Originally published on March 28, 2018
When you buy into an ICO through a Reg D Private Placement — as an Accredited Investor — make sure you know the rules about reselling your Tokens. Also, if you are working on an ICO project going this route, and getting paid in Tokens, this information may prove valuable. I’ve been hearing so many varied opinions on the resale rules, I wanted to try and simplify them for everyone. This isn’t legal advice, it’s just my personal opinion or interpretation of the traditional securities laws as applied to ICOs. Reg D Tokens are the same as what is traditionally referred to as “restricted stock,” “letter stock,” and “section 1244 stock.”
If you are an Accredited Investor (crypto or fiat millionaire after you account for your debt other than your primary residence mortgage, or reported income of 200K for the past two years or 350K joint with your spouse) and you buy ICO tokens through a Reg D offering, before you can sell your tokens, you:
You have to lock them up for a year, and
Wait for the company to remove the restrictive legend, and
Follow Rule 144,
Then you can sell them to anyone, on any public exchange they are traded on.
If you are an “Affiliate” of the company, which means you were an Advisor or equity holder for the ICO project in some capacity and got paid with tokens, it’s a bit more complicated to unload your stack of coins.
When a Reg D Private Placement offering is sold, it needs to be accompanied with a long (and boring) Offering Memorandum that is filled with legal boilerplate language. tZero’s is 199 pages. Typically they are around 30 pages, and include many disclaimers about the risk of the ICO purchase, the procedure for resale, the lock-up period, and any other important information about the Tokens. This Offering Memorandum has a legend — usually at the top of the offering — that outlines the restrictions. The Tokens can’t be resold until that Legend is removed by the ICO issuer. To get the legend removed, the ICO issuer has to either: (a) register the Tokens with the SEC, (defeats the purpose of the Reg D) or (b) get a legal opinion that the lock-up period is over and the tokens are no longer restricted (this one is also easier said than done).
Before ICO’s, Reg D Private Placements were most commonly used as part of an employee benefit package, compensation, seed money for start ups or M&A deals. Most of the people who got Reg D securities were affiliates of the company. Rule 144 created a way for affiliates to sell their restricted securities to the public.
Five conditions are required for an advisor on a project (affiliate) to meet the Rule 144 standards:
Holding Period: You have to hold them for 6 months if the issuing company is a “reporting company” (not the case for ICOs) or 1 year (bingo for ICOs). This one-year lock-up clock starts the minute that you pay money (or eth) for the ICO Tokens. If someone gifted you their ICO Tokens, the 1-year dates back to the original purchaser’s purchase date. For Advisors working for deferred token compensation, this clock would likely start the moment the Tokens are issued for sale to the public.
Public Information: Enough information about the issuing company must be publicly available before the sale, such as: (1) the nature of the business, (2) the identity of the officers, and directors, and (3) the ICO issuer ‘s financial statements with an accountant’s seal of approval.
Trading Volume: You can’t dump your tokens all at once and crash the market. An affiliate can only sell the greater of: (a) 1% of the overall tokens; or (b) the average weekly trading volume during the four weeks leading up to the filing of a “Notice of Sale” through Form 144.
Ordinary Brokerage Transactions: If you are an affiliate, you have to sell through a registered broker-dealer — and you can expect to pay 2.5–5% in commissions. (Damn it must be nice to be a broker-dealer!) Neither the seller nor the broker can solicit orders to buy the securities unless they meet specific conditions laid out in Rule 144A. This section of the rule allows qualified institutional buyers (QIBs) to trade private securities among themselves. This doesn’t exist yet in Crypto — but I would optimistically imagine it means any ICO Accredited Investors can trade amongst each other because it creates positive liquidity in the market and the sophisticated (aka rich) AI’s are not the mom and pops general public the SEC is concerned about.
Filing Notice of Proposed Sale with the SEC: If you are an affiliate who plans to sell more than 5,000 shares (doubtful this limit would apply to Tokens), or $50,000 USD worth of the Tokens in any 3-month period, you have to file a notice with the SEC.
Once you meet these 5 conditions of Rule 144, you then have to make sure the restrictive legend is removed from the Securities — which can be done by a transfer agent on the issuing company’s request. The issuing company needs an opinion letter from their attorney, and it can take a long time. If you get in a dispute over the removal of the legend, the SEC will not get involved; it falls to the State laws of the issuing company.
To file your application to sell your Reg D ICO Tokens, you can go to a Securities Broker, who can help you collect all the documents and submit the application. Once approved, the Tokens can be deposited directly in your wallet, and the ordeal is over, you can resell them to anyone willing to buy.
If you aren’t an affiliate, you apply directly through a transfer agent to remove the restricted legend on your securities. You will need the original token purchase agreement (which has to act like a stock certificate) and a legal opinion from a qualified attorney. The Transfer Agent has to remove the legend, and then you can sell the securities.
There’s a great article on Rule 144 for traditional securities here:
In summary, if you are an Advisor on a Reg D ICO, get paid up front, in cash. If you are an Accredited Investor buying a Reg D ICO, you had better trust the ICO issuer will get that legend removed so you can resell your Tokens after the year is up.