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Case study on US citizens/residents and ICO’s

July 31, 2017

I’ve been looking at the terms and conditions of ICO’s that exclude US citizens/residents such as

Let me explain a bit about that the legalities of the situation is.

The SEC wants to protect the US investing public so that there is a list of standards that the SEC makes US-funds go through such as registration with the SEC.  On the other hand, if say a French fund sells stuff to French residents, that’s something that the SEC isn’t concerned about.

The trouble is that we now live in a global world in which you can buy anything from anywhere, and the SEC is trying to figure out what to do.  In particular, the SEC doesn’t want US funds to undermine SEC regulation by just basing themselves off-shore.  At that same time, the SEC realizes that it’s a little silly and impractical to require funds that really are “foreign” to go through the entire US registration process if someone in the US really, really wants to invest in the fund.

So you end up with Regulation S.  It turns out Regulation S is this very long and complicated regulation, and it’s long and complicated because it’s an effort to strike a balance, and describe exactly what should happen in a particular situation.  The other problem with long and complicated regulations is that Regulation S was designed specifically to deal with traditional investments and it’s not clear what happens with new investments.

Also, Regulation S is a “safe harbour” regulation.  If you go through the long and complicated regulation, and you find that your fund exactly fits the terms of a Regulation S offering, you are “safe”.  But if you find that you don’t exactly fit, that doesn’t mean that you are in trouble.  It means that you aren’t in the harbour, but you can still be ok.

Now the problem with Regulation S for ICO’s is that if you run an ICO and it turns out that one person from the US signs up, then that doesn’t mean that you are in trouble.  This isn’t the same thing as selling cocaine or money laundering where you have zero tolerance.  On the other hand, if the SEC says “it’s ok to run a foreign company through Regulation S” then people will create paper companies in order to circumvent US regulation and we know this is going to happen, because it *did* happen which forced the SEC to tighten up regulations.

The other problem is US tax law.  Bad thing start happening tax wise if you are a US citizen that puts money into a foreign corporation with more than 10% ownership by US citizens.  Really bad things happen if the amount goes up to 30%.

What this means for ICO’s is that they want to discourage US citizens/residents from subscribing, but they don’t need to outright ban them.  If it turns out that you run an ICO and say 3% of your people turn out to be US persons, you can tell the SEC that “hey, we really are a foreign fund and we don’t need to be subject to US regulation.”  On the other hand, if say 50% of the people turn out to be US persons, then the SEC is going to be very annoyed.  So where is the limit?  Well, no one really knows.  My personal gut feeling is that if it’s under 5% no one is going to care.  If it gets to 30%, then you are skating on thin ice.

It also turns out not to be that difficult to come up with something that keeps the SEC happy.  It’s just a matter of doing it.

So one thing that the ICO has to do is to set things up so that they really discourage US citizens/residents from investing, without outright banning them.  What I think is going to happen in the end is that you’ll have someone in the US that serves as a “compliance broker”.  All US orders will go through the US broker, and they will make sure that all of the US regs are followed.

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