Those of you who work with investment funds will agree with me that this news is worth a separate blog posting. The Economic Growth, Regulatory Relief and Consumer Protection Act (the "Act") became law on May 24th, 2018. The Act significantly amends the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. There are many many changes to discuss, but my blog post will focus on just one change that is of importance to our private fund clients: venture capital funds with less than $10 million in capital commitments can have up to 250 investors and still rely on the exemption from the definition of "investment company" found in Section 3(c)(1) of the Investment Company Act.
Just to be clear, the old version of Section 3(c)(1) said that "any issuer whose outstanding securities are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of securities" would not be an "investment company" under the Investment Company Act.
Although simple on its face, the exemption actually contains a quite complicated method of calculating beneficial owners of securities, requiring to "look through" the record ownership of each potential purchaser. Also, all investors had (and still have) to be "accredited investors" under the Securities Act.
The new Section 3(c)(1) adds "(or, in the case of a qualifying venture capital fund, 250 persons)" after the words "one hundred persons" and at the end the following: "The term "qualifying venture capital fund" means a venture capital fund that has not more than $10,000,000 in aggregate capital contributions and uncalled committed capital ...".
This is an important change. For years, in order to be exempt from the provisions of the Investment Company Act, private funds relied on one of two available exemptions: Section 3(c)(1) that allowed only up to 100 "accredited investors" or Section 3(c)(7) that allows for unlimited number of "qualified purchasers", which is a much higher standard than "accredited investors". Under Section 2(a)(51) of the Investment Company Act, a "qualified purchaser" is, among others, a person with at least $5 million in investments, a company with at least $5 million in investments owned by close family members, or a company that has at least $25 million of investments. Given that the "qualified purchaser" is a much higher standard to meet, the private funds were typically constrained by the 100 "accredited investors" limitation in Section 3(c)(1).
The increased limit allows funds to have more investors, which means that the venture capital funds can now lower the minimum subscription amounts. This would attract more investors, and therefore facilitate the capital raising process.
However, note that this change applies only to venture capital funds, which is not a defined term in the Investment Company Act. However, a definition of a "venture capital fund" can be found in Rule 203(l)-1 promulgated by the SEC under the Investment Advisers Act. Is this the definition that should be used for the purposes of Section 3(c)(1) of the Investment Company Act? Does it mean that hedge funds that are private funds relying on the 3(c)(1) exemption are still limited to 100 investors?
Although some unanswered questions remain, I generally welcome this change because it aims to facilitate capital raising on the part of the VC funds, and consequently, by start-ups.
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 contact its author, Arina Shulga. Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law. She is also a member of Wall Street Blockchain Alliance.
Thursday, May 31, 2018
Monday, May 28, 2018
There are No Such Things as "Free" Airdrops
Recently, as the digital asset industry is coming to terms with the increased regulatory scrutiny of the initial coin offerings, airdropping of tokens to US persons has gained popularity. The main appeal, apart from the technological ability to widespread the tokens in no time, is the argument that since the tokens are "airdropped" for free, there is no sale of "securities" taking place, and therefore, there is no need to comply with the US securities laws.
Well, I am sorry to disappoint you, but this is a wrong argument to make. The US securities attorneys will point you to the 1999 SEC release that came out as a result of the so-called "free stock" offerings over the Internet in the late 1990s, well before such concepts of "airdrops" and "digital assets" became household words. The SEC then brought four enforcement actions against promoters and companies who offered and distributed free stock because they failed to properly register such offerings or qualify them for applicable exemptions.
The SEC Enforcement Director said "Free stock is really a misnomer... . While cash did not change hands, the companies that issued the stock received valuable benefits. Under these circumstances, the securities laws entitle investors to full and fair disclosure ... ."
The release then explains: "In each of the four cases, the investors were required to sign up with the issuers' web sites and disclose valuable personal information in order to obtain shares. Free stock recipients were also offered extra shares, in some cases, for soliciting additional investors or, in other cases, for linking their own websites to those of an issuer or purchasing services offered through an issuer. Through these techniques, issuers received value by spawning a fledgling public market for their shares, increasing their business, creating publicity, increasing traffic to their websites, and, in two cases, generating possible interest in projected public offerings."
