#2 Did You Know: Eligible Securities
Did you know that the Reg A exemption is available only for specific securities?
This post is part of an ongoing series exploring the basics and not-so-basics of Regulation A. You can find other posts in the series here. Contributions to this article made by Zachary Fallon, James Blakemore, Julian Russo, and Jenny Leung.
Rule 261(c) of Regulation A (“Reg A”)[1] defines the list of eligible securities that can be issued pursuant to Reg A to include “[e]quity securities, debt securities, and securities convertible or exchangeable to equity interests, including any guarantees of such securities.” It further expressly excludes from eligibility asset-backed securities, as that term is defined in Regulation AB.[2]
Reg A’s list of eligible securities largely tracks those specified in its authority-granting statutory provision, Securities Act Section 3(b)(3). This provision provides that only the following types of securities are eligible for issuance pursuant to any regulation adopted by the SEC pursuant to it: “equity securities, debt securities, and debt securities convertible or exchangeable into equity interests, including any guarantees of such securities.”
Yet, as the Commission noted in its Reg A rulemaking, the statute alone is not exactly clear which types of securities, if any, Congress intended for the SEC to exclude from the regulation. There is some evidence in the congressional record, however, that suggests the exemption was meant to be for ordinary — and not exotic — securities.[3]
Why should you care?
In recent years, many companies conducted token (digital asset) offerings that — wittingly or not — involved the sale of “investment contract” securities. Many such offerings involved the wide distribution of securities to retail investors without registration or an available exemption from registration under the federal securities laws. The impact of this lack of compliance continues to have serious repercussions for the entire digital asset ecosystem today.
One central and ongoing question among digital asset market participants is how to facilitate a securities law compliant token offering that results in such tokens functioning as useful mediums of exchange on the network.[4] In our view, Reg A continues to be the most viable regulatory option for network creators that issue security tokens in that the securities so issued are both widely distributable at issuance and unrestricted — features which will eventually bolster the tokens’ status as a non-security.[5]
But are tokens ordinary or exotic?
It depends.
Tokens definitely sound exotic, but in reality their features (i.e., the rights associated with them) are typically pretty ordinary, at least from a securities law perspective. For example, while tokens typically exist only in code and function on the back of novel technologies, such as blockchains, they often do little more than represent a tradeable right to network access or rights that are otherwise commonly found in traditional securities. So, while a Reg A issuer will generally have to adequately describe all aspects of its token and the network on which it functions, a focus on features should diminish concerns around eligibility.
Both Congress and the SEC have opened room for this approach. While initial drafts of the bill that eventually became Securities Act Section 3(b)(3) expressly excluded investment contracts from eligibility,[6] the law, as adopted, did not. Additionally, the SEC recently noted that “[c]ertain securities that may not have all of the characteristics traditionally associated with equity or debt securities, such as tokens, may qualify as Regulation A eligible securities, depending on the particular facts and circumstances.”[7]
So far, at least two Reg A offerings have demonstrated the appropriate facts and circumstances.
Who is next?
Endnotes
[1] Regulation A is an exemption from registration under the Securities Act of 1933 for public offerings. Regulation A has two offering tiers: Tier 1, for offerings of up to $20 million in a 12-month period; and Tier 2, for offerings of up to $50 million in a 12-month period. For offerings of up to $20 million, companies can elect to proceed under the requirements for either Tier 1 or Tier 2.
[2] 17 C.F.R § 229.1101(c) (defining Asset-Backed Securities).
[3] See Small Company Capital Formation Act of 2011: Markup of H.R. 1070 before the H. Comm. on Fin. Serv. for the 112th Congress, 157 Cong. Rec. 89, (daily ed. June 21, 2011).
[4] Hester Peirce, Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization (Feb. 6, 2020), https://www.sec.gov/news/speech/peirce-remarks-blockress-2020-02-06.
[5] Zachary Fallon et al, The case for Reg A: a response to Commissioner Peirce (Feb. 28, 2020), https://www.theblockcrypto.com/post/57207/case-for-reg-a-response-commissioner-peirce-sec-token.
[6] Small Company Capital Formation Act of 2011, H.R. 1070 112th Congress (2011), https://financialservices.house.gov/uploadedfiles/hr1070_repsubcom_xml.pdf.
[7] Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, 85 Fed. Reg. 17956, 18001 n.353 (proposed Mar. 31, 2020).
