Digital Security Offering – 10 Things to Know Before Creating a DSO | CP Oberheiden
Introduction: What is a Digital Security Offering (DSO)?
Conducting Digital Security Offerings (DSOs) or Security Token Offerings (STOs) is time-consuming and can be quite complicated. You will need to consider factors such as whether you need to register, which platform to use, how to create the coin or token, what it will offer, etc. Simply put, a DSO is an offer and sale of securities – digital securities – that exist on blockchain technology. They have no use value or consumption purposes and are generally used for investment purposes and their value is derived from the value of an external business asset. Understanding DSOs is essential for proper issuance and tracking. This article, written by blockchain and token offering lawyers in Oberheiden, PC, explains DSOs, their benefits, and the top ten things to consider before launching a DSO.
Advantages of DSOs
Digital Security Offerings (DSOs) offer many benefits to issuers, the public, government agencies, and capital markets. Here are a few:
- Immediate access to capital for businesses seeking to grow;
- Lower barriers to entry, in particular to split up certain assets such as real estate;
- Access to international markets and international investors through global offers;
- Automatic execution on smart contracts;
- Elimination of the third-party intermediary in transactions;
- Increase in the liquidity of the underlying asset; and
- Immutability and transparency through the use of blockchain technology.
The above are just examples of the benefits that a DSO has to offer. Either way, best practices dictate hiring an attorney experienced in DSOs, SEC filing requirements, and the definition of “security.”
“DSOs must still be registered with the SEC and comply with its ongoing reporting and disclosure obligations. A DSO may also be exempted from registration in certain circumstances. Failure to properly record or file an exemption could result in significant fines and penalties. Therefore, it is imperative to hire a lawyer experienced in digital security deals. – Dr. Nick Oberheiden, founding lawyer of Oberheiden PC
10 things to know for your DSO
A DSO can quickly become a long and complicated process. If you are considering starting a DSO, keep the following ten points in mind:
1. DSOs are offerings of securities and must either be registered with the SEC or follow an applicable registration exemption.
DSOs involving digital securities or digital securities offered to the public in DSOs must register with the SEC or be exempt, just like traditional securities. In closed cases, courts and the SEC use the Howey test to determine whether the offer constitutes an “investment contract” or a “security”—requiring registration. The Howey test has four parts: (1) an investment of money, (2) in a joint venture, (3) with the expectation of profits, and (4) derived solely from the efforts of others. All four factors must be met for the token or coin to be classified as a security token. If one or more pins fail the Howey test, the token or coin is instead considered a utility token and does not need to be registered.
2. Consider the possibility that your DSO project may contain other registration requirements beyond registering your token.
If the digital token is classified as a “security” for registration purposes, it is important to also determine if your company has additional registration obligations. For example, if you offer and sell digital securities, your platform may need to register as an exchange, and people who deal in digital securities may need to register as brokers or, sometimes, advisers. investment.
3. Many DSOs may qualify for one or more SEC registration exemptions.
The registration process takes an incredible amount of time and can involve significant expense. Fortunately, there are many companies that can take advantage of a registration exemption, including Regulation D and Regulation S. Regulation D allows an issuer to avoid registration if certain conditions are met regarding accredited investors versus unaccredited investors and the solicitation. Rules 506(b), 506(c), and 504 are the three key rules regarding Regulation D that issuers should keep in mind when completing Form D. If the issuer plans to offer the digital securities to non-US investors, can then use Rule S. Rule S applies when the offering takes place in a foreign country. In such cases, the offer is exempt under US law but must comply with the laws of the foreign country.
4. There are a few types of digital security tokens that issuers should be aware of when choosing the best option for their business plan.
Digital security tokens can come in the form of equity or debt tokens as well as tokens backed by digital assets. Equity tokens offer ownership interests similar to traditional stocks. Debt tokens work much like a short-term loan on the interest rate of the value lent to the business. Asset-backed tokens have their value derived from an underlying tangible or intangible asset of value. These digital tokens are distinct from utility tokens, which are not securities. Utility tokens are for consumption purposes and provide some utility to users. This “usefulness” is unrelated to the value of the business.
5. Unlike typical initial coin offerings (ICOs), digital security tokens cannot be sold anonymously.
While decentralized ledger technology often promotes anonymity – or more accurately, pseudonymity – these features are not allowed with DSOs. An issuer must know who they are selling their tokens to and often must comply with various AML requirements. In addition, issuers may even have to determine whether their investors are truly “accredited” investors in order to qualify for certain registration exemptions. Thus, knowing the identity of your investors is essential.
6. DSO issuers will be required to prepare a detailed and comprehensive white paper to distribute to potential investors.
A white paper is often the most important step in the DSO process. A whitepaper contains various important provisions such as details about the coin or token, information about the underlying technology, industry overview, business model, financial projections, future expansion plans, members of the issuer’s team and disclaimers. Failure to write a whitepaper that accurately describes the product can be devastating to your project.
7. Make sure to select an appropriate blockchain platform and service provider, if applicable.
When it comes time to create your token, you will also need to consider which blockchain platform would be right for your token and for your investors. Make sure you only deal with reputable service providers and make sure you have a safe and secure wallet. These are important due diligence procedures that should be undertaken in the preliminary stages before your DSO is even launched.
8. Be sure to properly define and present your digital security token to the public before your DSO.
Having a pre-DSO is very common and usually involves introducing your new token to the public and market. This is an important promotional step and gives people the opportunity to learn more about the token, your business, the platform, and overall business plans. Many investors will not contribute funds to a project that has not provided them with essential information typically provided at pre-token sale events, whether that information includes the token structure or company members. .
9. The costs and time involved in the process of registering (or exempting) federal securities can be considerable and represent a significant disadvantage for DSOs.
While many consider it an advantage that digital securities must be registered with the SEC, it is actually a disadvantage for issuers. Increased regulation, ongoing disclosure obligations, and ongoing reporting requirements make it very difficult for the SEC to track. In addition to compliance obligations for the security token, other factors such as exchange and promoters may need to be registered. The issuer may also be required to implement strict AML/KYC policies and procedures under the Bank Secrecy Act (“BSA”).
10. Be sure to monitor and exceed your investor’s expectations.
Investors willing to participate and contribute to the capital of your project have fundamentally trusted your company. Be sure to continually show them that you are meeting your business goals on time, complying with all applicable laws and regulations, performing appropriate contracts, and maintaining meaningful business relationships. It’s also important to think about how to exceed your trading goals to increase revenue and improve liquidity for your investors.
Do you plan to issue a DSO? Are you concerned about compliance obligations regarding your security token? If so, pay close attention to the ten tips in this article. You need to make sure you know your digital assets, the DSO process, what is required of you, and how to meet and maintain your current business and federal obligations, as important examples. Finally, and most importantly, invest time and resources in finding and retaining a lawyer experienced in handling DSOs. This includes making sure your attorney is familiar with the federal credential registration process, including the Howey test, and applicable exemptions.