corporate structure for the special purpose entity (“SPE”) that will conduct the STO; </li>
<li>Engaging with local counsel to implement chosen structure and supervise its organization and corporate governance; </li>
<li>Preparing all necessary corporate governance documentation; </li>
<li>Assisting in developing the token terms; </li>
<li>Structuring the STO to qualify for an exemption from registration in the U.S.; </li>
<li>Preparing a private placement memorandum (“PPM”), including the offering details, legal disclaimers, company overview, risks relating to the offering, the company and the industry, and financial reports; </li>
<li>Preparing subscription / token purchase agreement or Simple Agreement for Future Tokens (“SAFT”) that summarizes the terms of the investment and captures investors’ consent to such terms; </li>
<li>Conducting a legal review of the issuer website, announcements on all social media platforms, the White Paper, if any, and marketing materials;</li>
<li>Preparing Terms of Use for the issuer website; </li>
<li>Developing or reviewing Know-Your-Customer / Anti-Money Laundering questionnaires; </li>
<li>Reviewing and commenting on the agreements with other service providers in the STO process; </li>
<li>Making applicable U.S. federal and state securities law filings; </li>
<li>Working together with the tax, accounting, marketing, and other service providers to create legally compliant internal and external documentation related to the STO; and </li>
<li>Working with local counsel in the selected jurisdictions (as applicable) where the tokens will be sold to ensure that the tokens are offered and sold within the legal parameters of each such jurisdiction and that correct lock-up periods and caps on investor counts are implemented.</li>
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Conducting an STO is not a small undertaking. And selecting the right legal team is one of its key components.</div>
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<i style="font-family: times; text-align: justify;">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 <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i></div>
Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-17468508224050502572019-05-12T11:04:00.000-04:002019-05-12T18:28:03.711-04:00Preparing for a panel discussion on raising seed capital, successfullyI am in the process of organizing an event geared towards my favorite crowd: startup founders. They are the most demanding group of clients I have. There are many adjectives I would use to describe them: enthusiastic, big believers, convincing, lost, demanding, unreasonable, whining, driven, and again, enthusiastic.<br />
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For the upcoming panel discussion, I've invited as speakers two partners at venture capital firms that invest into NYC-based and international startups, an experienced angel investor who is on the board of one of the largest angel groups, and a founder of a startup that successfully raised capital before. As a moderator, my job will be to ask them questions, the answers to which should help the audience. What are the questions that I should ask? What are the questions that, if you knew the answer to, would help your company get funded?<br />
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Audience participation here is welcome!<br />
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And BTW here is the link to the event:<br />
https://www.eventbrite.com/e/successful-capital-raising-for-startups-tickets-61307312823<br />
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<i style="font-family: times; text-align: justify;">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 <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-21242534377200521822019-05-11T11:43:00.000-04:002019-05-12T18:37:06.898-04:00Getting Started with Your Security Token Offering On April 18, 2019, we conducted a joint webinar on raising capital by conducting security token offerings. My colleague and I covered the legal side of how to conduct an STO in compliance with applicable laws. The team at tZERO handled the technical and logistical aspects of hosting an STO and actually generating tokens. They also addressed such questions as secondary trading of the security tokens. You can view the entire webinar here: <a href="https://www.youtube.com/watch?v=r2oSwVmIE9s">https://www.youtube.com/watch?v=r2oSwVmIE9s</a><br />
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After the webinar, I created the following guide summarizing certain points that a potential STO issuer should consider. Here is my step-by-step guide:<br />
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<b>Step 1: Understand the regulations</b><br />
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Conducting a securities token offering involves issuing securities. Every offer and sale of securities must be registered with the Securities and Exchange Commission (the “SEC”) pursuant to the registration requirements of Section 5 of the Securities Act of 1933 (the “Securities Act”) <u>unless</u> such offering qualifies for one of existing exemptions. I previously posted a brief summary of several commonly used exemptions and regulations <a href="http://www.businesslawpost.com/2019/05/overview-of-us-federal-securities-law.html" target="_blank">here</a>. <br />
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<b>Step 2: Understand the technology </b><br />
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Choosing the correct blockchain for your token is the next big decision you have to make. It needs to be secure and integrate well with different platforms and exchanges (just imagine what a costly mistake would be selecting a blockchain that does not work with your chosen security token exchange!). Most of the token industry issues tokens based on the Ethereum blockchain and the ERC-20 protocol because of its interoperability and simplicity to design. However, the ERC-20 token does not have any transfer restrictions. <br />
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The following are the four standards that build on top of ERC-20 protocol and that are specifically designed for security tokens: <br />
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ST-20 developed by Polymath <br />
R-Token developed by Harbor <br />
ERC-1400 <br />
ERC-1404 developed by Tokensoft <br />
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Each has a unique set of conditions tailored specifically to security tokens. Often, the choice of a platform for token issuance will help determine which standard will be used since several platforms have their own standards, such as Polymath and Harbor. <br />
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<b>Step 3: Choose the token issuance platform </b><br />
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Choosing the right platform has a direct effect on the success of the offering. Several platforms have emerged that offer tokenization services to issuers. Some provide only technical assistance in generating the tokens, whereas others offer a more comprehensive set of services that include, in addition to tokenization, assistance with determining the terms of the offering, smart contracts creations, KYC/AML built-in checks, marketing assistance, and integrations with other blockchain participants. <br />
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Examples of token issuance platforms include Securitize, Polymath, tZERO, Securrency, Harbor, and Swarm, among others. Given that the platforms offer different services at different pricing points, issuers should obtain quotes from several platforms and choose the one best suited for their needs and budget. <br />
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<b>Step 4: Set up the issuer entity and resolve corporate governance questions </b><br />
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The legal structure of the issuer varies greatly, and occasionally we see the issuer setting up a separate subsidiary to conduct a securities token offering. Although it is possible to form a foreign entity to conduct the STO, such a structure requires compliance with the laws governing the issuance of tokens in the home jurisdiction as well as compliance with the laws of each country where the investors are located. Also, setting up a foreign entity will preclude reliance on certain exemptions described in my separate <a href="http://www.businesslawpost.com/2019/05/overview-of-us-federal-securities-law.html" target="_blank">post</a>, such as Regulation CF or Regulation A+ (both Tier 1 and Tier 2). <br />
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<b>Step 5: Structure the terms of your security tokens </b><br />
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There are no standard terms for security tokens. Some are structured to be more like shares in a corporation and offer voting and dividend rights. Others evidence a loan and the right to be repaid with interest, which may sometimes be convertible into an equity-like instrument. Yet other tokens can represent a profits interest or a revenue share, or simply a fractional ownership of an asset. One of the initial steps of an STO process is creating a summary of the token terms together with a competent legal adviser.<br />
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<b>Step 6: Select your STO team </b><br />
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The very first step in conducting a successful security token offering is assembling a team of service providers with prior experience in STO issuances. You will need to select a legal adviser, a token issuance platform, and possibly a marketing agency and a broker-dealer. Depending on the type of offering you elect to conduct, you may also need to retain services of a transfer agent and engage local counsel in jurisdictions where you intend to sell the tokens. In the future, I'll write about what types of services to expect from your legal adviser.
