It’s no shocker that the Coronavirus pandemic has slowed down venture capital investment dramatically, with 2020 now on pace to be well below the high levels of the past couple of years.  According to Pitchbook, VC deal flow through June 28 fell to just 4,675 funding rounds as compared with 6,357 in the first half of last year.  But a drop in dealmaking volume may not be the pandemic’s only impact on the VC market.  In the immediate aftermath of the dot com meltdown in 2001 and the financial crisis in 2008, VCs were able to negotiate for more favorable terms to protect their investment as a result of lower investment supply and the leverage that comes with it.  It stands to reason that we will see the same phenomenon now, with the pendulum swinging back in favor of VCs.  Consequently, companies and their founders need to understand these pro-investor terms so that they could at least try to minimize their severity and make good dealmaking decisions overall.  This blog post will review several of the deal terms most likely to be targeted by VCs in reaction to new market realities.

Liquidation Preference

Investors may seek to enhance their liquidation preference rights in two ways: preference multiple and participation.

In a normal, reasonably competitive market, such as existed the last several years, liquidation preference multiples have settled at one.  On a sale of the company, the VC would first get its money back.  Simple and fair.  It’s also consistent with what liquidation preference is intended to be, namely downside protection.  In a disappointing ultimate strategic outcome for the company, the investor arguably should get the amount of its investment back, plus accrued and unpaid dividends, before the common holders receive anything.

Investors are likely now to negotiate for some multiple of their investment, i.e., 1.5x, 2x, 3x, etc., on the theory that the deterioration of the risk/reward profile means that the investor should receive a higher reward upon exit to compensate for the greater risk.

Investors are now also likely to negotiate for participating preferred, i.e., the right to participate, after receiving their liquidation preference, in remaining proceeds with the common shareholders on a pro rata, as converted basis.  Participating preferred is often referred to pejoratively as a form of double-dipping, and in fact VCs rarely received it in recent years.  Without it, upon a sale of the company, investors would just compare the amount of the preference against the amount they’d receive on conversion and take the higher amount.  With participating preferred, they get both.

My view is that companies have the better argument here in that participating preferred goes way beyond liquidating preference’s intended purpose of providing downside protection.

Redemption Rights

A right exercisable by the investor that the investor be bought out after a certain number of years could be extremely risky to a company.  Most companies will not have the cash on hand or access to debt or equity financing needed to satisfy the redemption obligation.  The practical result of the redemption period expiring is a shift in leverage in favor of the investor to force either a sale of the company or a renegotiation of existing investment terms.  Over the last several years, VC deals have not included redemption rights.  The perceived longer path to liquidity, however, will now likely cause investors to seek redemption rights, particularly in later stage deals.  They may also seek shorter periods before redemption rights become exercisable, e.g., three years rather than five or seven.  One way for a company to mitigate the effect of redemption is to negotiate for deferred payment of the redemption price.  Investors may also require a company to create a sinking fund to ensure adequate capital for the redemption.


Investors will almost always get protection against economic dilution in the form of anti-dilution provisions which adjust the conversion rate of the preferred into common resulting in a larger number of common shares upon conversion in the event of a down round.  The method of calculating the conversion price adjustment is often the subject of negotiation.  In normal market conditions, most anti-dilution provisions are based on a weighted average formula which takes into account the number of shares issued in the down round relative to the number of shares outstanding, i.e., the actual dilutive effect of the round.  But there are different ways of calculating shares outstanding to arrive at the weighted average adjustment.  “Broad-based” anti-dilution is more founder-friendly than a “narrow-based” anti-dilution formula because it is more inclusive in terms of what is deemed outstanding resulting in less dilution than a narrow-based formula.  A broad-based weighted average formula would typically include within outstanding shares not just common shares actually outstanding, but also all shares issuable on exercise of options and on conversion of convertible securities such as preferred stock.  In contrast, a narrower formula might include in the calculation of outstanding shares only those shares of common that are actually outstanding (i.e., excluding shares of common issuable on conversion of options, warrants and, potentially, even the preferred stock itself).  While narrow-based anti-dilution formulas are more investor-friendly, the most investor-friendly category of anti-dilution protection is “full ratchet” anti-dilution which adjusts the conversion price all the way down to the lower down round price irrespective of the actual number of additional shares issued in the down round, i.e., regardless of its dilutive effect.

