Topic: You can Design an ICO to Avoid Security Regulation Problems (Read 126 times)

Managing Director Blockchain Business Consultants, [email protected]

The Nov 10 Wall Street Journal proclaimed that the Securities and Exchange Commission is “talking tough on Coin Offerings.”  Initial Coin Offerings (ICOs) that offer a share in profits or have equity features are indeed at risk of securities regulations—but an ICO designed as a utility token (an advance purchase of a product or service) without equity features should not be deterred by threats of securities regulators.  Indeed, most companies may have an opportunity to leverage ICOs to raise funds via advance sales without giving up equity—if they structure their ICO correctly.  This article explains how to do this, with a case study on an “Initial MemberCoin Offering” Blockchain Business Consultants are now working.
Kickstarter and sites like this allow people to buy products and services in advance to support a business launch or expansion legally.  But they are full of restrictions on the type of projects they will support, are for relatively small amounts of funding, and of course charge fees.  A business that can do an advance sale of a product, services or membership and wants to raise millions of dollars may be better off using an ICO with a tradable cryptocurrency token.  For big projects where current and future customers may be eager to help you finance the expansion (with a discounted price offer) but want the flexibility to bail out of buying in down the road (i.e. they need to be able to readily sale their utility token right to buy your service) this is a potentially huge, revolutionary application of blockchain and cryptocurrency.
We are running an “Initial MemberCoin Offering” (a utility token) now for Fortitude Ranch (FR), a large recreational and survival community that uses a country club membership. I own this company, and am also the Managing Director of Blockchain Business Consultants.  There are at least ten million “Preppers” in the United States who have made arrangements to survive a “collapse”:  a shut down in economic activity and loss of law and order.  Experts warn than a pandemic is inevitable due to either natural causes or bioengineering; where a terrorist group or nation like Iran or North Korea modifies an existing virus like Avian Flu to make it more contagious and deadly.  Our “Just in Time Delivery” economy, daily food shipments in cities, and dependent populations, are very vulnerable to a collapse in a functioning economy and loss of law and order that could last for months or years.  Food delivery trucks will not come into big cities during a pandemic, electric outage, or other disasters that trigger panic and lawlessness.  FR operates recreational and survival communities in remote mountain and forest areas to protect and sustain members during a collapse.   FR is especially attractive to join because it is a recreation/vacation facility as well as a survival retreat. 

The advance sale of Fortitude Ranch memberships via an Initial MemberCoin Offering (IMO) will fund expansion from two existing sites to a dozen sites across the United States, and an international location.  The FR cryptocurrency token, called a “Fortitude,” offers a discount price on Fortitude Ranch membership, protection from membership price increases, and priority in joining FR when there is a waiting list.
Fortitudes are not a Security, not an Investment, not Equity in or Ownership of Fortitude Ranch.
A fortitude token grants you the right to buy membership in FR at a fixed, discounted price. They also grant priority placement when there is a waiting list to join a FR location. They are pre-sales of memberships that we will use to finance buildout of our FR WV and CO sites, plus land purchase and construction in WI and NV, and up to 8 more U.S. sites and an international location if a full $15 million in funding is obtained from this membership pre-sale. 

Even when Fortitudes are exercised to buy FR membership, there is still no equity ownership of any kind in FR.  FR is run by its staff, not members.  FR is controlled by its staff, not members.  FR members have no say in the operation of the company, and no control over or share in the profits of the company.  Membership in FR is like being a member of a country club.  It is not LLC membership.  FR members get recreational use of the facility, shelter, survival services in the event of a major disaster or collapse. 
In July 2017 the Securities and Exchange Commission (SEC) issued a report on its investigation of “The DAO,” a large $150 million ICO that was followed by a hack attack on a website that lost several million dollars.  After investing the DAO ICO as to whether they “violated the federal securities laws” the SEC:
•   “determined that DAO Tokens are securities under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”)”
•   “determined not to pursue an enforcement action in this matter.”
Quoting the SEC Report, the “DAO Token granted the DAO Token holder certain voting and ownership rights” and “The DAO would earn profits by funding projects that would provide DAO Token holders a return on investment.”  In other words, DAO tokens were promoted and designed to operate as if the token holder held equity in a firm:  ownership rights and the ability to share in the DAO’s projects. A pure utility token like a Fortitude has no such rights. 
In a legal review of blockchain ICOs published by CoinBase.com, a law firm listed seven features of a blockchain token that could constitute a security: “1. Ownership interest in a legal entity, including a general partnership; 2. Equity interest; 3. Share of profits and/or losses, or assets and/or liabilities; 4. Status as a creditor or lender; 5. Claim in bankruptcy as equity interest holder or creditor; 6. Holder of a repayment obligation from the system or the legal entity issuer of the Blockchain Token; and 7. A feature allowing the holder to convert a non-security Blockchain Token into a Blockchain Token or instrument with one or more investment interests, or granting the holder an option to purchase one or more investment interests.”  The Fortitudes utility token and FR IMO does not have any of these 7 features. After reviewing the Supreme Court case of SEC v Howey, which established a test for whether an arrangement could be designed at investment contract or security, the legal review concluded: “we believe that an appropriately designed Blockchain Token that consists of rights and does not include any investment interests should not be deemed to be a security, subject to the specific facts, circumstances and characteristics of the Blockchain Token itself.”
Using the “Securities Law Framework for Blockchain Tokens” provided by CoinBase.com to “estimate how likely a particular blockchain token is be a security under US federal securities law,” the Fortitude Ranch IMO rated a score of 0, “very unlikely” to be deemed a security and subject to regulation. 

