Reg S vs online offerings: key issues

In the complex sphere of securities, the SEC’s Regulation S holds significant importance, but it is frequently misunderstood by many in the industry. Therefore, having a clear understanding about its role is essential for to be well-informed and avoid misconceptions.

 

Introduction

We often hear suggestions that a Reg S offering be added to an offering being made under one of the online offering exemptions (Reg A, Reg CF or Rule 506(c) under Reg D). This is very rarely a good idea. Reg S sits very uneasily with the online exemptions. Although the conditions under which such offerings can be made using general solicitation vary, each of them can use general solicitation. Reg S offerings cannot.

Reg S requires that offers and sales be made in an “offshore transaction”, which means no offer can be made to a person in the United States and that you have to know or reasonably believe that any buyer of securities is physically located outside the United States. Additionally, “directed selling efforts” in the United States are prohibited.

Eye on compliance!

Directed selling efforts are much broader than general solicitation, including any activities that “condition the market” and would include not just advertising, but also person-to-person sales communications.

The type of communications permitted under the online offering exemptions would generally blow both the offshore transaction requirement and the directed selling effort prohibition. As we all know, the term “offer” is interpreted very broadly in US securities law.

If you are making an offering under multiple “exemptions”, even if you don’t mention the Reg S offering, the SEC is likely to take the view that general solicitation activities will result in conditioning the market for the Reg S offering. The Staff has certainly asked issuers making offerings under several exemptions contemporaneously for an “integration” analysis – explaining why various communications should not be treated as resulting in the several offerings being treated as essentially one plan of financing.

Efforts to argue to the Staff that one communication relates to one offering, and another communication relates to an offering under a different exemption have been met with a robust skepticism, and the Staff have often seemed to take the view that communications for multiple offerings cross-market each other. This would be even more the case if one of the offerings were being made under Reg S, where the “market conditioning” prohibition is baked into the rule.

Mentioning the Reg S offering in communications in the United States, would of course be a violation of the “no offers in the United States” requirement. But if you didn’t mention it, you would run the risk of omitting disclosure of a material fact.

Reg S and Online Offerings: think twice

Although its technically possible, is rarely adding a Reg S element to any offering being made under an online offering exemption. It’s reasonable consider that if you did want to add Reg S, you would need a geofenced offering site accessible only to persons outside the United States.

You need a separate set of offering docs (to comply with the other conditions of Reg S, which I haven’t even touched on here). And you would need to ensure that no-one who invested came to the offering because of all the communications you used in the other offerings – the LinkedIn ads, the TikTok videos, the Insta pics, the You Tube videos. And that’s a difficult task.

And bear in mind that even if you were to structure an offering to meet the requirements of Reg S, you would still need to consider compliance with the securities laws of the countries your investors are from, as you would with any of the other “exemptions”.

In most cases, from a practical point of view, you are better off relying on the usual online offering exemptions, even to accommodate non-US investors.

 

* Credits: Sara Hanks, CrowdCheck.

Many Rights Make the KoreProtocol Right

Over the last few weeks, we have seen the highly entertaining farce of Craig Wright claiming to be Satoshi Nakamoto by registering a copyright to the original bitcoin whitepaper and code. He may very well be Satoshi. However, registering a copyright does not confer an official recognition of identity. Wei Lu, CEO of Coinsumer, proved it. Reacting to the press releases and social media statements made by Craig Wright and his supporters, the US Copyright office took the extraordinary step of publicly refuting the claim that a copyright registration is the same as official & proven recognition. This prompted the subject line of Coindesk’s May 23rd Blockchain Bites email: “Wright is wrong.”

The public blockchains provide an endless source of fun. Whatever their faults, one can’t blame them for being boring. The responsible, permissioned chains are, in contrast, boring. KoreChain in particular is relatively dull to thrill-seeking outsiders, while extremely exciting to those who truly understand private capital markets and how the KoreProtocol is spearheading innovation for private issuers and investors.

