Blockstack's Reg A+ Filing and the Future of Token Offerings - Ep.069

Transcript

Hi, everyone. Welcome to Unconfirmed, the podcast that reveals how the marquee names in crypto are reacting to the week's top headlines and gets the inside scoop on what they see on the horizon. I'm your host, Laura Shin. In case you didn't hear, Meltem Demiris of CoinShares and Jalajoban Putra of Future Perfect Ventures and I are all teaching a crypto workshop at Omega Institute in Rhinebeck, New York, from September 20th to the 22nd. Plus, there will be yoga, healthy food, and Omega's beautiful 250-acre campus. We'll be right back. If the idea of spending a few days in nature, enjoying activities, and talking crypto sounds fun to you, check out the show notes for the link to sign up. Also, Unchained is now on YouTube. You can find the most recent episodes there every week on the Unchained Podcast channel. And if you're not yet subscribed to

my weekly newsletter, go now to unchainedpodcast.com to sign up. Cyphertrace makes it easy for exchanges and crypto businesses to comply with cryptocurrency anti-money laundering laws. Today's guest is Zach Fallon, principal at Blakemore Fallon. Welcome, Zach. Hi, Laura. Thank you for having me. Last week, Blockstack announced that it is doing an initial coin offering via Reg A+. When I heard the news, I immediately thought of you since, as far as I understand, you pretty much wrote Reg A and were involved in drafting many of the crowdfunding roles. And now you advise teams in the crypto

space. Tell the listeners more of your background. Yeah, thanks. Thanks for having me, Laura. It's great to be here and speaking with the audience. As you suggested, I was at the staff of the SEC for a number of years. I was there for about nine years, and I started in their office of the general counsel. And then transitioned a few years later to their division of corporation finance in the Office of Small Business Policy. I did that at a time when the crowdfunding rules, the JOBS Act provisions, which were adopted to really allow the commission to adopt rules on their end, which facilitated crowdfunding, came about. And that was in 2012. So I was there from the beginning of the JOBS Act implementation by the staff at the SEC

and worked quite heavily on some of the regulations, as you know, Regulation A, peripherally on Reg CF, 506C offering rules as well. I was there through the adoption of the Reg A rules and stayed for years thereafter to help with the implementation of the rules. the interpretation of the rules and to work with our director for a period of time as his senior counsel. So yeah, no, great to be here. And so, but then you left to establish your own firm, which I believe caters to crypto companies. Yes. As far as what I've done since I left the SEC last year in April, some like-minded folks I was able to get in touch with. And we started Ketzall Consulting, which is a consulting firm that deals with regulatory technology, adoption

of regulatory technology type solutions, as well as Blakemore Fallon, its affiliated law firm. And we're based out of Dumbo in Brooklyn, although I work remotely here in the D.C. area. All right. So now let's talk about Blockstack. Explain what it means that Blockstack is conducting a token offering under Reg A+. What can it do? What can't it do? How much can it raise? From whom? Et cetera. Sure. Yeah. And I think that's a great place to start. I think for purposes of background, I can say quickly that what Regulation A is is and what it allows companies to do, irrespective of Blockstack. And then we can talk about how Blockstack may interact with that. So Regulation A is an exemption from registration for public securities offerings that consists of two

offering tiers. Tier one is for offerings of up to $20 million in a 12-month period. And tier two is for offerings of up to $50 million in a 12-month period. And for offerings of up to 20 million, companies can elect to proceed under the requirements of either Tier 1 or Tier 2. It looks like Blockstack is conducting a Tier 2 offering of up to $50 million in any given 12-month period. So what Regulation A is, is a disclosure-based exemption from registration. It allows issuers more flexibility with respect to testing the waters or soliciting interest in the offering in advance of their ability to actually make sales. That's sort of a novel thing under the securities laws traditionally, which you had to wait to actually have your offering qualified or deemed,

