By Alexander Savinkin
Boulevard A. Aladetoyinbo, Esq., Partner at Lex Futurus Group LLC, an international boutique law firm providing blockchain and decentralized ledger legal advisory services.
What are the main regulations that exist in your region if you’d like to launch an STO/ICO?
The extant securities rules and regulations that would apply, albeit indirectly, and in the finest capital market traditions and relevant legal fundamentals, to an initial coin offering (ICO), initial exchange offering(IEO), or any token generation event (TGE) in Nigeria, or stricto sensu, an STO, are Investment and Securities Act (2007), SEC Rules and Regulations (2013), Rules on Securitization, Green Bond Rules, Scripless Securities Settlement System (Business Rules and Guidelines) (S4) (the S4 is a rule on dematerialized securities transaction settlement, which the crypto securities improved upon greatly).
The question is, are new rules and regulations required, as the extant rules and regulations did not expressly have these new market investment products, services, architecture, and infrastructure in mind? The answer is yes, new rules and regulations are required. On November 2018, The Securities and Exchange Commission (SEC) inaugurated at its third Capital Market Committee (CMC) meeting a Fintech Roadmap Committee with the mandate to come up with recommendations preparatory to its financial technology market activities regulation i. e. virtual financial assets, initial coin offering, and other subject areas such as consumer protection, security and privacy, etc. This attempt is non-comprehensive and a half-measure when one considers the ICO, IEO, STO, TGE regulatory approach, step-by-step strategy, and especially industry-wide consultations, holding statements, guides, rules, laws and guidelines tailor-made for ICOs in particular, and across jurisdictions. There are short-term, mid-term, and long-term actions always involved. To thread with caution, it is too early in the day to judge, as the process has only just begun.
In the Federal Republic of Nigeria, there are no specific rules and regulations directly applicable to ICOs as a cryptocurrency capital market investment product at the moment, though the existing legacy securities regulations are applicable, depending on the facts, circumstances, characteristics, and economic realities intrinsic to each distributed ledger technology (DLT)/blockchain token offering or product.
One of the reasons for the lack of direct regulation as of yet, I surmise, is because the ICO phenomenon presents a very controversial question from the cradle; whether the token in an ICO is a cryptocurrency investment market product or just a pure utility token that offers access to goods and services on a platform, and nothing more. From the experience so far in the space, or specifically according to the most active national securities regulators like the SEC (USA), the token from an ICO is a regulated cryptocurrency capital market investment product. This situation in the United States would definitely affect the legislative compass and regulatory framework, attitude, and approach in Nigeria as the space grows. To wrap up, the extant regulations in Nigeria apply to any entity that is desirous of launching an STO/ICO.
What are the main reasons for a project team to choose one or another type of regulation? (type of project, softcap/hardcap, marketing strategy, product specifics).
ICOs, STOs, or any token generation event would have to consider the legal compliance in any of the jurisdictions where the entity is affected, whether or not there are bespoke laws and regulations, as the extant structure takes care of business somewhat.
Last year, Lex Futurus Group LLC., our global blockchain and decentralized ledger training, consultancy services, and legal advisory law office, with lawyers from across jurisdictions as the United Kingdom (UK), Nigeria, United States of America (USA), Malaysia and Russian Federation, was retained as the legal advisor to the genEOS project, for whom we drafted a securities regulation multi-jurisdictional legal opinion. The project had sought to raise in a SAFT-type PPM STO, USD2m to execute its fourth-generation blockchain project (Blockchain 4.0). Unfortunately, it could not reach its soft cap on December 23, 2018 and had to return contributions to the participants via the Ethereum token smart contract address on the 26th, 27th, and 28th of December that year. Barring any conflict of interest statement, this was both a credible and honorable project, whose cause of failure, according to post-mortem reviews, was that it did not maximize its marketing resources and advertising potentials.
Are there any examples of ICO/STO projects that have already complied with regulations? Do you consider their pick to be appropriate or not? (This particular question will serve as the key portion of the whole article.)
In Nigeria, the jurisdiction where I am duly qualified to practice as an Advocate and Solicitor of the Supreme Court, and where I have been practicing as a certified DLT/blockchain lawyer for years now, I am not aware of any ICO, STO, security token exchange/crypto securities exchange, stablecoin project, or any DLT project whatsoever, that has complied with extant regulations where indirectly applicable.
There is Nairacoin, a stablecoin project, which is planning an STO in Nigeria at the moment, with probably no intention for securities regulation compliance whatsoever. There are many Nigerian projects in this mode, who would rather take investors’ money and care nothing for them because these projects labor under the wrong impression that there are no regulations yet, and thus they are free to rumble in the crypto jungle with no consequences coming for them. We have seen projects raise millions of dollars, and some ongoing ones aim for such astronomical raises. Kora raised USD 12 million, while SureRemit raised USD 7 million. These were Nigerian ICO projects. The non-compliance of these projects poses serious business risks and could even result in jail time where the imposed penalties would be insufficient, especially if anything goes wrong.
