Practitioner Insight: After the Token Sale—How to Navigate the Federal Securities Law Issues
Alerts
December 19, 2017
Over the last few months, there has been fairly wide-spread recognition that most offerings in the United States of tokens and of Simple Agreements for Future Tokens (SAFTs) are securities offerings.1 As a result, most U.S. token and SAFT offerings are made solely to accredited investors in private placements under Rule 506(c) of Regulation D.2 On December 11, 2017, the Securities and Exchange Commission (SEC) dramatically emphasized the wisdom of this approach, both by publicly taking action to stop an unregistered public token offering, and through a written (and fairly unusual) statement by the SEC's Chairman discussing securities law issues related to token offerings.3
There has been much less public focus, however, on how the federal securities laws impact token issuers, token platforms, and token holders after the token or SAFT offering is completed. At some point, many (but by no means all) tokens that start out as securities may no longer be securities,4 and the federal securities laws may then no longer be relevant to the tokens or to the token platform.
Until a token no longer is a security, the federal securities laws will impose a number of restrictions and limitations on the company that issued the tokens, on purchasers and sellers of those tokens, and perhaps on token holders who would like to use the tokens for their intended commercial uses on the relevant token platform. This article will try to help token issuers think through some of these issues, especially in light of the relatively limited guidance on or public discussion of these issues by the SEC.
In this article, the term "S-Tokens" refers to tokens that are currently securities, but eventually will or may not be securities, because they have or will have some anticipated use or utility on an issuer's platform, and not to tokens that are digital representations of securities (such as tokens representing common stock or limited liability company interests, which are and presumably always will be securities). The term "platform" refers to the online protocol or protocols developed by a token issuer and on which a token is designed to be used.
Can Holders Use S-Tokens on the Platform?
We believe the answer is yes, even though the SEC and the courts have not yet addressed this issue. As discussed below, a U.S. holder can sell or transfer a token that is a security only in limited circumstances and ways. Nonetheless, we believe that a token holder may use such a token on a platform to obtain commercial goods or services, and that the transaction should not be treated as a securities transaction.5 We believe that this is true regardless of whether the holder is or is not an accredited investor.
How Can Non-Accredited Investors Receive S-Tokens?
We believe that there are several ways, some of which are listed below, although the SEC and the courts have not yet addressed this issue. In general, non-accredited investors cannot participate in the pre-sale or similar offering of tokens or an SAFT.6 However, in many cases, it is important for non-accredited investors to have access to S-Tokens, including to help generate and support significant use of the platform. Among the ways we think issuers may get S-Tokens into the hands of non-accredited investors are:
- Limited Direct Sales. We believe that an issuer should be able to sell S-Tokens directly to platform users, regardless of whether those users are accredited investors, if:
- the number of tokens sold are reasonable in relation to the number of tokens needed to engage in commercial transactions on the platform;
- the issuer imposes restrictions reasonably designed to prevent the same purchaser from purchasing so many tokens that it is likely that the tokens are being purchased for investment, rather than commercial purposes;
- the issuer receives a representation from the purchaser that she intends to use the tokens for commercial purposes on the platform, and if possible (although often this is not possible) codes the tokens so that their first use must be for a commercial transaction on the platform;
- the price at which the issuer sells the tokens is reasonable in light of the market value of the tokens; and
- the issuer discloses to the purchaser that the direct sale of tokens, and the use of the tokens on the platform, are commercial transactions that are not subject to the protections of the federal securities laws.7
- Sales to Employees (Rule 701). A company can sell or award its S-Tokens (or SAFTs for S-Tokens) to its employees, directors, and bona fide advisors and consultants, pursuant to a written compensatory benefit plan (the plan must be for compensatory purposes, and not for capital-raising purposes, and must meet several other requirements as well).8 We believe that employees and others who purchase or receive S-Tokens pursuant to such a plan, regardless of whether they are accredited investors, should be able to use those S-Tokens to engage in a bona fide commercial transaction over a platform, although again the SEC and the courts have not yet addressed this issue.
