Legal aspects of a Security Token Offering



  • While the blockchain technology offers a lot of advantages like immutability, transparency, and security, the fact that some of its applications were outside the purview of any regulatory framework was considered one of the most major limitations.

    These limitations manifested themselves in the form of scams that had marred the image of Initial Coin Offering (ICO). The ICO, which was considered to be a revolution for raising funds for crypto projects, however, more than 80% scam-rate because of the lack of oversight.

    Establishing security… Literally!
    Tokenization, initially, was not designed to fit into any legal system. However, with the introduction of the aspect of securities, the tokens automatically fall under the regulations that are applicable to any fundraising campaign(IPO, Crowdfunding, etc.).

    Security Token Offerings (STOs) created the perfect convergence for the advantages of blockchain technology and the protection offered to the investors by traditional stocks. The tokens offered in an STO are not mere utility tokens but actual security tokens backed by real assets. These tokens entitle the possessor to partial ownership in the assets or voting rights or both.

    Security Token Offerings are expected to open the floodgates to the opportunities of investments. Since the backbone of an STO is blockchain, it offers universal access and faster transactions.

    The Public Offering
    In case of a public STO, the company that issues the tokens will be subject to the investment prospectus requirements. This process is akin to that of an IPO. The prospectus is a legal document that provides detailed information about the offerings and the financial elements of your offering. The prospectus has to be approved by a financial regulator and is expected to provide pieces of information that could protect novice investors from fraud.

    The biggest markets for securities are the European Union and the United States, and the requirements for the prospectus outlined in the Prospectus Directive (2003/71/EC) and Regulation C, in that order.

    The Exemptions
    While the regulatory frameworks introduce rigidity, the exemptions can be utilized in diversifying the investors who buy your security tokens. This will help in enhancing the flexibility and access of your tokens without compromising on the security aspects.

    The United States
    Bringing in the STO under the legal purview of a regulatory body like the Securities and Exchanges Commission (SEC) puts a lot of restrictions on the companies and the investors as well. If not for these exemptions, only accredited investors – investors with more than $200,000 in annual revenue or net worth of more than 1 million dollars – would be eligible to participate in an STO.

    Regulation 506(c) – this a public solicitation where accredited investors may purchase the security tokens. It is essential that every investor has to pass the KYC/AML (Know Your Customer/Anti-Money Laundering) requirements.

    Regulation 506(b) – this is a private placement exemption without general solicitation where a maximum of 35 non-accredited investors make purchase tokens.

    Regulation Crowdfunding – as the name implies, this regulation is an exemption for small offerings up to a maximum of 1.07 million dollars during a 12 month period with a limitation on the amount that an investor can invest.

    Limited offering under Rule 504 is for eligible companies where up to 5 million dollars can be raised over a 12 month period and the issue has to comply with the blue sky laws.

    Regulation A+ – this regulation has a possibility of two tiers being applied. The first tier is for offering up to 20 million dollars in a 12 month period, and 2nd tier is for offering up to 50 million dollars in a 12 month period. There are certain complicated requirements that govern the second tier.

    The European Union
    The European Union legislation has published in its Prospectus Directive that the requirement to publish a prospectus does not apply to the following offers:

    An offer that is addressed solely to qualified investors
    An offer that is addressed to less than 150 persons per European Union state member other than qualified investors
    An offer addressed to investors who acquire securities for a total consideration of at least €100,000 per investor
    An offer where the denomination per unit is a minimum of €100,000 for 12 months
    In addition to these, there are local laws in some EU countries that provide exemptions for crowdfunding. Germany, for example, does not require a prospectus for domestic offers of up to €2.5 million. There are similar laws in Finland and Spain.

    The Worldwide Response
    Blockchain technology is relatively nascent and a lot of countries have been lukewarm in their response towards the crypto revolution. However, legal jurisdictions like the United States, Canada and some European countries like Malta, Luxembourg, Liechtenstein, and Estonia have been quite welcoming in preparing crypto regulations and embracing blockchain adoption.

    There are several established stock exchanges like the Swiss SIX Exchange, Gibraltar Stock Exchange, the London Stock Exchange, and the Australian Securities Exchange have been open about their development of digital asset platforms to enable security token trading.

    The Future
    All the new technologies that have revolutionized lifestyle have faced their impedance before becoming mainstream. Blockchain technology and tokenization would also fall into the same category. It has taken some time for traditionally rooted finance stream to note of blockchain. However, the fintech world is creating ripples using blockchain with J.P. Morgan tokenizing gold on Quorum and creating their own JPM Coin.

    Blockchain App Factory, with its expertise in blockchain, can help you create your STO compliant with all the regulatory requirements. Our team of experts will also help you market you are STO in the most effective fashion. Get in touch with us for any blockchain related needs that you have!