U.S. Securities & Exchange Commission (SEC)

BitcoinOur colleague Kristen Howell has published an alert reporting on an important development in the cryptocurrency industry. The U.S. Securities and Exchange Commission has declared that Bitcoin, Ethereum and other coins operating on truly decentralized platforms are not securities. The agency’s reasoning was revealed in remarks by William Hinman, Director of the SEC’s Division of Corporate Finance, at the Yahoo Finance “All Markets Summit: Crypto” on June 14. Hinman explained that since the value of cryptocurrency is not based on the expectation of profits resulting from the success or failure of the issuer, it does not compare to a typical security. You can read Kristen’s alert on the Fox Rothschild website.

Startups represented by seedling growthFor early-stage companies in need of capital, finding potential investors can be difficult and time-consuming, especially when conditions in the capital markets are tight. For many companies, using a “finder,” an individual or entity that identifies, introduces and negotiates with potential investors, to help locate potential investors may seem to be a promising solution to this problem. However, there are risks involved in using finders, including those arising from potential violations of the SEC’s broker-dealer registration requirements. These risks are significant and, as investors become increasingly wary of the potential consequences, could threaten a company’s ability to raise capital in the future and its prospects for long-term growth and success. Finders operating as unregistered broker-dealers also face significant risks, including the possibility of severe SEC sanctions.

On April 12 at the ABA Business Law Section Spring 2018 Meeting in Orlando, Fox partner Emily Yukich and associate Matt Kittay, as well as Martin Hewitt, prominent New Jersey attorney and chair of the ABA’s Committee on State Regulation of Securities, will provide an in-depth CLE presentation on these risks. They will discuss the main risks finders face when acting as an unregistered broker-dealer, cover a critical SEC No Action Letter on the topic (the M&A Broker Letter), and will look at certain state regimes in applying the general prohibitions and restrictions in place.

The program will take place from 9:00 AM to 10:00 AM at the Rosen Shingle Creek in Orlando.  If you’d like to attend, please register for the Spring Meeting on the ABA’s website.

Over $1.5 billion has been raised by token offerings – also known as initial coin offerings or ICOs – so far in 2017. Not surprisingly, many startups are eager to capitalize on this possible funding source.

Initial Coin Offering (ICO) concept illustrationAlthough ICOs can be a useful method of raising capital, a number of legal issues must be considered in structuring and completing an ICO. One such issue is whether the tokens being offered in an ICO will be considered securities. A report issued by the SEC late this summer highlights the issue.

The SEC’s report was related to a token offering by an organization called The DAO. In its report, the SEC concluded that the tokens issued by The DAO were securities. Prior to the issuance of the SEC’s report, some advisors were telling startups that ICOs would not raise the same sort of securities concerns as traditional capital raises. Although the SEC has not issued formal guidance or regulations in this area, the report makes it clear that at least some tokens will be considered securities and that some platforms will be considered securities exchanges.

Many practitioners argue that there is a distinction between “security tokens” (designed to raise capital) and “utility tokens” (designed with some functionality and not purely to raise capital). The analysis in determining whether a token is a utility token is complex. Some tokens with utility characteristics may even be securities.

The law surrounding ICOs and the treatment of tokens is still evolving. Startups wishing to purse an ICO should seek legal advice early in the process. The danger of not doing so can be dramatic – since the date of the SEC’s report, at least one ICO was cut short after the SEC launched an inquiry into the ICO. The founders had not considered securities implications of conducting the ICO and ultimately decided to refund the funds raised to investors.


On April 5, the Division of Corporate Finance of the Securities and Exchange Commission released two new compliance and disclosure interpretations (“C&DIs”) regarding Regulation Crowdfunding.  Regulation Crowdfunding was adopted in 2015 in order to implement the provisions of Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012 that exempt certain crowdfunding transactions from registration under the Securities Act of 1933.

