“D” for “Deterrent”? Our Experience Filing SEC Form D
Last week, Otomomos filed its Form D so we can use the SEC accredited investor safe harbor to offer our security token to pre-existing contacts. In what follows, we share our experience, which we found a bit annoying but not in the least intimidating.
As practitioners keep reminding us, there are two broad types of digital assets: Unregulated crypto, and securities.
One of our advisors, Andy Singleton, puts it thus:
To qualify as unregulated crypto, you will need a token that is created and earned by a community, and not by an issuer. True open source community crypto is a small and fascinating use case. Bitcoin is the perfect case. It was never sold by an issuer. Every bitcoin was earned through mining.
For almost anything else, you will need securities. [W]hen those issuers ask for investments, they are creating securities.
Many of our clients are “asking for investment” via a SAFT(E) or a Token Purchase Agreement which in itself is an investment contract, even if the future token may not be a security.
Other uses cases, such as our own, tokenize a SAFTE which is a contract for investment and hence a security.
In both cases, whether you like it or not, if you want to offer a security globally, you will be dealing with several sets of local regulators and rules.
Why the fuss?
Many issuers, especially in crypto, shy away from the U.S. because they perceive the U.S. too cumbersome (which it isn’t really) and too heavy-handed in its enforcement (which it arguably is though some action against non-compliant crypto issuers has been rather benign so far).
They think that by organizing their issuing entity outside the U.S. keeps their offering out of the U.S.
Not so: where you organize your fundraise from doesn’t solely determine what laws apply to it. Who you target does.
Some teams then claim they ”don’t target U.S. investors.”
However, not only will they miss out on what is still the deepest pool of investable capital in the world, what they’re really saying is “we have faith that those U.S. investors who want to invest in us will find a way, like using a VPN”.
Essentially, they’re making a risk calculation and go ahead doing a securities offering in the off-chance they get caught.
Wanting to do it right
The issue we all have to deal with here is that until laws change, we’re all forced to shoe-horn the sale of new assets with new characteristics into 1930s laws.
But if your offering is most likely going to considered a securities offering, a case can be made that the U.S. gives you a much higher degree of legal certainty than any other place in the world.
“Reg D” in a way is an example: it is a safe harbor that exempts a securities issuer from the much more burdensome investor protection and disclosure regulations that apply to retail offerings, by giving issuers a channel to offer to accredited investors only.
You can start a Reg D offering by filing Form D.
This Form D is a “Notice”, not an application. The form in itself is straightforward. It can even be filed within 15 days after you started approaching investors or raised some initial funds.
Item 1: The Issuer
As issuer, we used an onchain LLCs as issuer which we spun up using our otoco.io blockchain company assembler in Delaware.
In essence, this means that the issuer is a company on blockchain owned by an Ethereum wallet Otonomos controls.
Items 2 and 3: Contact information and Related Persons
The principal place of business can be an address outside of the U.S.: there is nothing that prevents an LLC incorporated in the U.S. from having its business address abroad.
Also, the issuer itself can be a foreign company altogether. The same applies to the “Related Persons” in Item 3: it can be anybody from anywhere, typically an Executive Officer or Director of the issuing company.
Item 4 of the Form (not shown here) then asks for the Industry Group which for most of our clients will be “Other Technology” — there is no special category for crypto or blockchain yet!
Items 5 and 6: Issuer Size and Exemptions
Things get more interesting from Item 5 on. Issuing companies will have to select their revenue band but revenues are not required to organize a Reg D offering.
In fact, entities can be spun up purely for the purpose of issuing a security, including using otoco.io, in which case they won’t have any revenues.
Item 6 asks what exemptions the issuer is using. We cannot go in detail here but all this is Googleable and quite well explained on the SEC site itself.
Most offerings will be either under 506(b) which, broadly, lets issuers approach pre-existing contacts who can self-accredit, or under 506(c) which allows for general marketing but all investors accreditation will have to be verified by the issuer, which can be heavy.
On accreditation, recent changes by the SEC broadened the accredition to include individuals with certain professional qualifications (such as investment professionals who sat for their Series exams).
Also, the wording of the recent changes leaves the door open to include more categories and will hopefully move away from the paternalistic and arguably unfair income or assets thresholds of the previous more narrow definition of who can accredit.
In practice, 506(b) is attractive as it will allow an Issuer to build a site specifically for fundraising purposes which lets investors self-accredit by ticking a box online before they are allowed to invest.
Otonomos built such a site for its own fundraising purpose hosted on tokensale.otonomos.com and here is how this section looks:
Technology also greatly helps in KYCing candidate investors, keeping track of their payments to the Issuer (both in fiat and crypto) and by providing logs that show investors agreed to the terms and conditions of the offering.
Items 7 to 10
Items 7 to 10 are more household in nature. Item 8 may be relevant in case of a Continuous Securities Offering e.g. a revenue sharing token issuance under a bonding curve which we wrote about in an earlier post.
Items 11 and 12
Item 11 and 13 (below) refer to some of the terms of the offering. Note that you don’t have to set the minimum amount high just because you raise from accredited investors. In other words, there is nothing that prevents you raising small amounts per investor in a Reg D offering, and a low minimum does not make your offering any less accredited!
Item 12 is only applicable if you use middleman to help you place your offering, but why would you if you have technology to help you.
Items 13 to 15
13 is self-explanatory however it’s worth remembering here that Reg D offerings, in contrast to e.g. Reg CF (crowfunding) do not put any cap on how much you can raise. The sky is the limit!
If some of your securities have been sold before you filed your Form D, Item 13 asks you to specify how much.
Item 14 is also self-explanatory but could be tricky since the number of non-accredited investors in a Reg D offering under 506(b) is limited to 35, and letting non-accredited investors in will trigger much more draconian financial disclosure.
Again, technology may come to the rescue by only letting investors who self-accredit proceed to invest online.
Item 15 is only relevant if you use finders or have a referral fee structure.
Item 16
Items 16 is the final field before signature. It basically asks for full transparency if any of the sponsors listed in Item 3 above will be paid out of the proceeds of sale. In and of itself, sponsors can take a payment out of proceeds but is perhaps unseemly. If they do, the amount is there for anybody to see.
The paper form then has a signature page but as mentioned above, the filing can also been done online via the SEC’s Edgar.
Hello, Edgar
Completion of all 16 Sections of Form D above should not take more than 5 to 10 minutes.
Online filing however is a bit of a pain, since you first need to get access to Edgar, which requires a notarized application to be uploaded and approved, which if successful generates login credentials by email.
Once logged in the actual filing of Form D is trivial.
Here’s a link to ours filed on 16 October 2016 on behalf of Otonomos Token Hub LLC, our issuing entity: https://otonomos.docsend.com/view/ucygnm4jzynwp4fh.
(Please note that to make sure us sharing this here is not seen as soliciting any investment, we’ll ask you to verify your email address when accessing this link).
Bring it on(line)
We’re having such fun using our customized platform to manage our offering that we are thinking of commercializing it, legal footnotes and all, so clients can use it for their own purpose and start a Reg D token offering with the press of a button.
We have a bit more work to do but hope to offer this as a Christmas present to our otoco.io users: an online capital formation module, based on a Reg D accredited investor offering which will have all legal disclaimers and terms pre-populated and can be customized for your sale, with your onchain LLC in Delaware or Wyoming as your issuing entity.
Expect more details in November.
