Security Token Offering (STO) Legal?
STO, which stands for Security Token Offering, refers to a movement taking place at the Initial Coin Offering (ICO) stage. PolyMatch introduced the concept, which features a new business model that mitigates risks for investors. With an ICO, investors can purchase tokens during an offering and such tokens can be traded, sold, or held. Further, the security tokens are essentially financial securities and therefore, they are backed by tangible assets, profits, or company revenue.
The STO approach may resolve the compliance and licensing requirement concerning securities laws. At this point, even if a token isn’t considered as a security, it may be designated as e-money, a payment service, or an alternative form of investment. To discern what one’s token is, it is best to perform an analysis. If it is a security, then it certainly comes under the purview of the SEC. It is also important to note that there are both federal and state laws for securities. State laws are known as blue sky laws and they apply when a state’s specific provisions are met.
In addition to the United States, the European Union has also implemented certain regulations for the issuance of securities. States within the EU make their own specific rules based upon directives, which is someone similar to the United States’ federal and state-specific securities model.
Back to the United States – regulations require that those interested in issuing a security draft and file a prospectus and get it approved by a securities regulator. There are also certain exemptions that may apply and that users should look into when it comes to their security.
Security Token Offering Basic Elements
Here are a few basic elements to keep in mind when determining whether the token is a security:
What Makes a Token Sale Subject to SEC Securities Laws?
The first and most important question to address is what makes a token a security. In the Unites States, the main focus is on the purpose of the investment. The centennial case that addressed this issue is Securities and Exchange Commission v. Howey Co., 328 U.S. 293 (1946). The test addresses four issues:
- whether the investment is of money or assets;
- whether the investment of money or assets is in a common enterprise;
- whether there is an expectation of profits from the investment; and
- whether any profit arises from the efforts of a promoter or third party. Instances where the answer is yes to the above four questions, then the token sale is likely subject to the U.S. securities laws.
Is The Token a Payment Instrument?
The definition of “security” is wide-ranging. Under Section 2(a)(36) of the 1940 Act, a security means, unless reported otherwise, “any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest . . .“ The full definition can be found online. The 1933 and 1934’s act’s definition of a security is essentially identical. Essentially, an e-money or payment service can be considered a security.
Does an Exemption Apply?
Even if the token falls under the definition of a security, there may be an exemption that applies. The exemption allows investors to issue the token, without being called a security and as a result, it wouldn’t be necessary to have a prospectus. The best way to determine whether one’s token is a security or if an exemption applies is to speak to a securities professional.
A Private Placement For Qualified Institutional Investors?
Another way to bypass securities laws is designation of the token as a private placement for qualified investors. The assumption here is that institutional investors are not prone to the same risks as everyday investors due to their knowledge concerning investments and securities. As a result, the sale is not subject to the same rules. For this exemption to apply, there must be a certain number of high net-worth individuals.
Again, although it is possible to determine whether a token is a security on one’s own, the secured transactions is a highly technical field that is best left to a professional. Therefore, if possible, reach out to someone who has experience dealing with these types of matters so that one can ensure that they are in compliance or whether an exemption applies.