Commodity Options. More recent versions of presale instruments have included token sale-related rights, which provide investors or issuers with a token call or put right, as applicable, upon the consummation of a token sale at an agreed price or discount. Such rights constitute a commodity option that would be subject to CFTC regulation as a swap,17 unless an exemption applies. Trade options are one such possible exemption, as they are generally exempt from regulation by the CFTC, other than for certain large trader reporting requirements and the CFTC’s general anti-fraud and anti-manipulation enforcement authority (the Trade Option Exemption).18 In order to qualify as a trade option and benefit from the Trade Option Exemption,19 the commodity option in question must be: • Intended to be physically settled if exercised; • Entered into with an offeror who is either an eligible contract participant (“ECP”)20 or a producer, processor or commercial user of, or merchant handling, the commodity (or products or by-products thereof) that is the subject of the option, and such offeror is offering to enter into such option solely for the purposes related to its business as such; and • Entered into with an offeree who is a producer, processor or commercial user of, or merchant handling, the commodity (or products or by-products thereof) that is the subject of the option, and such offeree is entering into such option solely for the purposes related to its business as such. The Trade Option Exemption was developed to afford commercial market participants with an exemption from trading in commodities that are physically delivered. The availability of the exemption for commercial market participants is not currently foreclosed to participants solely by virtue of their also being investors. As a result, an option to purchase tokens held by investors who are also network participants as part of their business may be eligible for the Trade Option Exemption if the conditions are met. Nevertheless, presale agreements are still heavily marketed to investors that are not commercial market participants. As a result, the Trade Option Exemption will not be available in many instances. The Hybrid Instrument Exemption (defined below) may be another avenue for exemption from commodities law regulations applicable to commodity forward contracts and/or commodity options. Under CFTC Rule 34.2(a), a “hybrid instrument” is defined to include an equity or debt security with “one or more commodity-dependent components that have payment features similar to commodity futures or commodity options contracts or combinations thereof.”21 Under Section 2(f) of the CEA, a hybrid instrument that is “predominantly a security” is exempt from the provisions of the CEA if, among other things, the instrument is (i) not marketed as a contract of sale of a commodity for future delivery (or option on such a contract) subject to the CEA (the Marketing Condition), and (ii) the purchaser is not required to make additional payments in addition to the purchase price (the Purchaser Payment Condition) (such exemption being the Hybrid Instrument Exemption).22 While token presale instruments may, in theory, be capable of qualifying for the Hybrid Instrument Exemption, because they are often primarily marketed to investors who themselves are solely or in large part motivated to purchase such instrument in order to receive the underlying commodity (i.e., the token), such instruments will often fail to satisfy the requirements of the Marketing Condition of the Hybrid Instrument Exemption. Coupled with the securities law issues discussed above, these commodities law issues compound the regulatory concerns surrounding the SAFT and similar presale instruments. Traditional early-stage financing structures, such as preferred stock and convertible promissory notes,23 are well-known structures that generally feature the necessary flexibility to address the needs of early stage companies/token issuers and token platforms. The Automated Convertible Note, which runs on OpenLaw, provides investors with greater protections with respect to their investments in token issuers while simultaneously addressing investor demand for exposure to consumer tokens in a manner compliant with applicable securities and commodities laws. First, due to the inherent and significant value of the unissued consumer tokens and corresponding network protocols of any creator or developer of such technologies, the Automated Convertible Note provides noteholders with certain voting rights with respect to the creation and distribution of tokens.24 Eventually, as the pathway for consumer token sales becomes more clear, these voting rights may be more narrowly tailored to apply only when such sales do not meet certain specifications, including regulatory compliance. In addition, noteholders may seek additional protections to prevent potential uses of the issuer’s token-based network that circumvent their consumer token-related economic and participation rights. Second, the ConsenSys Automated Convertible Note replaces