The Easy Settlement for Future Tokens (“SAFT”) was as soon as touted as a inventive resolution to execute “preliminary coin choices” (“ICOs”) that didn’t violate federal securities legal guidelines. The 2-step transaction contemplated by SAFTs was supposed to supply startups an preliminary infusion of money by promoting accredited traders the best to obtain blockchain-based “cash” or “tokens” (“digital belongings”) after they have been issued sooner or later. ICOs have been focused by the SEC since 2017, and the digital asset neighborhood has been awaiting a sign on whether or not SAFTs can be spared this scrutiny. As underscored by antagonistic SEC enforcement exercise, together with a current $1.224 billion disgorgement order by a federal district court docket within the SEC v. Telegram case, issuers considering choices of digital belongings sooner or later might need to contemplate compliant alternate options to SAFT fundraisings, and previous SAFT issuers ought to contemplate the mitigation steps outlined beneath.
Since 2013, each founders and legacy companies have raised capital for numerous enterprises by ICOs. The expertise’s novelty and the absence of clear steerage from regulators created uncertainty relating to the regulatory standing of these gross sales, together with whether or not they constituted securities choices. In July 2017, the SEC issued The DAO 21(a) Report of Investigation (“DAO Report”),1 which concluded that the tokens concerned have been “funding contracts” underneath the take a look at articulated in SEC v. W.J. Howey Co.,2 and due to this fact securities underneath the federal securities legal guidelines.3 The DAO Report explicitly served discover on the digital asset ecosystem that (i) digital belongings offered in ICOs represent “securities” if they’d in any other case meet the authorized necessities as such; (ii) the federal securities legal guidelines due to this fact apply to the providing, buy, and sale of such digital belongings; and (iii) the SEC would train its enforcement authority to sanction violations of the securities legal guidelines within the digital asset context.
A number of months after launch of the DAO Report, a bunch of legal professionals and distributed ledger trade members revealed a “white paper” describing the SAFT idea as a strategy to mitigate digital asset regulatory dangers.4 Beneath a typical SAFT framework,5 digital asset issuers first enter into SAFT agreements with accredited traders, who pay for the best to obtain digital belongings as soon as growth of the belongings and the blockchain platform and / or ecosystem wherein they are going to perform is accomplished and the belongings are issued. No digital belongings are issued initially, and the issuer information a Type D with the SEC claiming a Regulation D exemption (typically underneath Rule 506(c) involving basic solicitation) for conducting the rights providing (i.e., the rights are the securities) solely to accredited traders. Issuers then use the providing proceeds to develop the underlying expertise. As soon as growth of the belongings and related platform is full and the expertise purposeful, traders obtain the newly-issued digital belongings (often at a reduction to their market value). With the technical work accomplished, the SAFT construction contemplated that the platforms and related belongings can be purposeful by the point traders accessed them. The hope was that the digital asset issuance would escape regulatory sanction as a result of the belongings would have “utility” on the time they have been distributed, and the purchasers’ curiosity within the belongings might thus be seen as being for consumptive functions, reasonably than funding. With the belongings already purposeful and demand for them being spurred by purchasers’ need to make use of or devour the belongings, any subsequent appreciation within the belongings’ worth can be appropriately seen as now not predominantly as a result of issuers’ efforts (which might largely have been expended in the course of the growth interval between the rights issuance and launch of the digital belongings). Beneath such a assemble, the SAFT providing assumed that the digital belongings themselves wouldn’t be considered securities on the time of distribution, however reasonably as a wide range of forex or commodity referred to as “utility tokens.”
SEC v. SAFTs?
The SEC made its place on ICOs clear starting in fall 2017 by submitting enforcement actions towards REcoin, Plexcorps, and Munchee, adopted by Chairman Clayton’s assertion throughout a Senate listening to that “I imagine each ICO I’ve seen is a safety.” The Division of Enforcement then sprung into motion, issuing tons of of subpoenas to digital asset market members as a part of its broader digital asset enforcement push.