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<b>Step 7: Understand resale restrictions and secondary trading </b><br />
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It is important to carefully select the right exchange for your security tokens. Many exchanges allow trading of cryptocurrencies and utility tokens. Hosting the trading of security tokens requires exchanges to get additional regulatory approvals. It is my understanding that there are currently only two U.S. centralized exchanges that are authorized to trade security tokens: tZERO and<br />
OpenFinance. <br />
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There are several others that are in the process of getting the necessary regulatory approvals to trade security tokens. You should learn the listing requirements and understand the regulatory compliance of the exchanges ahead of conducting your STO. <br />
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I hope this guide, together with the webinar, will help you find answers to some of your questions regarding raising capital through the issuance of security tokens.</div>
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<i style="font-family: times; text-align: justify;">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 <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i><br />
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</style>Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-33377069314170528062019-05-11T10:43:00.001-04:002019-05-12T18:41:35.355-04:00Overview of US federal securities law exemptions available for raising capitalEvery offering of securities must be registered with the SEC unless it qualifies for an available exemption and I am often asked to describe various types of exemptions and regulations that are available to private companies raising capital. I go over Regulation D, Regulation CF, Regulation A+ rules with clients about once a week. I also teach the same at Fordham Law School. Below I am posting a summary that I hope you will find helpful. Note that the table does not include all available exemptions and regulations. Email me if you'd like a nice pdf version.<br />
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<i style="mso-bidi-font-style: normal;">Regulation CF (Crowdfunding):<o:p></o:p></i></div>
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<br /></div>
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Amount to be Raised:<o:p></o:p></div>
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Up to $1,070,000 in a 12-month
period<o:p></o:p></div>
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<br /></div>
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Type of Issuers:<o:p></o:p></div>
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US entities only<o:p></o:p></div>
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Other limitations apply<o:p></o:p></div>
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<br /></div>
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Investors:<o:p></o:p></div>
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Any investor (accredited<a href="https://www.blogger.com/blogger.g?blogID=306130308173238034#_ftn1" name="_ftnref1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "times new roman" , serif; font-size: 11.0pt;">[1]</span></span><!--[endif]--></span></span></a>
and non-accredited).<span style="mso-spacerun: yes;"> </span>However, there
are limits as to how much non-accredited investors can invest depending on
their net worth or income.<o:p></o:p></div>
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<br /></div>
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Marketing Limitations:<o:p></o:p></div>
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<span style="mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt;">Issuers can only communicate
and market through a registered crowdfunding portal.<span style="mso-spacerun: yes;"> </span>Any type of marketing and communication is
permitted through the portal (so long as not misleading). Outside of the portal platform, only very limited factual communications are permitted.</span></div>
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<br /></div>
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Resale Limitations:<o:p></o:p></div>
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These are restricted securities
that generally cannot be resold for one year unless (i) back to the issuer,
(ii) to an accredited investor, (iii) as part of a registered offering, or
(iv) to a family member or for estate planning purposes.<o:p></o:p></div>
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<br /></div>
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</tr>
<tr style="mso-yfti-irow: 5;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Filing Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Issuers must file Form C with
the SEC and update it annually so long as, generally, securities issued in Regulation CF offering are outstanding.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 6;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Information Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
In addition to providing
disclosures about the company and the offering, the issuers must provide
financial statements (which have to be audited if the offering exceeds
$535,000 and the issuer has sold securities in reliance on Regulation CF
before).<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 7; mso-yfti-lastrow: yes;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
General comments:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Although cheaper than
conducting a Regulation A+ offering, the $1.07 million cap on the gross proceeds makes it a relatively expensive undertaking.<span style="mso-spacerun: yes;"> </span>Also, the issuer must conduct its offering
through one of the registered crowdfunding portals.<o:p></o:p><br />
<br /></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<i style="mso-bidi-font-style: normal;">Regulation D Rule 506(b):<o:p></o:p></i></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr style="mso-yfti-firstrow: yes; mso-yfti-irow: 0;">
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Amount to be Raised:<o:p></o:p></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Unlimited<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 1;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Type of Issuers:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Any issuer, including foreign
issuers<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
Certain limitations apply (such
as that the issuer cannot be a “bad actor”)<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 2;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Investors:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Unlimited number of accredited
investors and up to 35 non-accredited but financially sophisticated
investors.<span style="mso-spacerun: yes;"> </span><o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 3;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Marketing Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
<span style="mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt;">No general solicitation or
advertising is permitted.<span style="mso-spacerun: yes;"> </span>Offers and
sales should be made only to those investors with whom the issuer has
pre-existing relationship.</span><span style="background: white; mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt; mso-fareast-font-family: "Times New Roman";"><o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 4;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Resale Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Restricted securities (i.e.,
not freely tradeable generally for at least one year)<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 5;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Filing Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Issuers must file Form D with
the SEC within 15 days after the first sale.<span style="mso-spacerun: yes;">
</span>The issuer also needs to make notice filings in every state where the
