Reg D Filing in the United States – What does it mean for Security Token Issuers?

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Security tokens are tangible assets represented digitally, which are issued, encrypted, transferred, and settled instantly using blockchain technology. Their decentralized nature allows for greater security in the trading of real assets and, likewise, can increase liquidity for traditional assets.

Perhaps the most attractive feature of security tokens is that unlike utility tokens, which are typically offered during an Initial Coin Offering (ICO), they fit within current frameworks for securities regulation, including securities registration exemptions such as Reg D, Reg A, Reg S and Reg CF.

Therefore, token issuers can leverage these exemptions to bypass the complexities involved in launching a public offering, and instead sell their own exempt private securities to select accredited investors.

Here, we explore Regulation D (Reg D) offerings, which are particularly advantageous for private companies and individual entrepreneurs, in addition to lending themselves particularly well to security token offerings.

What is Regulation D?

Regulation D is one of the most commonly used exemptions from the Securities Act of 1993 for private placements. They most commonly allow issuers to raise capital through the sale of equity or debt securities, without the need to register those securities with the U.S. Securities and Exchange Commission (SEC).

According to the SEC, in 2017, there were 37,785 Reg D offerings reported through Form D filings, accounting for more than $1.8 trillion raised in new capital from approximately 398,000 investors.

Issuers who are compliant and wish to register an exemption through Reg D are required to file a "Form D" with the SEC after they first sell their securities. Form D is a brief notice that includes the names and addresses of the company’s promoters, executive officers and directors, and some details about the offering.

The requirements for a Form D can be accessed on SEC’s EDGAR database.

*Resource: SEC Form D

What is the difference between each rule under Reg D?

Issuers filing for exemption under Reg D must also be aware that there are a number of rules, including Rule 504, Rule 505, Rule 506 (b) and Rule 506 (c) which must be respected for different fundraising target and approaches. Let’s examine them below:

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*Resource: SEC

In terms of filing requirements, ‘restricted securities’ are securities which cannot be sold before six months or one year without first registering with the SEC.

According to the SEC, among these four rules, during 2009-2017, Rules 506 (b) and 506 (c) account for 99.9% of the amounts reported sold through Regulation D.

Of these, Rule 506 (c) is by far the most popular rule used for security token offerings, largely because it has no upper offering limit and allows general solicitation to the public, rather than through a private offering.

Who Can Participate Under Reg D, Rule 506 (c)?

Instead of other rules which impose various reporting requirements for operators, Rule 506 (c) only requires issuers to ensure that all participating investors are accredited and meet know-your-customer or anti-money laundering (KYC/AML) reporting requirements.

The general solicitation process is usually carried out via investment banks which have a broker-dealer license and are members of Financial Industry Regulatory Authority (FINRA).

To onboard new investors, the investor accreditation check is generally undertaken by dedicated token issuance platforms, such as Rocket, which can help issuers to verify accredited investors, perform customer due diligence, and ensure they are compliant when they use Rule 506 (c) for their security token offerings.

However, issuers should pay close attention to the term ‘accredited investor’ in this scenario. Accredited investors are individuals who either have annual income of $200,000 or more, or likewise, have at least $1 million in total net worth.

Offering an STO to investors through rule 506 (c) of a Reg D exemption who do not meet these requirements will be in contravention of the SEC’s requirements.

Conclusion

For its ease of access and the ability to solicit STO offerings to a large potential investor base, Reg D, specifically combined with Rule 506 (c), has quickly become one of the de facto methods of securing exemption for security token offerings.

However, issuers should be aware that while filing a Form D is a necessary first step to exemption, there are still ongoing regulatory and reporting requirements for STOs, and as issuers proceed with their offering, they should be mindful of other regulations.

It’s always advisable to seek the advice of proven STO advisors, and to launch a token sale through a dedicated platform, to ensure customers are whitelisted according to due diligence reporting required by law.

For companies looking to raise money outside of Canada, Reg S should be applied, and Vanbex will discuss more details about Reg S in future articles.