CapitalRaising

The U.S. regulator floats expanded investor access and simplified financial disclosures.

This article appears in the October issue of Global Finance Magazine.

The Securities and Exchange Commission is considering a new route for raising capital that does not involve issuing equity or debt, but instead uses crypto assets. In August, the regulator released the aptly named Regulation Crypto Assets (Reg CA) for comment. 

The regulation, as initially written, would permit companies to raise up to $5 million over a four-year period or up to $75 million in each 12-month period. To raise the higher amount, the issuer would need to provide financial statements and comply with federal securities law’s anti-fraud and anti-manipulation provisions.

New Asset, New Rules

The new rule differs notably from alternative capital-raising methods under Regulation Crowdfunding, Regulation A, and Regulation D, which let issuers raise a maximum of $5 million, $75 million, and an unlimited amount of funds, respectively.

Reg CA, as proposed, would allow issuers to provide potential investors with principles-based financial disclosures, giving issuers the flexibility to select which financial information to disclose rather than following a prescriptive list of required information, with the intention that issuers focus on the substance of the information provided.

Secondly, the proposed rule does not include investment limitations for non-accredited investors, those who do not have a net worth of more than $1 million excluding their primary residence. Regulation Crowdfunding and Regulation A each cap the amount non-accredited investors can invest. For Regulation Crowdfunding, the maximum is $107,000 across all offerings in a 12-month period; if the investor’s net worth is less than $124,000, the limit is the greater of $2,500 or 5% of their net worth.

Regulation A limits non-accredited investors to 10% of their net worth for issuance of Tier 2 offerings (up to $75 million) but has no investment cap for Tier 1 offerings (up to $20 million). 

Regulation D, however, permits the issuance of private securities in any amount, but only issuances of $10 million or less are available to a maximum of 35 non-accredited investors. 

The proposal also includes a safe harbor for investment contracts issued under the rule if the issuer permanently ceases or promises to cease all essential managerial efforts it represented or promised it would under cover of the investment contract and makes a public filing that it satisfied those conditions with analysis that supports the claim. If met, the SEC would deem that the crypto asset subject to the investment contract would not be considered an investment contract with regard to the statutory definition of a security.

Suggested Rewrites

Reg CA’s comment period ends Oct. 20, when the SEC will review the comments before possibly revising and finalizing the rule and entering it into the Federal Register for enactment.

Early comments on Reg CA do not reject the 400-page proposed rule, but strongly stress addressing perceived design flaws.

The suggested disclosure exemption concentrates a great deal of risk, noted Tilden Moschetti, an attorney with Moschetti Syndication Law.

“None of the proposed safeguards carries the weight the release assigns to it,” he commented. “Principles-based disclosure does not verify anything. Antifraud liability arrives after the money is gone. A $5 million issuer cap says nothing about what one household can lose. And the prospect that some projects will generate useful network effects is not a reason to hand unsophisticated investors uncapped development risk.”

Neil Osanto, founder of the Persistence Analytics Group, suggested that the SEC could strengthen its framework with a narrow distinction in his comment letter. “Disclosure of a claimed condition is not the same as evidence that the condition has been achieved,” he wrote. “Where a material representation affects investor understanding or carries a regulatory consequence, the evidentiary standard should follow the consequence.”

The crypto industry should consider the federal securities law exemption a gift from the SEC, despite numerous courts concluding that crypto companies should be subject to those laws when the SEC, under Chair Gary Gensler, was suing them, Benjamin Schiffrin, director of securities policy at public advocacy firm Better Markets, told Global Finance.

“So this is just, as I said, kind of a gift to crypto,” he added. “I think that tells you everything that you need to know. You have the crypto industry getting everything it wants from the SEC, and this is just another example of that.”

Rob Daly covers economics and policy. Contact him at rdaly@gfmag.com.