As many who follow this space may know, we have created a unique cryptographic asset, a software token, to raise awareness of our operation. It has been a much more difficult and harrowing endeavor than we ever thought it would be. Oustide of doing something different than everyone else, we found it harrowing to attempt to weave through the various interpretations of what a security is and isn't. The following blog post series is the result of our canvassing the big minds in the very limited arena of lawyers who fully understand the Blockchain and crypto asseets as well as the law (as it pertains to the former). I say this not to be condescending, but to point out how small such a club actually is and how absolutely necessary it is for that club membership to expand dramatically.
The last thing any start up with less than a $100 million in funding needs is a cease and desist, or worse yet, a subpoena from a federal or state agency. We turned on the commenting facility of the site just for this series, and welcome one and all to openly participate in this discussion - particularly the legal community, those who have issued or purchased assets, and even regulatory representatives. I figure it is better to get this out in the open than to creep around hoping nothing happens. The vast majority of participants in the 2.0 space that I have met are hard working, honest individuals who do not mean to break the rules. I would like all to realize that and to take it into consideration. Our Crypto Asset can be purchased here [6], with a presentation here [7]. Thus, without further adieu, I present the first in a series of legal lectures (purposely cast in layman's language) on crypto assets, securities issuance and software tokens by the well spoken Jason Seibert an engineer and securities attorney.
How to Sell Tokens and Not Violate Securities Laws
by Jason Seibert
Congratulations! You figured out how to code and you think you want to raise money by way of a “Token” offering to help get your business off the ground. If you don’t know how to code, or you don’t know what a “Token” offering is, then this article really isn’t for you. I’m not going to take the time to explain the Blockchain to you, or side chains, or mining, or really anything other than how to sell someone a “Token” and not violate the state or federal securities laws.
This will be a multi-part series at the request of Mr. Middleton and I’m happy to provide this information on a generic level. Honestly, if at any time you have a more detailed question, or need to know specifics, that’s a good thing – try to communicate those questions in the comments section attached to this blog and I’ll see if I can address your concerns in a few words. If it’s a complex issue though, you might want to consult with your attorney. On that note – standard disclaimer folks – your facts may be different than my facts and my analysis, so if you rely solely on this information without consulting an attorney, you are pretty much on your own, although you will be headed down the right path. Walk with care.
The more you are selling a product, the less likely you are selling a security. If you have a user’s guide that accompanies your Token instead of an offering document, you are probably on the right track (you are smart folks, you know how to look around at what other people are doing and copy and paste from the interwebnets – if someone’s document says “offering document” on it, you probably want to think twice about using it). Think of it this way – if it walks like a duck and talks like a duck, it’s probably a duck. If you publish an online statement about how excited you are about your “ICO” (initial coin offering), you are headed down the path of a security; however, if you publish an online statement about how excited you are to be selling software and how people can get an advanced ticket to ride, then you are probably headed down the path of selling a product. Get it?
By way of example, let’s say I’ve decided to release a new product based on existing blanket technology utilized in the Snuggie ™ market, and I’m going to call it the “Snuggie of Things” (listen, this is a parody and I have no intention of offering this product, nor do I have any intention of violating any intellectual property laws here folks – I do, however, plan to utilize the fantastic qualities of my Snuggie ™ whenever possible – don’t judge me). To avoid crossing into the securities laws, I pretty much just have to offer the blanket and nothing else – oh, right, and I should probably sell the blankets myself. Keep it simple. However, if I offer to pre-sale the comfortable lounging blankets and claim that they will increase in value and that a secondary market will develop prior to the release of the “Snuggie of Things,” and I offer the pre-sale of blankets through a third-party vendor along with an offering document and describe it as a “IBO” (initial blanket offering) – then I’m pretty much selling securities – or at least that’s what the regulators will say. Get it?
If you want me to actually quote the dozen or so state and federal securities laws that support this point of view, you’ll have to pay me to do it, or you could trust in the fact that the securities laws are broadly interpreted and designed to adapt to the ever changing ways people try to raise money by taking it from other people.
Are there arguments that Token sales are not securities? Sure. Pretty easy ones to make, if you only look at the Federal Securities laws in a micro-vacuum without consideration of 70+ years of jurisprudence, or if you don’t know what a merit review state is, or if you have never faced cease and desist orders from multiple jurisdictions, or if you rely on what your friend’s attorney said over drinks.
But, but…my attorneys told me I wasn’t selling securities??
Great, okay, you asked your attorney if you were selling a security and what did you tell him or her? “It’s just software,” right? Did you tell them everything? Or did you tell your attorney what you thought they wanted to hear after you read a few cases I hinted at above? Chances are if your attorney actually understood what a Token is, or how you’ve worded your “software sale” they probably would have told you that you are going to have to ask for permission or beg for forgiveness later.
