Is Reg A+ Ideal for ICOs? Not So Fast: Exceptions Don’t Make Rules.
Two highly publicized Reg A+ token offerings have been recently approved by the SEC for Blockstack and YouNow’s Props, within 24 hours of each other.
Blockstack is a native decentralized applications infrastructure platform that anchors itself in Bitcoin beliefs, and YouNow was an existing YouTube-like app that backed itself into a token usage and relies on a proprietary assemblage of blockchain technology.
Soon after these 2 announcements in mid-July, the SEC issued a no-action letter to Pocketful of Quarters, Inc. for their gaming platform inter-operable token.
Those who rejoiced implied that the SEC now “gets” tokens and is loosening their grip on the industry. But is that the case?
Are Reg A+’s and no-action letters the ideal models for future ICOs and token distribution events in the US?
Not necessarily. Not so fast.
The SEC has been obsessed with proving that their current (1933 Act) Securities framework can be applied to tokens, so they went out of their way to latch on to a handful of companies willing to walk that path with them.
Although these 3 companies seem to be on the right path for growth, and I wish them much success (disclosure: I’m an investor in Blockstack), the processes they chose are not for everybody. US tech companies are not lining-up to file Reg A+’s, and we can’t draw a pattern out of a couple of data points.
On a positive note, I was quite impressed by the Blocstack FAQ on their Stacks Token website. It is in large part a more user friendly interpretation of the key disclosures in their A+ circular (which is difficult to read for the average consumer). It includes a variety of disclosures on participation eligibility, token pricing, exact vesting schedules, previous investors terms, token liquidity, and several other clarifications in plain English. The breadth of disclosures reminded me of the standards I prescribed when I wrote Safe ICO Practices (SIP) two years ago.
The Blocktack FAQ is a must read, in addition to their exemplary Stacks Token website. Although a Reg A+ process isn’t so easily replicated as a best practice (because each one is different), the types of disclosures that Blockstack published could be more easily benchmarked as a best practice for future ICO/Token projects. They rival and exceed even the best ICO sales sites in terms of being comprehensive and clear, and they even go beyond what Messari is attempting to do with their ICO registry. On a related note, I had tried doing something similar with TokenFilings about 2 years ago, and quickly learned that self-registration is not so easy, in part because there are lots of data gaps at the source. Without reporting standards, companies will just report what they want to report.
Let’s not be fooled by what the Reg A+ process is, and what it is not. The Reg A+ is not really the beacon that the blockchain industry has been waiting for.
Completing a Reg A+ is a daunting effort, both in scope and financial burden for the filer.
The process takes several months to materialize, and culminates into a document that is close to 200 pages. It is almost like doing a mini IPO. The process itself is full of uncertainty, and requires audited financial statements. The costs have been pegged in the $1.5-2 Million range, mostly in legal, accounting and compliance process fees.
Then, there are restrictions on the token itself. For example, the Blockstack token is deemed to be a security in the US, therefore it cannot trade on the cryptocurrency exchanges, although it could trade on international exchanges who might see as a utility, but they have to geo-fence US consumers. In addition, residents in Texas, North Dakota, Nebraska, Arizona, Canada and Japan were not eligible to participate.
With YouNow, the Props token has an internal currency equivalent to insulate it from potential fluctuations, and it doesn’t trade externally. If a user wants to transfer their tokens to cash-out into an ERC-20 equivalent, there are strict KYC/AML requirements (a cost that YouNow is subsidizing initially). In addition, users have to certify that their holdings do not exceed 10% of their net assets.
For Pocketful of Quarters, the bulk of the no-action letter is a list of 10 token related limitations that are quite restrictives about their usage, especially in and out of the platform.
For the above reasons (and further intricacies), the Reg A+ bar is simply too high for most blockchain startups. It doesn’t fit the typical startup lifecycle when companies spend their formative years trying to reach product-to-market fit via several iterations, while relying on VC funding to grant them limited financial runways until they reach milestones. Imagine if an average Seed or Series A venture round were to be padded by an extra $2M (which could be 50% of the total funding), just to go through a Reg A+ process.
The reality is that most startups don’t have the resources, money, time or energy required to jump through these hoops, just because it is the process that the SEC is suggesting. Fitting everything into existing frameworks is not the best way to encourage innovation, and is a slap in the face of entrepreneurs. Innovation and regulation are clashing.
Is there a Will to Innovate on Regulation?
It is lame and disgenious for the SEC to dig their heels into the 1933 Securities Act and claim their hands are tied by it. The SEC has previously shown they do have flexibility in amending provisions and requirements, such as in this 2019 update, SEC Proposes Offering Reforms for Business Development Companies and Registered Closed-End Funds.
At a time when even some existing SEC regulation has been criticized for being daunting on small tech companies, how can such a serious process like Reg A+ be the standard for tiny tech startups that have limited checkbooks and resources? Here’s another recent update from the Securities and Exchange Commission to modernize and simplify certain disclosure requirements in Regulation S-K designed to simplify compliance for small companies, the FAST Act Modernization and Simplification of Regulation S-K: A Small Entity Compliance Guide.
Given that the SEC has shown they can implement updates, why don’t they meet the blockchain industry half-way by proposing a new registration process, specifically designed for token offerings?
Yes, the SEC has dozens of existing processes and a long Forms List for a variety of rules and Acts, but why not recognize that token-based registrations have unique enough characteristics to warrant a related amendment resulting in a more prescriptive and clear process that companies could actually follow without guesswork?
For example, take the Blockstack FAQ and turn it into a user-friendly registration process that doesn’t cost $1.5M-$2M in legal fees, but maybe $250K at the most.
Yes, there is a fine balance between pleasing regulators, forewarning investors and empowering users, but I’m not sure that the current regulation paths are so easily navigated.
The reality is that Reg A+ is not the type of invasive surgery that most blockchain startups are calling for. There simply aren’t enough tech companies who are willing (or able) to be strung along by the SEC so early in their start-up life. This kind of process would have killed projects like Ethereum and many others that avoided it by seeking external regulatory jurisdictions, or just being lucky by being early when the SEC’s radar was not so sensitive towards token-based offerings.
Indeed, the SEC was able to show that you can follow their existing framework, and “do tokens”, but these were exceptional cases that came with a restrictive straitjacket. There’s a popular French proverb that comes to mind,- “Une hirondelle ne fait pas le printemps”, and it means:
“The appearance of one sparrow doesn’t signal the arrival of spring.”