In this multi-part series, Zuber Lawler Partner Josh Lawler responds to questions from the U.S. Securities and Exchange Commission in accordance with a request for comments from Commissioner Hester M. Peirce. You can view his responses to questions five through six here.

There Must Be Some Kinda Way Out of Here[1]  Part III —  Public Offerings

Public Offerings. People who have conducted or attempted to conduct registered or qualified token offerings have expressed frustration about the cost and feasibility of registration. Tokens and their issuers can differ significantly in some aspects from traditional securities and their issuers. Allowing token issuers to use appropriately tailored registration regimes may protect investors better than insisting that they use registration forms and mechanisms that are designed for other types of securities offerings.

7. Could disclosure guidance and/or targeted relief address the concern, or are new forms or other mechanisms needed?

All of the above. In terms of offerings in a capital raising context of tokens that do not represent traditional financial products[2], you should consider whether registration with substantive review still makes sense. The S-1 process is expensive and, as currently designed, also horribly inapplicable. You can fix some of that imprecision with new forms that are more flexible to account for the ranges of use cases and contexts applicable to tokens and their sale, but it doesn’t change that the review process is manual and therefore extremely slow. The S-1 comment and review process will push many token projects out of the United States.

There is also a question as to whether the current process works in context of assets that are not traditional financial products. The current procedure is best suited for professionally underwritten offerings, conducted through highly regulated exchanges, of securities that derive value based on the financial performance of an issuing entity. For the most part, offerings of digital assets that are not traditional in their value proposition are neither underwritten[3] nor offered through a regulated facility. Even if a token project were to take the route of a public offering by way of an S-1, or even a tier 2 Regulation A offering, the vast majority of retail purchasers are not going to read a prospectus and will not likely have the experience needed to evaluate the information regardless. Rather, most purchasers of tokens for investment base their decision on information originating outside of any formal offering process, often from sources other than traditional issuers (which, in many cases do not exist).

Any solution must consider (i) that issuers (some of whom are not traditional for profit entities) have many more options than they used to as far as channels to market and sell digital assets, (ii) retail investors are, on their own, unlikely to avail themselves of information that is not readily available in easily digestible format[4], often coming from unofficial, sometimes anonymous sources and (iii) the market is subject to widespread profiteering based on concerted efforts to generate hype to create purchasing frenzies, which range from well-meaning exaggeration through outright fraud and deceit.

Restating your question; how do we assure that retail investors receive accurate information in a manner that they will access in favor of noise that is potentially deceptive in nature?
While it may take some trial and error to determine what actually works[5], here is a rough [6], conceptual framework for regulation of Capital Raises involving sales of tokens (that do not represent traditional “securities”):

a. Allow, but do not require registration of a Capital Raise of tokens with the SEC. The registration process may be more like Tier 2 Regulation A qualification than S-1 registration. There would be no substantive review other than that all required disclosures are included. The process should be swift and not require a great deal of interaction with the Commission. The registration may be filed by any person (subject to US jurisdiction and possibly bad-boy exclusions). That is in recognition that the organization minting the tokens may not be a US entity, but we still want to encourage participation.

b. Once a Capital Raise token sale is qualified, the Commission would provide public access to the information (through a dashboard page of SEC.gov).[7] That information would remain “effective” for some minimum period (30 days), which may be extended at will by the filer.  During the duration of effectiveness, the filer (and/or other acceptable designee(s)) must maintain the accuracy of the information such that anyone looking to verify a statement in respect of the offering can check the SEC filing and know while the registration is effective that the statements contained therein are subject to Securities Act requirements in respect of misstatements and omissions. Registrants would have the ability to revise their information in real time through a web interface.[8]

c. The selling entity may use the registration form as an offering document, but they do not need to do so, so long as all information that they provide to anyone in the course of conducting the Capital Raise is materially in line with the information effective at the time they make such statement (some allowance made for reasonable time to update on involuntary events). All information means all information through any channel, be it traditional or otherwise. Provisions would need to be made to foster easy connection between potential investors and the relevant information on the SEC Website.  A QR code as a link on all printed and on-line material may be helpful. Registrants should be encouraged to include that link as part of the token purchase process where possible.