My favorite case involving “software” actually comes from SEC v. Glenn W. Turner Enterprises and derived from my great state of Oregon in 1973. SEC v. Glenn W. Turner Enterprises, 474 F.2d 476 (1973) [10]Glenn Turner sold self-improvement cassette tapes (don’t get all retro hipster on me, yes, they sold cassette tapes, stay focused) under the “Dare to be Great” slogan. How it worked: Part of the program included a portion of income through the sale of cassette tapes to people, who, in turn, could have the opportunity to sell the program and tapes to others. Turner argued he was just selling tapes. The federal court determined, which was upheld by the Ninth Circuit Court of Appeals, that because of the remedial nature of the securities laws, the statute should be broadly interpreted to include schemes that in substance, if not form, are securities. You see, when the purchaser of the “software” was told he or she could sell the product him or herself, and make money doing it, that was enough. This case created the “functional test.” End result? Permanent injunction and asset seizure. What does it mean? If the contract functions like a security, no amount of efforts to claim it is not a security will convince the courts. Now, listen, your attorney may tell you that selling cassettes and an opportunity to sell cassette tapes is different than what you are doing – that’s great, good for you – you’ve paid your attorney to tell you what you want to hear. I’m telling you that when it comes to defending a regulatory action, if you have to explain what you are doing, you have already lost and you should get ready for a long and expensive fight. So – how do you explain what you are doing?
You: “Listen, man, it’s just software, we are advance-selling a ticket to be able to use the software in the future. It’s like Kickstarter meets Mozilla because we have a non-profit that will be funded through the token sale, and that might contribute to our for-profit development of the open-sourced ecosystem software that will power this nascent technology into a newer, more disruptive, blockchain 2.0 and Web3.0 space…did I mention Internet of Things – it’s totally about the Internet of Things” (Note – make sure you use a lot of fancy buzzwords that only you and your FinTech startup friends use to dazzle your attorney.)
Your attorney: “Oh, I see, okay. Well, if you are selling something others are going to use, then that wouldn’t be a security. That will be $300,000 for our in-depth, boiler-plate, analysis that we’ve done a hundred times and maybe we took the time to cut and paste your company’s name into the document we gave you.”
REALITY
When you sell a “Token,” what are you selling? If company “A” offers to sell you a token, which you can convert into a usable element of software at a later date (because it hasn’t actually been developed yet), on the surface, it is a worthless transaction that promises you nothing but the very ether it occupies. You have no way of recovering your value unless the company actually succeeds in creating its product, or, as is pitched in the sales effort, you can resell your “token” in a secondary market, where its value may increase. Speculative acquisition of a contract for future potential performance with no guarantees of success, but for the potential for increased value through a secondary market, is the kind of risky venture that has plagued the securities laws for hundreds of years. This type of offering, a general solicitation because it is published to the internet, would fail review in nearly every state securities regulator’s office in the union.
But you think the Jobs Act and Regulation A+ means you won’t violate the securities laws. Think again. You actually have to register your offerings with the SEC and follow complex filing rules, including filing pre-sale documents with both the Securities and Exchange Commission and with any state you are going to sell. Regulation A+ also says that unless you are selling an equity interest, or a security convertible into an equity interest, Regulation A+ is not for you. A “Token” is not an equity interest, nor is it convertible into an equity interest.
But you think you are going to rely on Section 4(a)(6) of the 33 act [11] – A.K.A. Crowdfunding Exemption [12]. A crowdfunding exemption is an exemption from registering the sale of securities and has certain requirements to comply. In short – you are selling securities.
You can attempt to bypass the securities laws, or rely on exemptions to avoid registration, but the simple truth is – just don’t sell securities and you won’t have to worry about it.
Prior to becoming a lawyer, Mr. Seibert was the Senior Data Engineer at Integra Telecom, Inc. for the Northwest Region, the Senior Data Communications Analyst for Electric Lightwave, Inc., a data engineering contractor for several technology firms, a Field Engineer for Digital Equipment Corporation, and an Electronic and Computer Switching Systems Journeyman at Cheyenne Mountain Air Station, HQNORAD, USAF, Colorado Springs, Colorado and a member of the 21stSpace Command 721st Communications Squadron. Mr. Seibert is a licensed attorney, in good standing, admitted to the Oregon State Bar, the United States District Court for the District of Oregon, the United States District Court for the Eastern District of Texas (a.k.a. “The Rocket Docket”), the United States District Court for the District of Columbia, and the Ninth Circuit Court of Appeals. Mr. Seibert has worked in both plaintiff and defense cases involving securities issues and Bitcoin, and has represented parties across the United States in state, federal, arbitral, and administrative proceedings.