The SEC DAO Report also noted that “registration provisions of the Securities Act contemplate that the offer or sale of securities to the public must be accompanied by the “full and fair disclosure” afforded by registration with the Commission and delivery of a statutory prospectus containing information necessary to enable prospective purchasers to make an informed investment decision.”  While not an equity offering, the “White Paper” for the FR IMO does provide details on Fortitude Ranch construction, expansion plans, including pro forma financial statements in an equity offering memorandum provided as an attachment.  They are provided as a separate attachment, not a part of this IMO white paper, to reinforce the message that the Fortitude is not a security, and not a purchase of equity or anything like it. 
Despite the DAO’s apparent violation of security law, offering what in effect was an equity interest in a future stream of profits, it is important to note that the SEC decided not to pursue any action against them (nor have any state regulators we are aware of, or any foreign governments).  Since FR’s IMO is clearly not an equity offering or security offering we are exempt from any security registration requirements.  In addition, because there is full disclosure of risks as if we were offering equity, no fraud, and care to exercise the highest security in the Fortitude Ranch IMO to guard against hacks or any problem that could lead to a loss of funds, we are confident that there is no reasonable security violation risks even if some regulatory authority in the future invents new criteria to insist that any token must be registered as a security.

This is why we “coined” the term: “Initial MemberCoin Offering,” making it clear this is a utility token, an advance purchase of a priority right to buy discounted price membership in FR.  Fortitudes are "utility tokens," advance purchase of memberships that allow both protection against FR membership price increases and priority in joining at times when demand for membership exceeds available space at a FR facility. If your business can presale a product, service or membership, it should be possible to safely launch an ICO if you avoid any equity features 
Historically ICOs have funded development of new blockchain technology. The Fortitude Ranch Initial MemberCoin Offering (IMO) marks a turning point in ICOs—funding existing companies applying blockchain technology. Blockchain technology is very valuable for FR to keep our member identities and their security passwords for crisis entry into Fortitude Ranch locations absolutely secure, for voting and polling using blockchain, and for the issue and trading of “Fortitudes”—our cryptocurrency token for discount, priority membership purchase.
Unlike most ICOs offering tokens for services or businesses that do not yet exist, FR is an established, market tested, proven company. There is no R&D or business development spending needed for this business, just rolling out the proven business plan by building out our existing WV and CO sites, and expanding to new locations across the U.S. and overseas.

We expect FR tokens to grow in value and price because they are sold at discount to current membership price and membership prices will rise over time (while Fortitude owners have the low price locked in).  In the event of a major crisis or media reports on threats, demand for membership in FR will surge beyond our capacity, and the price of Fortitudes may spike since those who want to get in will need Fortitudes to have first place in the wait list.

An ICO may succeed if the product or service is highly desired.  It is more likely to be successful if people interested in your service also see upside potential for the value of the token.  For example, since Fortitudes lock in a discounted price, as FR membership prices rise over time, the value of Fortitudes will likely increase.  If there is a surge in demand to join FR as a result of a major media story about a pending threat, or rising international tensions, or intelligence on a pending attack, FR will not be able to meet demand for new members.  Buying land and building facilities takes a year.  By owning sufficient Fortitudes, you can buy insurance that you will have priority access to FR.  Because of the priority FR token holders have in gaining membership when FR has a waiting list to join, the price of Fortitudes could surge since owning Fortitudes may be the only way that some new members can get into FR location in times of crisis or high demand.   
The fact that a utility token’s price may rise does not make it a security, as an analysis by “Strategic Coin” explains:
“Utility tokens are not designed as investments; however, many people contribute to utility token ICOs with the hope that the value of the tokens will increase as demand for the company’s product or service increases. Utility token price fluctuations can be compared to those of sporting event tickets. The value of a ticket to a future sporting event may increase if one or both of the teams wins a significant number of games and becomes a contender for the championship. . . . Simply put, while both equity and utility token prices may fluctuate, the key difference is that equity tokens entitle the holder to ownership rights, while utility tokens function as coupons and do not provide holders with an ownership stake in a company’s platform or another asset.”