investors reside.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 6;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Information Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
If the issuer accepts money
from non-accredited investors, it must provide a private placement memorandum
with specific mandated disclosures specified in Rule 502 of Regulation D.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 7; mso-yfti-lastrow: yes;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
General comments:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
This exemption may not be
suitable for those offerings that are conducted online through unrestricted web
portals because of the restriction on solicitation and advertising (because
posting offering details on a website is generally considered to be
advertising).<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<i style="mso-bidi-font-style: normal;">Regulation D Rule 506(c):<o:p></o:p></i></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr style="mso-yfti-firstrow: yes; mso-yfti-irow: 0;">
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Amount to be Raised:<o:p></o:p></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Unlimited<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 1;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Type of Issuers:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Any issuer, including foreign
issuers<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
Certain limitations apply (such
as that the issuer cannot be a “bad actor”)<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 2;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Investors:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Accredited investors only<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 3;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Marketing Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
<span style="mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt;">General solicitation and
advertising are permitted.<span style="mso-spacerun: yes;"> </span></span><span style="background: white; mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt; mso-fareast-font-family: "Times New Roman";"><o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 4;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Resale Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Restricted securities<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 5;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Filing Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Issuers must file Form D with
the SEC within 15 days after the first sale.<span style="mso-spacerun: yes;">
</span>The issuer also needs to make notice filings in every state where the
investors reside.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 6;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Information Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
None<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 7; mso-yfti-lastrow: yes;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
General comments:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Many issuers rely on this
exemption. The issuer has to take reasonable steps to verify that purchasers of securities sold in any offering under Rule 506(c) are accredited investors.<br />
<br /></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<i style="mso-bidi-font-style: normal;">Regulation A+ (Tier 1):<o:p></o:p></i></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr style="mso-yfti-firstrow: yes; mso-yfti-irow: 0;">
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Amount to be Raised:<o:p></o:p></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Up to $20 million per year <o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 1;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Type of Issuers:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
US and Canadian entities only<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
Certain types of entities (such
as <span style="color: black; mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt;">shell companies, issuers of penny stock or other types of
investment vehicles) </span>are ineligible<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 2;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Investors:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Accredited and non-accredited
investors<span style="mso-spacerun: yes;"> </span><o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 3;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Marketing Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
<span style="mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt; mso-fareast-font-family: "Times New Roman";">Generally
marketing and advertising are permitted, but certain limitations exist. <span style="mso-spacerun: yes;"> </span>When using “test-the-waters” marketing or
before the registration statement has been qualified with the SEC, the issuer
has to specifically state whether a registration statement has been filed and
if yes, then provide a link to the filing.<span style="mso-spacerun: yes;">
</span>Also, there needs to be a disclaimer saying that no money is being
solicited and that none will be accepted until after the registration
statement is qualified with the SEC.<span style="mso-spacerun: yes;">
</span>All solicitation material must be submitted to the SEC as an
exhibit.<span style="mso-spacerun: yes;"> </span><span style="background: white;"><o:p></o:p></span></span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 4;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Resale Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Unrestricted securities, but
limitations on trading exist<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 5;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Filing Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Issuers must file Form 1-A with
the SEC and get qualified.<span style="mso-spacerun: yes;"> </span>Companies
need to count their shareholders for the purposes of Section 12(g)
registration.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 6;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Information Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Form 1-A requires detailed
disclosures about the issuer, including financial statements which need not
be audited unless audited financial statements already exist.<span style="mso-spacerun: yes;"> </span>Generally, the level of disclosure is
similar to that required in an initial public offering.<span style="mso-spacerun: yes;"> </span><o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 7; mso-yfti-lastrow: yes;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
General comments:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
<span style="mso-spacerun: yes;">Issuers raising money in a Regulation A+ Tier 1 offering must comply with the individual "blue sky" laws of each state where they plan to sell their securities.</span><br />
<br /></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
Regulation A+ (Tier 2):<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr style="mso-yfti-firstrow: yes; mso-yfti-irow: 0;">
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Amount to be Raised:<o:p></o:p></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Up to $50 million per year <o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 1;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Type of Issuers:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
US and Canadian entities only<o:p></o:p></div>
<div class="MsoNormal">
Certain types of entities (such as <span style="color: black; mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt;">shell companies,
issuers of penny stock or other types of investment vehicles) </span>are
ineligible<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 2;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Investors:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Any accredited and
non-accredited investor.<span style="mso-spacerun: yes;"> </span>However,