the conversion and exchange rights featured in other token presale instruments with appropriately limited rights to participate in the future token sale of the issuer (the Token Purchase Option) as well as certain additional economic rights that reduce the securities law-related regulatory risks associated with consumer token sales discussed above. In particular, the Token Purchase Option included in the Automated Convertible Note does not represent a conversion or exchange of the convertible note (which is itself a security), but is a supplemental right provided alongside the other traditional rights granted to the noteholders. The exercise of such Token Purchase Option also provides the parties with flexibility to structure the subsequent sales or distributions of any consumer tokens that could be deemed securities, including by enabling the parties to delay the issuance and sale of such tokens until a time when the relevant token-based network has achieved sufficient decentralization.25 The Token Purchase Option can be further limited at the time of purchase to require that any noteholder’s purchase of tokens be for an actual use or to limit the total number of consumer tokens reserved for distribution or sale to investors, thereby ensuring that any distributions or sales thereof occur in a manner that supports the broader consumer token-based network. The Token Purchase Option included in the Automated Convertible Note is coupled with a “most favored nation” (MFN) pricing provision, which guarantees noteholders the best token sale and distribution terms offered by the issuer to any third party. The Token Purchase Option is supplemented with certain token economic rights that are triggered upon consummation of a token sale by the issuer. In particular, in such event the Automated Convertible Note enables the noteholder to elect for such convertible note to either be repaid a pre-negotiated multiple of the convertible note’s aggregate principal amount or converted into preferred stock of the issuer. While the Automated Convertible Note does not dictate the terms of such preferred stock, the parties could agree to modify customary preferred stock rights to provide economic benefits to the holders of such stock upon consummation of future token sales, including through the inclusion of token-based dividend and/or redemption rights. The careful balancing of the Token Purchase Option and these additional economic rights should enable issuers to provide investors access to consumer tokens while protecting development of the underlying network and consumer tokens from the application of the securities law. Finally, the Automated Convertible Note is preferable to other token presale agreements from a commodities law perspective for several reasons. First, conferring future participation rights on an investor to participate in a token sale (i.e., the Token Purchase Option), or conferring economic rights to an investor in respect of future distributions, is not clearly a swap under the CEA and subject to CFTC regulation. There is no set strike price or final price differential that creates market risk that the CFTC would necessarily be incentivized to regulate in the commodity options market. While no regulatory certainty currently exists as to the treatment of the Token Purchase Option as a swap (or not) subject to CFTC jurisdiction, the Token Purchase Option seeks to reduce economic risk and loss attributable to other token presale agreements and simply affords the investor an MFN pricing provision to purchase the token at spot, which is likely to drastically reduce economic risk of loss for an investor. In addition, a noteholder cannot be said to have provided anything of value in exchange for the Token Purchase Option, as such noteholder is under no obligation to purchase tokens in any token sale and may elect to have the entire principal amount of the convertible note repaid upon consummation of such token sale in the same manner as though the issuer had completed a change of control. The ConsenSys Automated Convertible Note also provides built-in protections for token purchasers who will also participate on the network as part of their business and intend to benefit from the Trade Option Exemption. If such Trade Option Exemption is not otherwise available, it will direct the user to confer with counsel as to whether such instrument should be regulated as a swap and if the noteholder and issuer meet the requirements to be eligible to enter into the swap. In order to trade over-the-counter, swaps must be entered into between ECPs. While some investors (and certain token issuers) may qualify as ECPs, token issuers who are early-stage companies that do not have at least US$10 million gross assets would not satisfy the ECP test. A swap entered into by parties who are not ECPs would be in violation of the CEA and CFTC regulation, and both parties could face penalties and sanctions for such actions. Separately and importantly, swaps are also subject to trade reporting obligations. As a result, if the Token Purchase Option