With additional leverage moving their way, VCs could be expected to negotiate for greater anti-dilution protection.  In most cases, I expect investors will only seek a more narrow-based version of weighted average anti-dilution protection by including fewer categories of options and convertible securities in the calculation of fully-diluted outstanding shares.  In more extreme cases, they may push for a full ratchet anti-dilution feature.

Preemptive Rights

VCs typically receive preemptive or pro-rata rights, i.e., the right to participate in a future round in proportion to ownership.  Normally, these rights don’t generate much friction in a negotiation, with any negotiation here being typically limited to which categories of issuances would be excluded and thus outside the reach of the right.  As a practical matter, preemptive rights are usually waived by investors in connection with subsequent rounds.

In the current environment, it could be expected that VCs will negotiate for the right to invest in subsequent rounds above their pro-rata ownership, perhaps 1.5x – 2x their ownership interest. This enhanced right could be valuable because it would allow investors to “load up” on successful portfolio companies in subsequent financings.

Cram Downs

A significant portion of those rounds that will successfully close in this climate will likely be down rounds, which typically result in harmful consequences and thus a serious morale problem for founders and employee holders.  Earlier preferred stock investors are protected with antidilution rights which get triggered in a downround resulting in a more favorable conversion rate and ultimately more common shares on conversion.  But that comes at the expense of greater dilution to the common holders.  Another consequence of a down round is that it often results in employee stock options being underwater.  These events could result in a serious hit to company morale.

To combat the foregoing morale issues, VCs may seek to force earlier investors to bear the brunt of the down round by either waiving their anti-dilution rights, which would minimize the dilutive hit to the common holders, or converting their preferred shares outright into common which would remove much of the preferred stock liquidation preference stack above the common holders.  Convincing previous investors to waive antidilution rights or convert is no easy task but, if successful, could greatly benefit employee holders and the new investors by reducing the amount of liquidation preference outstanding and giving the remaining preferred stockholders greater control over the company.

The impact of the Coronavirus and COVID-19 on venture capital investment will likely be similar to what we saw in the aftermath of the 2008 recession and the 2001 dot-com meltdown. VC investors will redirect their attention away from sourcing new deals and toward managing their existing portfolios, trying to determine which should survive and which should be liquidated or shut down. Faced with a distressed investment market, many surviving companies without sufficient reserves will be forced to try to raise additional funds in “down rounds”, i.e., at pre-money valuations lower than the post-money valuation of their previous round. This blog post will address the resulting economic dilution and other consequences to previous investors and founders, as well as the protection against economic dilution that VCs always negotiate for.

Economic Dilution

The first consequence of a down round is economic dilution to founders and previous investors. Suppose a company raises $4 million in a Series A round at $1 per share at a pre-money valuation of $12 million ($16 million post-money). The investor would receive 4 million shares constituting 25% of the post-money capitalization. Now imagine the company is later forced to raise an additional $4 million but at a pre-money valuation of only $10 million. The company would issue the new investor 6,400,000 shares at $0.625 per share ($10,000,000/16,000,000 shares). As a result, the previous investor’s shares would now be worth only $2.5 million (4 million shares x $0.625), a $1.5 million writedown from its original $4 million value representing economic dilution of 37.5%.

Enhanced Rights

Just as down round investors negotiate aggressively on valuation, they also tend to push for more favorable features in other non-price terms. If the lower valuation and lower price reflect the new investors’ perception of higher risk, down round investors are likely to want to protect against such greater risk with enhanced rights such as multiple, senior and participating liquidation preferences, milestone based staggered funding, cumulative dividends, redemption, board control, senior tag-along and drag-along rights, more robust vetoes and other enhanced rights. Faced with no alternatives, companies may have no choice but to accommodate these demands.

Underwater Shares

The aggressive terms sought by down round investors would typically leave existing shareholders worse off. But because the approval and/or cooperation of these shareholders may be needed to complete the down round and beyond, the company may be forced to sweeten the deal for these shareholders. For example, if the down round investors demand a multiple liquidation preference, the shares held by junior preferred and common shareholders could be worthless. In the hypothetical $4 million down round above, if the down round investors negotiate for and receive a 4x liquidation preference, they would receive $16 million off the top from the proceeds of any sale of the company and the other shareholders and optionee employees would get nothing unless the company were sold for more than that.