As of late, a prospective client planning an STO approached LF Nigeria — the boutique law firm of Lex Futurus Group LLC., which is legally compliant in Nigeria — and requested for consultancy and legal advisory services. If the client pulls this off, it would be the first regulation-compliant STO in Nigeria to date under the Investment and Securities Act (2007), SEC Rules and Regulations (2013), Rules on Securitization, and the rest. The first STO approved by the Spanish Financial Authority (SFA) would be conducted in the spring of this year, even as the largest Spanish stock exchange, Bolsa de Madrid (BME), plans to start an issuance process for collateral pledge certificates on blockchain technology.
What are the recommended legal arrangements (legal structure) for pre-sale (private sale) investment deals (ST buyout, SAFT, options, etc.)?
There are many recommended legal arrangements suitable for a token generation event leveraging a distributed ledger technology as an Internet-based, cross-border capital formation strategy. These range from stiftung foundation, venture capital fund, equity crowdfunding, mutual fund, hedge fund, pension fund, a collective investment scheme (CIS), private equity, etc., which are all ideal for a pre-sale investment deal or even a public sale investment deal. In the Nigerian capital marketplace, these areas remain virtually an uncultivated, lush forest of investment capital market opportunities in the distributed ledger technology space.
The quest to foster credibility on the cross-border, Internet-based blockchain token offering space led to the collaboration for the specialized legal document framework known as Simple Agreement for Future Tokens (SAFT), which was devised in 2017 by Marco Santori of Cooley LLP and Protocol Labs. It is an investment vehicle to enable the conduct of regulation-compliant ICOs. The Filecoin ICO, a decentralized file storage project raised USD257m, Polymath Network, a security token issuance platform raised USD59m etc. They all utilized the SAFT framework. STOs have been using the SAFT framework investment model document, and it has found significant traction overtime, though it has seen unabashed criticisms and staunch disapproval, as some believe that it does not solve any extant securities regulation issue, and that it has not been tested by the fire of judicial interpretation through case law jurisprudence under US federal securities laws. Nonetheless, these same issues would crop up under the Nigerian securities regulation and case-law as time goes on.
What are the main liabilities of an STO team to the ST holders and who is in control over the fulfillment of this obligation?
Both a public company and a private company can tokenize all sorts of claims and interests in a company, from which liabilities, rights, and obligations may legally arise. This tokenization can be done on the blockchain or on any other distributed ledger technology platform with the implementation of any particular, suitable smart contract token standard. The liabilities of the STO team to the security token holders are the liabilities of an incorporated entity to its members, as the security token holders are nothing more than shareholders in the company, according to the Nigerian corporate governance general rules.
The liabilities are the same as the liabilities of a public company filing under private placement rules. Section 339 of the Nigeria SEC Rules and Regulations (2013) defines private placement as securities issuance by a public company to select persons. Such is exempt, and thus unregistered, where the STO process is conducted as a private sale and offering of securities and is therefore not made available and accessible to members of the public on a national securities exchange. But these STO team liabilities/company liabilities to its security token holders, shareholders, members, or whatever name they’re called, depend largely on the forensic niceties and cosmetic nuances of the various securities regulations of any relevant jurisdiction involved in the final analysis.
The question of liabilities of the STO team are expected to be fully exhibited in the STO documents as the case may be. Such documents where required are its Private Placement Memorandum (PPM), or additionally its white paper, the SAFT, and any other relevant documents or agreements connected to the offering, which spell out liabilities arising from the lack of full disclosure to misleading statements and representation, as though it is a prospectus offering under an initial public offering (IPO), where filing and due registration statement are prerequisites.
In Section 22 of the Companies and Allied Matters Act (CAMA) Laws of the Federation of Nigeria (LFN) 2004 for instance, a private company is obligated to put a share transfer restriction clause in its Articles of Association and set a membership limit at 50. According to Section 23 of the CAMA, consequences of the breach by a private company of the subsections (1) and (2) of Section 22 of the CAMA are loss of privileges and exemptions (from security offering registration), which private companies enjoy, while the CAMA would automatically continue to apply to private company as if it were not a private company. What this directly means is that the private company would become a public company both de facto and de jure. Relief is only granted to such a company by a court of competent jurisdiction on grounds of accident and inadvertence, where sufficient cause exists, or upon equity, good conscience, and fairness.
The STO team, issuer/founder, co-founder, smart contract developer, and advisory board, who control(s) the heart of the private placement security token sale exercise are in control over the fulfillment of relevant obligations, as stated in the company documents as the case may be. This is notwithstanding whether the principal and directing mind(s) of the company running the STO are called board of directors (BoDs) or directors. Fundamentally, in the case that an STO project fails or turns out to be a scam, the STO process fund contributors are entitled to refund from the directing mind(s) of the project, as was the case with our client, genEOS, who refunded the contributors when their STO could not reach the USD 2 million soft cap milestone. This is the professional industry minimum standard.
