Beijing time, at 20:00 on November 9, Omer Ozden, founder of RockTree LEX, shared the topic "the Offensive of STO Compliance" in "Mars Learning Community " while having an in-depth conversation with rotating group manager Junjie Fan.
Junjie Fan: 1.How to do anti-money laundering(AML) when using ETH/BTC to raise funds during the process of private placement?
Omer Ozden: Each jurisdiction has different rules for AML. They are also sometimes closely related to ATF (Anti Terrorist Financing) and other activities. The rules you follow are where your organization is. US requirements are different from Hong Kong requirements are different from Singapore requirements, which has different rules than Canada. And regulators such as FinCen, FinTrac, etc..
The first thing LEX does for a project is the prepare an AML/KYC Policy. That’s first. The Policy’s purpose is to prevent the Company from being used by criminal elements (whether you are intentional or not) for money laundering or financing terrorists. It enables the Company to know and understand the investors (or customers). And how to deal with and report suspicious activities. This has to be tailored for the type of project and jurisdiction, and the type of fund raising. For private placements, your Policy will deal with what to do.
However, another purpose of this Policy is to Protect the Company. The shareholders and the executives. That is key, because as you know, in blockchain and cryptocurrency, AML and KYC is one of the key areas the government monitors and checks with Blockchain projects.
Also, what LEX does is we make sure the policy is actually being used. The Policy cannot be too complicated. We have to give training to the Company to make sure the people in the company are practicing the system of AML in the policy – in addition to making sure your company has the appropriate controls for detection and reporting suspicious activities in accordance with the laws of your jurisdiction. Again, this is for your protection. A lot of groups get a policy and then put it in the drawer and forget about it. This is a big mistake. You need a system to handle this properly and in a practical way. This means maintaining “risk-based” due diligence, identification, verification and KYC program. You make an assessment as to the risk of the investor. The more they invest for example, the more documents you collect. If they are an investor from a risky country, you collect more documents.
Most of your audience know the types of documents to collect. For private placements, you want to separate out individuals and companies. For example, for individuals you can have ID documents and verification of address. Corporations have documents and information on the entity and the individual persons controlling the corporate entity.
One more point to make here. Depending on where your private placement is, you will need to collect certain documents related to the investor to fit in within exemptions – for example, Rule 506(b) requirements under Regulation D are different than Rule 506(c) requirements, which is related to KYC.
Junjie Fan:2. How are you helping develop the roadmaps for STOs?
Omer Ozden: LEX has prepared a global infrastructure for STOs. We have our offices in Beijing, New York and Toronto. We have signed partnerships with various groups in the United States, and other countries specifically for processing STOs. For example, we work very closely with Sharespost. I will be in Singapore next week with the founder for various meetings with the head of IMF, and the Prime Ministers of Singapore, India and Canada to discuss blockchain and digital assets. This is apart of preparing the roadmap for STOs on a global basis.
LEX is also currently preparing the “Understanding Security Tokens: Guidelines for Government & Practitioners” with the Token Alliance, led by former Commissioner of the SEC, Mr. Paul Atkins and former Chairman of the U.S. Commodity Futures Trading Commission, Dr. Jim Newsome, and other leading experts around the world.
LEX is the only expert from Asia co-authoring these STO guidelines, which are anticipated to be the “Bible” for STO practitioners and government. We are happy to share this with the groups we work with when finished. This comes after LEX co-authored with the Token Alliance the famous 110 page report “Understanding Utility Tokens: Guidelines for Government & Practitioners”, which we submitted to U.S. Congress, the SEC and CFTC in July 2018. For those who want a copy, please come see us. This is for practitioners, projects and governments who are interested in generation and distribution of utility tokens. i.e. the “Utility Token Bible”. Our “STO Bible” will also soon be available.
Since Blockchain is a global phenomenon, it is really important to be international. You have to understand China. You have to understand United States. You have to be in both places. Plus you need to understand other jurisdictions. “Jurisdictional Arbitrage” is a key strategy of blockchain projects. Whether Utility Token or Security Token. We unite East and West. This is critical for Blockchain, as well as STOs. This is what we do for you
Junjie Fan:3. How to avoid investor restrictions when using Reg S to raise funds in the process of private placement?
Omer Ozden:Regulation S is a complex Regulation under the Securities Act of 1933. It is an exemption from Section 5 of the 1933 Act. It’s a safe harbor for extraterritorial offers, sales and resales of securities under Rules 903 and Rule 904 under the 1933 Act. Regulation S provides certainty that in the context of a global offering, it is exempt from Section 5 Registration Requirements.
But one thing that companies should know is that Regulation S does not exempt them from the “Anti-Fraud provisions” of U.S. This is a major difference between ICO and STO. In an ICO, projects can write many things about their project. Sometimes even make up things that are not true. And there are not strict laws that protect the investors from this behavior. But under the Securities laws of every country, and particularly common law jurisdictions such as the United States, Canada, Hong Kong, UK, Singapore, and Australia, there are very strict requirements under “Antifraud” provisions. That’s why you need to be legally compliant for STO. And that’s why the larger investors will invest into STOs rather than ICOs. So this is a key piece for you to predict what will happen with the STO market over the next 12 to 36 months. More institutional investors for STOs, meaning more money in the cryptocurrency and digital asset market.
