Home » Blog » What Are “Unregistered Securities?”
The Securities and Exchange Commission has reportedly sent letters of inquiry to numerous companies in the US digital currency community in recent weeks. The letters, an example of which can be seen here, seem to be part of a general effort to identify and crack down on companies believed to be selling unregistered securities or failing to comply with other securities rules. Some in the digital currency community have even speculated that the SEC’s latest efforts may be part of a coordinated move by the US government against bitcoin and its cohorts.
In spite of SEC and state level enforcement action and at least one high profile prosecution, the securities registration issue remains a persistent stumbling block for bitcoin startups. The most likely explanation for this is that many digital currency entrepreneurs lack familiarity with securities laws or the expertise to understand how they apply to startups capitalized with digital currencies. Others are undoubtedly familiar with the law and have made a conscious decision not to comply. If you fall into the former group, here are some notes to make you more aware and give you a place to start your research.
What are securities?
The Securities Act of 1933 defines a security in part as follows:
“any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, pre-organization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights”
Bottom line: companies that sell securities to US persons must register and comply with SEC and state level rules unless an exception applies.
The nature of the consideration received in exchange for securities does not have an impact on securities laws. In other words, accepting bitcoin instead of dollars in exchange for stock in a startup company does not negate the obligation to register. While registration may be an unwelcome hassle and expense, failing to register places the company and its officers at risk of substantial penalties, up to and including prison time.
Who regulates securities issues in the US?
The Securities and Exchange Commission regulates interstate offerings of securities. Intrastate offerings (that is, an offering limited only to residents of a single state) may be exempt from SEC jurisdiction under certain circ*mstances, but are not exempt from state level regulation. Many US states have equivalent rules that incorporate the key aspects of federal securities law into their own regulatory regimes (though these are often older than corresponding federal laws). Collectively, these are commonly known as “Blue Sky Laws.”
Certain transactions that convey a financial interest are automatically exempt from registration requirements. For example, sale of an interest in a general partnership would not be subject to securities laws because such an interest would not be considered a security.
Other transactions are exempt, provided certain criteria are met. Typically, exemption criteria regulate the number and type of investors, the amount raised in total and within a given period of time, and the type of advertising or solicitation used (see Regulation D, Rules 504, 505, and 506).
What if I bought unregistered securities?
Though a purchaser of unregistered securities most likely would not be guilty of a crime, the fact that an issuer should have registered, but didn’t do so, should give potential investors a moment of pause. Failure to register may be an indicator of fraudulent intent or management incompetence. For example, in the Shavers case cited above, the SEC’s enforcement action for sale of unregistered securities uncovered and stopped a classic Ponzi Scheme.
So what?
Digital currency entrepreneurs must carefully consider the legal obligations associated with a capital structure that includes securities (to say nothing of the hassle of having outside investors). By definition, such a company becomes an “issuer,” also known as a public company. “Going public” creates its own set of reporting and record keeping requirements independent of securities registration. These requirements may be burdensome to the point of being onerous. On the other hand, unregistered fundraising opportunities, such as equity crowdfunding under the JOBS Act or equivalent state laws, appears to be a natural complement to the digital currency industry. If you are considering either of these sources of funds, consult an attorney or CPA who specializes in securities law.
