Security Token Offerings: STOs Replacing ICOs?

Based on a strong legacy of investor protection and oversight by regulators, security token offerings (STOs) are poised to overtake initial coin offerings (ICOs) that were conducted without regard to regulations. Understanding why and how this shift is happening is key to positioning your company to attract investors while protecting it from risk.

Understanding the Difference Between STOs and ICOs

With an initial coin offering (ICO), companies receive investor funding in exchange for cryptocurrency tokens. Most of these were done out of compliance with regulations.  Investors buy into these offerings in hopes that those tokens will increase in value, at which point, they can be traded for a profit. This is a classic example of a securities offering, which is supposed to be regulated, but ICOs were conducted largely as if they were unregulated.  While they offer a lot in the way of convenience and speed, ICOs were also a prime area for fraud when bad actors created ICOs with the intent to take the money and defraud the investors.  Even the good actors of ICOs often broke securities laws because they mistakenly thought that ICOs were unregulated.

A security token offering, or STO, is also a type of cryptocurrency token, but one that recognizes that the tokens or the token offering is regulated by securities laws. STOs can either be tokens that were sold as securities but is often thought of as relating to tokens that give their owners a share of the business profits, a stake in the business itself, or some other offering that is based on the business or asset itself. Because STOs are securities, they are regulated by the securities laws and the applicable securities regulators. These factors make it far less likely that investors will encounter fraud. The reality is that almost all ICOs were actually just illegal STOs, a notion that the SEC has often stated.

STOs, Regulation D, and Accredited Investor Verification

As the market moves away from ICOs as a means of raising capital, companies who have previously relied on this method may find that itis more work to operate within the regulatory framework of an STO. That being said, that very framework is what provides more public and investor trust in your business, so it is ultimately worth the effort.

STOs may rely on many different securities exemptions to conduct a sale, but it’s most often done in reliance on the Rule 506(c) exemption with a Form D filed with the SEC. These types of offerings may solicit anyone, but can only sell to accredited investors. For Rule 506(c) offerings, STO issuers are required to take reasonable steps to verify that investors are accredited investors.

Investor verification is vital to the success of a project involving an STO. Failing to properly verify your investors may result in serious consequences, as non-compliance may result in the SEC requiring the issuer to return all the investors’ monies as well as face potential legal actions.

To learn more, visit us at https://www.VerifyInvestor.com

Vote on Proposal to Extend “Test-the-Waters” Accommodation

More types of issuers may soon have more flexibility when considering new securities offerings, as the Securities and Exchange Commission (SEC) has voted to propose expanding “test-the-waters” accommodation to all issuers including investment companies.

If the proposal goes ahead, all issuers will be able to gauge market interest in initial public offerings and other proposed registered securities offerings, by corresponding with potential investors in person or in writing before publicly announcing the offering. Under the current rules, only companies that qualify as emerging growth companies, or EGCs, have access to the test-the-waters" accommodation. Companies with more than $1 billion in annual revenues would generally not qualify as EGCs.

“Opening up this provision to more issuers is a move designed to enhance issuers’ ability to conduct successful public securities offerings and lower the cost of capital”, said SEC chairman Jay Clayton, who added, “The proposed rules would allow companies to more effectively consult with investors and better identify information that is important to them in advance of a public offering.”

Regulation D, Rule 506(c) and “Test-the-Waters” Accommodation

If your organization is considering a new offering, understanding how this proposal and Regulation D, Rule 506(c) intersect is important.

Regulation D, Rule 506(c) allows companies to publicly solicit for funds and advertise while still conducting a private offering without registration with the SEC. Under Regulation D, Rule 506(c), companies can solicit and advertise their offerings, without registration, provided that all the investors in the offering are accredited investors and - most critically - the company has taken reasonable steps to verify their investors are accredited investors during the purchasing stage. Information like tax returns, brokerage statements, and lawyer or accountant certifications can be used to verify accreditation. The services we offer at VerifyInvestor.com provides issuers with the protection of SEC compliant safe harbor Rule 506(c) accredited investor verifications without the extra work on their end.

Under the proposed expanded “test-the-waters” accommodation, during the solicitation or offering stage, issuers will still be required to ensure that they are communicating with potential investors that they reasonably believe to be qualified institutional buyers or institutional accredited investors. However, unlike rule 506(c), the new “test-the-waters” accommodation is designed for registered offerings. Any potential investor solicited has to meet those requirements so that they are assumed financially sophisticated enough to handle the communications. Notably, the SEC has not proposed a verification standard or requirement for ensuring that an investor has the right status, instead opting to allow issuers to rely on the methods they currently use to establish a reasonable belief. This, they say, is intended to give issuers more flexibility in choosing effective and appropriate methods for each offering and each investor.

The dominant provider of accredited investor verification services

Understanding Your Obligations as an Issuer

Using VerifyInvestor.com is the best way to ensure that your investors are accredited for your Rule 506(c) offering as we provide licensed attorney verification reviews for every accredited investor verification. Note that failing to properly verify your investors may result in serious consequences, as non-compliance may result in the SEC requiring the issuer to return all the investors’ monies as well as face potential legal actions. 

The SEC proposal is subject to a 60-day comment period after appearing in the Federal Register, meaning that it is one step closer to becoming a reality. Being able to “test-the-waters” could result in a greater number of 506(c) offerings if issuers elect to generally solicit investors rather than going through a registered offering. Whether the expanded accommodation becomes a permanent fixture of the investing world, or if the SEC decides to keep the current accommodation, this move indicates the agency’s willingness to adapt regulations to fit the real-time needs of the market.

Regardless of the outcome, Rule 506(c) will continue to represent an attractive option for issuers seeking to avoid the expense and scrutiny involved in a public offering.

VerifyInvestor.com can help give your organization the peace of mind you need to connect with potential investors without jeopardizing your future success.

To learn more about verifying potential investors, simply reach out to our team at https://www.verifyinvestor.com/contact.