Copyright: yupiramos / 123RF Stock Photo

The first new C&DI addresses the disclosure requirements of Rule 201, and specifically the related party disclosure requirements of Rule 201(r).  Rule 201(r) requires that in connection with a crowdfunding offering, a crowdfunding issuer must disclose and describe any related party transactions that are currently proposed or that occurred since the beginning of the issuer’s last fiscal year in which the amount involved is greater than 5% of the total amount that the issuer raised under the crowdfunding exemption over the previous 12 months, including the amount proposed to be raised in the current offering.

C&DI Question 201.02 clarified that for purposes of this requirement, crowdfunding issuers should calculate the 5% threshold for disclosure of related party transactions based on the target offering amount plus the amount already raised during the previous 12 months, even if the issuer indicates that it will accept offering proceeds in excess of the target offering amount. In other words, the possibility of accepting additional offering proceeds in excess of the target offering amount should be disregarded for purposes of calculating the 5% threshold for disclosure.

The second C&DI released by the Division of Corporate Finance clarifies Rule 202(b)(2), which provides that an issuer is no longer required to comply with the ongoing reporting requirements of Rule 202 once the issuer has filed at least one annual report pursuant to Rule 202 and has fewer than 300 shareholders of record.

C&DI Question 202.01 provides that, when calculating the number of shareholders of record for purposes of Rule 202(b)(2), the issuer is required to count all shareholders of the same class of securities issued in the crowdfunding offering, even if some of those shareholders did not obtain such securities in connection with the crowdfunding offering.

The full text of the two new C&DIs described above, along with all previously released C&DIs regarding Regulation Crowfunding, can be found on the SEC’s website.  In addition, an overview of the Regulation Crowdfunding rules can be found in this earlier Emerging Companies Insider post.

Two states have brought legal action against the U.S. Securities and Exchange Commission (SEC) for exceeding the authority granted to it under the Jumpstart Our Business Startups (JOBS) Act. Massachusetts and Montana, which initiated the lawsuit at the behest of the North American Securities Administrators Association, believe that the SEC exceeded its authority in issuing the rules known as Reg A+ in 2015.

Copyright: / 123RF Stock Photo

Massachusetts Secretary William Galvin and Montana State Auditor Monica Lindeen oppose the aspects of Reg A+ that lift state securities registration requirements, known as blue sky laws. They argue that the SEC went beyond its authority and encroached upon an area of the law traditionally reserved to the states. Galvin, in particular, who submitted two sets of comments in 2013 and 2014 before the SEC voted on the new rules in March of 2015, argues that this form of state law preemption contradicts congressional intent and puts investors at risk.

Most observers believe that the lawsuit brought by Massachusetts and Montana lacks substantive merit if one focuses on the investor protections built into Reg A+. Nonetheless, given the relative youth and novelty of Reg A+, the litigation may serve to temper enthusiasm for the new rule, at least temporarily. It is unclear when the Court of Appeals will issue its ruling.

The SEC recently gave its blessing to a marriage of old and new:  traditional private placements conducted via the Internet. In doing so it lifted the veil on how VC firms can create “pre-existing, substantive relationships” with initially anonymous web-based investors.

Copyright: karenr / 123RF Stock Photo
Copyright: karenr / 123RF Stock Photo

Something Old:  Three years ago the JOBS Act lifted the long-standing prohibition on “advertising or broadly soliciting interests in privately held securities.” However, for a variety of reasons firms and issuers generally prefer the tried and true approach, a private sale of securities known as a 506(b) offering. To qualify for the 506(b) safe harbor, the offering cannot include a general solicitation and general advertising. But if issuers can show a “pre-existing, substantive relationship” with the prospective investor, the offering is not considered a general solicitation or advertisement.

Something New:  Enter the modern, “Add to Cart, Click” anonymity of the Internet. Potential investors from around the world are just a Google search away from a VC firm’s web-based portfolio, creating opportunity…and risk. How does a VC firm take advantage of an online platform and still establish a pre-existing, substantive relationship with prospects?