does not otherwise qualify for the Trade Option Exemption, issuers and investors will want to carefully consider the swap analysis with regard to their respective Token Purchase Option. Importantly, the ConsenSys Automated Convertible Note does not qualify for the Hybrid Instrument Exemption because, as a threshold matter, the Purchaser Payment Condition is not satisfied. However, it is this element — i.e., no payment or price risk taken on by the purchaser — of the Token Purchase Option that arguably places it outside the definition of swap as discussed above. Of course, while each instrument would need to be analyzed on its own merits, and while regulatory certainty does not yet exist with respect to the application of CFTC regulation to the Token Purchase Option, this alternate structure represented by the ConsenSys Automated Convertible Note at a minimum significantly mitigates the regulatory risks of the SAFT and other similar presale structures, and at best may offer a clear path to avoid characterization as a swap subject to CFTC jurisdiction. The ConsenSys Automated Convertible Note is preferable from a securities law perspective for many similar reasons: the investor is receiving a more traditional security, the various rights they are purchasing are far less ambiguous, and appropriate disclosures regarding the material aspects of the investment are more easily crafted. If you have questions about this article, please contact one of the authors listed below or the ▇▇▇▇▇▇ lawyer with whom you normally consult: ▇▇▇▇▇.▇▇▇▇▇▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ New York ▇▇▇▇▇▇▇.▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ New York ▇▇▇▇▇▇.▇▇▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ New York ▇▇▇▇▇.▇▇▇▇▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ Silicon Valley The Book of Jargon® — Cryptocurrency & Blockchain Technology This article is published by ▇▇▇▇▇▇ & ▇▇▇▇▇▇▇ as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the lawyer with whom you normally consult. The invitation to contact is not a solicitation for legal work under the laws of any jurisdiction in which ▇▇▇▇▇▇ lawyers are not authorized to practice. A complete list of ▇▇▇▇▇▇’▇ Client Alerts can be found at ▇▇▇.▇▇.▇▇▇. If you wish to update your contact details or customize the information you receive from ▇▇▇▇▇▇ & ▇▇▇▇▇▇▇, visit ▇▇▇▇▇://▇▇▇.▇▇▇▇▇.▇▇▇▇▇▇▇▇▇▇▇▇▇.▇▇▇/5/178/forms- english/subscribe.asp to subscribe to the firm’s global client mailings program.
Appears in 1 contract
Sources: Token Presale Agreement
Commodity Options. More recent versions of presale instruments have included token sale-related rights, which provide investors or issuers with a token call or put right, as applicable, upon the consummation of a token sale at an agreed price or discount. Such rights constitute a commodity option that would be subject to CFTC regulation as a swap,17 unless an exemption applies. Trade options are one such possible exemption, as they are generally exempt from regulation by the CFTC, other than for certain large trader reporting requirements and the CFTC’s general anti-fraud and anti-manipulation enforcement authority (the Trade Option Exemption).18 In order to qualify as a trade option and benefit from the Trade Option Exemption,19 the commodity option in question must be: • Intended to be physically settled if exercised; • Entered into with an offeror who is either an eligible contract participant (“ECP”)20 or a producer, processor or commercial user of, or merchant handling, the commodity (or products or by-products thereof) that is the subject of the option, and such offeror is offering to enter into such option solely for the purposes related to its business as such; and • Entered into with an offeree who is a producer, processor or commercial user of, or merchant handling, the commodity (or products or by-products thereof) that is the subject of the option, and such offeree is entering into such option solely for the purposes related to its business as such. The Trade Option Exemption was developed to afford commercial market participants with an exemption from trading in commodities that are physically delivered. The availability of the exemption for commercial market participants is not currently foreclosed to participants solely by virtue of their also being investors. As a result, an option to purchase tokens held by investors who are also network participants as part of their business may be eligible for the Trade Option Exemption if the conditions are met. Nevertheless, presale agreements are still heavily marketed to investors that are not commercial market participants. As a result, the Trade Option Exemption will not be available in many instances. The Hybrid Instrument Exemption (defined below) may be another avenue for exemption from commodities law regulations applicable to commodity forward contracts and/or commodity options. Under CFTC Rule 34.2(a), a “hybrid instrument” is defined to include an equity or debt security with “one or more commodity-dependent components that have