Via 2017 and 2018, SAFT issuance elevated a number of fold as SAFTs’ regulatory standing remained unsure (versus conventional ICOs, whose standing the SEC had already made clear by its enforcement actions). Filecoin, the primary mission to make use of the SAFT construction, raised greater than $257 million by its August – September 2017 SAFT providing to fund its still-ongoing technical growth. Components that probably account for its escaping regulatory scrutiny (so far) embody (i) its issuer, Protocol Labs, being a part of the group that conceived of SAFTs adamantly sustaining that they are often executed compliantly if the transactions’ fundraising interval stays fully separate from the underlying digital belongings’ issuance, and the issuer disengages from the digital asset platform when the belongings are issued (maybe accounting for the continuing delay in issuance of Filecoin whereas the expertise continues to be developed); and (ii) purchasers will use Filecoin’s FIL digital asset to compensate suppliers of unused file space for storing for using that extra capability, demonstrating an precise utility. It stays to be seen whether or not the SEC will proceed to disregard Filecoin as soon as FIL is definitely issued to the market.
Shortly after Filecoin debuted the SAFT idea with its rights providing, Intangible Labs raised $133 million within the preliminary exempt-offering step of its spring 2018 SAFT, aimed toward creating its Foundation digital asset. In December of the identical yr, the issuer determined to return the capital to its traders and terminate the mission after receiving authorized recommendation that sure of the tokens it might situation within the second step of its SAFT can be thought of securities.6 Intangible Labs cited issues that the SEC would view SAFTs as repackaged conventional ICOs, stating “if the whole lot of the traders’ choices relating to the long run tokens have been made on the time a SAFT was bought [then] the tokens wanted to be registered as of such date.”7 As defined beneath, within the context of current SEC enforcement exercise and caselaw, issuers must be cautious of using the SAFT framework going ahead.
The Newest Salvos: Telegram Injunction and Kik Litigation
Telegram was the creator of a digital messaging platform, and deliberate to make use of the SAFT exempt providing to fundraise for creating its Telegram Open Community (“TON”) Blockchain and the Gram digital belongings used for funds thereon. The Telegram SAFT’s preliminary fundraising step was an exempt providing in late 2017 and early 2018 of rights agreements to obtain the Grams as soon as they have been issued sooner or later. The SEC sued Telegram in October 2019, submitting an emergency motion that sought a brief restraining order and preliminary injunction to ban Telegram from finishing the issuance of its digital asset, known as “Grams.”8 On March 24, 2020, following expedited discovery and a listening to, the U.S. District Courtroom for the Southern District of New York (“SDNY”) granted the SEC’s Movement for a Preliminary Injunction towards Telegram.9 The SEC argued that the 2 steps of the SAFT have been actually one built-in providing and that traders made the choice to buy the Grams tokens (not simply the long run rights to obtain them) on the time of the exempt providing, based mostly on Telegram’s advertising efforts. The SEC additional argued that the Grams themselves (not simply the rights offered within the SAFT’s preliminary transaction) have been securities as a result of traders have been motivated to buy the best to obtain them based mostly on an expectation of revenue upon resale, in addition to Telegram’s intention to stay the “guiding drive” behind the TON Blockchain. The SEC additionally maintained that the Grams lacked the restrictive legend they need to have had as exempt securities, whereas contending that the “financial actuality” of Telegram’s SAFT was that the rights providing to accredited traders was half of a bigger scheme to distribute Grams into the secondary public market. In response to the SEC, the accredited purchasers had acted as “underwriters,” such that Telegram was not entitled to depend on the exemption it claimed underneath Rule 506(c) of Regulation D, as a result of the providing was a disguised public providing reasonably than a personal placement. Conversely, Telegram argued that the underlying Grams have been forex and never securities, and their standing as securities must be judged sooner or later when delivered to the preliminary purchasers as purposeful utility tokens. Telegram seen the anticipated secondary-market sale of Grams by the preliminary purchasers as personal transactions wholly unrelated to the SAFT transactions. The Courtroom finally sided with the SEC and granted its movement for a preliminary injunction. In doing so, the Courtroom ignored the formalities underlying the SAFT design, concluding that Grams have been securities reasonably than merely devices that saved or transferred worth. Additional, the Courtroom dominated that the supposed and anticipated resale of Grams into the general public market through the SAFT providing amounted to the distribution of unregistered securities by two built-in transactions. In its remaining judgment issued in June 2020, the Courtroom ordered Telegram to pay a civil penalty of $18.5 million and disgorge $1.224 billion to traders.10
4 days earlier than the injunction was granted in Telegram, and earlier than a special decide within the SDNY, the SEC and digital platform Kik Interactive Inc., issuer of the Kin token, filed cross motions for abstract judgment. The SEC initially sued Kik in June 2019, claiming that its 2017 providing, a portion of which was performed as a SAFT, was an issuance of unregistered securities.11 In its court docket filings, Kik relied on most of the identical arguments as Telegram, together with that at time of issuance Kin tokens would have purposeful utility and act as a forex on a not-yet-developed decentralized ledger. The digital belongings would thus be seen as bought for consumption of their utility reasonably than for funding functions. To that finish, Kik has contended that Kin tokens had a number of varieties of utility after they have been issued. The SEC maintains nonetheless, because it did towards Telegram, that the preliminary sale of rights agreements to accredited purchasers was built-in with each the following issuance of Kin and a public sale of the tokens that was performed concurrently. As in Telegram, the SEC argued that the standing of the digital belongings as “utility tokens” on the time of distribution was irrelevant, and the preliminary exempt providing date was the proper time to investigate the belongings as securities.