But there have been what appear to be utility token ICOs that do have profit sharing and equity features.  For example, “PAquarium” did an ICO to fund building the largest aquarium in the world.  If they’d just offered tickets or membership benefits this would have been a safe ICO—but they designed and pitched it as an investment, with their token owners given a share of future profits.  Thus, their token is subject to securities regulations.
Compared to the historic, typical ICO offering tokens for a blockchain application project, most of which will likely fail, using ICOs for established, proven businesses presents far less risk. While some tokens have risen in price, most ICOs with a promise of future software development that may yield a profitable business will eventually become worthless.  Unless the FR business fails, Fortitudes should maintain their value and strong worth as a discount and priority standing for FR membership in times of inadequate capacity to meet demand.  Established businesses offering pre-sale of new products and services should have good prospects for doing advance sales via an ICO.
Another factor that will contribute to your utility token ICO success is your use of blockchain and cryptocurrency beyond the token issue.  Most ICO investors now are high tech, blockchain fans.  Some do not like the idea of ICOs being used for non-blockchain development applications.  This is rather foolish, since the expansion of blockchain into widespread business use is happening, and will be beneficial to blockchain developers, cryptocurrrency geeks and investors.  But you’ll have more investment interest from this community if your business plans to leverage blockchain. Fortitude Ranch is using blockchain technology to keep our member identities and their security passwords for crisis entry into Fortitude Ranch locations absolutely secure (the first rule for Prepping is don’t tell anyone you’re a Prepper).  Blockchain applications like Aragon will also be used for voting and polling on issues like new Fortitude Ranch locations.  You need to be careful so that token holders don’t have “rights” to determine new locations, but “opinions that will be considered” to avoid having equity, security features that lawyers and regulators may use against you.
If you buy an advance product purchase right on Kickstarter and later change your mind, it may be difficult or impossible to recover your investment.  But with a tradable cryptocurrency token you get via an ICO (or IMO), you can readily sell your token. They are also easy to gift.  So, for example, if someone was not sure they wanted to join Fortitude Ranch, a token buy is better—they have the option to later join or not.  If you later decide it’s not for you, you can sell your tokens.  Or if your financial situation changes, or you move from being near a future FR site to a location you consider too far, then you can sell your Fortitudes.  You are not committed to spending on FR membership until you convert your Fortitudes to FR membership.  The Fortitude is in effect insurance that you can buy access to FR, a “contingent membership” in FR. 

Some companies are doing both ICOs and complying with SEC regulations D or A+ or Crowdfunding.  But doing this can prevent advertising the opportunity and effectively force you to limit your product, service, or membership sales to accredited investors—rich people.  We believe it is fundamentally wrong (and unconstitutional since the Constitution does not give the federal government this right to regulate citizen’s investments or spending, and the 10th Amendment clearly says the federal government may not issue laws dealing with any area not specifically granted in the Constitution) for Big Government and the Nanny State to bar the vast majority of the population from such opportunities. Initial Stock Offerings today are for the rich who get privileged treatment by Big Banks.

The promotion and sale of utility tokens can enable non-wealthy Americans, and anyone around the world who wants to purchase them, the freedom to purchase a discounted advance membership in FR or your new products and services.  Blockchain technology, cryptocurrency, and ICOs are helping to liberate people from the overreach of Big Government and the Nanny State.
Since a pure utility token is not a security, and not limiting sales to accredited investors, you also should not need to implement “Know Your Customer” requirements (unless you’re offering banking services).

Token buyers who find that any part of the offering or marketing were fraudulent can file legitimate lawsuits for fraud—regardless of whether or not a token is a security or registered.  All investments and utility tokens should be made only if due diligence research assures you that the business is not just legitimate and likely to succeed, but conducted with the highest standards of integrity and full disclosure.  The presence or lack of an SEC stamp of approval has little relevance to a company’s likelihood of success or honesty.
ICOs are a great new opportunity for all types of businesses to do advance sales of products and services to raise money without selling equity or dealing with the high costs of lawyers, securities regulation, and interference of government bureaucrats. Every company needs to constantly develop new products and services—but may not have the cash to do so, or reliable bankers who will lend at good rates.  But current and future customers may be eager to help with advance purchases of utility tokens.  You offer a discounted price and get an interest free loan, no loss of equity, to develop the new service.  The utility token offered in an ICO gives buyers the flexibility to sell their purchase right to someone else if conditions change for them and they no longer want to buy, and the tokens value may rise—so this is a far more attractive and doable deal.  We believe it has great applications for business financing, and may prove to be the most valuable application of blockchain and cryptocurrency.
If interested in considering an ICO, please contact Blockchain Business Consultants, www.bchainconsult.com.