- Giveaways. We believe that a company should be able to give away limited numbers of S-Tokens to individuals, regardless of whether they are accredited investors, if the terms of the giveaway reasonably suggest that the recipients are likely to use the S-Tokens for commercial purposes on a platform.9 These terms may include giving each person a limited number of tokens and obtaining representations that they will use the tokens for commercial purposes on a platform.
- Registration or Qualification. A company may register its S-Tokens under the Securities Act (generally on form S-1) or qualify the S-Tokens pursuant to a Regulation A or A+ offering, and after that registration or qualification, the S-Tokens could be freely offered to non-accredited (and accredited) investors. While several companies are in the process of registering or qualifying their S-Tokens, and others are considering doing so, these are expensive processes, and many companies do not have the resources (or time) to register or qualify their S-Tokens.
- Foreign Purchasers. Subject to compliance with applicable foreign law, a company may sell its S-Tokens to non-U.S. people who are not accredited investors, and those people can use those S-Tokens for commercial purposes on a platform (again, as permitted by applicable foreign law).10
- Purchases on Foreign Exchanges by U.S. Non-Accredited Investors. It currently is relatively easy for a U.S. person, regardless of whether she is an accredited investor, to purchase S-Tokens on foreign exchanges and other token trading markets. In general, the federal securities laws do not prohibit or regulate the purchase of securities; instead, they regulate the offer and sale of securities.11 As a result, the mere purchase of an S-Token on a foreign exchange by a U.S. person who is a non-accredited (or accredited) investor generally is not prohibited by the federal securities laws.12 This conclusion assumes that the purchaser does not know or have reason to know that the seller of the S-Tokens is a U.S. person, and that the purchaser does not buy the S-Tokens with the intention of reselling them in the United States.
This analysis, though, misses what may be the more important federal securities laws issues with U.S. persons purchasing S-Tokens on foreign exchanges. First, as discussed below, a foreign exchange or trading market that generally permits U.S. persons to buy and sell S-Tokens may need to register in the United States as an exchange or as an alternative trading system (ATS).13 Second, a U.S. company could be deemed to have made an impermissible public offering in the United States if the company takes steps to list its S-Tokens on a foreign exchange which permits trading by U.S. persons.14
How Can Holders Sell S-Tokens?
We believe that there are several ways that a holder of S-Tokens, such as an accredited investor, or a vendor who has received those S-Tokens in exchange for goods or services on the Platform, can sell those S-Tokens; again, though, the SEC and the courts have not yet addressed this issue.
- One-Year Holding Period (Rule 144). An S-Token, including an S-Token purchased pursuant to a SAFT, should become freely tradeable after one year from the sale of the S-Token or the SAFT.15 One important limitation to this rule is that the one-year holding period starts all over again at any time the company that issued the S-Token, or an affiliate of that company, holds the S-Token.16 So, for example, when the company that issued the S-Tokens also provides goods or services in return for S-Tokens, the one-year holding period for those S-Tokens starts again each time the company resells those S-Tokens.
- Accredited Investor Sales After Three Months (Section 4(a)(7)). An accredited investor may, under certain conditions, resell S-Tokens to other accredited investors, after 90 days from the time the S-Token was first sold.17 As a practical matter, this provision may not be attractive because, among other reasons: (i) the company that issued the tokens must make certain information available to the purchaser, including the company's audited financial statements,18 which many companies that issue S-Tokens don't have; and (ii) the seller cannot sell the S-Tokens by means of a general solicitation or general advertising,19 which significantly limits the ability of sellers to find potential purchasers for the S-Tokens.
- Sales on a U.S. Exchange or ATS. Several entities have announced plans to create a regulated market in the United States that would permit the trading of S-Tokens. Assuming the Financial Industry Regulatory Authority (FINRA) grants the ATS applications to permit these markets to operate, individuals who sell tokens on these markets will be subject to the one-year or (if applicable) three-month holding periods described above, unless the tokens are registered with the SEC on form S-1 or qualified under Regulation A or A+ (these options are discussed below).