there are limits on how much non-accredited investors may invest depending on
their net worth or income.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 3;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Marketing Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
<span style="mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt; mso-fareast-font-family: "Times New Roman";">Generally
marketing and advertising is allowed, but certain limitations exist. <span style="mso-spacerun: yes;"> </span>When using “test-the-waters” marketing or
before the registration statement has been qualified with the SEC, the issuer
has to specifically state whether a registration statement has been filed and
if yes, then provide a link to the filing.<span style="mso-spacerun: yes;">
</span>Also, there needs to be a disclaimer saying that no money is being
solicited and that none will be accepted until after the registration
statement is qualified with the SEC.<span style="mso-spacerun: yes;">
</span>All solicitation material must be submitted to the SEC as an
exhibit.<span style="mso-spacerun: yes;"> </span><span style="background: whitesmoke; color: #232323; letter-spacing: 0.3pt;"><o:p></o:p></span></span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 4;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Resale Limitations:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Unrestricted securities (at the
federal level)<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 5;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Filing Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Issuers must file Form 1-A with
the SEC and get qualified.<span style="mso-spacerun: yes;"> </span>After the
offering, the issuer has ongoing reporting obligations.<o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<span style="color: black; mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt;">Tier 2 offerings
are exempt from complying with state “blue sky” laws (although states can
(and generally will) still require that information provided to the SEC also
be filed with the state, and that the issuer pay filing fees.</span><span style="mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt;"><o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 6;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
Information Requirements:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
Form 1-A requires detailed
disclosures about the issuer, including audited financial statements.<span style="mso-spacerun: yes;"> </span>The level of disclosure is similar to that
required in an initial public offering.<br />
<br />
Tier 2 issuers are required to include audited financial statements in their offering documents and to file annual, semiannual, and current reports with the SEC on an ongoing basis.<span style="mso-spacerun: yes;"> </span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
<tr style="mso-yfti-irow: 7; mso-yfti-lastrow: yes;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 130.25pt;" valign="top" width="174"><div class="MsoNormal" style="text-align: justify;">
General comments:<o:p></o:p></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 337.25pt;" valign="top" width="450"><div class="MsoNormal" style="text-align: justify;">
<span style="mso-bidi-font-family: "Times New Roman"; mso-bidi-font-size: 11.0pt; mso-fareast-font-family: "Times New Roman";">Companies are required to engage the services of a transfer agent.<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<i style="mso-bidi-font-style: normal;">Regulation S:<o:p></o:p></i></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
Regulation S is an exclusion from
the registration requirements of the Securities Act for offerings made outside
of the United States by both U.S. and foreign issuers.<span style="mso-spacerun: yes;"> </span>A compliant Regulation S offering must follow
two general conditions: (i) the offer or sale must occur in an “offshore
transaction” and (ii) there be no “directed selling efforts” into the United
States.<span style="mso-spacerun: yes;"> </span><o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
Regulation S transactions are
divided into three categories.<span style="mso-spacerun: yes;"> </span>Category
One, which includes offers and sales by “foreign issuers” for which there is no
“substantial U.S. market interest” or offerings of securities in “overseas
directed offerings” is the least restrictive, with no resale limitations.<span style="mso-spacerun: yes;"> </span>Category Two securities, which include
securities issued in equity offerings by reporting foreign issuers and
offerings of debt securities, non-participating preferred stock by reporting
issuers or non-reporting foreign issuers, may not be resold to U.S. persons
during a 40-day distribution compliance period.<span style="mso-spacerun: yes;">
</span>Category Three is typically the most relevant for the smaller private issuers.<span style="mso-spacerun: yes;"> </span>Category Three includes offerings of all
other securities, including equity offerings by domestic non-reporting issuers
(i.e., private companies with no reporting requirements with the SEC).<span style="mso-spacerun: yes;"> </span>Resales to U.S. persons of securities issued
in Category Three offerings are restricted for one year unless they are done in
compliance with an available resale exemption.<span style="mso-spacerun: yes;">
</span><o:p></o:p></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div style="mso-element: footnote-list;">
<!--[if !supportFootnotes]--><br clear="all" />
<hr align="left" size="1" width="33%" />
<!--[endif]-->
<br />
<div id="ftn1" style="mso-element: footnote;">
<div class="MsoFootnoteText" style="text-align: justify;">
<a href="https://www.blogger.com/blogger.g?blogID=306130308173238034#_ftnref1" name="_ftn1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "times new roman" , serif; font-size: 10.0pt;">[1]</span></span><!--[endif]--></span></span></a>
Rule 501(a) of the Securities Act defines accredited investors (in the case of
natural persons) as those whose individual net worth (alone or with a spouse)
exceeds $1 million (excluding the value of their primary residence) or those
whose annual income exceeded $200,000 (or $300,000 together with their spouse)
in each of the two most recent years and they reasonably expect reaching the
same income level in the current year. <o:p></o:p></div>
<div class="MsoFootnoteText" style="text-align: justify;">
<br /></div>
<div class="MsoFootnoteText" style="text-align: justify;">
<i style="font-family: times;">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 <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i></div>
</div>
</div>
<!--EndFragment--></div>
Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-5132577171367182392019-03-21T11:48:00.001-04:002019-03-21T12:16:31.376-04:00Fundraising Startups and their Associated Persons - Can They Be Broker-Dealers?Continuing with the theme of broker-dealer registration, I now switch to the issuer safe harbor. As you know, a broker is "any person engaged in the business of effecting transactions in securities for the account of others." The key phrase here is "for the account of others". Since many startup companies cannot attract the attention of broker-dealers to help them secure funding, the companies do it themselves. Raising funds on the company's own behalf is not considered to be a broker-dealer activity. However, even if the issuer itself is not a broker, anyone working for it may be because they would be selling securities of the issuer for the account of the issuer, not their own. This brings into question the fundraising activities of issuer associated persons: its partners, officers, directors or employees. Note that <a href="https://www.law.cornell.edu/cfr/text/17/240.3a4-1" target="_blank">Rule 3a4-1(c)(1)</a> definition of "associated persons of the issuer" does not include independent contractors.<br />
<br />