payment features similar to commodity futures or commodity options contracts or combinations thereof.”21 Under Section 2(f) of the CEA, a hybrid instrument that is “predominantly a security” is exempt from the provisions of the CEA if, among other things, the instrument is (i) not marketed as a contract of sale of a commodity for future delivery (or option on such a contract) subject to the CEA (the Marketing Condition), and (ii) the purchaser is not required to make additional payments in addition to the purchase price (the Purchaser Payment Condition) (such exemption being the Hybrid Instrument Exemption).22 While token presale instruments may, in theory, be capable of qualifying for the Hybrid Instrument Exemption, because they are often primarily marketed to investors who themselves are solely or in large part motivated to purchase such instrument in order to receive the underlying commodity (i.e., the token), such instruments will often fail to satisfy the requirements of the Marketing Condition of the Hybrid Instrument Exemption. Coupled with the securities law issues discussed above, these commodities law issues compound the regulatory concerns surrounding the SAFT and similar presale instruments. Traditional early-stage financing structures, such as preferred stock and convertible promissory notes,23 are well-known structures that generally feature the necessary flexibility to address the needs of early stage companies/token issuers and token platforms. The Automated Convertible Note, which runs on OpenLaw, provides investors with greater protections with respect to their investments in token issuers while simultaneously addressing investor demand for exposure to consumer tokens in a manner compliant with applicable securities and commodities laws. First, due to the inherent and significant value of the unissued consumer tokens and corresponding network protocols of any creator or developer of such technologies, the Automated Convertible Note provides noteholders with certain voting rights with respect to the creation and distribution of tokens.24 Eventually, as the pathway for consumer token sales becomes more clear, these voting rights may be more narrowly tailored to apply only when such sales do not meet certain specifications, including regulatory compliance. In addition, noteholders may seek additional protections to prevent potential uses of the issuer’s token-based network that circumvent their consumer token-related economic and participation rights. Second, the ConsenSys Automated Convertible Note replaces the conversion and exchange rights featured in other token presale instruments with appropriately limited rights to participate in the future token sale of the issuer (the Token Purchase Option) as well as certain additional economic rights that reduce the securities law-related regulatory risks associated with consumer token sales discussed above. In particular, the Token Purchase Option included in the Automated Convertible Note does not represent a conversion or exchange of the convertible note (which is itself a security), but is a supplemental right provided alongside the other traditional rights granted to the noteholders. The exercise of such Token Purchase Option also provides the parties with flexibility to structure the subsequent sales or distributions of any consumer tokens that could be deemed securities, including by enabling the parties to delay the issuance and sale of such tokens until a time when the relevant token-based network has achieved sufficient decentralization.25 The Token Purchase Option can be further limited at the time of purchase to require that any noteholder’s purchase of tokens be for an actual use or to limit the total number of consumer tokens reserved for distribution or sale to investors, thereby ensuring that any distributions or sales thereof occur in a manner that supports the broader consumer token-based network. The Token Purchase Option included in the Automated Convertible Note is coupled with a “most favored nation” (MFN) pricing provision, which guarantees noteholders the best token sale and distribution terms offered by the issuer to any third party. The Token Purchase Option is supplemented with certain token economic rights that are triggered upon consummation of a token sale by the issuer. In particular, in such event the Automated Convertible Note enables the noteholder to elect for such convertible note to either be repaid a pre-negotiated multiple of the convertible note’s aggregate principal amount or converted into preferred stock of the issuer. While the Automated Convertible Note does not dictate the terms of such preferred stock, the parties could agree to modify customary preferred stock rights to provide economic benefits to the holders of such stock upon consummation of future token sales, including through the inclusion of token-based dividend and/or redemption rights. The careful balancing of the Token Purchase Option and these additional economic rights should enable issuers to provide investors access to consumer tokens while protecting