- Foreign Sales (Regulation S). A U.S. person generally can sell S-Tokens directly to non-U.S. purchasers who are located outside of the United States.20 Most offshore sales of S-Tokens, though, likely occur through offshore exchanges and trading markets, rather than as direct sales to a known foreign purchaser. These sales are technically problematic because, in order to take advantage of the SEC rule governing offshore sales (Rule 904), any foreign exchange on which the S-Tokens are sold would have to be specially designated by the SEC.21 Not surprisingly, few (if any) foreign exchanges that permit trading of tokens have been specially designated by the SEC.22
Rule 904, however, is a "safe harbor."23 This means that a seller of S-Tokens can't "violate" that rule; she either complies with the rule and knows that her sale of S-Tokens is consistent with the federal securities laws, or she does not comply with the rule and she takes the risk that her sale of S-Tokens does not comply with the federal securities laws.
A U.S person who sells S-Tokens on a foreign exchange, and who does not know or have reason to know that the purchaser of those S-Tokens is or will be a U.S. person, may have a reasonable argument (but not a rock-solid argument) that she did not violate the federal securities laws by making that sale. As discussed above, a U.S. person who buys S-Tokens on a foreign exchange has a fairly strong argument that her purchase did not violate federal securities laws, if she did not know or have reason to know that the seller of the S-Tokens was a U.S. person, and if she did not purchase the S-Tokens with the intention of reselling them in the United States.24 - Rule 144A. Certain very large institutions (but not humans), called qualified institutional buyers (QIBs), generally may freely buy S-Tokens from and sell S-Tokens to each other, subject to certain information requirements.25 Anecdotally, QIBs currently appear not to be a significant segment of the S-Token secondary markets.
- Registered or Qualified S-Tokens. As discussed earlier, some companies that issue S-Tokens or are considering registering the S-Tokens, or qualifying them under Regulation A or A+. This permits the company to sell the S-Tokens to any purchaser, regardless of whether the purchaser is or is not an accredited investor. Holders of registered or qualified S-Tokens generally may resell those S-Tokens, especially on an exchange or ATS, regardless of whether the purchaser is or is not an accredited investor.26
Other Emerging Securities Law Issues
- Broker Registration Issues—Paying Distributors of S-Tokens. In general, a person or entity who receives compensation (in any form) for selling or distributing securities, such as S-Tokens, must be a registered representative of, or registered as, a broker-dealer.27 As a result, a company issuing S-Tokens (or a SAFT for S-Tokens) generally should not pay any person for distribution, introduction, finder, or investor referral services, unless that person is a broker-dealer or a registered representative of a broker-dealer.28
- Investment Company Issues. Companies that issue S-Tokens can inadvertently become investment companies (such as a mutual fund) if, as is sometimes the case, the company holds a significant number of S-Tokens for itself. If, for example, a company sells its S-Tokens to more than 100 investors, and the company holds S-Tokens whose value, either initially or over time, exceeds 40 percent of the value of the company's total assets, the company can be an investment company.29 An investment company is subject to significant substantive provisions under the Investment Company Act, including (among others) restrictions on affiliated transactions, limitations on leverage and borrowing, limitations on its ability to issue options and restricted stock to officers and directors, limitations on its capital structure, and a requirement that it hold all securities (such as S-Tokens) with a bank or another qualified custodian.30
- Reporting Company Issues (Section 12(g) of the Exchange Act). Generally, a company should not become a "reporting company"—that is, a company that must (among other things) file annual, quarterly, and other reports with the SEC—by virtue of issuing S-Tokens. A company must register as a reporting company if it has total assets of at least $10 million, and has a class of "equity securities" held of record by 2,000 or more investors (or by 500 or more investors who are not accredited investors).31 We believe that S-Tokens should not be treated as a class of equity securities,32 because S-Tokens typically lack any similarity to equity securities.
Some companies that issue S-Tokens, however, may give S-Token or SAFT holders the ability under some circumstances to convert into common or preferred stock of the company. Those companies should consider whether that conversion feature may cause the company to become a reporting company if the S-Tokens (or SAFTs) are held by 2,000 or more record holders. And, of course, tokens that are digital representations of equity securities (such as common stock issued in the form of tokens) presumably are equity securities in their own right. - Will the SEC Give a Company a Pass on These Issues, Since the SEC Hasn't Given Any Guidance on Them? No. A company that issues S-Tokens cannot ignore the federal securities laws, even though the SEC may not have given substantive guidance on how those laws apply in novel situations, such as those presented by S-Tokens. A company may dramatically reduce the risk of lengthy SEC (and perhaps token-holder) litigation, however, if the company can demonstrate good faith attempts to comply with the federal securities laws, even if subsequently the SEC (or a court) determines that the company was not in full technical compliance with those laws.