Catch Me a Catch…But How?:  In a recent no-action letter, Citizen VC, the SEC’s Division of Corporation Finance helped bridge the gap. Citizen VC, Inc. is an online venture capital firm that facilitates through its website indirect investment in private companies from seed to late-stage. In a letter to the SEC, Citizen VC outlined its procedures for developing pre-existing, substantive relationships with its online investors, and the SEC did not disagree with its methods.

Citizen VC set forth a two-step process for establishing pre-existing, substantive relationships. First, visitors to Citizen VC’s password-protected site must register and be accepted for membership. Prospects complete a generic online “accredited investor” questionnaire.  Depending on its evaluation of the questionnaire, Citizen VC will initiate the “relationship establishment period,” which is not limited to a specific time period.  According to Citizen VC, this period is a “process based on specific written policies and procedures created to ensure that the offering of Interests is suitable for each prospective investor.” (Citizen VC, Inc., Incoming Letter p.2). Citizen VC connects with and collects information from prospects in a variety of ways, assessing each prospect’s sophistication, financial circumstances, and ability to comprehend investments and their risks. Citizen VC’s relationship-building activities include:

  1. offline telephone introductions and conversations to discuss investing experience, goals and strategies, financial suitability, awareness of risks and other matters;
  2. an introductory email;
  3. online interaction to answer questions about Citizen VC, its website and its investments;
  4. confirming a prospect’s identity and gathering financial information and credit history using third party services;
  5. encouraging the prospect to review the website and ask questions regarding investment strategy, philosophy and objectives; and
  6. fostering online and offline contacts between the prospect and Citizen VC.

Prospects are finally admitted as members when Citizen VC determines that “(i) the prospective investor has sufficient knowledge and experience in financial and business matters to enable it to evaluate the merits and risks of the investment opportunities on the [website], and (ii) it has taken all reasonable steps it believes necessary to create a substantive relationship with the prospective investor.” (Citizen VC, Inc., Incoming Letter p.3)

Specifically, the SEC agreed with Citizen VC that the most important factor when determining whether a “substantive” relationship exists is the “quality” of the relationship between the issuer and the investor. It also agreed that issuers cannot rely on a specific duration of time or particular short form accreditation questionnaire to establish such a substantive relationship.

Citizen VC shows that building the right relationship between issuer and investor is a process of communication and evaluation at multiple steps. Matchmakers looking to bring investors and portfolio companies together online now have greater certainty of how to structure their activities to satisfy the 506(b) safe harbor.

JR Lanis writes:

The Securities and Exchange Commission has issued new rules, termed Regulation A+, which were promulgated under Section 401 of the 2012 Jumpstart Our Business Startups Act, also known as the JOBS Act, which expand upon the previous Regulation A. The new rules ease securities laws to allow smaller and independent investors to engage in the rapidly expanding equity crowdfunding market. These equity-based crowdfunding platforms are different from other “social’ crowdfunding websites, such as Kickstarter, which offer backers non-equity based incentives to participate.

Copyright: qingwa / 123RF Stock Photo
Copyright: qingwa / 123RF Stock Photo

Previously, only accredited investors—generally defined as individuals who earn over $200,000 in income or who have $1 million in assets (excluding their primary residence)—were permitted to purchase shares in private companies through equity crowdfunding. Accredited investors make up less than 1% of the U.S. population, severely limiting those who could invest.  Traditionally, the other 99% of investors had to wait for a company’s initial public offering to purchase its stock. This protected less sophisticated investors from the risks inherent in early stage investments, but it also meant that most Americans were prevented from getting in “on the ground floor” of the next Facebook or Google.

Regulation A+ creates two new tiers of exempted filings for issuers that would have been ineligible under the previous Regulation A rules. Tier 1 provides an exemption for securities offerings of $20 million or less, annually. These offerings will be available to accredited and unaccredited investors without restriction. Tier 2 provides an exemption for securities offerings of $50 million or less, annually. Accredited investors may purchase securities in Tier 2 offerings without limit. However, unaccredited investors are limited to 10% of the greater of their annual revenue or net assets.