d. The SEC would develop a new form for this purpose which would include requirements for certain information that would always be relevant[9], and would also have a series of schedules that would be applicable to specific frequently appearing token use cases.[10] The information requests applicable to tokens of different use cases would reflect factors that drive their value proposition. A registrant would use whatever schedules apply to their token use case(s). As new use cases appear in the market the SEC may release (and revise) the schedules.
e. The filer(s) of the registration document, and any Person who purchases tokens or a right to receive tokens at a discount to the price at which they are being made available to the general public should have an equivalent of underwriter liability (subject to a due diligence safe harbor) for material misstatements and omissions of information relating to that token sale (whether it was registered with the Commission or otherwise).[11]
f. Projects might also be encouraged to use this type of registration process if doing so provides them with a liability shield against liability for publicly made misstatements from any source that materially benefited the Capital Raise.[12] That would potentially act as a wedge of truth against the din of public hype statements that may not be from people actually associated with the Capital Raise or token in question (particularly true if the Capital Raise is not an initial token launch).

On a related note, the process for obtaining guidance through the “no action” letter process should be emphasized. That goes regardless of what rules ultimately govern. In the scheme that is laid out above, for instance, there will absolutely be fact driven questions about what sales qualify as Capital Raises.[13]

8. Should the Commission develop tailored disclosure requirements for offerings or classes of specific categories of crypto assets? What types of disclosures would be important for investor protection? Should disclosure occur both at the time of sale and on an ongoing basis? If so, what information should the ongoing disclosure contain and how should that disclosure occur?

Yes, it is crucial to recognize that a token is whatever it represents. You don’t treat stocks and bonds the same way. Why would you treat a layer one protocol native token derived from smart contracts operating independently the same as a medium of exchange token native to a distributed application managed by a single centralized entity. While there is some overlap in basic information, there are many types of information that are only relevant to one of the two (and may not even exist for the other).

The types of disclosure applicable to particular use case tokens is THE critical question. The real problem with a position that “tokens are securities” is that secondary market trading of securities requires GAAP audited financial statements that require information that often does not exist and is of almost no relevance. Fortunately, for most use cases, the type of information that would be relevant is fairly easy to determine and often accessible.[14] For most use cases, the industry could provide an appropriate starting point for what information should be disclosed, and from where it may be sourced.

The question of ongoing disclosure is a harder one. The type of information is not so hard, but establishing who is responsible for the maintenance of the information is tricky. Also, it is not really possible to prohibit trading of a digital asset, so the rules around requirement of public reporting in order for brokers/exchanges/etc. to operate likely will not be helpful.

One approach is to incentivize organizations associated with active tokens (trading or active in terms of use case) to maintain information in order to maintain an SEC validation as a token for which required information is available and up to date. Regulated exchange entities could be required to disclose the status of a token (validated or not) prior to executing a trade. For tokens for which there is no obvious organization, we might take a play from many token projects and incentivize third-party provision of the information through a payment (a transaction fee on a trade or, potentially, a token issued by the Commission).[15]

The ideal disclosure timeline is probably not periodic. Tokens that don’t derive value based on profits and losses and balance sheet are not limited to time periods required for the accounting and audit process. Certain important information in respect of things like circulating supply and liquidity can be provided close to real time through automation.[16] If there is an organization acting as a filing entity, then a reporting of “other events” similar to the 8K requirement may make sense. For tokens that are more closely tied to traditional business models (for example, tokens acting as a medium of exchange within a software platform) there might be some periodic requirement of disclosure reminiscent of a Management Discussion and Analysis to disclose circumstances that might affect supply and demand and circulation.

9. Does Regulation A under the Securities Act, including the disclosure and ongoing reporting requirements, provide a useful vehicle to conduct offerings of crypto assets? Would revising aspects of Regulation A make it more useful for crypto asset offerings?

