Initial coin offerings have taken off in 2017.

The SEC took two strong steps this week toward increased regulation of the cryptocurrency markets and specifically regulation of Initial Coin Offerings (“ICOs”). These steps included the halting of an ongoing ICO and a strong statement by the SEC’s chairman regarding ICOs and their status under the Federal securities laws. These steps were the SEC’s strongest actions to date regarding ICOs, but what is the probable long-term result here? This is getting very interesting as you pit the regulators and their application of traditional securities law concepts against an increasing strong demand in the investment community to invest in these cryptocurrency vehicles.

An ICO involves the offering of a token, “coin” or other digital product. In exchange for their investment, investors receive these tokens or coins. The company then uses the proceeds of the ICO for various corporate purposes similar to a regular offering of securities. ICOs have generally not been registered with the SEC.

On December 11, 2017, the SEC halted the ICO that was being conducted by Munchee Inc., a company that developed a restaurant review app. This action was based on the fact that the company had not registered this offering with the SEC. This ICO involved the issuance of MUN Tokens by Munchee, which the company said might increase in value. Munchee planned to raise about $15 million in this ICO. The SEC said that an investor could reasonably expect to earn a return on these Tokens, and accordingly the Tokens issued in the ICO were “securities” and should have been registered under the Federal securities laws. Munchee accepted the SEC’s findings without admitting or denying anything. The company agreed to halt the offering and to return all proceeds that it had received from investors in the offering.

The investigation of this matter was conducted in part by the SEC’s new Cyber Unit (a division of its Enforcement Section). The SEC had also issued other materials regarding concerns with cryptocurrencies and ICOs, including an Investor Bulletin issued on July 25, 2017 and a Report of Investigation issued on the same date.
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waldryano
waldryano

I don’t know when Congress decided that every piece of legislation had to have a nifty acronym, but the House Financial Services Committee recently passed (on a partisan basis) what old-fashioned TV ads might have called the new, improved version of the “Financial CHOICE Act”.  The word “choice” is in solid caps because it stands for “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs”.

Whether and for whom it creates hope, opportunity or something else entirely may depend upon your perspective, but whatever else can be said of the Act, it is long (though at 589 pages, it is slightly more than half as long as Dodd-Frank), and it addresses a very broad swath of issues.  Here’s what it has to say about some key issues in disclosure, governance and capital formation, along with some commentary.
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Photo by Oblivious Dude
Photo by Oblivious Dude

The SEC’s Division of Corporation Finance recently issued new Compliance and Disclosure Interpretations (“C&DIs”) for Securities Act Rule 701 which clarify application of the Rule in the context of mergers. In a nutshell, Rule 701 provides an exemption from SEC registration requirements for private companies, private subsidiaries of public companies and foreign private issuers to offer their own securities, including stock options, restricted stock and stock purchase plan interests, as part of written compensation plans or agreements, to employees, directors, officers, general partners and certain consultants and advisors.

Under Rule 701, the aggregate sales price or amount of securities sold in reliance on Rule 701 during any consecutive 12-month period must not exceed the greatest of $1 million, 15% of the total assets of the issuer (measured as of the issuer’s most recent balance sheet date, if no older than its last fiscal year end), or 15% of the outstanding amount of the class of securities being offered and sold in reliance on Rule 701, (again, measured at the issuer’s most recent balance sheet date, if no older than its last fiscal year end). If the aggregate sales price or amount of securities sold during any consecutive 12-month period exceeds $5 million, the issuer must deliver specific written disclosures a reasonable period of time before the date of sale, including a copy of the summary plan description under ERISA or, if the plan is not subject to ERISA, a summary of the material terms of the plan, information about the risks associated with investment in the company’s securities, and financial statements meeting the requirements of the SEC’s Regulation A as of a date no more than 180 days before the date of the sale.

In the context of a merger transaction, the newly issued C&DIs provide the following guidance:
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Photo by Chad Cooper
Photo by Chad Cooper

Good, but not surprising, news for issuers considering a Regulation A+ offering. Back in May 2015, Massachusetts and Montana sued the SEC in an attempt to invalidate the Regulation A+ rules.  Montana had attempted to obtain an injunction to prevent the Regulation A+ rules from going into

Photo by Michael Tipton
Photo by Michael Tipton

The SEC’s crowdfunding rules (under Regulation Crowdfunding) became effective earlier this week. From the legal and legislative perspectives this was a big day since it marked the effective date of

one of the most heavily anticipated and promoted components of the JOBS Act. It is also the last provision of the JOBS Act to be put into practice. Reward-based crowdfunding has been operational for a long time and has had some pretty positive results, but the SEC’s equity crowdfunding rules were going to be a way for small investors to make equity investments in small companies and help foster the growth of the tech and innovation economies.

Unfortunately, as reported in my prior blog post and just about everywhere else, the execution of the final crowdfunding rules has resulted in a system that is probably not viable for most situations. While the new rules may work in some cases, they create barriers that I believe will prevent widespread use of equity crowdfunding as a financing vehicle. One of the best summaries of Regulation Crowdfunding problems and deficiencies can be found in this post which quotes Jeff Lynn, the CEO of Seedrs (a prominent crowdfunding platform). He is certainly a guy who believes in the crowdfunding concept, but he says that the crowdfunding regulations in their current form are not workable. Lynn also advises US regulatory authorities to study the UK crowdfunding model, which he believes allows companies to raise funds while still providing investor protection.