As the SEC democratizes the equity crowdfunding market with Regulation A+, it is also implementing new regulations to increase protections for these new investors. Most notably, an issuer in Tier 2 will be required to submit audited two-year financial statements to the SEC.  Tier 1 filers generally need only provide an unaudited balance sheet and income statement for two years. Some experts believe that Regulation A+ will primarily help startups that have exhausted their ability to raise “seed” money.

Regulation A+ affords the general public the opportunity for outsized gains previously only available to accredited investors. It also means that early stage companies have additional sources of capital available to them. However, first-time investors should remember that returns are not guaranteed. For every Uber and Snapchat, there are countless companies that do not survive.

Alan A. “JR” Lanis, Jr., is a partner in Fox Rothschild’s Los Angeles (Century City) office.

JR Lanis writes:

The Securities and Exchange Commission has announced new Lesbian, Gay, Bisexual, and Transgender (LGBT) inclusive interpretations of the terms “spouse” and “marriage.”  This update brings SEC regulations into compliance with the Supreme Court’s decision in United States v. Windsor, which struck down the Defense of Marriage Act’s exclusion of lawfully wedded same-sex couples from federal recognition.

Copyright: tonobalaguer / 123RF Stock Photo
Copyright: tonobalaguer / 123RF Stock Photo

The succinct SEC order states that the Commission will read the term “spouse” to include “an individual married to a person of the same sex if the couple is lawfully married under state law, regardless of the individual’s domicile,” and the term “marriage” to include “a marriage between individuals of the same sex.”  These new definitions apply to the federal securities statutes administered by the SEC, the rules and regulations promulgated under those statutes, releases, orders, and any guidance issued by the staff or the SEC.  Full text of the order can be found here.

The SEC has lagged almost two years behind numerous other federal agencies that updated their regulations after the Windsor decision was announced on June 26, 2013.  In August 2013, the Treasury Department and the Internal Revenue Service issued orders recognizing legally married same-sex couples as married for federal tax purposes.

The SEC made this announcement one week before the Supreme Court decided in Obergefell v. Hodges that the 14th Amendment requires all states to issue marriage licenses to same-sex couples.  This landmark ruling only strengthens the Windsor ruling and will likely precipitate similar decisions from other agencies to make their regulations more LGBT-inclusive.

Alan A. “JR” Lanis, Jr., is a partner in Fox Rothschild’s Los Angeles (Century City) office.

Big and small dogs.
Copyright: / 123RF Stock Photo

At an open meeting on March 25, 2015, the SEC adopted final rules to facilitate smaller companies’ access to capital via update and expansion of Regulation A, summarized in this press release.

A Two-Tier Approach

One core feature of the new rules is the establishment of a tiered system for these so-called “mini-IPO” style offerings, which will allow non-accredited investors to participate in two types of offerings:

  • Tier 1, for offerings that raise up to $20 million in proceeds in a 12-month period, including no more than $6 million of securities sold on behalf of selling securityholders; and
  • Tier 2, for offerings that raise up to $50 million in proceeds, including no more than $15 million of securities sold on behalf of selling securityholders.

Eligibility Requirements and Offering Restrictions

Although the new rules provide companies and investors with a powerful option for fundraises alongside Regulation D / Rule 506 offerings (see here for a helpful Reg. A / Reg. D comparison chart by Kiran Lingam of SeedInvest), there are various restrictions to the regime, including:

  • The final rule will include a limitation on the overall amount of securities that may be sold on behalf of selling securityholders.
  • The exemption will not be available to certain bad actors and to other entities, such as investment companies.
  • Tier 2 will require the issuer to provide audited financial statements, file regular and special event reports, and limit the amount of securities non-accredited investors can purchase in a Tier 2 offering.

Industry response has been generally positive, recognizing that the new rule will permit smaller and emerging companies to have an opportunity to raise substantial capital.

The new rules should be effective 60 days after publication in the Federal Register.