How to Do a Compliant ICO— Part 2

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Blockchain companies once believed that as long as they offered “utility tokens” and did not attempt to defraud their purchasers, they were exempt from federal securities regulation. A utility token is a token that is meant to be used for consumption, such as to access a company’s goods or services. Although a utility token may not be a security, the facts and circumstances surrounding the offer and sale of that token will determine whether the securities law apply.

When the SEC stopped Munchee from selling its “utility tokens,” it sent a clear message that whether the offer or sale of blockchain tokens is an offer of sale of securities depends on the facts and circumstances surrounding the offer or sale, not the name given to token — even tokens that have utility can be securities depending on the facts and circumstances under which the tokens are sold.

To prevent companies from selling blockchain tokens in violation of U.S. securities laws, the SEC created a task force to go after such violations. The North American Securities Administrators Association (“NASAA”), consisting of the state and provincial regulators of the United States and Canada, followed suit with their own “crypto-sweep,” starting May of this year.

Due to increased regulatory efforts, blockchain companies planning to sell tokens must understand whether they are selling securities and create a sales and communication strategy to ensure compliance with the law. In today’s space, this is especially critical because companies are selling their tokens both to customers to consume and to investors as an investment. This is complex from a marketing and compliance perspective and one misstep in promoting your tokens can bring an enforcement action from securities regulators.

In part 1 of this article, we went over what is a security to help you analyze whether the offer and sale of your tokens may be considered securities. In this part, we came up with the following 3 step process to help you start thinking about your sales and communication strategy:

1. Identify your target audience

When preparing a sales and communication strategy for your blockchain project, you must first identify your target audience. Are you selling your tokens to customers so that they can access your products or services or are you selling your tokens to investors to raise money?

Depending on who your audience is, they will have different expectations of you and you should frame your communications accordingly. This is especially crucial for blockchain companies because many blockchain companies have advertised their tokens as though they are investments, regardless of their target audience. Thus, the public now has an expectation that when they are purchasing tokens, they are “investing” in those tokens and anticipate a profit in return.

However, the purpose of blockchain tokens isn’t necessarily for investment. Blockchain companies are creating tokens so that their customers can access particular goods or services. If this is your business model, you likely want to attract actual customers and should frame your communication accordingly.

If you want to attract customers, you should communicate with them like a consumer of any product or service. Consumers want to know what your products and services are and why they should buy them from you. They are not investors, so they do not expect you to make them a profit when they make a purchase.

Your potential investors, on the other hand, are looking to make a profit. If you approach someone with an investment opportunity, they will want to know how you will make them a profit before they will hand over their money. Unlike customers, investors aren’t looking to buy your tokens to consume. Thus, your communications with potential customers should be completely different than your communications with potential investors and there should be no overlap between the two.

2. Determine your goal

Once you’ve identified your target audience, you’re ready to determine your goal. Your goals will reflect your target audience’s goals. By identifying who your target audience is, you can identify what their goals are and what you can offer to help them meet those goals.

For example, if your target audience are customers, their goal is to determine whether buying your tokens will help them fulfill a need. Your goal is to determine what their needs are and how your tokens will help them fulfill those needs in order to convince them to buy your tokens.

Most utility tokens are created for access to a blockchain company’s goods or services. This raises the question of what are your goods and services and why a customer would want to buy them.

For example, going back to the arcade example from part 1 of this article, imagine it’s your first time at an arcade. You see a game you want to play, so you try to stick a quarter in the coin slot to start the machine. It doesn’t work, so you ask for help. You’re told that you can only play games in the arcade if you buy their tokens. You don’t want to sit on the sidelines and watch everyone play, so you hand over your cash for tokens and now you can play.

The arcade created a captive audience where the only way you can operate its machines is by buying and using their tokens. You want to use the machines, so you buy the tokens. By selling you those tokens, the arcade has fulfilled your need.

Similarly, many blockchain companies have created platforms where the only way you can access their goods or services is by purchasing their tokens. If this is you, you have to educate your customer on what your goods and services are and why they should buy them.

3. Determine how you can communicate

How you communicate with your target audience will depend on who they are and what your goal is in communicating with them. If your target audience is a customer, your goal is to convince them to buy a product or service from you. On the other hand, if your target audience is an investor, your goal is to convince them that you will make them profit from the money that they are giving you.

If you’re advertising to customers, you must comply with certain consumer protection laws such as the truth in advertising law. On the other hand, if you’re advertising to investors, you must comply with securities laws.

The requirements and bounds of your investor-communications will be determined by whether you register your offering or find an exemption to registration.

For example, under Rule 506(b), you can sell to an unlimited number of accredited investors and up to 35 unaccredited but sophisticated investors, but you cannot generally solicit or advertise the securities. If you sell to accredited investors only, you can decide what information you give them as long as it’s not fraudulent, but if you sell to even one unaccredited investor, you are required to give them as much information as you would give to an investor in a registered offering.

Creating your communication strategy

After going through the three-step process outlined above, you are ready to create your communication strategy. Your communications include anything you distribute to the public, such as your website, blog posts, YouTube videos, press releases, and any interaction with the public, including events where you speak and even those where you are only attending as an audience member. It can even include communications with close friends and family members.

Before communicating about your tokens to anyone, it is important for you to create a communication strategy and train anyone you engage to market your tokens or provide customer support on your tokens on this strategy.

Securities regulators will review every single communication you’ve distributed or endorsed to determine whether you’ve violated the securities laws. Common mistakes that clients make are asking for a review of their communications after they have already distributed them and allowing untrained moderators to answer customer inquiries.

The right time to review your communications and train your staff is before a communication has been made, not after.

Although we have outlined a step-by-step process for you to follow to create a communication strategy, we are only providing this information as a general guideline to help you start thinking about your communications. The laws pertaining to token sales are complicated. We strongly encourage you to seek professional help before attempting to sell your tokens. We have helped clients navigate issues of securities laws and consumer protection laws and would love to help you do the same!


This article is also published on Medium.


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This article is provided for informational purposes only and should not be construed as legal advice. Read our disclaimer here.

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