a registration statement deemed effective in order to begin making sales and offers. That is not the case with Reg A. You can sort of make these offers ahead of time. There were limited ability to do it in the registered context, but generally the testing and waters provisions in Reg A are quite robust and allow for a lot of flexibility of communication with potential investors or in Blockstake's case, potential network participants. It also allows for sales to retail investors, which is great because you don't have to limit sales to accredited investors only. It provides for the preemption of state securities laws. So Blockstack does not have to register at every state in which it plans to conduct the offering. It can register at the federal level only and submit notice filings to the states in which it plans to conduct the offering. And importantly, too, the

securities sold in a Reg A offering are unrestricted. That is, they're not subject to the typical one-year holding period that comes with a private offering of securities. With Reg A, though, as you've seen in the offering statement filing itself, it does require a substantive narrative and financial disclosures to be included in a document filed with the SEC. In Blockstack's case, that requires the inclusion of audited financial statements because they're conducting a Tier 2 offering. And as a result, once they're qualified, they'll be required to file ongoing annual and semi-annual reports.

But a lot of that information will be based off of what you see already in their public filing once it's in fact qualified. You know, what can they do? They can, as I said, they can start telling people that they're intending for this to happen now. And that's also related to the testing the waters provisions, which allows them to notify potential participants and see if people are going to be interested in this. That helps for them to figure out from a cost perspective whether or not it's worth pursuing this at all. So I think that's a really helpful thing. And yeah, I think as of last week, they basically publicly filed, which is a good sign that they have a good sense of the issues that the staff cares about and that they plan on moving forward with the filing and not staying in the

sort of the dark non-public submission stage of the offering. Yeah. So does that mean essentially that you think the likelihood that this will be approved is pretty high? Like, does it mean that they've pretty much worked very closely with the SEC to even get to this point? I think it's safe to say they've worked closely with the SEC to get to this state. Now, and the reason I know that is because it's not just this initial 1A filing. It's also, if you look at the EDGAR filing page, which is the company's profile page on the SEC's website, you can see previous filings. That is a draft offering statement, or if you look at it, it's a DOS filing. And then you can see a draft offering statement that was amended, a DOSA. And both of those happened in the fall, I believe, and into the

winter. And so they've already had back and forth with the staff on substantive issues. They've likely been able to address many of the issues, but whether or not they've addressed them all is an open question. It's not entirely clear from the filing what issues remain outstanding. I suspect there are, there are, There are issues outstanding, but I don't know how substantive they are at this stage. But what I would say is that typically, and this is just typically, companies publicly file when they have a good sense of those concerns and have some confidence in their ability to address them. So in that sense, I think it bodes well. And one other thing I wanted to be sure I understood. So filing under Reg A-plus means that WOC stack will get an exemption, right? registering for public filing. But then I also noticed like in,

in what they wrote, they said that they anticipate treating the Stacks tokens as securities. So just to understand the exemption is like from filing requirements or is It's not an exemption for their tokens to not be securities, right? Right. Can you just explain? Yeah. Yeah, sure. So the block stack is not taking the position that their tokens are not securities. They're taking the position that they are investment contract securities. And so the way the regulatory framework works is really the statutory default position is in the Securities Act of 1933 is to require registration of companies. And so that is, that's, those are the provisions in Section 5 of the 33 Act. And those

deal with companies that are ready to go to register their offering in a very public way and to wait to make sales until their offering has been deemed effective by the staff. Now, that's not practical for many companies, particularly smaller companies and startup companies. And so what the SEC has done over the years and what the statute provides for is a series of exemptions from registration, which don't affect the securities, their status as securities, but rather – provides more flexible ways in which the issuer can offer and sell those securities to persons in the market. And so you have Regulation D, which is largely for accredited investors, which is a private offering, and that is an exemption from registration in the same way that Regulation A is an

exemption from registration. It doesn't mean that the what the person is selling, what the company is selling is not a security. It just means that they have this more flexible path, which doesn't result in the registration requirements and the implications that come with them downstream, like with respect to ongoing reporting and those sort of issues. And then something else that fascinated me is so they are allowed to raise the funds in Bitcoin and Ether in addition to dollars. Do you think that that is something that would have been difficult for them to make happen? Or is there like nothing in the Jobs Act regulation that would, you know, have made that difficult? No, I don't think there's anything. There's nothing in the jobs act, certainly, that would have contemplated Bitcoin or Ether. But I do think that the SEC has been pretty clear