One source of leverage earlier preferred investors often have at their disposal is that they typically have a series-based veto over future funding rounds, i.e., a funding round requires the consent of some vote threshold of that series of preferred. Similarly, founders and other key employees may have leverage to the extent they’re considered indispensable to the future operations and ultimate success of the company. This in turn may result in the down round investors being forced to relax their position, or the company agreeing to more favorable voting rights for the preexisting investors and founders or other protections to ensure against any transaction that doesn’t result in any portion of proceeds paid to them.

Anti-(Economic)Dilution Protection

An earlier round investor can protect itself against percentage dilution from a subsequent round by exercising its preemptive rights to buy its pro rata share of the next round, thus preserving pre-round percentage ownership. But the preemptive right holder may not have the means to participate in the next round. One way to protect against economic dilution from a subsequent down round is through exercising a veto right over future issuances. But a veto right will only give an investor the ability to block a transaction; if the investor waives the veto or otherwise elects not to exercise, the veto won’t protect the investor from the negative economic impact. For that kind of protection, the investor will need to negotiate in advance for anti-dilution protection in the form of price adjustments. Preferred stock is almost always convertible into common based on a conversion formula that typically starts out at a 1:1 ratio, i.e., one common share on conversion for every preferred share owned. If there’s a down round, the anti-dilution provisions kick in and automatically adjustment downward the conversion price of the holder’s preferred shares resulting in a larger number of common shares being issued to the investor upon conversion.

The magnitude of the conversion price adjustment, and thus in the number of additional shares issuable upon conversion, depends on which of the three basic formulas are used: broad-based weighted average, narrow-based weighted average and full ratchet. In either type of weighted average anti-dilution formula, the adjustment amount will depend on the relative size of the down round and measured by comparing the number of shares issued in the down round against the number of shares outstanding on a fully-diluted basis, with the difference being how broadly or narrowly “fully-diluted” is defined.

Under a broad-based weighted average formula, we look at the number of common shares outstanding on a fully-diluted basis after giving effect to the exercise or conversion of all outstanding warrants, options, convertible securities or other equity derivative securities. This formula dampens the magnitude of the conversion price adjustment the most by spreading the dilutive effect over the most possible securities.

The narrow-based weighted average formula, on the other hand, only takes into account currently outstanding common and preferred stock, or in a more granular version only outstanding common stock and issuances of common stock equivalents at a conversion or exercise price lower than the then applicable conversion price (e.g., in-the-money stock options). A more extreme version of this formula only includes the protected security and the dilutive issuance itself (together with outstanding common). In any event, this type of formula provides an intermediate adjustment by arriving at a blended conversion price higher than the down round price.

The most extreme version of anti-dilution and the most protective for the preferred shareholder is called full ratchet because the conversion price would simply ratchet all the way down to the down round price irrespective of how few or how many shares were issued in the down round. This results in the largest downward adjustment in the conversion price and greatest upward adjustment of shares on conversion to the protected holder and the most dilution to junior security holders.

One overlooked impact of anti-dilution rights is that they also increase the voting power of the rights holder, but whereas the economic impact of the additional shares resulting from a lower conversion price is only experienced upon a liquidity event such as a sale of the company, the shift in voting power happens right away because voting on general matters at the common stock level is based upon shares owned on a fully-diluted basis.

As mentioned above, anti-dilution adjustments cause junior investors and common stockholders who have no anti-dilution protection to suffer disproportionate dilution from the down round. The value of their securities shrinks as a proportion of the pre-money capitalization of the down round. Consequently, approval for the down round (if required) may be difficult to secure from these stockholders without an upward adjustment to the conversion price of the protected holder’s shares (i.e., higher than if the anti-dilution adjustments were strictly followed) and, even where junior security holder approval is not needed, it may be necessary to sweeten the deal for founders and key employees by offering them additional stock options or bonuses in order to retain and incentivize them.

Title III crowdfunding may be an attractive capital raising alternative during the current Coronavirus pandemic because it allows companies to use the internet to solicit potential investors and not be restricted to accredited investors. But some of the requirements under Regulation Crowdfunding may diminish its utility for issuers with urgent capital needs as a result of COVID-19. Recognizing this, the Securities and Exchange Commission on May 4 stepped up and issued temporary final rules relaxing certain timing and financial information requirements for offerings initiated under Regulation Crowdfunding between May 4 and August 31. The temporary rules allow issuers that meet certain eligibility criteria to assess interest in a Regulation CF offering before having to prepare full offering materials, and then once launched, to close the offering and have access to funds sooner than would be possible without the temporary relief. The temporary rules also provide an exemption from certain financial statement review requirements for issuers targeting $250,000 or less within a 12-month period in reliance on Regulation CF.