Whether such persons have to register as broker-dealers depends on facts and circumstances of each case. In 1985, the SEC adopted <a href="https://www.law.cornell.edu/cfr/text/17/240.3a4-1" target="_blank">Rule 3a4-1</a> that acts as a narrow nonexclusive safe harbor for associated persons. Complying with the requirements of this Rule means that such associated person will not be required to register as a broker-dealer while engaging in fundraising activities. First, the person needs to meet <u>all three general requirements</u>:<br />
<ol>
<li>Not be subject to a statutory disqualification at the time of his participation; AND</li>
<li>Not be "compensated in connection with his participation by the payment of commissions or other remuneration based either directly or indirectly on transactions in securities"; AND</li>
<li>not at the time of his participation be an associated person of a broker or dealer (ie, its partner, officer, director or employee).</li>
</ol>
With respect to the second requirement, the SEC noted in the Proposing Release that "This prohibition is intended to preclude compensation arrangements which vary with or depend upon the success of the sale efforts by associated persons." This does not seem to prohibit compensating the associated person for the participation in the capital raise but precludes varying the amount of compensation based on the amount raised. One needs to be very careful with structuring the compensation of persons engaged in fundraising for the company.<br />
<br />
If the three general conditions are satisfied, the associated person then needs to meet <u>one of the following three criteria</u>:<br />
<ol>
<li>Participate only in transactions involving offers and sales of securities to institutional investors, including broker-dealers, banks, investment companies or in connection with mergers, asset sales or certain other transactions (not really applicable to startups) - Rule 3a4-1(a)(4)(i)(A, B, C, D); OR</li>
<li>Limit activities to (i) preparing written offering materials subject to approval by a partner, officer or director of the issuer, while not engaging in oral solicitation, (ii) responding to investor inquiries, provided that responses are limited to information in the offering document, or (iii) ministerial and clerical work in effecting the transaction; - Rule 3a4-1(a)(4)(iii); OR</li>
<li>Perform (throughout the offering or starting at the end of the offering) substantial duties on behalf of the issuer other than marketing the securities, provided that this person is not a broker-dealer or its associated person within the prior 12 months and does not participate in the sale of securities of the issuer more than once every 12 months - Rule 3a4-1(a)(4)(ii). </li>
</ol>
The issuer's founders, directors, officers, and employees would most likely rely on the third criterion when raising capital for their company. However, it is important to remember that such fundraising efforts cannot happen more than once every 12 month period and that their compensation cannot depend on the success of their fundraising activities.<br />
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As I previously mentioned, this Rule is a nonexclusive safe harbor. However, it is difficult to judge what activities would be permissible if you step outside of the strict confines of the Rule. The SEC has repeatedly brought actions against associated persons of the issuers for failure to register (although often in connection with other charges such as fraud).<br />
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In conclusion, all startup founders should carefully structure their fundraising efforts so that their team is not deemed to be unregistered broker-dealers.<br />
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<i style="font-family: times; text-align: justify;">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 <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i><br />
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Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-88003280298366187402019-03-12T16:20:00.000-04:002019-03-12T16:20:45.496-04:00International Brokers - Do They Have to Register with the SEC?Due to the globalization of business dealings, issues often arise with respect to the proper registration of foreign persons as "brokers" or "dealers" under the U.S. federal securities laws (colloquially referred to as "broker-dealers"). Sometime, it is a U.S. person soliciting outside of the United States. Other times, it is a non-U.S. resident who may be reaching out to the U.S. persons. Below is a brief analysis of how the U.S. federal registration requirements apply to such international brokers.<br />
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First, the basics. Section 15(a)(1) of the Securities Exchange Act of 1934 (the "Exchange Act") makes it unlawful for any "broker" or "dealer" to use interstate commerce to "effect any transactions in, or induce or attempt to induce the purchase or sale of, any security." The term "broker" is defined in Section 3(a)(4) of the Exchange Act to mean any "person engaged in the business of effecting transactions in securities for the account of others." Through numerous no-action letters, we know that the hallmarks of broker activity are: solicitation of potential investors, negotiation of deal terms, handling securities and/or funds, settling transactions, and receiving compensation that is tied to the success of the offering. Further, the courts look at whether this person is "in the business" of doing so, i.e., certain degree of regularity.<br />
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There are several exemptions to the registration requirements for municipal securities brokers, government securities brokers, associated persons of the issuer (more on this in the next blog post), and online investment portals. There is also a narrow common law exception for "finders" that with time has become so narrow that I am not certain it still exists.<br />
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<i>B-Ds located in the U.S.</i><br />
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The approach with respect to broker-dealers that are located in the United States but work only with foreign investors is unsettled. The SEC's general position was to require registration of broker-dealers physically located in the United States even if their activities were only directed at foreign investors located outside of the United States. This broad extraterritorial approach was limited by the U.S Supreme Court holding in <a href="https://www.supremecourt.gov/opinions/09pdf/08-1191.pdf" target="_blank">Morrison v. National Australia Bank Ltd.</a> in 2010, that held that Section 10(b) of the Exchange Act only applied to conduct in connection with the domestic securities transactions (note that the case was about a different section of the Exchange Act, but courts later extended the analysis to broker-dealer registration provisions). In particular, the Court held: "When a statute gives no clear indication of an extraterritorial application, it has none."<br />
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<a href="http://www.dodd-frank-act.us/Dodd_Frank_Act_Text_Section_929P.html" target="_blank">Section 929P of the Dodds-Frank Act</a>, enacted into law less than one month after the <i>Morrison</i> decision, supported the SEC extraterritorial approach by amending the Securities Act and the Exchange Act to provide that the U.S. courts have jurisdiction over "(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors, or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States." However, certain courts still applied the <i>Morrison</i> approach where the matters required interpretation of U.S. securities laws. For example, in <a href="http://business.cch.com/srd/SECvBenger15-a.pdf" target="_blank">SEC v Benger</a> (2013), the court held that the broker-dealer registration requirements did not apply to a person located in the United States that solicited foreign investors to invest into foreign securities. It was unclear how to reconcile the <i>Morrison</i> case with the Congressional intent until the Tenth Circuit's decision in <a href="https://law.justia.com/cases/federal/appellate-courts/ca10/17-4059/17-4059-2019-01-24.html" target="_blank">SEC v. Charles D. Scoville and Traffic Monsoon LLC</a> that just became available in January 2019. The heart of the case was the SEC civil enforcement action against defendants running a worldwide ponzi scheme. The Court affirmed that the SEC correctly used the conduct-and-effects test to reach a securities transaction outside of the United States. So, while the conduct-and effects test brought back by the Dodd-Frank Act will be used in governmental actions, as stated <a href="https://www.lexology.com/library/detail.aspx?g=6d3d0a85-a0f9-41f5-9bc0-ec310470fcd7" target="_blank">here</a>, private actions under the antifraud provisions will continue to be governed by the <i>Morrison</i> test. Another great analysis that supports the above can be found <a href="http://clsbluesky.law.columbia.edu/2017/04/11/proskauer-rose-discusses-the-secs-extraterritorial-reach/" target="_blank">here</a>.<br />