that purchasing securities or or sorry, purchasing, well, yeah, purchasing securities with using Bitcoin or Ether as the currency with which you pay for it is fine. There are, and plenty of people do that in these offerings, and it doesn't really affect the analysis. The one thing that, sort of the wrinkles that come up in Reg A largely have to do with when you're describing in a very public way the process by which you accept investment dollars or coins. You have to keep in mind that there are different ways in which they can be valued. There are different times in which they, you know, in a very volatile market where the currency may be worth one thing when you give it to the company, but something else when it actually hits

their coffers and sort of how you characterize that Delta and how you address the risk that somebody maybe gave you what they thought was $10, but it ends up only being worth $7. The potential implications around that, I think, are the only things that really come up in Reg A with respect to accepting investments in something other than USD. All right, we're going to discuss the time lock on the funds in a moment. But first, a quick word from our fabulous sponsors. Did you know that if money laundering were an economy, its GDP would be the size of Canada's? Large volumes of tainted crypto assets move through financial networks, often below the radar of banks.

Cybercriminals use unregulated crypto exchanges to avoid detection. No wonder governments around the world are rolling out tough, new anti-money laundering laws for cryptocurrencies. Complying with those laws isn't easy. Banks and exchanges need the best cryptocurrency intelligence available to avoid penalties. Now you can use the same powerful AML and compliance monitoring tools used by regulators. Cyphertrace is securing the crypto economy. To learn more, visit cyphertrace.com slash unchained. Back to my conversation with Zach Fallon of Blakemore Fallon. So the time lock on these funds for the Stacks tokens, is that something that's typical for jobs at crowdfunding rules? Or are they electing to do

that? I think they're electing to do that. And it's interesting to me, this is one of the interesting wrinkles in the filing itself, is that as I was describing Regulation A earlier, one of the primary benefits, as against, say, conducting an offering as a private placement, is that the securities you sell once the offering has been qualified are not restricted securities anymore. which means they're not subject to the traditional holding period of one year for private companies. And so that's an important benefit of using Regulation A. And the company does mention quite clearly, as they should, that these are not restricted securities for purposes of federal

securities laws. Nevertheless, the company is implementing a time lock policy And it's not entirely clear to me why that is. It must be there must be some business reason for doing so. But there wasn't a regulatory reason as such. Yeah. And actually, it's even longer than the one year. It's they're saying that it'll be a year and 11 months. But one other thing, actually, I don't know if you notice this. It was saying that while the tokens are locked up, they cannot be used for any purpose, even within the network. which I thought was strange because these are supposed to be utility tokens. So do you think that there's like a regulatory reason for that? I think there's potentially a regulatory reason for not having them freely tradable on registered exchanges and alternative trading systems that are operated by registered broker-dealers because

those don't really exist at the moment. So having them be freely tradable off-network is not controversial in my view at this stage because there really isn't anywhere to do that. And the company sort of acknowledges that. That they won't be able to be used on the network is interesting. I don't have a strong sense of why that may be. I should also just preface generally that this is their first public filing. We don't know when it will be qualified or if it will be qualified. As I said, there's a good chance that they've addressed a lot of the issues, but the staff at the SEC still has the right to raise additional comments. The company still has the right to change the disclosures that are in here. To the extent

that we're looking at the four corners of what has been filed, it's a moving target on some level. So a lot of the stuff in here may change. And I'm not saying that I'm not focusing on the time lock when I say that, but just sort of generally keeping in mind here that what we're looking at is really a draft and it won't be final until it is actually qualified and they can begin to operate the network. And when you say we don't know how long, so there's no kind of typical timeline for the SEC to give a decision on this type of filing? There's no mandatory timeline, I'd say. The staff typically in a non-crypto offering would turn around comments pretty quickly, within, I would say, probably a month's time from the time you file something or non-publicly submit something until you get formal

