Security Token Issuance

Security token issuance in Europe

The new European Markets in Crypto-Assets (MiCA) Regulation has no specific regulation for Security tokens. It means that security token offering (STO) should be conducted in accordance with EU financial legislation. In Europe Security tokens are mostly classified as transferable securities and as a result are regulated by Markets in Financial Instruments Directive (MiFID II) and the EU Prospectus Regulation 2017/1129 (Prospectus Regulation). To STO, the issuer must prepare and publish a prospectus and obtain all necessary authorisations. A prospectus is a large legal document that includes all the information required for the issuance of a securitisation token.

Despite such strict rules there are a large number of exceptions, for example:

• the Prospectus Regulations do not apply to an offer of securities to the public with a total consideration in the European Union of less than EUR 1 000 000, which shall be calculated over a period of 12 months;
• the obligation to publish a prospectus shall not apply to any of the following types of offers of securities to the public:
• an offer of securities addressed solely to qualified investors;
• an offer of securities addressed to fewer than 150 natural or legal persons (other than qualified investors) per each state in European Union;
• an offer of securities whose denomination per unit amounts to at least EUR 100 000;
• an offer of securities addressed to investors who acquire securities for a total consideration of at least EUR 100 000 per investor, for each separate offer;
• other cases.

In addition, the Prospectus Regulations also provide that Member State of EU may decide to exempt offers of securities to the public from the obligation to publish a prospectus provided that he total consideration of each such offer in the European Union is less than a monetary amount calculated over a period of 12 months which shall not exceed EUR 8 000 000. Thus, EU Member States can set their exemption limits from prospectus publication at national level.

In the context of tokenization of assets we can pick up the Markets in Crypto-Assets (MiCA) Regulation and following type of the tokens:

• Crypto-assets concerns “asset-referenced tokens”, which aim to stabilise their value by referencing another value or right, or combination thereof, including one or several official currencies. That second type covers all other crypto-assets, other than e-money tokens, whose value is backed by assets.
• In order to issue this category of tokens, it is also necessary to go through the authorisation procedure, but here too there are no exceptions. Namely, an offer to the public can be made without authorization if:
• over a period of 12 months, calculated at the end of each calendar day, the average outstanding value of the asset-referenced token issued by an issuer never exceeds EUR 5 000 000, or the equivalent amount in another official currency, and the issuer is not linked to a network of other exempt issuers; or
• issuer never exceeds EUR 5 000 000, or the equivalent amount in another official currency, and the issuer is not linked to a network of other exempt issuers; or
• the offer to the public of the asset-referenced token is addressed solely to qualified investors and the asset-referenced token can only be held by such qualified investors.

Security token issuance in the United States of America

Securities offered or sold in the U.S. must be registered with the SEC, unless the securities or the offering falls within an exemption from registration. Foreign companies may register their securities with the SEC. But a full SEC registration requires a significant amount of time and resources, making it generally infeasible for private issuers, including issuers of preferred share tokens. Luckily, the Securities Act provides several registration exemptions that permit issuers to offer and sell securities without undertaking this burden.

Among the exemptions are the following:

• Regulation A (T1 and T2);
• Regulation D (506b);
• Regulation D (506c);
• Regulation S;
• Regulation CF.

Regulation A (T1 and T2)

Regulation A is an exemption from registration for public offerings. Regulation A has two offering tiers: Tier 1 and Tier 2. In Tier 1, a company can raise a maximum of $20 million within a year. The company must submit offering statements to the SEC and get approval from state regulators where it intends to sell the securities. Although there are no ongoing reporting obligations, the company must provide a final report on the offering.

Tier 2 allows companies to raise up to $75 million in a year. These companies must furnish audited financial statements and regularly file reports, including a final status report. Unlike Tier 1, Tier 2 issuers don't need to register with state securities regulators, but they still need to submit their offering to the SEC. Additionally, Tier 2 offerings come with extra requirements, such as restricting the amount non-accredited investors can invest in them.

Regulation D (506b)

Although the exemptions under Regulation D permit the sale of securities to individuals located in the United States, generally those individuals need to be “accredited investors.” Under Regulation D, if the sale is to be generally advertised to the public, the issuer has an obligation to verify that all purchasers are accredited by requiring them to provide documentation evidencing they qualify as such, which can be a costly and cumbersome process. In simple words, general partnerships can raise an unlimited amount of money from an unlimited number of accredited investors and as many as 35 non-accredited investors, as long as they do not publicly advertise or solicit investments for the fund. However it is not allowed to take on non-accredited investors without offering the same disclosure documents typically required under Regulation A of U.S. securities laws. To state that the firm is raising capital in a 506(b) offering, a firm simply checks the 506(b) option when it completes its Form D notice, the filing that confirms which exemption the fund is claiming. The SEC requires Form D to be filed within 15 days of the first close.

Regulation D (506c)

Rule 506(c) permits issuers to broadly solicit and generally advertise an offering, provided that:

• all purchasers in the offering are accredited investors;
• the issuer takes reasonable steps to verify purchasers’ accredited investor status; and
• certain other conditions in Regulation D are satisfied.

In short, accredited investors are eligible to invest in 506(c) offerings, but unlike with the 506(b) exemption, the fund’s Partnership or the firm must take “reasonable steps to verify” that the security purchasers are accredited or hire a third party to perform the verification. Firms can publicly market (advertise) their capital-raising offer to a larger investor base, beyond just one-on-one conversations and emails within their personal and professional networks.

Regulation S

Regulation S, which was adopted by the SEC in 1990, provides that offers and sales of securities that occur outside of the United States are exempt from the registration requirements of Section 5 of the Securities Act of 1933. The rule under (Regulation S) is referred to as Offshore Offers and Sales, and offers an exemption for qualifying foreign offerings made by U.S. companies. In simple words, Regulation S is a registration exemption which allows securities (or security tokens) only to be sold to non-US investors (accredited or unaccredited) exclusively outside of the United States.

Simply saying, for token issuers who wish to sell their token to nonaccredited investors, Regulation S provides a safe harbor from registration so long as the offer and sale of securities occur solely outside the United States (whether the buyers are U.S. or foreign investors). Otherwise, the issuers will be subject to SEC regulation and enforcement.

However, issuers can benefit from Regulation S by complying with two basic conditions:

• the offer and sale of the securities must be made in an offshore transaction, meaning, the offer to buy must not have been made to a person in the United States, and either the buyer is, or is reasonably believed to be, physically located outside the United States, or the transaction is executed on an offshore market.
• there can be no “directed selling efforts” in or into the United States of the securities offered under Regulation S.

CF Regulation

CF Regulation relates to Crowdfunding. For CF regulation applies following rules:

• All transactions under Regulation Crowdfunding must exclusively occur online, facilitated by an intermediary registered with the SEC, which could be either a broker-dealer or a funding portal. Companies are permitted to raise up to a maximum aggregate amount of $5 million through crowdfunding offerings within a span of 12 months.
• There are limits placed on the amount individual non-accredited investors can contribute across various crowdfunding opportunities within a one-year period. Full disclosure of information is mandated in filings with the Commission, as well as to investors and the intermediary overseeing the offering.

In addition, securities procured through crowdfunding transactions generally have a lock-up period of one year, during which they cannot be resold.