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<i>Foreign B-Ds located outside of the U.S.</i><br />
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Foreign brokers that operate outside of the United States generally have to register with the SEC if they use any interstate commerce to effect securities transactions with persons in the United States. This would include the use of the Internet and advertising materials. There are, however, several significant exceptions for this general rule codified in <a href="https://www.law.cornell.edu/cfr/text/17/240.15a-6" target="_blank">Rule 15a-6 under the Exchange Act</a>.<br />
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Although repeating the entire Rule here is beyond the scope of this blog post, I would like to draw your attention to several of its provisions. The first one exempts from registration requirements those foreign broker-dealers that engage in "unsolicited transactions" in the United States. As the SEC clarified in its <a href="https://www.sec.gov/divisions/marketreg/faq-15a-6-foreign-bd.htm" target="_blank">FAQ</a> (Question 9), there could be more than one such transaction. However, the focus should be on the foreign broker-dealer activities to determine whether solicitation had occurred. The SEC warned that it interprets "solicitation" broadly to include phone calls encouraging use of such broker-dealer's services, advertising materials, and trading recommendations.<br />
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Another exception allowed foreign broker-dealers to forego registration in the U.S. for direct solicitation of securities transactions (and the effecting of such transactions without involving a U.S. broker-dealer) so long as such solicitations were directed at foreign persons temporarily present in the United States. The SEC noted in <a href="https://www.sec.gov/divisions/marketreg/faq-15a-6-foreign-bd.htm" target="_blank">FAQ Question 1</a> that, although the question of "temporary presence" was a factual one, it was the overall intention of the SEC to exclude from the registration requirements those foreign broker-dealers who effected transactions with a foreign person located in the U.S. with whom they had a "bona fide, pre-existing relationship before the foreign person entered the U.S., so long as such person: (1) is not a U.S. citizen and (2) is not a lawful permanent resident of the U.S. (i.e., a “Green Card holder”)."<br />
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There are several more exemptions included in the Rule that are beyond the scope of this summary blog post.<br />
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In conclusion, as you can see, the broker-dealer registration requirements are quite complex as they apply to foreign broker-dealers soliciting and effecting transactions with U.S. persons or on U.S. soil. Foreign broker-dealers, whether they are in the U.S. or not, should carefully consider application of the U.S. securities laws to their broker-dealer activities as they interact with their clients.<br />
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<i style="font-family: times; text-align: justify;">This article is not legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. </i><br />
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Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-79192189362779996542018-11-08T17:41:00.000-05:002018-11-08T17:41:21.919-05:00Operating an Unregistered Digital Tokens Exchange is UnlawfulIt didn't come as a surprise that the SEC today <a href="https://www.sec.gov/news/press-release/2018-258" target="_blank">published</a> an <a href="https://www.sec.gov/litigation/admin/2018/34-84553.pdf" target="_blank">order</a> announcing a settlement of charges it brought against Zachary Coburn, the founder of EtherDelta, a digital token trading platform.<br />
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The SEC has in the recent past brought charges against token issuers for failing to register their token offerings or comply with an available exemption, as well as against platforms for failing to register as broker dealers. I previously wrote about them here and here. Today's SEC order is long overdue but is much needed. It sends a clear signal to the crypto industry that it is not outside of the existing regulations and that all crypto industry participants will be regulated to the extent required by the existing laws. The crypto exchanges should register just like the traditional exchanges or operate pursuant to an available exemption.<br />
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Beginning in July 2016, EtherDelta provided a platform for trading Ether and various digital tokens (about 50), as well as a smart contract that ran on the Ethereum blockchain that was coded to validate the order messages, confirm trade order terms and conditions, execute orders, and update the distributed ledger to reflect the trade. The website resembled an online securities trading platform. Users could enter orders to buy or sell specified quantities of any token at a specified price.<br />
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The platform continued its operations even after the SEC's <a href="https://www.sec.gov/litigation/investreport/34-81207.pdf" target="_blank">DAO Report</a> that was issued on July 25, 2017, where the SEC advised that a platform that provides secondary trading in digital tokens that are securities is required to register with the SEC as a national securities exchange (or be exempt from such regulations).<br />
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Although Zachary Coburn posted on Reddit that "his platform function[ed] just like a normal exchange]", it was "decentralized ... Centralized exchanges won't be able to show you verified business logic [in a publicly verified smart contract]". The decentralized nature of the exchange is not a new argument. Many of our prospective clients (which never became real clients) claimed that their contemplated crypto exchanges did not need to register due to their decentralized nature. <br />
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Section 5 of the Securities Act prohibits any exchange from effecting any transaction in a security unless registered with the SEC as a national securities exchange or operates pursuant to an exemption. An "exchange" is defined in <a href="https://www.law.cornell.edu/uscode/text/15/78c" target="_blank">Section 3(a)(1) of the Exchange Act</a> (and also the Exchange Act <a href="https://www.law.cornell.edu/cfr/text/17/240.3b-16" target="_blank">Rule 3b-16(a)</a>) that say that an exchange is "any organization, association, or group of persons, whether incorporated or unincorporated, which .... provides a market place or facilities for bringing together purchasers and sellers of securities...". One of the exemptions is for alternative trading systems (ATSs) that comply with Regulation ATS (they must, among other things, be registered as broker-dealers, file Form ATS with the SEC, and establish written safeguards and procedures for protecting users' confidential trading information).<br />
