Regulation of ICO: what each company must know to comply

Regulation of ICO: what each company must know to comply
There have been many articles written about an ICO process being an unregulated activity, which led many startups to believe that raising funds through a token sale was perfectly fine. And even when the SEC issued a report following the investigation of The DAO, the fundraising efforts continued.

Many companies still do not realize that there are existing laws and regulations in place in many countries that can apply to the sale of tokens, including the securities law regulating the offering of securities, which was confirmed by SEC Commissioner Michael S. Piwowar at the 50th Annual Securities and Regulation Seminar. But tokens are not shares after all, so why should they be treated as securities?

Unfortunately, they do if they provide certain rights attributable to securities without even being connected to the equity in the company. The definition of securities is much broader than shares or stocks in the company; it includes a myriad of rights that could be offered to investors in exchange for the contribution. So even when the company is selling tokens that do not provide an equity but provide a share of the company’s profit, such tokens would fall under a definition of securities and its offering would be regulated by the securities law.

The same goes for fundraising activities. When tokens are sold to raise capital their sale is also regulated by the securities law to protect the investors just like in any other case of raising capital. For example, one of the most recognized methods of attracting capital is the initial public offering (IPO), where the company issues additional shares offered to the public in exchange for the funds to be used as a working capital. Because such investment opportunities available to a public at large and could be very risky for uneducated investors, the securities rules and regulations require registration of such offerings obligating the companies to provide a large volume of information about the companies’ business, financial, principals, etc. to allow investors to make a more informative decision.

Selling tokens instead of stocks as a capital raising method does not relieve the company from the obligation to register their offering.
However, there are exemptions to the registration requirements if the company is willing to accept certain limitations such as the amount of capital being raised, the number and type of investors, the limitations on public advertising, etc. These exemptions are widely used by companies, which do not want to go through the lengthy and expensive IPO process.

The same exemptions can also be used to sell securities tokens to the early investors and raise capital required to build a company’s product. Once the company’s product is build, the company can use the initial coin offering (ICO) process to sell utility tokens and acquire customers, while offering the early investors to exchange their securities tokens for the new utility tokens at a great discount. This way, the company will achieve the same result as it was planning to achieve by selling tokens to raise capital through the ICO, but it will be done in compliance with the securities law.

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