The KoreProtocol defines many types of shareholder rights in private digital securities. These rights, some mandatory and some discretionary, are well-established in securities law and corporate law. The innovation and complexity of shareholders rights is only limited by the willingness and imagination of the participants. In the absence of automation and a single source of immutable truth, the implementation of rights can become a bureaucratic nightmare. This, more than anything, becomes a limiting factor for innovative contracts. By defining shareholder rights rigorously in the KoreProtocol and implementing the full workflows in KoreChain for their exercise, the KoreProtocol and the KoreChain take away the pain and effort of managing these rights. This opens up private capital markets to very flexible and complex shareholder agreements to suit the needs of the participants.

The KoreProtocol and the implementation within KoreChain include rights such as (to give a few of the more prominent examples):

  1. Voting/non-voting
  2. Financial participation in the form of dividends or revenue
  3. Distribution of revenue or dividends as cash, reinvested securities, or other forms of payment
  4. First right of refusal
  5. Tag-along rights
  6. Drag-along rights
  7. Pre-emptive rights

Each of these rights and their numerous variations have implications and consequences in secondary market trading and in corporate actions. The KoreProtocol provides a structured way to define these rights and their impact on securities transactions. The KoreProtocol implements complete end-to-end management of financial transaction processes, some of which may be very long-running.

The definition of protocol functions to handle all the complex scenarios in securities transactions is not a trivial undertaking. However, it is much easier than the actual implementation of the protocol since that requires handling long-running processes and making tradeoffs between manual and automated processes, data sharing mechanisms, and choice of endorsers. Every step of the process must be fully compliant with securities laws, corporate laws, and the provisions of the underlying contracts.

Trying to shoehorn securities transactions into inadequately defined protocols and delegating the implementations to someone else is to do the worldwide financial community a huge disservice. Implementing the rights of issuers and investors is a very complicated undertaking. For example, ERC-1404, in the words of its creators, “…solves for the compliance challenges that are part of the issuance process and beyond.”

How does ERC-1404 solve the problem of whether senders can send tokens to a receiver and whether receivers can receive tokens from a sender? By defining two functions: CanSend() and CanReceive(). The github code itself shows one function:

detectTransferRestriction(fromAddress, toAddress, numTokens) //I made it a bit readable.

With no trace of irony, the authors of this protocol point out that: “The specific logic covering who can send and receive can be configured outside the token contract itself.”

It is easy enough to write protocols as long as we leave the messy details of implementation to someone else!

In reality, the transfer of digital securities in a fully-compliant way is quite complicated. It is not just a matter of “who can send and receive”, but also a question of the circumstances under which securities can be transferred or not. There are complex workflows and numerous checks that need to be followed before any transfers, whether P2P, beneficial, or trade-related, can occur. The checks relate to the jurisdictions and exemptions under which the securities are issued, domicile of the participants, securities laws that govern all subsequent inter- and intra-jurisdictional securities transactions, corporate laws, the rights spelled out in the shareholders’ agreements, and the presence or absence of various types of events such as corporate actions, regulatory actions, and economic events.

To be fair, the creators of simplistic protocols may very well be aware of these complexities; however, the fact remains that they come nowhere near expressing the richness and complexity of global private capital markets. Also, they offer no guidelines for implementation or even a hint of the treacherous complexities.

At KoreConX and in KoreChain, knowing the business as we do by being an SEC-registered transfer agent, we chose to not only develop a comprehensive protocol but also implement it in all its complexity. Tapping into our worldwide partner network of securities lawyers, secondary market operators, broker-dealers, academics, and other thought-leaders, we tackled the problem by creating a legal base that incorporates much of the complexity of securities law and corporate law worldwide. This includes inter-jurisdictional transactions, Blue Sky laws in the US, Canadian provincial laws, etc.

Private capital markets provide enormous flexibility for creating complex shareholders’ agreements. We have so far not seen two offerings or agreements that are similar. The public markets are relatively standardized, which can be a strength in terms of offering liquidity at the expense of flexibility of contracts. Private companies and their investors want more control and flexibility.

By incorporating the various types of rights (some mandatory, some optional, and some that are negotiated) into the KoreProtocol and implementing through the KoreChain, our mission is to create the right infrastructure to preserve and foster innovation in global private capital markets while also furthering the cause of efficient liquidity.

www.koreconx.com

www.KoreConX.io