What are the limitations of various security regulations in crowdfunding STOs - A/ CF/ D/ S?
Regulation A limitations
Regulation A is not available for “at-the-market” offerings. The SEC Staff has taken the view that most forms of variable pricing, such as “early bird” or “pre-sale” pricing, are at-the-market. This means early-bird discounts or stepped pricing cannot be used in a Regulation A offering (this does, however, work in Regulation CF). The way you change prices in a Regulation A offering is to file a post-qualification amendment to the Offering Statement and get it re-qualified, so timing can be unpredictable (in theory the SEC could take a month to respond to the filing). (Note that price increases of less than 20% can be made by a filing that doesn’t require re-qualification.) Regulation A is also not available for “investment companies.” In very general terms, an investment company is any company that has 40% of its assets invested in minority holdings in other companies
That means “ICOs of ICOs” do not work. A company founded to invest in other companies’ ICOs cannot use Regulation A and is effectively limited to Regulation D offerings to accredited investors. You also need to engage brokers for Regulation A offerings when selling into certain states.
Regulation CF limitations
You can only raise $1.07 million in any 12 months under Reg CF. Additionally, while Regulation A permits you to “test the waters” and find out whether there’s any interest in your offering without having to make any filings, you can’t make offers (that includes any communications encouraging interest in tokens) under Regulation CF without first making a filing with the SEC. Additionally, there are restrictions on transfer of Regulation CF securities for one year; you’ll have to build compliance with these requirements into the smart contract. It’s also not clear that offerings that make use of blockchain technology will comply with the requirements of Regulation CF. Regulation CF requires that funds be held by escrow agents -- specific types of banks or brokers -- until released to the issuer (or back to the investor if the offering fails to make its target). Blockchain smart contracts with funds held in electronic wallets do not meet this requirement (although some escrow agents such as Prime Trust have moved into this space). Therefore it would seem that the initial distribution of ICOs in a Regulation CF offering in most cases might need to be done in a more “traditional” manner and then blockchain trading could only happen after the distribution had closed.
Regulation D limitations
Securities sold under Regulation D are “restricted,” which means you will have to set up procedures in your smart contract to limit their resale or ensure that they are only traded to accredited investors. Since the offering will be made over the internet, the specific type of Regulation D offering you will be making is that under Rule 506(c). That requires you to take reasonable steps to verify that the investors in your offering are accredited. This verification process is something you could actually build into the smart contract: you could make those service providers validators of the transaction effected through blockchain technology.
Regulation S limitations
Equity securities of non SEC-reporting US companies are subject to a one-year period during which the securities cannot be resold to US persons. Debt securities (including FUCS) are subject to a 40-day period. This means it’s important to establish whether the securities are equity or debt. As with Regulation D, issuers are going to have to reflect these requirements in the smart contracts that govern trading.
You may wish to use Geofencing technology here and to block all US IP addresses. Regulation S securities cannot be “offered” to US persons, which means you cannot have an open-to-everyone website that describes Regulation S securities, even if the site says “we can’t sell these to US persons.” That is still an “offer” in the US. Best practice if you have any link to the US is to put the website that describes Regulation S securities behind a firewall that requires investors to certify as to their non-US status and their location before they are permitted to view details of the offering.
Additionally, compliance with the provisions of Regulation S that provide the best protection for issuers with links to the US require that investors certify that they aren’t “US persons” and promise not to resell to US persons.
Regulation S only tells you how to deal with US regulations, by the way. You also need to make sure that you comply with the regulations of the countries where the investors are located. Block IP addresses from any jurisdictions where you know the securities can’t be sold.