It pains me to say it, but Open Props’ recent announcement of the coming termination of its ongoing Regulation A (“Reg A”) digital asset securities (Props) offering and the cessation of support for its Props Loyalty Program leads me to one stark conclusion:
While compliant, Reg A is neither a business nor investor friendly or workable regulatory path for cryptocurrency-related companies that intend to offer and sell investment contracts on an ongoing basis.
I’ve chosen those words carefully. Let me explain.
SEC Review and Qualification
All companies that seek to qualify a Reg A offering statement with the SEC are subject to an SEC staff comment and review process. This process involves the staff’s substantive review of and comment on a company’s offering materials. This back and forth elicits comprehensive disclosure of the company’s business plans and finances in order to, among other things, provide investors with the information they need to make informed investment decisions.
While all companies seeking to qualify a Reg A offering go through the same process, to date, crypto companies seeking to rely on the exemption have borne the brunt of a unique headwind in the review and qualification process. In short, as early Reg A crypto adopters, they have been tasked with building the digital asset industry’s initial examples of and precedent for robust, public crypto-company business, network, token and financial disclosure that has been reviewed and commented on by the SEC staff.
This is no easy (or inexpensive) task, and one for which there is no additional reward. Any project that comes in their wake owes them a debt of gratitude.
Separately, crypto companies, like Open Props, that have endeavored to offer and sell their tokens in compliant continuous, ongoing digital asset offerings do not necessarily enjoy any reprieve from that initial qualification and review process. The Reg A process for ongoing offerings requires companies to continually assess (for so long as an offering remains ongoing) whether any changes to the disclosure contained in their offering materials requires another filing with, and qualification by, the SEC in order to continue with the offering. This imposes a non-insignificant ongoing compliance and monitoring obligation on these companies and their legal counsel, involving frequent contact with the SEC staff in charge of their filing. This obligation is independent of any ongoing, periodic filing requirements.
Crypto companies, whose businesses are often inextricably intertwined with the issuance of the network’s native digital asset, have to be acutely aware of ongoing compliance in order to be able to not only continue with their offering but also the operation of their networks. In short, cessation of a crypto company’s ongoing Reg A digital asset offering for the failure to compliantly account for substantive (or greater) changes to its business, network, token, and/or finances can effectively be synonymous with cessation of such company’s ongoing business operations.
For crypto companies in continuous offerings, Reg A is hard in, then eyes open.
The Howey Wave Doesn’t Crest?
As difficult as it is for a crypto company issuing digital assets to get into the Reg A regime, it is even more difficult for them to get out.
Why? Because, while the securities law status of an offering of digital assets pursuant to Reg A is not in dispute, the operative facts and circumstances surrounding transactions in those assets may change over time in such a manner that they no longer constitute securities transactions. And, while the company issuing those assets may initially be the appropriate party to bear the securities laws disclosure obligations and associated liabilities related to these assets, that may not be the case two or three years later. It just depends… but, in any event, good luck convincing anyone tasked with regulating securities markets to acknowledge when transactions in a specific digital asset that at one time implicated the securities laws no longer do. At least, that is, until the Howey test crests and the Ripple settles.
So, for crypto companies, Reg A is hard in, eyes open, and no out.
Liquid and Frozen
Whereas the SEC, its Chair, and the SEC staff have been clear in their view that digital asset offerings typically involve the offer and sale of securities, until recently, they have been less forthcoming on how to potentially accommodate regulated intermediation of transactions in compliantly-issued digital asset securities at scale. This is not necessarily without good reason, given, for example, the general limitations of SIPC to protect against investor losses that can follow broker exposure to investment contracts, but in the meantime holders of securities issued in compliant publicly-available digital asset offerings have largely been frozen in their ability to find liquidity.
In sum, for crypto companies and their network participants, Reg A is hard in, eyes open, no out, and frozen.
For these reasons, the Reg A path to compliant public digital asset securities offerings and aftermarkets in the U.S. has and will continue to be the exception, not the rule. I applaud companies, like Open Props, that have undertaken significant efforts to comply with U.S. law. Yet, while certainly unfortunate for them and their community of supporters, the outcome of their efforts has demonstrated for me the shortcomings of perhaps the only viable exempt regulatory path for compliant public digital asset securities offerings available in the U.S.
I supported Props’ efforts at the outset and continue to support their efforts today.