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The SEC found that "EtherDelta operated as a market place for bringing together the orders of multiple buyers and sellers in tokens that included securities" without registration or exemption, regardless of its decentralized nature. The SEC also found Coburn to be an active and integral part of EtherDelta who exercised complete control over its operations.<br />
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I assume that EtherDelta was never registered as a legal entity. However, its digital decentralized nature did not prevent the SEC from charging Coburn, the man behind the platform, for operating an unregistered exchange. <br />
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<i style="font-family: times; text-align: justify;">This article is not legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. Ms. Shulga is the co-founder of <a href="http://www.rsglobal.law/" target="_blank">Ross & Shulga PLLC</a>, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law.</i><br />
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Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-72012996445170504992018-10-21T09:45:00.000-04:002018-10-21T09:45:05.973-04:00Investment Funds Primer - Crypto Funds OverviewI was motivated to write this series of blog posts after attending the <a href="http://www.stern.nyu.edu/experience-stern/about/departments-centers-initiatives/interdisciplinary-initiatives/financial-technology-fintech/fintech-community/fintech-conference-2018" target="_blank">NYU Stern FinTech Conference</a>, where I led lunchtime discussion about crypto funds and investing. In this blog post, I aim to summarize what I see as the state of development of this recently new but quickly growing investment class. In the next blog post, I will try to explain the regulatory vacuum that allows (and explains) some of this proliferation.<br />
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First, let's talk about the statistics so we can understand the magnitude of what is happening. It is <a href="https://cryptofundresearch.com/cryptocurrency-funds-overview-infographic/" target="_blank">estimated</a> that currently there are 621 crypto funds around the world (a half of them being in the United States), 198 of which were launched in 2017 and a projected 220 in 2018. Roughly half of the crypto funds (303 out of 621) are small: they have less than $10 million AUM and less than 5 employees. 188 crypto funds have AUM between $10 million and $50 million, and only 37 funds have AUM of over $100 million (such as <a href="https://www.panteracapital.com/" target="_blank">Pantera Capital</a>, <a href="https://cryptofundlist.com/galaxy-digital-assets/" target="_blank">Galaxy Digital Assets</a>, <a href="https://www.alphabit.fund/" target="_blank">Alphabit Fund</a>, and <a href="http://fortune.com/2018/06/26/polychain-capital-bitcoin/" target="_blank">Polychain Capital</a>). So, to summarize, 621 crypto funds manage over $7.1 billion, and it is all done by less than 5,000 people globally (most of whom are located in the U.S.).<br />
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Now, let's talk about the crypto fund strategies. Crypto funds are private investment vehicles that raise money to invest into various types of crypto or digital assets. The <a href="https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/12-the-rise-of-the-crypto-asset-investment-fund-an-overview-of-the-crypto-fund-ecosystem" target="_blank">main categories</a> are crypto hedge funds and crypto venture capital funds. Crypto hedge funds act more like typical hedge funds: some actively trade cryptocurrencies on various exchanges, others adopt a buy and hold approach, some are passive index funds that invest in indices of top performing cryptocurrencies, yet others invest into crypto funds of funds, some are AI-driven quant funds that use machine learning to execute statistical arbitrage strategies, and some are token basket funds that invest into baskets of crypto assets. Crypto venture capital funds invest into ICOs, tokens, and equity of blockchain-related startups.<br />
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At this point I would like to briefly summarize the U.S. laws that apply to investment funds generally. There are no specific regulations yet that apply only to crypto funds. <br />
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The Securities Act of 1933 regulates the process of how the funds can raise investment capital. Onshore fund offerings are typically conducted in reliance on Regulation D under the Securities Act. Funds are also subject to the anti-fraud and insider trading regulations under the Securities Act and the Securities and Exchange Act of 1934. Their disclosures to investors may not contain false or incomplete information.<br />
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The Investment Company Act of 1940 (the "Company Act") <a href="https://www.law.cornell.edu/uscode/text/15/80a-3" target="_blank">regulates</a> trading activities of entities that "engage primarily, in the business of investing, reinvesting, or trading in securities" and are "investment companies." Most traditional hedge funds rely on exemption from the definition of "investment company" found either in Section 3(c)(1) or 3(c)(7) of the Act. This means that funds either cannot have more than 100 investors or all of investors have to be "qualified purchasers" - a much higher standard of wealth than what is required to be an accredited investor.<br />
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The Investment Advisers Act of 1940 (the "Advisers Act") r<a href="https://www.law.cornell.edu/uscode/text/15/80b-2" target="_blank">egulates</a> the fund managers that are in the "business of advising others . . . as to the value of securities or as to the advisability of investing, purchasing, or selling securities" and after the Dodd-Frank Act, generally requires them to register with either state agencies or with the SEC.<br />
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The Commodities Exchange Act (the "CEA") <a href="https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm" target="_blank">regulates</a> commodity swaps and other commodity derivatives and investment advisers that advise commodity pools.<br />
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As I will explain in the next blog post, some crypto funds escape from most of the current regulations because they do not invest into, or advise on, securities. The question of what is a "security" becomes paramount. Investing in commodities can place the crypto funds outside of regulation of the Company Act, the Advisers Act, and the CEA, thus significantly lowering barriers to crypto fund formation and management. This helps explain the growth phenomenon of the crypto funds.<br />
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<i style="font-family: times; text-align: justify;">This article is not legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its author <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a>. Ms. Shulga is the co-founder of <a href="http://www.rsglobal.law/" target="_blank">Ross & Shulga PLLC</a>, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law.</i><br />
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<br />Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0tag:blogger.com,1999:blog-306130308173238034.post-28453600704538959432018-10-09T17:18:00.000-04:002018-10-09T17:19:01.658-04:00Investment Funds Primer: Different Hedge Fund Structures. Part I of ManyAs our investment fund practice expands, we have decided to post a series of blogs relating to the basics of hedge fund and private equity fund structuring issues and considerations. <br />
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<b>What is a hedge fund</b>? <br />