Under Regulation S, there are Three Categories. And you have to analyze each transaction under each of the categories. Because they will determine what restrictions are required, and how you can sell the securities in the future, which is a very important thing for both the Company and the Investor. For example, Category 1 Regulation S transactions are “offshore transactions” that there are no “directed Selling efforts” in the US. You have to also look at something called SUSMI (Substantial US Marketing Interest). One good thing about STOs currently, is there is not a SUSMI for STOs and thus many transactions can fit under Category 1. Category 2 involves transactions that are not under Category 1, and they are equity securities of a foreign issuer that is a reporting company under the Exchange Act of 1934 or Debt Securities of a company reporting under the Exchange Act of 1934 or non reporting foreign companies – such as Chinese companies. Category 3 are for transactions not eligible for Category 1 or 2. For each type of transaction, different restrictions need to be placed on the securities and there are different time periods for holding the securities.
Understanding Regulation S, as well as Regulation D, and Section 5 are important aspects for Asian companies seeking to do STOs.
The good thing about understanding US Securities Laws is that they were the first complex securities laws in the world (they were implemented right after the stock market crash of 1929 in the United States), and just about every country follows their general structure and concepts, with certain modifications for their own country. Especially common law jurisdictions. So the ability to do an STO in the United States, means you have most of what you need to conduct an STO in other jurisdictions.
Junjie Fan:4. Are there any cases that approved by REG A+ in the existing STO projects?
Omer Ozden: As mentioned, RockTree LEX is a apart of a group of experts that works with the SEC and CFTC on blockchain and cryptocurrency called the Token Alliance and also the Digital Chamber of Commerce. As previously mentioned, our two Co-Chairs are the former Commissioner of the SEC and the former Chair of the CFTC. We work together to get guidance from the SEC and get information that is critical for properly conducting Utility Token offerings and Security Token Offerings. Through our work with the US government, LEX works closely with Valerie Szczepanik, who on October 18th, 2018 was made the head of the SEC’s Strategic Hub for Innovation and Financial Technology (FinHUB) and Associate Director in the SEC's Division of Corporation Finance for STO and other blockchain based projects. The last time we spoke, she told us that there were multiple filings for STOs and ICOs under Regulation A+ but none have been approved yet. Regulation A+ has been successfully used for non-STO equity offerings however.
Junjie Fan:5. How to increase the chances of a successful REG A+ application? What are the methods? Which kind of assets is easier?
Omer Ozden: I think the better way to look at this is to look at all the tools available for a company under the SEC’s rules and regulations under the Securities Act of 1933 and the Exchange Act of 1934. LEX is an expert in all of these tools. The LEX team has completed over 120 public securities offerings and utility token offerings and hundreds of private securities offerings in 18 different countries, and most of these had a US aspect to them.These include dozens of IPOs in the United States, plus other countries. Under SEC rules, you need to consider Section 5 of the Securities Act and what is available through that, such as Form F-1 and Form S-1 filings. Also Form S-3 and Form F-3 filings. You need to consider Regulation D, and the various exemptions under that. And we already talked about Regulation S.
There are also Regulation A+ and Regulation CF. Don’t waste your time working with advisors who have not done IPOs in the US and especially for Chinese companies form the US. Your experts should have (i) done at least 10 IPOs in the US, and (ii) have extensive experience working with Chinese companies. Otherwise, don’t do an STO with them. They can lead you down the wrong path. And with securities laws, going down the wrong path can be very costly and dangerous to the team. I was on the team that did the first IPOs in the United States for technology companies. We invented the VIE structure in 2000 and did the private placements under Regulation D and Regulation S plus the Section 5 offering for companies such as NetEase, Baidu, Alibaba, New Oriental, plus many other companies in China and outside of China.
Regulation A+ for STOs is a good example of people being led the wrong way. Why? First, Regulation A+ filings for STOs (or even Utility Tokens) have yet to be “qualified” by the SEC based on my latest discussions with the SEC. Secondly, Regulation A+ is available for US and Canadian companies. Not for other types of companies.
My advice for STOs currently, in addition to working with a group that has done at least 10 IPOs in the US, is to make sure you’re the engineering of your Security Token is simple. It is important to architect your Security Token properly. This is the first step. The best is some equity based Security Token of a company that is high growth. Or some simple security related to dividends or profit distribution. Designing complex Security Tokens at this stage of the game, such as ABS, or security tokens for art, or other areas, can work, but for it to be successful, it’s too early. And eventually, you need to deal with the listing exchanges and the government authorities, and the more complex you make it, the less chance they will understand it. And also the less chance the investors during the early days of STOs in 2018 and 2019 will understand it.