Helping Clients Navigate Through a Variety of Broker-Dealer Requirements
Dilendorf & Khurdayan advise clients on a broad range of broker-dealer issues associated with security token offerings (STOs), initial coin offerings (ICOs) and related activities.
The US Securities Exchange Act of 1934 (the “Exchange Act”) defines a broker as “any person engaged in the business of effecting transactions in securities for the account of others.” Definition of a dealer covers a person that is “engaged in the business of buying and selling securities for his own account, through a broker or otherwise” but excludes persons who buy or sell securities for their own accounts but not as part of a regular business. Entities as well as individuals may be considered broker-dealers.
Broker-dealer definition is interpreted very broadly. For example, any intermediaries in securities transactions generally fall within the definition of a broker and must register as a broker with the SEC. They must additionally join a self-regulatory organization (such as FINRA or a registered national securities exchange).
Determining whether a specific activity, particularly in the context of ICOs and STOs, requires broker-dealer registration is very fact-specific. You must analyze multiple factors recognized in the SEC’s regulations, reports and no-action letters.
For example, a person or entity involved in the following activities may be required to register as a broker-dealer:
- Conducting or assisting with sale of securities;
- Receipt of transaction-based compensation;
- Soliciting purchasers;
- Participating in discussions and negotiations between the company and prospective investors;
- Effecting securities transactions for the account of others for a fee;
- Providing support services to registered broker-dealers.
These are just a few examples of instances when a person or entity may subject itself to mandatory broker-dealer regulations. Importantly, utilizing an unregistered broker-dealer in a token sale may subject the transaction to being rescinded and may force the STO/ICO sponsor to return all of the collected funds to purchasers, as discussed further.
Regulation of Broker-Dealers and STO/ICO Marketing
For STO/ICO sponsors, broker-dealer issues most often arise in the context of their marketing campaigns. When launching a token generation event, many blockchain businesses rely in part on bounty campaigns or agreements with marketing companies to market the token sale. In a bounty campaign, the business offers compensation to any individuals who complete certain specified tasks related to marketing, debugging or otherwise helping with the token sale.
However, if a virtual token is a security, then any person who receives compensation for marketing such security may qualify as a broker under the Exchange Act.
Determining who is a broker under SEC regulations requires to assess the unique facts and circumstances of a given relationship. The courts consider a number of factors in making that determination, including whether a person participates in soliciting a securities transaction, and whether his or her compensation is related to the outcome of such a transaction.
Providing Legal Guidance for Our Clients’ STO/ICO Marketing Needs
The risk posed to a token sale by the inadvertent use of unregistered brokers can make the difference between a successful launch and failure. Our attorneys apply their expertise in the areas of securities laws and regulations to develop marketing strategies that are sensitive to the application of such laws and regulations to token-generation events.
- Reviewing existing relationships with third parties engaged or to be engaged in marketing a token sale to ensure compliance with US laws governing the use of brokers;
- Carefully structuring bounty campaigns and other marketing efforts involving third parties to reduce or eliminate the risks associated with broker regulations;
- Drafting, reviewing, or modifying agreements with marketing companies to ensure compliance with US law.
As broker-dealer issues arise in various aspects of digital token sales and digital platforms, and are subject to heightened scrutiny by SEC, you should consult with attorneys well in advance of launching STO/ICO.