For more information about the regulation of coin offerings, please contact Amy Caiazza or any member of the fintech and financial services practice at Wilson Sonsini.
This article was authored by Robert H. Rosenblum, with significant assistance from Amy Caiazza. The opinions expressed in the article are the authors' views and do not necessarily reflect the views of Wilson Sonsini.
1 See SEC Division of Enforcement, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Rel. No. 81207 (July 25, 2017), available at https://www.sec.gov/litigation/investreport/34-81207.pdf (stating that tokens may be securities and if so must be offered in compliance with the U.S. federal securities laws); SEC Chair Jay Clayton, "Governance and Transparency at the Commission and in Our Markets," Remarks at the PLI 49th Annual Institute on Securities Regulation (Nov. 8, 2017) (reiterating that tokens may be securities and stating that the SEC will continue to monitor token offerings); Dave Michaels and Paul Vigna, "SEC Chief Fires Warning Shot Against Coin Offerings," Wall Street Journal (Nov. 9, 2017) (quoting SEC Chair Clayton as stating that "I have yet to see an [Initial Coin Offering (ICO)] that doesn't have a sufficient number of hallmarks of a security").
2 In general, an accredited investor is a natural person with an annual income of at least $200,000 or along with her spouse a joint annual income of at least $300,000, a natural person with a net worth of at least $1 million (exclusive of the value of her house), or an entity with at least $5 million in assets. See Rule 501(a) of Regulation D under the Securities Act of 1933 (Securities Act). Rule 506(c) of Regulation D permits a company privately placing its securities to "generally solicit" for investors, as long as (among other things) each purchaser of securities is an accredited investor.
3 SEC, "Company Halts ICO After SEC Raise Registration Concerns," Press Release (Dec. 11, 2017), available at https://sec.gov/news/press-release/2017-227 (describing cease-and-desist order against issuer offering tokens); (SEC Chair Jay Clayton, "Statement on Cryptocurrencies and Initial Coin Offerings" (Dec. 11, 2017) (Clayton Statement), available at https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11 (outlining certain investor considerations and securities law concerns related to cryptocurrencies and ICOs).
4 As we have discussed in a prior Wilson Sonsini alert, we believe that a token no longer will be a security at least by the time that the principal driver of the token's value is its commercial usage on one or more reasonably mature and well-functioning token platforms, and its value no longer is principally driven by the continued entrepreneurial or managerial efforts of the sponsor of the tokens and the platform. Robert Rosenblum, "ICOs at the End of 2017: What We Think We Know and What We Don't Know," Wilson Sonsini Alert (Oct. 16, 2017), available at https://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert-initial-coin-offerings-1017.htm. As a result, the fact that a token may be a "utility token," in the sense that it has or will in the future have commercial utility on a token platform, is not the determining factor as to whether the token currently is a security, particularly when the platform on which it will be used is not yet developed. We believe this approach is consistent with SEC guidance regarding when tokens are securities, including the Clayton Statement, which states that a token that represents an interest in a book-of-the month club may not be treated as a security, "many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books, and distribution networks all to come."
5 Our view is based, in part, on the fairly unique dual nature of many tokens. While tokens are or may be securities, they also have other attributes, such as serving as a medium of exchange for commercial transactions on a platform. When the token is used as a medium of exchange, we believe that its commercial aspects predominate over its securities aspects, and that the transaction is better viewed as a commercial transaction than as a securities transaction. Significantly, both parties to the transaction presumably intend to engage in a commercial transaction, and that intent should, we believe, have substantial weight in determining that the transaction is a commercial transaction and not a securities transaction. Essentially, neither party to a transaction they each view as commercial should reasonably expect to receive the protections of the federal securities laws with respect to that transaction. Also, applying the federal securities laws to such a transaction makes little sense; it would often prevent what may be a valuable commercial transaction from occurring at all, and in other cases might require the purchaser to provide the seller with information about the issuer of the token, and that information likely would have little relevance to the intended commercial transaction. (See the discussion of Section 4(a)(7) of the Securities Act, below.)