As you can see, there is really no such thing as "free" distribution of securities, including digital assets. Even if money does not change hands, issuers that are conducting airdrops are receiving something else that is perhaps more valuable to them at the time: marketing, publicity, visibility, customer base.
Therefore, issuers that are conducting similar free token giveaways should ask themselves a question whether they expect to derive ANY benefits or value from doing this? Would they be doing the airdrops at all if no benefit or value was expected? If the answer is "yes, they expect to receive certain value," then these tokens should be treated as "securities" and be available (even if free of charge) only to verified accredited investors or in a way that is compliant with another available exemption from the registration requirements of the Securities Act.
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 contact its author, Arina Shulga. Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law. She is also a member of Wall Street Blockchain Alliance.
Well, I am sorry to disappoint you, but this is a wrong argument to make. The US securities attorneys will point you to the 1999 SEC release that came out as a result of the so-called "free stock" offerings over the Internet in the late 1990s, well before such concepts of "airdrops" and "digital assets" became household words. The SEC then brought four enforcement actions against promoters and companies who offered and distributed free stock because they failed to properly register such offerings or qualify them for applicable exemptions.
The SEC Enforcement Director said "Free stock is really a misnomer... . While cash did not change hands, the companies that issued the stock received valuable benefits. Under these circumstances, the securities laws entitle investors to full and fair disclosure ... ."
The release then explains: "In each of the four cases, the investors were required to sign up with the issuers' web sites and disclose valuable personal information in order to obtain shares. Free stock recipients were also offered extra shares, in some cases, for soliciting additional investors or, in other cases, for linking their own websites to those of an issuer or purchasing services offered through an issuer. Through these techniques, issuers received value by spawning a fledgling public market for their shares, increasing their business, creating publicity, increasing traffic to their websites, and, in two cases, generating possible interest in projected public offerings."
As you can see, there is really no such thing as "free" distribution of securities, including digital assets. Even if money does not change hands, issuers that are conducting airdrops are receiving something else that is perhaps more valuable to them at the time: marketing, publicity, visibility, customer base.
Therefore, issuers that are conducting similar free token giveaways should ask themselves a question whether they expect to derive ANY benefits or value from doing this? Would they be doing the airdrops at all if no benefit or value was expected? If the answer is "yes, they expect to receive certain value," then these tokens should be treated as "securities" and be available (even if free of charge) only to verified accredited investors or in a way that is compliant with another available exemption from the registration requirements of the Securities Act.
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 contact its author, Arina Shulga. Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law. She is also a member of Wall Street Blockchain Alliance.
Friday, February 16, 2018
State Securities Regulators Crack Down on Crypto
In recent months, the Securities and Exchange Commission (the “SEC”) and the Commodity Futures Trading Commission (the “CFTC”) have issued warnings to those involved in cryptocurrencies, initial coin offerings, and token generation events. Following the lead of the federal regulators, the state securities regulators have halted certain offerings of cryptocurrency and initial coin offerings citing fraudulent activity as chief among their concerns.
On January 24, 2018, the Texas State Securities Board (the “TSSB”) prevented a “global cryptocurrency” from being offered to Texas residents in what the TSSB considered to be an offering of unregistered securities. Note that R2B Coin was a resident of Hong Kong, and its manager was an entity domiciled in Hong Kong and Dubai. R2B Coin promoters claimed that their coin would become one of the leading, most stable and most usable cryptocurrencies in the world. The Texas residents were solicited by being invited to participate in the USA Conference Calls and through the defendants’ website. The TSSB found that the R2B Coins were not registered or qualified in Texas and the defendant was not registered as a dealer with the SEC. Further, the TSSB found that the defendant engaged in fraud in connection with the offer and made misleading and deceptive statements. It is interesting to note that there is no direct connection between Texas and the defendants, other than the website offering accessible by everyone and the invitation to join one of the USA Conference Calls.
