Key Takeaways
- Regulation D relies on resale restrictions to prevent a private secondary market, which conflicts with how crypto coins are designed to be freely transferable and traded.
- Public securities work because there is a registered marketplace for trading, but private offerings cannot be marketed on “appreciation of the security itself” without creating the very secondary market the SEC wants to avoid.
- Real estate syndication returns can be framed around the underlying asset’s performance and appreciation without a secondary market, while crypto coin returns are primarily driven by external exchange pricing.
- A coin offering may not fit under Regulation D, but investing in the company behind the coin can be possible if investor profits are not based on the coin’s market appreciation or depreciation.
- Crypto-related Reg D structures may work when the income is generated by an operating business (for example, a mining operation) rather than by trading value on an exchange.
Transcript
Why Crypto Offering Clients Show Up (and Why Most Can’t Be Helped)
In 2022, I got a number of phone calls from potential clients who were interested in syndication and putting a fund together. In 2023, I had a lot less of this one type of client, but I still had some, and probably will have some in 2024 as well. Now, what is this type of client? It’s the person who’s looking to put together a crypto offering. So in this video, we’re going to talk about the big challenge with crypto, and why most of the time I actually can’t help them.
The Regulation D Framework and Why It Exists
What is the big problem with crypto and Regulation D? Well, Regulation D is an exemption to the SEC rules, which allow somebody to raise an unlimited amount of money from an unlimited number of accredited investors and possibly up to 35 non-accredited investors in any 90-day period, depending on the rule that you fall into. But why is a crypto offering itself, why is the coin itself different? Well, the biggest problem is that it’s a round peg in a square hole.
In the round peg category, we’ve got the SEC rules. The exemptions to a security filing are basically where the SEC has said, “Look, we want people to be able to invest into these things, it’s good for America, it’s good for our economy. We want that private investment world to be robust, but we need to put some protections in place.” What we don’t want – this is the SEC talking – is for there to be a private marketplace that exists that we are not able to regulate. So that’s their problem: they don’t want this secondary private market that exists.
Resale Restrictions: The SEC’s Guardrail Against a Private Secondary Market
To prevent this, what the SEC has said is to put a restriction on resale. So essentially, I cannot buy a private security with the intent of basically turning it around and selling it just because of the appreciation of the security itself. If you think about when you buy a share of Apple stock, theoretically, you’re buying a share of the income of the stock itself, but why am I actually buying it? Because I am thinking that the price of the value itself of that share of security is going to go up. Not that it’s tied to income or anything like that; I really care at the end of the day, if I’m not getting dividends from something, I’m expecting that share value to appreciate.
Now, that can’t exist without having a marketplace, right? The marketplace, obviously for Apple is the stock exchange. It’s registered, the shares are traded publicly, there’s no interaction between me and Tim Cook. I don’t call Tim on the phone and say, “Hey, buddy, what do you think’s gonna happen with your company in the next week?” It just doesn’t happen.
So that whole world is based on this appreciated value of why an investor actually invests into a security that’s public, like a stock. Now, if I were to do that for a private security, there’s no mechanism there for me to actually have that banking on the appreciated value of the security itself. I am only choosing to invest based on my guess of the appreciated value of the underlying asset.
Why Syndication Works for Real Estate Without a Secondary Market
Real estate’s an easy example: if there’s a syndication that’s been put out for an apartment building, my guess as an investor is rent growth is going to drive up the more rents. The cap rates, even if they stay the same, the appreciated value of the underlying asset of the apartment building itself is going to go up. That’s how I’m going to profit from it. So there’s no secondary market. There’s no me investing in the security for the elements of the security itself. That’s the round peg of this.
Why Crypto Coins Don’t Fit: The External Market Is the Entire Point
When we talk about the square hole of crypto, that’s entirely different. What’s being invested into is only the appreciated value, right? There’s no actual day-to-day mechanism, like there’s no profits in that element in Bitcoin itself, it’s not actually creating value. It’s just a marker of something that people have decided has some value. But it’s that decision about that value that’s appreciating or depreciating.
So the only way that market really exists is because it’s got an exterior market. It’s got that market where it’s being traded on exchanges, and people are making money or losing money based on their investment into that Bitcoin or whatever that coin is itself. So that’s the change that’s taking place.
The Core Conflict: Coins Are Meant to Be Freely Transferable
The problem with not being able to resell this security is that if I’m not able to resell the security, well, by its very nature, a coin is supposed to be decentralized and basically be fungible. So I can trade these things without having any sort of restriction. I can give it to my brother-in-law, I can sell it to somebody across the country, I can sell it to somebody across the world. That’s what the whole point of the coin was, that it would rise and fall based on some other external thing, whatever that value is, and then I can freely trade it.
But the SEC has said the exemptions to the rules are strictly for those who are not able to resell it for those purposes. I’m not able to make an investment for that. And so if I have a client in front of me who wants to put a coin together, it is possible that we can invest in the company that’s behind the coin, it’s possible to put that through, but the profits from it can’t be based on the appreciation or the depreciation of the crypto coin itself. It’s an exterior thing that rises and falls in that sort of secondary market, which is completely adverse to what the security regulations, the exemptions to the registration requirements are.
When a Crypto-Related Structure Might Work Under Regulation D
Now I know that’s kind of technical and advanced, but hopefully that makes some sense. It just doesn’t work. They’re just a round peg and square hole, the two are not going to see eye to eye. So that’s the conversation that I have with people who come to me with strictly coin offerings. If they have a business like a mining operation or something that is different, where the underlying thing that’s going to generate that income is not based on an exterior market thing, and being not resellable is okay, we find a mechanism in order to do that, then it works fine.
Closing: Invitation to Talk About a Regulation D Offering
If I can help you with your securities offering, with your Regulation D offering, I’d be happy to help. Give me a call. My name is Tilden Moschetti, Moschetti Syndication Law Group.