By contrast, an instrument like a share of common stock is always a security, and has no non-security commercial purpose. A buyer or seller of a share of common stock therefore always reasonably should expect the protections of the federal securities laws.
By contrast, an instrument like a share of common stock is always a security, and has no non-security commercial purpose. A buyer or seller of a share of common stock therefore always reasonably should expect the protections of the federal securities laws.
6 Most token pre-sales and SAFT offerings are made pursuant to Rule 506(c) of Regulation D under the Securities Act. Rule 506(c) requires, among other things, that all purchasers are accredited investors. A token issuer could make a private placement to accredited investors and up to 35 non-accredited investors under Rule 506(b). However, among other issues, an issuer relying on this provision cannot publicly offer and advertise its offering to potential investors, which may significantly limit the number of investors in the pre-sale or SAFT offering.
7 We believe that these or comparable conditions reasonably assure that the tokens are being sold as commercial instruments and for commercial purposes, and in a transaction that neither party reasonably expects to be governed by the federal securities laws. See note 4 for a further discussion of some of these arguments.
9 Arguably, any giveaway of a security should be permissible. Section 5 of the Securities Act requires registration only of an offer or a sale of a security. Section 2(a)(3) of the Securities Act provides that the terms "offer" and "sale" relate to a proposed disposition of a security "for value." A free give away of a security arguably does not involve the receipt of value by the issuer. Nonetheless, the staff of the SEC (and perhaps the SEC itself) appears to informally take the position that the term "value" has an unexpectedly broad meaning, and may include the good will or similar positive benefits a company may receive for a stock give away. Regardless of the validity of this position, we believe that a limited giveaway of the type described in the text is best viewed as a commercial activity to seed liquidity on a platform (by putting into circulation the tokens that are the medium of exchange for the platform), rather than the use of securities to derive goodwill or other benefits from investors.
10 As discussed in footnote 13, however, the offer and sale of S-Tokens to foreign investors also may or will need to comply with Regulation S under the Securities Act, and the application of a number of provisions of Regulation S to S-Token sales is uncertain.
12 See, e.g., Rule 904 of Regulation S under the Securities Act (governing re-offers and resales of securities offered and sold outside the United States, but not limiting the re-purchasers of those securities).
13 An unregistered foreign (or domestic) exchange or trading market that permits U.S. persons to buy and sell S-Tokens may be acting in violation of the exchange and ATS registration requirements under the Securities Exchange Act of 1934 (Exchange Act). See Section 5 of the Exchange Act (requiring an exchange to register if it uses, directly or indirectly, any means of interstate commerce to effect or report securities transactions); Section 3(a)(1) of the Exchange Act (broadly defining the term "exchange"); Regulation ATS under the Exchange Act (permitting certain trading markets that otherwise would have to register as exchanges to instead register as alternative trading systems).
14 Rule 903 of Regulation S under the Securities Act governs offshore offers and sales of securities. The application of Regulation S to S-Token offerings is in many respects uncertain. First, Regulation S is a "safe harbor", not a mandatory provision; as a result, a company's failure to comply with Regulation S does not mean that the company necessarily has acted illegally. See Preliminary note 5 to Regulation S. Second, Rule 903 of Regulation S often has specific rules for offers and sales of "equity" securities and for offers and sales of "debt" securities. In many cases, S-Tokens appear to be a new class of securities that are neither equity nor debt securities (but see the discussion of debt securities, below). As a result, it is not clear how, or whether, many of the provisions of Rule 903 apply to offers and sales of S-Tokens.
Nonetheless, the thrust of Rule 903 and of Regulation S is to limit the ability of securities sold outside of the United States to flow back into the United States, at least for some period of time, and there are several provisions in Rule 903 that apply to offshore offers and sales of S-Tokens, and that may be inconsistent with a U.S. (or any) company listing its S-Tokens on a foreign exchange that permits U.S. buyers and sellers to participate. See, e.g., Rule 902(c) and Rule 903(a)(2) (prohibiting directed selling efforts made in the United States, which could include registering S-Tokens on a foreign exchange and publicizing to U.S. investors the availability of that foreign exchange for purchases and sales of the S-Tokens).