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Hedge funds are often unfairly confused with hedging. “Hedging” is the practice of attempting to reduce risk (similar to getting an insurance), but the goal of most hedge funds is to maximize return on investment. Hedge funds are also often confused with private equity funds. Hedge funds generally invest in publicly traded securities and derivative instruments. Their portfolios can be marked to market. Investors can at any time invest into the funds as well as redeem their interests (subject to limitations, of course). Some hedge funds do invest a portion of their assets in illiquid securities though “side pockets,” but those are less common. Private equity funds, on the other hand, invest in securities of private companies, and therefore are much less liquid. They place significant restrictions on the investors’ ability to invest (only during the subscription period) and exit the fund (mostly only at the expiration of the fund’s term that can be as long as ten years). <br />
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<b>Hedge fund structures </b><br />
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<u>Single domestic fund</u>. A stand-along domestic fund is typically a Delaware limited partnership or a Delaware limited liability company. The investors become its members, and the investment managers acts as the fund’s manager or general partner. If the fund is set up as an LLC, the manager receives limited liability protection as a manager of the company, whereas if the fund is set up as an LP, it does not. Therefore, to limit personal liability of the investment manager, it is important to establish a separate investment management entity as an LLC. <br />
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In cases where the investment manager will manage only one fund, the investment manager may also act as a general partner of the LP / manager of the LLC. Alternatively, the investment manager may act through its own entity advising various funds. In such case, it becomes necessary for the fund to enter into an investment management contract with the investment manager, in addition to having it or another entity be the general partner / manager of the fund. <br />
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<u> Fund of funds</u>. These structures have recently become very popular. Funds of funds are investment vehicles that, instead of investing into securities or other assets, invest into other hedge funds, private equity funds, or other type of funds. Some funds invest across a broad spectrum of assets, including hedge funds, private equity funds, venture capital funds, and real estate funds. Funds of funds provide for maximum diversification of investment and therefore spearing of the risk, as each “portfolio” fund itself invests in multiple assets or securities. It is also easier to invest into funds of funds, as the investment manager can rely on the due diligence done by the managers of the portfolio funds. Further, investing into funds of funds allows investors access to those funds that have high minimum investment amount, thus excluding smaller investors. Note that investing into funds of funds may be more expensive, since the fund of funds’ management fee is layered on top of the management fees of each portfolio fund. It is of course possible for the funds of funds to make direct investments into the underlying funds’ securities in addition to the underlying funds themselves. <br />
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<u> Parallel funds</u>. Parallel funds typically involve an onshore fund and an offshore fund that invest directly into the underlying portfolio of assets. The onshore fund has a general partner that itself is a pass-through entity for U.S. federal income tax purposes. The onshore fund pays management fees to the management company and makes an incentive allocation to the general partner. The offshore fund will also pay management fees to the management company, but will also pay an incentive fee to it. Such management company is typically an affiliate of the general partner. Recent tax changes (2008) disallowed the management company to defer the time of the receipt of the incentive fee from the offshore fund, and therefore some offshore funds have created mini-master funds descried below. <br />
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The parallel fund structure allows funds to invest differently in the underlying portfolio due to tax or regulatory considerations, although the objective is for the underlying portfolios to be identical. <br />
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<u>Master-feeder funds</u>. In a master-feeder structure, each of the onshore and the offshore feeder funds hold an interest in an entity that is treated as a partnership for U.S. federal income tax purposes, the master fund. The master fund invests into the underlying portfolio of assets. Investors in the onshore and the offshore feeders participate in exactly the same investments, and have the same compensation arrangements for the fund managers. In some master-feeder funds, the master fund makes an incentive allocation to its general partner or managing member and pays the management fee to the management company. It is also possible that each of the feeder funds pays a management fee to the management company, and the onshore feeder makes an incentive allocation to its general partner, whereas the offshore fund pays an incentive fee to a management company that is an affiliate of the general partner of the onshore fund. However, as we mentioned above, this structure is no longer common.<br />
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Frequency of redemption requests at the feeder fund level must correspond to the frequency allowed by the master fund, since the money is invested by the master fund and the feeder would need to redeem some of its interest in the master fund in order to meet the redemption request at the feeder fund level. <br />
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Typically, the master fund would have a limited number of partners: only the general partner, the onshore feeder, and the offshore feeder. <br />
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<u> Parallel funds with mini-master</u>. In this structure, the onshore fund has the same structure as in the parallel funds structure described above. The offshore fund structure, however, has changes. Since it will be treated as a corporation for U.S. federal income tax purposes, it cannot make incentive allocations. So instead it pays an incentive fee to the management company. Due to the elimination of deferral fee arrangements in 2008, some investment managers have modified this by adding a mini-master structure. <br />
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In the mini-master structure, the offshore fund is the sole limited partner in a partnership (mini-master) and the general partner of the mini-master is the same as the general partner of the onshore fund or its affiliate. This allows the offshore fund to make incentive allocation to its general partner. <br />
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Of course, these are the most basic structures, and in real life, they are much more complicated. But we thought we would start our fund blog series with the basics.<br />
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In the next blog post, we will describe the types of investors that invest into such funds, and the legal considerations involved in dealing with different types of investors. In the later blog posts, we will describe how to set up funds (again, from the legal perspective), and what laws and regulations apply to the funds and the fund managers. <br />
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<i style="font-family: times; text-align: justify;">This article is not legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to <a href="mailto:arina@rsglobal.law" target="_blank">contact</a> its authors <a href="https://www.linkedin.com/in/arinashulga/" target="_blank">Arina Shulga</a> or <a href="http://www.rsglobal.law/attorneys-team/kristina-subbotina/" target="_blank">Kristina Subbotina</a>. Ms. Shulga is the co-founder of <a href="http://www.rsglobal.law/" target="_blank">Ross & Shulga PLLC</a>, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law.</i></div>
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Arina Shulgahttp://www.blogger.com/profile/00341717363159207169noreply@blogger.com0