development of the underlying network and consumer tokens from the application of the securities law. Finally, the Automated Convertible Note is preferable to other token presale agreements from a commodities law perspective for several reasons. First, conferring future participation rights on an investor to participate in a token sale (i.e., the Token Purchase Option), or conferring economic rights to an investor in respect of future distributions, is not clearly a swap under the CEA and subject to CFTC regulation. There is no set strike price or final price differential that creates market risk that the CFTC would necessarily be incentivized to regulate in the commodity options market. While no regulatory certainty currently exists as to the treatment of the Token Purchase Option as a swap (or not) subject to CFTC jurisdiction, the Token Purchase Option seeks to reduce economic risk and loss attributable to other token presale agreements and simply affords the investor an MFN pricing provision to purchase the token at spot, which is likely to drastically reduce economic risk of loss for an investor. In addition, a noteholder cannot be said to have provided anything of value in exchange for the Token Purchase Option, as such noteholder is under no obligation to purchase tokens in any token sale and may elect to have the entire principal amount of the convertible note repaid upon consummation of such token sale in the same manner as though the issuer had completed a change of control. The ConsenSys Automated Convertible Note also provides built-in protections for token purchasers who will also participate on the network as part of their business and intend to benefit from the Trade Option Exemption. If such Trade Option Exemption is not otherwise available, it will direct the user to confer with counsel as to whether such instrument should be regulated as a swap and if the noteholder and issuer meet the requirements to be eligible to enter into the swap. In order to trade over-the-counter, swaps must be entered into between ECPs. While some investors (and certain token issuers) may qualify as ECPs, token issuers who are early-stage companies that do not have at least US$10 million gross assets would not satisfy the ECP test. A swap entered into by parties who are not ECPs would be in violation of the CEA and CFTC regulation, and both parties could face penalties and sanctions for such actions. Separately and importantly, swaps are also subject to trade reporting obligations. As a result, if the Token Purchase Option does not otherwise qualify for the Trade Option Exemption, issuers and investors will want to carefully consider the swap analysis with regard to their respective Token Purchase Option. Importantly, the ConsenSys Automated Convertible Note does not qualify for the Hybrid Instrument Exemption because, as a threshold matter, the Purchaser Payment Condition is not satisfied. However, it is this element — i.e., no payment or price risk taken on by the purchaser — of the Token Purchase Option that arguably places it outside the definition of swap as discussed above. Of course, while each instrument would need to be analyzed on its own merits, and while regulatory certainty does not yet exist with respect to the application of CFTC regulation to the Token Purchase Option, this alternate structure represented by the ConsenSys Automated Convertible Note at a minimum significantly mitigates the regulatory risks of the SAFT and other similar presale structures, and at best may offer a clear path to avoid characterization as a swap subject to CFTC jurisdiction. The ConsenSys Automated Convertible Note is preferable from a securities law perspective for many similar reasons: the investor is receiving a more traditional security, the various rights they are purchasing are far less ambiguous, and appropriate disclosures regarding the material aspects of the investment are more easily crafted. If you have questions about this article, please contact one of the authors listed below or the ▇▇▇▇▇▇ lawyer with whom you normally consult: ▇▇▇▇▇.▇▇▇▇▇▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ New York ▇▇▇▇▇▇▇.▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ New York ▇▇▇▇▇▇.▇▇▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ New York ▇▇▇▇▇.▇▇▇▇▇▇▇▇@▇▇.▇▇▇ +▇.▇▇▇.▇▇▇.▇▇▇▇ Silicon Valley The Book of Jargon® — Cryptocurrency & Blockchain Technology This article is published by ▇▇▇▇▇▇ & ▇▇▇▇▇▇▇ as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the lawyer with whom you normally consult. The invitation to contact is not a solicitation for legal work under the laws of any jurisdiction in which ▇▇▇▇▇▇ lawyers are not authorized to practice. A complete list of ▇▇▇▇▇▇’▇ Client Alerts can be found at ▇▇▇.▇▇.▇▇▇. If you wish to update your contact details or customize the information you receive from ▇▇▇▇▇▇ & ▇▇▇▇▇▇▇, visit ▇▇▇▇▇://▇▇▇.▇▇▇▇▇.▇▇▇▇▇▇▇▇▇▇▇▇▇.▇▇▇/5/178/forms- english/subscribe.asp to subscribe to the firm’s global client mailings program.
Appears in 1 contract
Sources: Token Presale Agreement