As SEC hunts for ICO frauds, lawyers explain compliant securities tokens

By Staff Reporter

Regulators are increasingly clamping down on digital tokens issuances. Spearheading the enforcement actions against fraudulent issuances is the US Securities and Exchange Commission (SEC), which recently penalized two token issuances: Paragon and Airfox.

They had failed to meet the legal requirements for traditional securities.

Yet, there is not a lot of information out there on how to actually go about structuring securities token offerings which are seen as revolutionizing the $7-trillion securities market.

The road to legally-compliant issuances, however, is easier said than done because traditional securities law, in itself, is confusing, Carlos Domingo, the co-founder and chief executive of digital token platform Securitize told Blockchain Asset Review.

“You can ask five different securities lawyers the same question about current regulations and get five different answers,” he said. “And that’s even before we add blockchain technology into the mix.”

There are a number of loopholes that need to be addressed with regards to current securities regimes to get more regulatory clarity with regards to STOs.

For instance, the current disclosure regime is not well-equipped for specific disclosures that will need to be made with respect to all of the current and new digital securities, said Marc Boiron, a partner at law firm FisherBroyles.

For example, when Paragon and Airfox each file a Form 10, a comprehensive report on the company’s utility tokens, to register their tokens with the SEC as a security, it is unclear what specific information about the utility tokens will need to be disclosed in order to comply with regulations.

“I doubt changes here will occur anytime soon,” Boiron said.

In addition, more streamlined rules around secondary trading of private securities are necessary. The web of related regulations is currently so complicated that very few securities attorneys agree on how to interpret them.

“With the SEC recognizing how complex this space has become, I believe regulations will evolve,” Boiron said.

To make matters worse, most lawyers are completely unprepared to provide any thoughtful advice on digital securities.

“Only one out of 100 lawyers is a real securities lawyer and only a seasoned expert should have any business offering advice on digital securities,” said Juan Pablo Cappello, a partner at Miami-based law firm Private Advising Group.

“If you look them up and they practiced real estate law, personal injury law, was a litigator before reinventing themselves nine months ago as a “blockchain” lawyer, then please, find a real expert.”

While there may not be a need for a paradigm shift in securities regimes catering to blockchain assets, there are issues with regards to how well the current regulations jibe with the new technologies.

Allison C. Yacker, a partner at Katten Muchin Rosenman LLP said: “And often, there is not a clean fit. Issues around digital securities are presenting numerous opportunities for lawyers to consider these new issues.”

There are clearly areas where there is a need for more regulatory clarifications.

“The more clarity the SEC can provide regarding digital tokens and ancillary issues, such as custody and capital treatment for registrants holding such assets, better off the industry will be,” said Yacker of Katten Muchin Rosenmen.

For instance, new legislation will also have to provide guidance on how to resolve overlap among different regulators, where the characteristics of crypto assets may not be 100 percent clear (such as with Ether and XRP), or how to regulate digital tokens that have utility characteristics.

“Currently, only judges are providing the final word on what is a security,” she said, adding “ultimately legislators should weigh-in to help provide certainty and to plug loopholes that might let bad actors can rip-off the public and tarnish the promise of this new technology.”

Boiron of FisherBroyle believes that a uniform global securities law around the secondary trading of securities would also be incredibly helpful to improve efficiencies around cross-border trading.

“However, it is extremely unlikely that this will be established anytime soon,” he said.

Robin Sosnow, a partner at NYC-based Digital Securities Law Group, believes that one way, legislators could improve the current framework for the mass adoption of digital securities is by relaxing the definition of the ‘accredited investor’.

This would allow for more retail investors to participate in private company offerings.

Digital securities will change the public securities markets by eliminating a number of intermediaries, experts believe.

These include such firms as Depository Trust Co., the trust company that performs the functions of a central securities depository, and Cede & Co., the financial institution that processes transfers of stock certificates on their behalf, said Boiron of FisherBroyles.

“Eventually, this could drastically reduce the reliance on brokerage accounts. This will bring the same liquidity that exists in public securities markets but at a lower cost and with greater accuracy,” Boiron said.

Digitization of securities with the help of blockchain can also bring much-needed liquidity to private assets that were previously too difficult to sell because either selling fractional interests was too inefficient (eg. art or real estate) or were rarely sold because the necessary channels did not exist (eg. stocks of private companies).

IPO share certificates began as paper documents before they became an electronic record of share ownership and transfer.

Blockchain technology and the use of digital securities are the next steps in the evolution.

While the STOs are seen as the next big thing in the blockchain sector, a lot of questions remain. The foremost amongst them is whether the STOs are likely to fuel another hyped phenomenon just like ICO bubble that took the world by storm over the past two years but has since deflated with the onslaught of regulations.

Sosnow of Digital Securities Law believes that the failure of ICOs, which has raised more than $20bn in 2018, has in fact helped fuel a growing interest in STOs.

“Many of the shortcomings of ICOs are being answered by the compliance-centric digital securities offerings,” Sosnow said. “Even among the most conservative securities lawyers, the interest in digital securities is brewing.”

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