To be eligible for the relaxed temporary rules, an issuer must have been organized and have had operations for no less than six months prior to the commencement of the offering. The SEC believes this eligibility requirement is appropriate because the temporary relief is intended primarily to assist existing companies that require additional funds because of adverse effects caused by the closures and safety measures designed to slow the spread of COVID-19, not newly formed companies. In addition, a company would be ineligible if it previously conducted a Regulation CF offering but failed to comply with its requirements.

Omission of Financial Statements from Initial Form C Filing

An issuer seeking to conduct a Regulation CF offering to address urgent funding needs triggered by COVID-19 may not have current financial statements available, or may have difficulty securing reviewed or audited financials due to the crisis. Therefore, under existing Regulation CF rules that require reviewed or audited financials, such an issuer may find it difficult to launch a timely offering. The issuer may also be more reluctant to incur the cost of reviewed or audited financials during the pandemic without some indication the offering has a chance of succeeding.

The temporary relief will allow issuers to go live with offering information on a funding portal prior to posting financial statements. Specifically, the temporary rules allow eligible issuers to omit required financials in the initial Form C filed with the SEC, to the extent such financials are not otherwise available, and commence its offering on the funding platform. The financials must then be included in an amendment to the Form C and provided to investors and the portal before the portal accepts any investment commitments. This will allow issuers to test the waters and gauge investor interest in an offering before going through the effort and expense of preparing financials.

Increase in Dollar Threshold Triggering Reviewed Financials

Under existing rules, an issuer targeting more than $107,000 but not more than $250,000 in a 12-month period must provide financial statements that are reviewed by an independent public accountant. The SEC recognizes that obtaining reviewed financial statements could pose serious challenges to an issuer with immediate capital needs due to COVID-19. By allowing issuers to gain more timely access to capital, the temporary rules are expected to benefit eligible issuers affected by COVID-19 that may be facing unexpected delays in securing financing due to a temporary inability to retain an independent accountant.

Accordingly, the temporary rule allows eligible issuers in offerings of up to $250,000 (rather than $107,000) to provide financial statements that are only certified by the principal executive officer, assuming reviewed or audited financials are not otherwise then available.

Suspension of 21-Day Requirement

Current rules provide that information in an offering statement must be publicly available for at least 21 days before securities may be sold, although the funding portal may accept investment commitments during that time. In light of the need for expedited access to capital among small business issuers affected by COVID-19, the temporary rules replace the 21-day rule with a requirement that the intermediary make the mandated issuer information publicly available on its funding platform before securities are sold in the offering. Accordingly, an issuer may close a raise during the temporary rule offering period as soon as it’s raised the target offering amount, even if the offering hasn’t been live for 21 days, as long as the closing occurs at least 48 hours after the last investment commitment and the funding portal notifies investors of the early closing.

Relaxation of Cancellation Process

Regulation CF investors normally have an unconditional right to cancel an investment commitment for any reason until 48 hours prior to the deadline identified in the offering materials. If an issuer reaches its target offering amount before the stated deadline, it may close the offering only if: (i) the offering remains open for a minimum of 21 days; (ii) the intermediary provides notice about the new offering deadline at least five business days before the new deadline; (iii) investors are given the opportunity to cancel their commitment until 48 hours prior to the new deadline; and (iv) at the time of the new deadline, the issuer continues to meet or exceed the target offering amount.  Although these rules are intended for investor protection, the SEC acknowledges they may also diminish the utility of Regulation CF for issuers with urgent capital needs as a result of COVID-19.

To provide relief to issuers with urgent funding needs, the temporary rules provide that any investor seeking to cancel a commitment must do so within 48 hours of making the commitment, unless there’s a material change to the terms of the offering or to the information provided by the issuer. In addition, once an issuer has received binding commitments (i.e., commitments for which the 48-hour general cancellation period has run) that equal the target offering amount, the issuer may close the offering on a date earlier than the deadline identified in its offering materials. In order to do so, the issuer must comply with additional disclosure requirements and the intermediary must provide notice that the target offering amount has been met, but is not required to provide the five business days’ notice of the earlier closing deadline, as would normally be required.

As mentioned above, the temporary relaxed rules apply only to offerings initiated under Regulation CF between May 4 and August 31, 2020.