The main problems with the new crowdfunding regulations are practical ones. First, the funding limit of $1 million each year is just too low for most companies. This is similar to the problem that we saw with Regulation A for a long time – essentially no one used it because the limit was too low in relation to the costs (although the old Regulation A limit was $5 million, substantially higher than the current crowdfunding limit). Regulation A+ has fixed this problem for Regulation A offerings, but the low limit remains a huge challenge for crowdfunding offerings. This low limit problem is made worse by the costs associated with a crowdfunding offering, which will be substantial for a small company. Legal and accounting work will be required. Companies must also use a registered funding portal in connection with the offering, and this will add to the cost burden. Finally, companies cannot “test the waters” before beginning an offering to see if the offering is even viable for them. The combination of all of these factors creates significant practical roadblocks for crowdfunding that cannot be overcome without some adjustments (as discussed below). 
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Corporate Venture Capital
Photo by Saulo Cruz

Corporate venture capital has quickly developed into a major funding source for startup companies. This type of startup funding is available to some innovative startups and early stage companies, and the dollars involved are significant. This all sounds great, but is this type of funding right for your startup?

According to the National Venture Capital Association and PWC’s Money Tree survey, 905 corporate venture capital deals were closed during 2015 with $7.5 billion invested (primarily in high growth startup companies). These transactions comprised 21% of the total number of venture capital deals closed in 2015 and represented 13% of the total venture capital funds invested in that year. Not surprisingly, the biggest chunk of these investments went to software companies ($2.5 billion in 389 deals, which represented 33% of all corporate venture deals in 2015), while biotech deals were second ($1.2 billion in 133 deals, which represented 16% of all corporate venture deals that year).

Many large and familiar companies have implemented venture capital programs. Some of the most well-known corporate venture funds are Alphabet’s GV (formerly Google Ventures), Microsoft Ventures, and Salesforce Ventures. Most of these corporate venture funds are sponsored by large technology companies, but Airbus Group Ventures is an example of a fund established by a non-technology company in a specific industry space. While each of these programs has some independent characteristics, the commonalities are a strong desire to foster innovation (either generally or in specific industry segments) and an ability to step out of the normal corporate mold and commit funds to situations with higher risk profiles when compared to normal corporate investments like real estate and straightforward corporate industry acquisitions.

There are a number of significant potential advantages associated with corporate venture capital. For me, two of the biggest potential advantages are the broader investment scope and the more long-range expectations which may result in a corporate venture investment as compared to a normal external venture investment. A corporate venture capital investor can
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Photo by Patricia J. Lovelace © All rights reserved
Photo by Patricia J. Lovelace © All rights reserved

This week, the SEC published a series of new Compliance and Disclosure Interpretations (“CDIs”) related to the newly revised Regulation A, which became effective on June 19, 2015. While many of the new CDIs addressed procedural and interpretational issues under the new rules, there was an important development that could make Regulation A that much more useful for companies.

The positive news comes in the form of the SEC staff’s response to Question 182.07 which asks whether issuers would be able to use Regulation A in connection with merger or acquisition transactions that meet the criteria for Regulation A in lieu of registering the offering on an S-4 registration statement. Based on the SEC’s final adopting release, it did not appear that Regulation A would be available for use in these types of business combination transactions. However, the interpretation published yesterday clarifies that issuers may, in fact, use Regulation A in connection with mergers and acquisitions. The one exception is that Regulation A would not be available for business acquisition shelf transactions that are conducted on a delayed basis.

This is a very positive development for issuers that want to issue equity in connection with acquisitions of other companies, but do not wish to become a public reporting company under the Exchange Act. Previously, these issuers had very few
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Reg A+ is now effective!
Photo by Lisandro M. Enrique © 2015 All rights reserved

Today is June 19th.  It is an exciting day for companies that need to raise capital because Reg A+ finally goes into effect.

As a reminder, Reg A+ is a nickname for SEC Regulation A, as amended by the SEC.  Reg

BSA requires broker-dealers to know who you are
Photo by St. Murse

As we blogged about in May, the Bank Secrecy Act (“BSA”), which requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering, applies to entities that we may not traditionally think of as “financial institutions,” including securities broker or dealers. Compliance with the BSA is no easy task. And if a recent notice of new proposed rule by the U.S. Treasury’s Financial Crimes Enforcement Network (also known as FinCEN) becomes law, it’s not about to get any easier.

FinCEN’s stated intent with the proposed rule is to clarify and strengthen customer due diligence requirements for banks, brokers or dealers in securities, mutual funds and futures commission merchants and introducing brokers in commodities. Under current regulations, each of these institutions must establish, document and maintain a Customer Identification Program (or “CIP”) appropriate for its size and business that meets certain minimum requirements, including, among others, the adoption of certain identity verification procedures, and the collection of certain customer information and the maintenance of certain records. The proposed rule adds two (2) new elements to the CIP requirements.

First, the proposed rule
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Waiting for the results of the JOBS Act?
Photo by Gueorgui Tcherednitchenko

President Obama signed the JOBS Act into law on April 5, 2012 amid much fanfare and optimism. Small and medium sized fast-growing technology companies and their executives were especially sanguine about this new act as it appeared that it would provide access to much-needed additional expansion capital. These companies were still reeling from the recession and the substantial reduction in available venture capital financing, and they saw the JOBS Act as a potentially positive event. A little more than two years later, has this initial optimism proved to be warranted? Let’s take a look at some of the provisions of the Act.

A new regulatory structure for crowdfunding was initially the most anticipated provision of the JOBS Act. I never believed that crowdfunding would be as beneficial as some people did, but I hoped that it could provide some additional access to capital for smaller companies which were starved for funds. Unfortunately we are still waiting for the SEC’s final crowdfunding regulations. The SEC appears to be caught between two complaining factions here – one which thinks the proposed rules are too restrictive and won’t work, and one which thinks
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