In addition, the definition of a debt security for purposes of Regulation S includes "any security other than an equity security." As a result, assuming that an S-Token is not an equity security, it arguably should be treated as a debt security for purposes of Regulation S, even though many S-Tokens lack any traditional indicia of debt securities, such as the rights to principal and interest payments from the issuing company, or the right to participate in any assets, revenue or other economic performance of the issuing company. If S-Tokens are or may be debt securities for purposes of Regulation S, then Rule 903 may require the company issuing the S-Tokens to impose other restrictions on the S-Tokens that are inconsistent with a listing on a foreign exchange. See, e.g., Rule 902(g) and Rule 903(b)(3), requiring U.S. companies that issue S-Tokens overseas to, among other things, disclose that U.S. persons may buy and sell the S-Tokens only if they are registered under the Securities Act or if they are sold pursuant to an available exemption from registration.
Also, if S-Tokens are debt securities for purposes of Rule 903, then a U.S. company that issues the S-Tokens overseas would need to have those S-Tokens represented by a temporary global security which is not exchangeable for definitive securities for at least 40 days following the closing of the offering. See Rule 903(b)(3)(ii)(B). While many SAFTs may not be exchangeable for definitive securities for at least this 40-day period, it is not clear that many SAFTs technically are "temporary global certificates" within the meaning of Rule 903.
Nonetheless, the thrust of Rule 903 and of Regulation S is to limit the ability of securities sold outside of the United States to flow back into the United States, at least for some period of time, and there are several provisions in Rule 903 that apply to offshore offers and sales of S-Tokens, and that may be inconsistent with a U.S. (or any) company listing its S-Tokens on a foreign exchange that permits U.S. buyers and sellers to participate. See, e.g., Rule 902(c) and Rule 903(a)(2) (prohibiting directed selling efforts made in the United States, which could include registering S-Tokens on a foreign exchange and publicizing to U.S. investors the availability of that foreign exchange for purchases and sales of the S-Tokens).
In addition, the definition of a debt security for purposes of Regulation S includes "any security other than an equity security." As a result, assuming that an S-Token is not an equity security, it arguably should be treated as a debt security for purposes of Regulation S, even though many S-Tokens lack any traditional indicia of debt securities, such as the rights to principal and interest payments from the issuing company, or the right to participate in any assets, revenue or other economic performance of the issuing company. If S-Tokens are or may be debt securities for purposes of Regulation S, then Rule 903 may require the company issuing the S-Tokens to impose other restrictions on the S-Tokens that are inconsistent with a listing on a foreign exchange. See, e.g., Rule 902(g) and Rule 903(b)(3), requiring U.S. companies that issue S-Tokens overseas to, among other things, disclose that U.S. persons may buy and sell the S-Tokens only if they are registered under the Securities Act or if they are sold pursuant to an available exemption from registration.
Also, if S-Tokens are debt securities for purposes of Rule 903, then a U.S. company that issues the S-Tokens overseas would need to have those S-Tokens represented by a temporary global security which is not exchangeable for definitive securities for at least 40 days following the closing of the offering. See Rule 903(b)(3)(ii)(B). While many SAFTs may not be exchangeable for definitive securities for at least this 40-day period, it is not clear that many SAFTs technically are "temporary global certificates" within the meaning of Rule 903.
15 Rule 144(b)(1)(ii) and (d)(1)(ii) under the Securities Act (providing for a one-year holding period for securities issued by a non-reporting company). For purposes of the one-year holding period requirement, S-Tokens acquired pursuant to a SAFT should be deemed to have been acquired at the time the SAFT was acquired. See Rule 144(d)(3)(ii) under the Securities Act ("If the securities sold were acquired from the issuer solely in exchange for other securities of the same issuer, the newly acquired securities shall be deemed to have been acquired at the same time as the securities surrendered for conversion or exchange . . .").
22 As discussed earlier, unregistered foreign (and domestic) exchanges and markets that permit U.S. persons to buy and sell S-Tokens may be acting in violation of the exchange and ATS registration requirements under the Exchange Act.
