Experienced STO Team
Are you preparing to launch an STO? Are you worried about running afoul of various federal compliance obligations? If so, then you need a comprehensive compliance review by our Blockchain Compliance Team.
STOs stand for security-token offering. These offerings involve digitalized securities offered to the public on blockchain technology in order to develop a project.
STOs differ from IPOs in that STOs involve digital assets stored on the blockchain. Both IPOs and STOs entail ownership interests and sometimes voting rights and rights to dividends.
That said, because STOs involve novel technology, federal agencies have taken up the task of investigating companies issuing these “security tokens.” Do not let your project get dragged into a protracted investigation without ensuring your compliance.
At Oberheiden, P.C., we have a knowledgeable and dedicated Blockchain Compliance Team that is eager to evaluate your project for potential compliance issues under federal law.
Do not launch a project without having an attorney review your platform, coin and token, and business structure.
Put Oberheiden, P.C. on your side today to resolve your uncertainty.
STOs and Security Tokens versus ICOs and Utility Tokens
Both STOs and ICOs involve offerings of tokens on blockchain technology to fund a platform or other company project. But there are many differences.
To start, an STO issues security tokens, while an ICO issues utility tokens. STOs must register with the SEC or be exempted. This is important because STOs are securities—digital securities—and must therefore follow all the formalities of a traditional security.
Because ICOs offer what´s called utility tokens and because utility tokens are not “securities,” they do not need to be registered or exempted.
ICOs actually developed first after blockchain technology and smart contract applications began to take hold. However, ICOs were not registered and did not need to follow SEC rules and regulations.
Many ICOs were riddled with fraud and misrepresentations, causing the SEC to take an aggressive stance against ICO issuers and developers.
As a response, STOs were formed with the requirement that they must comply with federal regulatory requirements. This offers greater protection to investors.
Top 5 Considerations for Your STO
Launching an STO is a major business decision. While the potential for profits is significant, the possible penalties involved with an SEC investigation or DOJ prosecution can be multiple times greater.
Before your business launches an STO, consider the following five points:
1. The security tokens issued during your STO will likely need to be registered with the Commission as a “security” or be exempted.
The first and most important issue is whether your token or coin needs to be registered as a “security.” This is a preliminary analysis that must be completed as soon as possible.
The SEC and courts use the Howey Test to determine whether a novel asset or digital platform is an “investment contract,” or a “security.” The test has four prongs, all of which must be satisfied:
- An investment of money;
- In a common enterprise;
- With the expectation of profits;
- Derived solely from the efforts of others.
To further explain this test, the SEC published its “Framework for ´Investment Contract´ Analysis of Digital Assets” in 2019.
If your attorney determines that your token or coin is a security token, you will proceed with an STO and have to register the offering or be exempted.
If the token or coin is not a security token but is instead a utility token, the term used for your offering is an ICO. In such latter cases, you will not have to register or be exempted because the utility token is not a security in the first instance.
2. Once your security tokens are classified as “securities,” the platform offering the tokens as well as the individuals involved may all need to be registered.
As soon as your tokens or coins are classified as “securities,” there are several additional considerations that your attorney will need to evaluate.
First, your STO and security tokens will now be subject to the reporting and disclosure requirements of the Exchange Act of 1934. This may require filing ongoing annual, quarterly, and other special reports with the Commission.
In addition, these issuing companies will need to evaluate whether their employees and other personnel have any registration requirements for broker-dealers or investment advisers under the federal securities laws and Investment Advisers Act.
Lastly, if your platform is issuing tokens or coins that are classified as “securities” under the law, then the platform itself may need to be registered as an “exchange.”
These above requirements require the analysis and skill of an attorney experienced in blockchain projects and coin offerings and the various federal compliance obligations accompanying such projects.
3. Make sure your STO contains and plans for careful marketing and advertising during every stage of the issuance.
After the details of your STO are developed and the coin or token is crafted to the desires of your business, you will need to decide how to market and advertise this to the public.
Marketing and advertising are important because it increases your visibility and promotion of your coin or token. This is often essential, as many companies cannot get their message out to the public without effective marketing and advertising strategies.
That said, issuers should be careful because there are certain exemptions to registration that limit the way investors are solicited. An attorney experienced in securities regulation and exemptions as applied to blockchain projects and STOs should be retained to help you on this issue.
4. An STO issuance may involve other federal compliance obligations other than the federal securities laws such as those under the BSA.
Many issuers who are launching a project involving security tokens may be deemed non-bank financial institutions or otherwise be subject to the Bank Secrecy Act (“BSA”).
To be compliant with the BSA, many issuers will have to develop anti-money laundering compliance programs, have robust know-your-customer policies, file suspicious activity reports, as some initial requirements.
The idea behind these regulations is to facilitate the legitimate flow of money and ensure that investor funds are invested in security tokens and projects that are genuine and free from crime and illegality.
Also important for issuers of security tokens is understanding how these requirements impact your availability of registration exemptions. For instance, some exemptions are only applicable for tokens that are marketed and sold to accredited investors.
Therefore, if the company plans to be exempted from registration and wants to sell to accredited investors, it will have to have clear and detailed KYC policies in place that assess the “accreditation” status of investors.
5. Failure to follow the registration requirements under the Securities Act of 1933 and the disclosure and reporting requirements under the Exchange Act of 1934 could lead to substantial penalties.
Once you are subject to the SEC registration provisions, companies must follow a myriad of federal provisions and must ensure continuous compliance.
Also, regardless of whether companies need to register or not, they will still be subject to the antifraud provisions. Failure to comply with these federal requirements may lead to both civil and criminal penalties.
Other penalties that the SEC could impose include injunctions, disgorgement orders, revocation of license, loss of employment, and loss of ability to do business with the government—not to mention the reputational harm.
Need Assistance with Your STO?
STOs offer many advantages. But if done incorrectly or without having a proper footing grounded in the law, the disadvantages can clearly outweigh the advantages.
Before you launch your STO, it is imperative to retain an attorney experienced in analzying STO projects and assessing whether your business may have compliance obligations.
At Oberheiden, P.C., we have the Blockchain Compliance Team you need to accomplish this task before you proceed with your new coin or token project.
Be proactive. Do not risk a federal investigation and all your time and invested money without securing the legal compliance advice you need.
Contact us today for a free and confidential consultation.
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