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The Importance of SEC Qualification for Crypto Assets

May 2, 2019

What does it mean for a crypto asset to be SEC-qualified? How exactly does it impact your investment? And does it really matter? These are questions that investors are asking a lot lately. With more and more crypto assets on the market, it's hard to know which ones to choose. We firmly believe that SEC-qualification under Regulation A+ is vital for the long-term growth and success of the crypto asset industry and necessary for your investment strategy. Here's why.

As SEC Chairman Jay Clayton has stated, tokens and offerings that feature and market the potential for profits based on the entrepreneurial or managerial efforts of others contain the hallmarks of a security under U.S. law.   This leaves two options for issuers of digital assets: 1) register as a security, or 2) qualify for an exemption from registration.  Most security token offerings are opting for the latter.  The primary exemption that STO issuers are using is Reg D.  The main drawback of the Reg D exemption is that it is only open to accredited investors.  The Reg D offerings are the only Security Token Offerings that are now trading.  The other exemption to full registration is Reg A+.  Through Reg A+, a U.S. or Canadian company is afforded the opportunity to:

  • Raise-up to $50 million in 12 months using a "public solicitation" of its shares and have the offering be exempt from SEC and state securities law registration.
  • Confidentially submit its offering memorandum to the SEC and enjoy the opportunity to "test the waters" before pursuing a mini-IPO.
  • Enjoy a streamlined, expedited review process where the company is required to make its offering memorandum public just 21 days before SEC qualification and the beginning of its roadshow.
  • Combine public funding (through Reg A+) with private funds from venture capitalists to create a larger round of fundraising.

A small number of STO issuers are choosing this route including CERES.  As of the date of this Blog, no REG A+ STO has gained SEC approval.

What is SEC-qualification under Regulation A+?

For anything to be traded as an investment under Regulation A+, it must be considered a "security" by the SEC. Securities are, by definition, certificates or other financial instruments that have monetary value and can be traded in a given market. Once an asset is SEC-qualified, companies are legally allowed to crowdfund under Regulation A+ as either a Tier 1 or Tier 2 security. SEC-qualified securities are required to register with the SEC (Tier 1 securities also have to register with the state securities registrar where they plan to attract investors. They also need to provide investors with an offering circulator. Tier 1 securities can crowdfund up to $20 million in a 12-month period, while Tier 2 securities can crowdfund up to $50 million in the same timeframe.  

Why Does SEC-Qualification Matter?

ICOs that exploded in 2017 and 2018 are a thing of the past.  Most of these issuers in those heady days argued that their coin, token, or asset was anything but a security and therefore not subject to rigorous SEC review.  

When a crypto asset doesn't register with the SEC under Regulation A+, they are not bound by SEC oversight and regulations. They don't have to provide any paperwork or guidance to investors. In fact, they aren't allowed to refer to buyer's as "Investors." If you sign an ICO contract that lists you as a "buyer" instead of an "investor," that company has not registered with the SEC; they are under no legal obligation to provide anything in exchange for your money. They can even stipulate that you are not guaranteed the coins that you agreed to purchase. This has gotten many ICOs in trouble with the SEC and is largely the reason why so many of them failed in 2017.

Simply put, SEC-qualification requires the company in question to be "above board" with investors. It requires them to follow specific laws and provide you with adequate resources to make the right choices for your portfolio. A lack of SEC-qualification is a way for crypto companies to avoid SEC oversight and regulation and raise money from unsuspecting buyers without any consequences if their crypto asset fails.

If you are considering an Initial Coin Offering, sometimes referred to as an "ICO," or otherwise engaging in the offer, sale, or distribution of a digital asset you need to consider whether the U.S. federal securities laws apply.  A threshold issue is whether the digital asset is a "security" under those laws. The term "security" includes an "investment contract," as well as other instruments such as stocks, bonds, and transferable shares.  A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of "security" under the federal securities laws.  In this guidance, we provide a framework for analyzing whether a digital asset has the characteristics of one particular type of security – an "investment contract." Both the Commission and the federal courts frequently use the "investment contract" analysis to determine whether unique or novel instruments or arrangements, such as digital assets, are securities subject to the federal securities laws.

-Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets” via SEC.gov

Who Can Invest Under Regulation A+?

Anyone can invest under Reg A+. If you're an accredited investor with a net worth of $1 million OR an annual income of $200,000 over the last two years ($300,000 if married), you can invest as much as you want in both Tier 1 and Tier 2 securities. If you're not an accredited investor, you can still invest in Reg A+ securities, but you cannot invest more than 10% of your annual income (or 10% of your net worth).

What's the Risk of Investing in Unregistered ICOs?

If a crypto asset fails to register with the SEC and raises money via crowdfunding without implicitly telling buyers that they are not a registered security, they run the risk of being shut down or heavily fined by the SEC. Investors are on the hook for the payments, and the companies usually crumble shortly thereafter. This was the case for Crypto Asset Management, Blockvest, and dozens more.  

If you're going to invest in crypt assets, make sure you select a company that has done their due diligence and registered with the SEC. It's the only way to protect your investment.

CERES is currently in the process of seeking SEC qualification under Tier 2 of Regulation A+. If approved, investors will be able to purchase CERES Coins and CERES Tokens as part of a Security Token Offering (STO).  

To learn more, contact us at info@cerescoin.io.