Regulation authorities in different countries, including the SEC in the US, are doing all they can to ensure that they keep up with the rapidly evolving digital asset industry. One of the recent developments, the Initial Exchange Offering (IEO), has been gathering a lot of momentum since its invention.

IEOs are similar to the Initial Coin Offering (ICO). They are initial offerings of tokens by startups or companies that seek to raise capital.

IEOs evolved from the ICOs. The only thing that the IEOs have done is taking the coin offering process to cryptocurrency exchanges where the exchanges offer the coins/tokens on behalf of the startups or companies. In exchange, the companies or startups behind the IEO pay a small fee to the exchange platform.

IEO issuers have taunted IEOs to be highly secure by arguing that the IEOs are thoroughly vetted by the exchanges before being allowed to run on their platforms. However, the US Security Exchange Commission (SEC) issued a warning in January 2020 saying that some of the exchanges issuing IEOs are not registered with it and yet they are enticing investors with the propaganda that the IEOs they are offering are secure.

Though IEOs are known to be among the most secure coin offerings that investors can invest in, unregulated exchanges are taking that advantage to give investors false promises of high returns. Investors should be wary that IEOs can be conducted in violation of the federal securities laws making them lack most of the investor protections that are associated with the registered exchanges.

As such, there are certain issues that both IEO issuers and investors should take into account when issuing and investing in IEOs in the USA. These include:

Is the IEO offering security tokens?

Since IEOs are built on top of the ICO framework, they mostly do not deal with securities. However, the startup or company issuing the IEO should be well advised by its legal advisors to ensure the tokens they are issuing do not fall under securities (that is if they do not want to issue securities).

However, there is still a probability that an IEO could involve the sale/offering of security tokens. In so doing, the IEO becomes subject to the registration requirements that apply to offerings that fall under the federal securities laws.

If the IEO is a securities offering, the company or startup offering the IEO should among other things provide important disclosures about its project/business, the digital asset being offered and the terms of the offering.

On this issue, IEO issuers could approach IEO advisory firms for directions on how to best formulate the IEO.

Is the platform issuing the IEO a securities exchange?

If the IEO issues security tokens, the exchange platform on which the IEO is being run should be registered with the SEC as a securities exchange. Or alternatively, the exchange should have applied to operate under exemptions; for instance, it could apply to operate as an alternative trading system (ATS).

The regulations that govern the registered national securities exchanges and ATS are aimed at protecting investors from fraudulent or manipulative trading practices that exchanges may indulge in.

If the exchange offering the IEO is a broker, is it registered with the SEC?

Most trading platforms opt to operate as brokers rather than securities exchanges.

The exchanges operating as brokers in the US are required to register with the SEC as members of the Financial Industry Regulatory Authority (FINRA), an independent, non-governmental organization that comes up with and imposes the rules governing registered brokers and broker-dealer firms in the US. Additionally, they should only run IEOs that issue utility tokens but not security tokens.

FINRA members are subject to regulatory requirements that aim at safeguarding investors by ensuring that the brokers and broker-dealer firms act in a manner consistent with SEC’s customer protection standards.

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