feedback from the staff. You may get interim informal feedback from the particular team reviewing it. But I think a month is a good rule of thumb. And what you see in the crypto market is, with crypto Reg A filings is much longer turns. So I think if you do the math on what's publicly available here in the file, it looks like the staff is taking handling turns in slightly over around two months, I would say, which is not normal for the regular Regulation A offering, but does highlight the aspect that what we're dealing with here is something novel from their perspective. and that they are really working to understand the issues

that are the implications of the network. These are complicated things. And every network, as you know, has its own bespoke features. And trying to categorize anything writ large in the space can be difficult, even though once you boil things down, sometimes they look very much the same. Getting there is a process. And I think that's often why things take some time. One other thing I noticed is that investors can only purchase up to $3,000 worth of Stacks tokens. Does that have to do with the crowdfunding rules or is that something they're choosing? It could be. I haven't seen, I didn't see that in the offering, but I do know that in regulation aid generally with respect to retail non-accredited investors, there are, if you want to take advantage of a

tier two offering and state gets the preemption of state laws, the provision I mentioned before, one of the requirements is that you limit the sale to non-accredited investors to the greater of 10% of their net worth or income for natural persons. And To the extent that it's possible, they may be using that as a metric of 10% net worth or income, but I don't know that that's the case because you never know who could potentially fall above or below that based on network participants. It might not be based on a Reg A requirement, although, as I said, the closest thing in the regulation is this idea of limiting sales to non-accredited investors with an investment limitation. Yeah, perhaps it has to do with them wanting to distribute the tokens to

as many people as possible for utility purposes or like, you know, seeding the network. Yeah, you know what? Sorry. I mean, that is a good point. And that idea that, you know, people are only purchasing the amounts in which they intend to use is a sort of important criteria that the staff looks at with respect to whether or not something is a security. So to the extent that they can avoid concentrated holdings of the tokens, then I think that benefits them in that regard. One other thing I couldn't help but notice is that New York investors are not allowed to participate in this offering. And actually, Blockstack is based here in New York. Do you think that has to do with the BitLicense? It may very well. And if you look actually at the Blockstack, their address, Blockstack Token LLC anyway, is in New Jersey.

So, um, just to add some color to what is your sense is probably my sense as well. New Jersey benefiting from, well, I won't go into that. Um, but so has your firm seem seen much interest from teams wanting to do a reggae plus token offering? Yes, for sure. There's there, you know, the, the, it waxes and wanes and interests. And I think, um, There definitely are companies interested in pursuing Regulation A, and rightly so. In many ways, it may be the best regulatory-compliant option that certain companies have based on their intended user models and their business models. So we

are definitely seeing interest in the space, but I think some people are concerned about costs, which I think is a legitimate concern. They're concerned about time to qualification. So how long are they going to be stuck in the SEC's review process? There are certainly uncertainties there. But for companies with the right profile, I think it is a great option. It's not the only option. And I think at the end of the day, most people will typically tend towards the private placements, the Reg D and Reg S offerings, and will pursue a path that is, in their view, contains less friction and cause potential uncertainty and public scrutiny. But having said that, I think you'll probably see more 1As

come online in the coming months. I wouldn't be surprised by that. Yeah. And just to note, Blockstack actually also is raising funds via Reg S, which, as far as I understand, enables them to raise funds outside the U.S. Is that correct? Yes. Reg S is not an exemption as such. It's a safe harbor, which basically says if you comply with it, then your offering will be deemed to not sort of interact with U.S. jurisdictional means and you'll be offshore. And you can do those offerings concurrently with a Regulation A offering and not have to worry about the integration of the two for purposes of the exemption. So that if you make sales to people overseas pursuant to Reg S and sales to persons in the U.S. pursuant

to Reg A, then they won't sort of blend those two things together and say, hey, you violated – when you lump them together, there was no violation for the whole thing. And one other thing is you said that some of the teams that seemed perhaps interested in doing a Reg A Plus token offering were concerned about the cost and the time it takes. So what is the typical cost for doing that? And what is the amount of time it would typically take? Yeah, so, you know, timing is really important. It's impossible to forecast definitively, particularly in this space. Traditionally, with a non-crypto offering, as I said, you can kind of get a good sense of a month to get comments back. Maybe it takes you a couple of weeks

