Initial Coin Offerings: An Overview of Regulatory Considerations

by Wilson Sonsini Goodrich & Rosati

In recent months, a variety of companies have considered "initial coin offerings" (ICOs) as a way to generate money for their businesses. Companies considering ICOs should be aware that, depending on the structure of the coins they are offering, an ICO may involve an offering and sale of securities subject to regulation by the Securities and Exchange Commission (SEC) and/or swap contracts subject to regulation by the Commodity Futures Trading Commission (CFTC). An ICO also may subject a company to potential regulation as a money services business, which could mean that the company needs to comply with anti-money laundering, money transmission, and other applicable laws. Importantly, although the coins being issued may be called tokens or referred to in some other way, regardless of what they are called, the following discussion applies.

When do the SEC and/or CFTC have jurisdiction over an ICO and the coins being offered?

The following flow chart provides an overview of when companies are most likely to need to consider SEC and/or CFTC regulatory issues:

If the coin is not subject to SEC or CFTC jurisdiction and the issuer is not a money services business, is there anything the sponsor should worry about?

Typically, the most significant issue is that—unlike cash received from the sale of stock or other financing instruments—any revenue from the sale of coins is taxable as income to the company.

What are the consequences of SEC and/or CFTC jurisdiction?

Companies subject to potential SEC jurisdiction may need to consider:

  • Registering the ICO under the Securities Act of 1933 (Securities Act) or Regulation A+ or Regulation Crowdfunding (if available) under the Securities Act, or complying with the exemptions for private offerings provided in Regulation D under the Securities Act, which requires limiting sales to "accredited investors." If coins are sold only to accredited investors, there may be limitations on the ability of investors to resell the coins, especially to non-accredited investors.
  • Structuring the sale to avoid receiving transaction-based compensation or paying transaction-based compensation to any person who is not a registered broker-dealer
  • Avoiding providing advice to any purchasers or potential purchasers regarding transactions in the coins, to avoid investment adviser issues
  • Structuring the company so that by holding the coins, no holder of a significant amount of coins becomes an "investment company"

Companies subject to potential CFTC jurisdiction may need to consider:

  • Structuring the sale and offering to avoid providing advice to any purchasers or potential purchasers regarding transactions in the coins
  • Ensuring that transactions are conducted on a registered commodities or securities exchange or restricted to "eligible contract participants," which generally includes financial institutions, insurance companies, commodity pools, and wealthy individuals (those with at least $10 million in discretionary investments)
  • Structuring the company so that by holding the coins, no affiliate is a "commodity pool" based on its holding in the coins
  • Structuring the ICO to totally or partially avoid requirements applicable to commodity pool operators, for example by limiting investors to "qualified eligible participants" (those with investments of at least $2 million)

When might the sponsor of an ICO become a money services business, and what are the consequences?

Sponsors can become money services businesses by, among other things, dealing in currency or transmitting money. Money services businesses are subject to a wide range of federal and state regulations, including anti-money laundering and "know-your-customer" provisions, privacy laws, licensing requirements, and other regulations. Some sponsors may be able to take advantage of exemptions from these regulations—for example, for money transmitters that facilitate the purchase and sale of goods and services—depending on how an ICO and coin transactions are structured.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Wilson Sonsini Goodrich & Rosati

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