What is the timeframe when going through the registration process (by stages)?
Incorporating a company in Nigeria takes one to two weeks. In the event that a planned project seeks to carry out an STO process under the extant securities regulation in Nigeria, it would have to first incorporate as a legal entity under the Companies and Allied Matters Act (CAMA) 2004 as a private or public company limited by shares, depending on the kind of legal structure to imbue it with corporate personhood. It may also secure legal compliance as a non-profit.
To conduct an STO process, an incorporated entity may utilize the Private Placement Memorandum (PPM) as the offering document to the selected private investors, and the company would be bound to observe a disclosure obligation to the investors and file for exemption at the Securities and Exchange Commission (SEC) Nigeria, which is the national securities regulator, having its jurisdiction embedded in Section 13 of the Investment and Securities Act (2007).
What are the documents that need to be prepared for the registration process?
The more established, popular, and global industry practice is that private companies conduct an Internet-based blockchain smart contract security token offering as a private placement securities offering. In Nigeria, we have not yet had an STO conducted by either a private company or a public company. I’m not aware of one, at least, to the extent of my research on this subject, and close interaction with the Securities and Exchange Commission Nigeria, before whom I have once made a presentation on legal issues in distributed ledger asset tokenization and crypto securities regulation. Until then, the necessary legacy legal documentation in both private placement and an initial public offering would be required to form the legal basis for compliance with the extant securities regulation; then proceed to adopt and thus implement the STO smart contract mechanism.
Who will have regulatory control over exempt securities that cannot be traded within a given time?
The Securities and Exchange Commission Nigeria, which is the national securities regulator, retains regulatory control over securities that are exempt from registration, and are thus not tradeable within a lock-up period. As stated previously, this jurisdiction is derived from Section 13 of the Investment and Securities Act (2007).
What is the cost structure of the STO registration process?
The STO registration cost structure depends on a number of factors, which include a legal service charge and a filing process charge. This remains largely a variable cost structure too, as different legal service providers or securities/crypto securities lawyers would charge differently, coupled with the actual STO registration cost structure.
What tax residency is allowed for project founders? (Do you need to be a Nigerian citizen if you want to raise money in Nigeria?)
As already said, there is no bespoke cryptocurrency investment capital market product regulation in Nigeria at the moment, so the question of tax residency has not been considered as of yet. Nonetheless, the extant of taxation laws may be applicable to cryptocurrency-based, tax-worthy financial events. A good illustrative case is the United States v. Coinbase Inc., where the tax authority, the Internal Revenue Service (IRS) sought a tax obligation enforcement against Coinbase, a convertible virtual currency exchange and custodial service provider.
Are there any additional regulations that must be complied with if a project raises capital from non-Nigerian investors?
Under the Nigerian securities regulation? Yes. These are generally know your customer (KYC), anti-money laundering (AML), and counter-financing of terrorism (CFT) compliance, which are due diligence measures prerequisites for non-Nigerian investors.
Is there any special territory in your country that is a tax haven or has other beneficial regulations for cryptocurrencies and blockchain startups?
There is no tax haven in Nigeria, but the extant regulations can definitely be beneficial to cryptocurrency and blockchain startups, depending on their finances and startup capital. The Central Bank of Nigeria (CBN) has guidelines for financial technology companies wishing to set up shop in Nigeria.
What is the legal status of cryptocurrencies in your country?
The existing legal tender laws in Nigeria do not recognize and categorize cryptocurrencies as currencies, or money. Therefore, cryptocurrencies remain de facto commodities, or even securities, where the intrinsic fact and circumstances reveal that they have been financialized and packaged into a capital market investment product.
Can you describe general/ special taxation schemes for cryptocurrency owners and token issuers?
At the moment, there are no general/special taxation schemes for cryptocurrency owners and token issuers in Nigeria. In fact, it has hardly ever crossed the mind of Federal Inland Revenue Services (FIRS), the country’s tax authority, to take an official taxation action or enforcement action concerning cryptocurrency transactions within Nigeria, as the government continues to lose potential taxation revenues. To the best of my knowledge, neither has the FIRS really taken its time to train its members to understand the socio-economic implications, opportunities, and possibilities of cryptocurrency technology.
This is meant only for general informational purposes in regard to regulation, or the lack thereof, within the present Nigerian legal order, while offering a bit of international perspective. This is not to be taken as legal advice. Consult a savvy crypto lawyer in the space to help you out if that’s what you need.
Questions asked by Alex Savinkin
Former number cruncher in investment funds & strategy consulting. One of Geekforge Founding Fathers. Blockchain and technical singularity true believer.
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