In each instances, the SEC’s argument for analyzing the digital asset’s standing as securities on the time of the SAFT’s rights providing transaction was based mostly, partly, on the rivalry that neither issuer’s providing certified for the Rule 506(c) exemption from registration (as every had claimed). Within the SEC’s view, the purported two transactions envisioned by the SAFT have been actually all one unregistered public providing to which no legitimate exemption utilized. The SEC has additionally argued that the Kik court docket ought to apply the identical reasoning to the Kin providing as was utilized in Telegram. Nevertheless, it’s attainable the Kik court docket might attain a special final result because of differentiating elements. Versus Grams, Kin have already been issued and are being utilized for a few of their marketed performance. This will weaken the SEC’s declare that Kin lacks utility or that Kik’s ongoing efforts will probably be wanted to help the token (reasonably than any subsequent appreciation in worth being attributed predominantly to market forces performing in a decentralized community). As well as, whereas the SEC criticism highlighted underlying public coverage issues relating to purchaser anonymity and cash laundering dangers in Telegram (which concerned a $1.7 billion providing by an offshore issuer), comparable issues weren’t included within the company’s filings and is probably not current to the identical diploma in Kik (a $100 million providing by a Canadian issuer).12 These issues have been underscored by the joint assertion of the SEC, CFTC, and Division of the Treasury’s Monetary Crimes Enforcement Community (“FinCEN”) on anti-money laundering controls relevant to digital asset market members, which was launched on October 11, 2019 – the identical day the SEC filed its Telegram Criticism.13
The above instances clarify that the SEC continues to focus enforcement assets on digital asset financing occasions, and can marshal the financial actuality and integration doctrines in doing so. This focus might intensify for SAFT choices within the wake of the SDNY’s Order within the Telegram, a crucial consideration for potential future SAFT issuers. Issuers who’ve executed SAFTS previously also needs to analyze them in mild of the SEC’s issues expressed in Telegram, and decide if mitigation measures are wanted to restrict potential publicity to enforcement actions and personal litigation. One potential mitigation possibility is rescinding token choices underneath Part 12(a) of the Securities Act of 1933 or related state legislation and issuing new exempt devices. This will defend traders from civil legal responsibility underneath the legislation of many states, however supplies no cowl towards claims underneath federal legislation14 or towards enforcement actions by state authorities. Any issuer contemplating rescission should additionally analyze whether or not holders of their digital belongings might fulfill any related exemptions from registration, for the reason that rescission includes reselling the safety again to the issuer. One other mitigation possibility is conducting an change provide for consideration or new digital belongings, 15 the providing of which might must be registered or to fulfill an exemption from registration. No matter mitigation steps previous SAFT issuers may select, the SEC has made clear that it’s going to proceed to observe future SAFT choices and pursue enforcement actions to additional outline the bounds of permissible conduct. Issuers must be prepared.
1. Securities & Trade Cmn., Report of Investigation Pursuant to Part 21(a) of the Securities Trade Act of 1934: The DAO, Exch. Act. Rel. No. 81207 (Jul. 25, 2017), https://www.sec.gov/litigation/investreport/34-81207.pdf.
2. SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946).
3. The DAO Report reached this conclusion by figuring out that the devices concerned an funding of cash in a standard enterprise with an inexpensive expectation of income to be derived from the entrepreneurial or managerial efforts of others. See SEC v. Edwards, 540 U.S. 389, 393 (2004); SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946); see additionally United Housing Discovered., Inc. v. Forman, 421 U.S. 837, 852-53 (1975) (The “touchstone” of an funding contract “is the presence of an funding in a standard enterprise premised on an inexpensive expectation of income to be derived from the entrepreneurial or managerial efforts of others.”). This definition embodies a “versatile reasonably than a static precept, one which is able to adaptation to satisfy the numerous and variable schemes devised by those that search the usage of the cash of others on the promise of income.” Howey, 328 U.S. at 299 (emphasis added).
4. See J. Batiz-Benet, The SAFT Undertaking: Towards a Compliant Token Sale Framework (Oct. 2, 2017), https://saftproject.com/static/SAFT-Project-Whitepaper.pdf.
5. N.B., the SAFT framework is modeled after the SAFE format (Easy Settlement for Future Fairness) itself a comparatively current fundraising mechanism whereby an investor obtains the best to obtain a sure quantity of fairness within the firm sooner or later in change for an up-front funding, although with out initially specifying the share value. Receipt of the fairness is commonly triggered by the incidence of a selected occasion (reminiscent of an acquisition, financing, or the like), at a conversion fee based mostly on a reduction or valuation cap.
6. Nader Al-Naji (CEO), Letter to Foundation Group (Dec. 13, 2018), https://www.basis.io/.
7. Anthony Zeoli, Preliminary Coin Choices: Why the SAFT is Lifeless … (Mar. 26, 2018), https://www.crowdfundinsider.com/2018/03/131044-initial-coin-offerings-why-the-saft-is-dead/.
8. Criticism, SEC v. Telegram Grp. Inc., No. 19-cv-9439 (S.D.N.Y. Oct. 11, 2019), https://www.sec.gov/litigation/complaints/2019/comp-pr2019-212.pdf.
9. SEC v. Telegram Grp. Inc., No. 19-cv-9439 (S.D.N.Y. Mar. 24, 2020) (opinion and order granting preliminary injunction), https://www.sec.gov/litigation/complaints/2019/comp-pr2019-212.pdf.
10. SEC v. Telegram Grp. Inc., No. 19-cv-9439 (S.D.N.Y. Jun. 26, 2020) (remaining judgment), https://www.sec.gov/news/press-release/2020-146.
11. Criticism, SEC v. Kik Interactive Inc., No. 1:19-cv-05244 (S.D.N.Y. Jun. 4, 2019), https://www.sec.gov/news/press-release/2019-87.
12. See Criticism, SEC v. Telegram Grp. Inc., No. 19-cv-9439, at 3, 10, 28 (“many [Gram] purchasers’ identities will probably be shrouded in secrecy”; Gram transactions will probably be executed on “unregulated markets … that promise anonymity and encryption functionality to masks transactions” making it “troublesome, if not unimaginable, to hint who has bought Grams”; and the flexibility to switch Grams can be built-in into Messenger’s disappearing content material platform, and though mandating that customers fulfill “Know Your Buyer/Anti-Cash Laundering” necessities was contemplated, Telegram may have no entry to this data, has said it would by no means present this data to 3rd events or governments, and the data could also be successfully ineffective in any case as a result of it might be unimaginable to determine person identities in Grams’ secondary markets). Neither the SEC’s Criticism nor Movement for Abstract Judgment in Kik expressed comparable issues.
13. CFTC, FinCEN, SEC, Public Assertion, Leaders of CFTC, FinCEN, and SEC Subject Joint Assertion on Actions Involving Digital Belongings (Oct. 11, 2019), https://www.sec.gov/news/public-statement/cftc-fincen- secjointstatementdigitalassets.
14. See Part 14 of the Securities Act of 1933 (individual can’t be obligated to waive rights relating to compliance with the federal securities legal guidelines’ registration provisions); Stoiber v. SEC, 161 F.3d 745 (D.C. Cir.1998), cert. denied, 119 S.Ct. 1464, 143 L.Ed.second 549 (1999) (rescission provide supplies no safety towards SEC sanctions).
15. See Part 14(e) of the Securities Trade Act of 1934.