Regulation A is the closest of the existing paths to legal sale.  Putting aside the question of whether following the Regulation A transaction tokens sold in a Capital Raise would be treated for all purposes as “securities,”[17] it is the most logical place to provide an ongoing regulatory structure for sale of tokens in a Capital Raise. It would need revision, which might include some of the concepts specified in my response to your question 7. I reference my response to Question 8 in respect of ongoing disclosure requirements. We should consider not tying any ongoing requirements of disclosure (beyond during a Capital Raise) to registration of an offering/sale of tokens in a Capital Raise. Reason being that the two activities may, in many cases, not properly fall to the same person/entity. This is particularly true in context of an initial Capital Raise by an operating company, with subsequent placement of on-chain governance with a DAO or other inchoate body.

[1] With a tip of the hat to Jimi, Josh Lawler is neither a joker or a thief, but he is a seasoned securities attorney who applies a keen understanding of the technology underpinning distributed ledger use cases to navigate legal grey spaces.  Accordingly, he has lots of opinions. Thanks for asking.

[2] And potentially also traditional securities. The process right now is extremely difficult and discourages many companies from making themselves available on the public markets.

[3] Notwithstanding the lack of a formal underwriter, the use of statutory underwriters (or at least short term purchasers who would be statutory underwriters if the tokens they flip were securities) is prevalent and requires meaningful regulation.

[4] We should also consider that many investors may prefer languages other than English.

[5] A short to medium term sandbox may be a good approach to help flesh out a more permanent regulatory structure.

[6] Emphasis on “rough.” This is obviously very different than traditional registration. While it may not be realistic to expect this big of a leap, I submit with the hope that aspects of it might be useful for adoption into a workable framework.

[7] It is tempting to start suggesting use of AI agents for all manner of things, including digesting the information provided into understandable nuggets for the general public. It would also be fairly simple for an AI agent to continuously monitor internet traffic and major discussion areas for information in conflict with a token offering registration statement. Notwithstanding the likelihood that these advances may become available, it likely does not help this exercise, so I’ll try to refrain.

[8] Real time revision allows a filer to maintain the information current irrespective of filing date. That will be important, as information may change suddenly and the registrant should have continuing responsibility for the accuracy of the information.

[9] Information that would (almost) always be relevant might include total token supply, initial tokenomics (including discounted presales), key team members, token use case description (which may incorporate information from the attached (more tailored) schedules and near, medium and long term marketing plan, to name a few.

[10] Token value, theoretically, should be driven (in most situations) by growing demand for usage against a managed (often fixed) supply. The schedules would be where the Commission would request information that is specific to the use cases. Some frequently appearing use cases include: medium of exchange, rebate/loyalty points, resource/feature/location access, value proxy (to allow for a token with a floating value to be used for transactions measured in fiat denominations) and fungible asset representation.

[11] In our experience, the biggest abuse of the public is associated with a discounted presale with ability to freely sell such tokens immediately upon their public launch. The hope is that by providing potential liability this type of purchaser will require that a token project register and maintain accurate public disclosure and that these market participants would be incentivized to conduct due diligence as part of their purchase process in the same manner done by underwriters in many registered offerings.

[12] Meaning that potentially a token project might be civilly liable for material misstatements of unknown third-parties unless they have maintained a registration statement throughout the time of their Capital Raise. I would expect that the penalty here may be rescission, and that a plaintiff would need to establish that they justifiably relied on the misstatement.

[13] If nothing else, our recent period of a “war on crypto” has illustrated that it is a very creative industry ready to apply all sorts of new mechanisms to assure regulatory compliance. It would be unbelievably helpful to have a reliable path to a “sanity check” on what works and what does not.

[14] I’m a fan of Messari (https://messari.io/), who have been providing detailed data on digital assets for quite some time. The issue is that most people don’t understand it and don’t have the time to really dig into it. That said, much of this information can be accessed and processed to fit a friendlier disclosure framework. We could also require automatic updating of certain types of data (especially for on-chain information).

[15] Perhaps I go too far . . .

[16] No reason why the regulation of tokens should not borrow from decentralized exchange and information service methodologies.

[17] Certainly if the ’34 Act requirements remain unchanged, then the tokens cannot be classified as securities. I prefer that we recognize that the tokens are never “securities” unless they represent securities as traditionally understood, with a nod to the fact that the Commission may regulate some things that are not “securities,” like certain digital assets.