24 In both these cases, the principal federal securities law concern is whether the U.S. person who bought or sold the S-Tokens on the foreign exchange acted as an underwriter of the S-Tokens, or otherwise engaged in a public offering of the S-Tokens that required the transaction to be registered under Section 5 of the Securities Act. In both of these cases, because there was no intention by the U.S. person to sell the S-Tokens to other U.S. persons, it may be reasonable to conclude that the transactions did not constitute a distribution in the United States by an issuer or underwriter that would be subject to the registration requirements of Section 5. And, as discussed earlier, the U.S. person purchasing S-Tokens on a foreign exchange has the additional argument that the registration and similar requirements of the Securities Act generally apply to people who and entities that offer or sell securities, not to purchasers of securities. Nonetheless, it bears emphasizing that any argument along the lines discussed above is heavily dependent upon the particular facts, and the purchaser or seller does not have the protections or certainty afforded by a regulation such as Rule 904 of Regulation S.
25 Rule 144A under the Securities Act. In general, a QIB is an institution with at least $100 million in securities investments. Rule 144A(a)(1).
26 Registered or qualified S-Tokens are not restricted securities, and therefore generally are not subject to the resale limitations of Rule 144. See Rule 144(a)(3). In general, as long as the person selling the registered or qualified S-Tokens is not an affiliate of the issuer and is not acting as an underwriter for the S-Tokens (which will usually be the case if, among other things, the seller is selling limited numbers of tokens following the completion of the issuer's offering of the S-Tokens), the seller's resales will not be subject to the registration provisions of Section 5 of the 1933 Act by reason of Section 4(a)(1) (exempting transactions by a person other than an issuer, underwriter or dealer), perhaps Section 4(a)(2) (exempting transactions not involving a public offering), and in some cases Section 4(a)(4) (exempting transactions sold in ordinary brokers' transactions).
27 See Section 3(a)(4)(A) of the Exchange Act (defining a broker as a person engaged in the business of effecting transactions in securities for the account of others); Dominion Resources, Inc., SEC Staff No-Action Letter (March 7, 2000) (stating that finders who introduce buyers and sellers of securities and receive fees based on those sales are subject to broker-dealer registration); Brumberg, Mackey & Wall, SEC Staff No-Action Letter (May 17, 2010) (stating that receipt of compensation based on transactions in securities is a hallmark of broker-dealer activity).
28 See, e.g., Clayton Statement (stating that those who operate platforms or facilitate transactions in tokens may be illegally unregistered broker-dealers); SEC, "SEC Charges Private Equity Firm, Former Executive, and Consultant for Improperly Soliciting Investments," Press Release (March 11, 2013) (announcing charges against a finder that allegedly acted as an unregistered broker-dealer and against the principal of the firm that paid him for his activities with aiding and abetting his violations).
29 Section 3(a)(1)(C) of the Investment Company Act of 1940 (Investment Company Act) (providing that an issuer is an investment company if the value of the securities it holds exceeds 40 percent of the total value of its assets, less cash and government securities), and Section 3(c)(1) of the Investment Company Act (providing that an issuer with 100 or fewer beneficial owners of its outstanding securities is excepted from being an investment company). There is a reasonable argument that, under Section 3(c)(1), beneficial owners of S-Tokens often should not be treated as beneficial owners of outstanding securities of the issuer. Among other reasons, the holders of the S-Tokens often have no right to participate in the assets, profits, or other economic returns of the issuer. There also is a reasonable argument that, for purposes of the 40 percent test under Section 3(a)1)(C), the S-Tokens should not be treated as securities in the hands of the issuer, in large part because the company issuing the S-Tokens is relying on its own efforts, and not the efforts of others, to generate a profit on the S-Tokens (which is generally why the S-Tokens are treated as securities in the hands of the purchasers of those S-Tokens). These arguments, however, are still untested with the SEC and the courts.
32 See Section 3(a)(11) of the Exchange Act (generally defining "equity security" as any stock or similar security, or other securities convertible into or derivative of equity securities). Generally, S-Tokens do not have characteristics of stock, such as the right to dividends or a share of profits or assets of the issuing company.