On February 9, 2018, the Attorney General for the State of New Jersey issued a cease and desist order against BitsTrade, an investment pool guaranteeing profits. The Attorney General found that the investment in the investment pool was a security and that BitsTrade failed to register itself as a broker-dealer under the New Jersey Uniform Securities Laws. Again, BitsTrade had no connection to New Jersey, other than the fact that BitsTrade had a website accessible by anyone. It is unclear whether any New Jersey residents invested into BitsTrade. Regardless of the connection, the NJ Attorney General concluded that the BitsTrade Investment was an unregistered security; BitsTrade was not registered in NJ as a broker-dealer; and it engaged in fraud by omitting to provide all of the material information regarding the company and the offering to the prospective investors.
Finally, a class action lawsuit was brought to the U.S. District Court of the Middle District of Florida against BitConnect, the crypto-lending and exchange platform that recently shut down as a result of what many believe to be a failed ponzi scheme. This lawsuit makes it BitConnect’s fifth class-action lawsuit in the U.S and the third in the State of Florida.
On January 24, 2018, the Texas State Securities Board (the “TSSB”) prevented a “global cryptocurrency” from being offered to Texas residents in what the TSSB considered to be an offering of unregistered securities. Note that R2B Coin was a resident of Hong Kong, and its manager was an entity domiciled in Hong Kong and Dubai. R2B Coin promoters claimed that their coin would become one of the leading, most stable and most usable cryptocurrencies in the world. The Texas residents were solicited by being invited to participate in the USA Conference Calls and through the defendants’ website. The TSSB found that the R2B Coins were not registered or qualified in Texas and the defendant was not registered as a dealer with the SEC. Further, the TSSB found that the defendant engaged in fraud in connection with the offer and made misleading and deceptive statements. It is interesting to note that there is no direct connection between Texas and the defendants, other than the website offering accessible by everyone and the invitation to join one of the USA Conference Calls.
On February 9, 2018, the Attorney General for the State of New Jersey issued a cease and desist order against BitsTrade, an investment pool guaranteeing profits. The Attorney General found that the investment in the investment pool was a security and that BitsTrade failed to register itself as a broker-dealer under the New Jersey Uniform Securities Laws. Again, BitsTrade had no connection to New Jersey, other than the fact that BitsTrade had a website accessible by anyone. It is unclear whether any New Jersey residents invested into BitsTrade. Regardless of the connection, the NJ Attorney General concluded that the BitsTrade Investment was an unregistered security; BitsTrade was not registered in NJ as a broker-dealer; and it engaged in fraud by omitting to provide all of the material information regarding the company and the offering to the prospective investors.
Finally, a class action lawsuit was brought to the U.S. District Court of the Middle District of Florida against BitConnect, the crypto-lending and exchange platform that recently shut down as a result of what many believe to be a failed ponzi scheme. This lawsuit makes it BitConnect’s fifth class-action lawsuit in the U.S and the third in the State of Florida.
All of the aforementioned cases come on the heels of the Massachusetts Securities Division ordering Caviar to cease operations and the TSSB ordering AriseBank to cease operations.
State securities regulators are becoming more active and it is causing concern for an industry trying to fit the square peg of ICOs into the round hole of state and federal regulations. But the recent actions taken by state securities regulators shed light on areas that future ICO issuers should be aware of. Aside from the obvious recommendation to be accurate and avoid materially misleading statements, the following guidance has also been highlighted in several of the aforementioned cases:
State securities regulators are becoming more active and it is causing concern for an industry trying to fit the square peg of ICOs into the round hole of state and federal regulations. But the recent actions taken by state securities regulators shed light on areas that future ICO issuers should be aware of. Aside from the obvious recommendation to be accurate and avoid materially misleading statements, the following guidance has also been highlighted in several of the aforementioned cases:
- Conduct a “blue sky laws” analysis of the ICO and make notice filings or other relevant applications in the states where the company is headquartered and resident states of all investors (note that New York requires pre-filing);
- Disclose the true identity and qualifications of the issuer’s principals;
- Provide full and accurate disclosure about the issuer and the offering. Avoid grandiose claims or determinative forward-looking statements of investment growth, such as using the phrase “guaranteed” or “outstanding returns”;
- Avoid using adjectives that subjectively tout the ICO, including words like “best”; and
- Avoid inadvertently acting as a broker-dealer and transacting in securities without being properly licensed.
This article is not a 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 contact its authors, Andrew Silvia and Arina Shulga. Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law.
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