to respond to those comments and then sort of again and maybe going through that cycle two or three times again. maybe a fourth time. So you're looking between three to six months, right? I mean, something in that window. A lot of it depends on your ability as a company to respond quickly to comments. So if you're in a rush and you sit on the comments for a while, the SEC is not going to take even lateral action. They're just going to wait for you to respond with revised document that addresses their questions. So a lot of it is in the company's boat. And with the staff, you can kind of forecast a 30-day turn each round. And sometimes they get significantly quicker as the issues disappear. With crypto, as I said, the timing seemingly doubles. I don't want to say in every instance, but that

time can take a potentially longer, right? And so I think we're seeing that. I think that's part of the frustration. As far as costs, costs vary widely. And so, you know, there's nothing in the regulation which suggests you need an attorney to draft the offering statement. But if you look at Blockstack's offering, you can see why there are attorneys involved or you can see the product of attorney involvement. And I think, you know, this is sort of one of the beautiful things about disclosure generally that's been filed publicly is that the block sack token offering statement is really robust. It's a large document, 140 or some odd pages at least. And if you compare that to what a lot of people, what a lot of investors have gotten in their

15 to 20 page white papers, you can see the sort of the benefit of it. Now, of course, there's a cost associated with that, which is that it takes time to produce this. It takes time to have the back and forth with the staff. But the product is... The delta is meaningful. And it's not just about the disclosure, but it's also about the company's accountability for that disclosure. And so to their credit, Blockstack is doing this and they're saying these things and they're willing to stand beside them. in the aftermarket as saying this is, you know, we told you everything you needed to know. We complied with the exemption. And, you know, they should get credit for that, for sure. But it's not, I think for their purposes, it's probably

not inexpensive to come up with a document like this. Yeah, I would definitely say that it was pretty refreshing to see all the risks laid out in plain English. For instance, they mentioned everything from like there could be a bug in the software, Blockstack could lose its crypto assets. There could maybe the stacks, there will never be a trading market for stacks or the stacks might never be worth anything. There could be a hard fork. I mean, it just goes on and on and on. And I had this conversation with SEC Commissioner Hester Peirce recently on Unchained, which thank you, Zach, for facilitating that. And she talked about how she thought disclosures were important and you could definitely... look at this filing and see what she's talking about. So last

question for you. What do you think is the significance of this Blockstack reggae token offering? Like, do you think that this kind of indicates this is where the future will be going? Or, you know, as somebody who's watched both the crowdfunding rules and then the ICO craze, like, what's your take on what this means? Well, what I think it means is that the market has been, well, what I think it showed, we will show is how starved the market has been for an example like this. Whereas there's no shortage of private placements pursuant to Reg D or Reg S that have been happening in this space. I guarantee you that 99.9%, if not 100% of them, don't have disclosure like this that they're providing their investors. They're not necessarily required to, so state that for the record. But you can see sort of the benefit

of this path. Now, it doesn't solve some of the more pressing concerns that both those who have offered in the private placement market or in this reggae market will encounter. And that has largely to do with the after markets trading. And that's something that Regulation A doesn't address, although they address it in the filing as risks. Like as you said, it may never trade anywhere. Those sort of friction points are not solved through Regulation A. It is not a panacea in that regard. So what the issuers will encounter is going to be the same, but it does show that there is another viable path and one which allows you to freely communicate with people who may be participants. You can build your following in a compliant way publicly while you're waiting to be qualified, and I think that's a good thing. All right. Well, it's

been great having you on the show. Thanks for coming on Unconfirmed. Oh my gosh. Yes. Thanks so much. This has been great. Thanks so much for joining us today. To learn more about the topics we discussed, be sure to check out the links in the show notes of your podcast player. If you are not yet signed up for my email newsletter, go to unchainedpodcast.com right now to get my thoughts on the top crypto stories of the week. And be sure to check out our new channel on YouTube. Unconfirmed is produced by me, Laura Shin, with help from Raylene Gallipoli, Fractured Recording, Jenny Josephson, and Daniel Ness. Thanks for listening.