COVID-19 induced declines in private and public company valuations have left many employee stock options “underwater” or “out-of-the-money”, i.e., exercise prices exceeding fair market value. This is a problem for employees and companies alike. Underwater options no longer serve their retention and incentivization objective, but nevertheless use up finite authorized shares and count against authorized capital and option plan caps. Consequently, companies should seriously consider restoring financial incentives by either repricing or exchanging the underwater options. This post will review stock option repricings and exchanges, and will address relevant corporate governance, securities law, accounting and investor relations considerations relating to each technique.

Option Repricing

In a true repricing, the company unilaterally reduces the exercise price of the underwater option, either by amending the existing option grant/option agreement or by cancelling the option and replacing it with a lower priced option.

The primary advantage of the repricing technique is its simplicity. Another advantage applicable to public companies is that repricing does not generally trigger the federal securities laws’ tender offer rules.

There are a few disadvantages. First, stockholders generally view repricings unfavorably as a windfall to employees not shared by existing stockholders. Second, NYSE and Nasdaq listed companies must secure stockholder approval unless the plan under which the options were granted explicitly allows repricings without such approval. In soliciting stockholder approval, a public company must disclose in a proxy statement all material information necessary for stockholders to make an informed decision, including the reason for the repricing, historical price variations, the employees eligible to participate in the offer and what happens to shares underlying repriced options. Proxy advisory firms (e.g., ISS, Glass Lewis) generally oppose repricings unless the vesting schedule is adjusted, the exercise price is reset at or above fair market value and the repricing proposal excludes officers and directors. ISS has indicated that repricing underwater stock options after a recent precipitous drop in a company’s stock price demonstrates “poor timing and warrants additional scrutiny.” Further, ISS has indicated that the options being repriced should have been granted “far enough back (two to three years) so as not to suggest that repricings are being done to take advantage of short-term downward price movements.” As a result, repricings as a practical matter are typically limited to underwater options where the exercise price of the surrendered option is above the stock’s 52-week high, where officers and directors are either excluded or included on less favorable terms and where the new stock option has a longer vesting period than what remains under the cancelled stock option.

On April 8, 2020, ISS issued COVID-19 specific guidance, which stated that, during the pandemic crisis, ISS will generally recommend opposing any repricing that occurs within one year following a steep drop in a company’s stock price and will examine specific repricing factors, such as whether surrendered options are added back to the plan reserve, whether replacement awards vest immediately and whether executive officers and directors are able to participate.

Even if a company’s option plan explicitly allows repricing (meaning that stockholder approval is not required), ISS has indicated that a repricing without stockholder approval will likely result in an adverse recommendation for the company’s say-on-pay proposal and, in certain circumstances, for the election of the members of the company’s compensation committee.

For private companies, both the underwater stock option and the repriced stock option will count towards the “hard cap” and “soft cap” limits under Rule 701 of the Securities Act of 1933, the safe harbor for compensatory offerings. The hard cap is a limit on the number of equity awards that a company may grant in reliance on Rule 701 in any 12-month period; in certain situations, a repricing will blow the cap, making the exemption unavailable. Under the soft cap, a company that exceeds $10 million in equity awards in any 12-month period must provide sensitive disclosure (including financial and risk disclosure) to its equity award holders.  See previous blog post on Rule 701 here.

Finally, repricings may result in an accounting charge to the extent the value of the new options exceeds the value of the repriced options.

Option Exchange

The alternative to option repricing is exchanging the underwater options for fewer lower exercise priced options, i.e., at a ratio of less than one-for-one, so that the value of the new options is no higher than the underwater options.

The primary advantage here is that it reduces the overhang of (useless) equity inasmuch as it results in fewer options being outstanding. Further, there should be no accounting charge as a result of the exchange because the value of the new options is no higher than the exchanged options.

Companies effecting an options exchange must comply with federal securities law tender offer rules which are generally triggered when stockholders are asked to make an investment decision about selling or exchanging one security for another or modified one. The tender offer rules require that the company file a Tender Offer Statement (Schedule TO) with the SEC, attach a detailed Offer to Exchange (which makes the offer to the optionholders) and deliver it to the optionees. The company must keep the tender offer open for at least 20 business days.

As is the case with repricings, option exchanges effected by listed companies must be approved by the stockholders under NYSE and Nasdaq rules (unless the underlying plan provides otherwise). See above regarding the process of seeking stockholder approval. Proxy statement disclosure is somewhat more complicated in an exchange as compared with a repricing because the company must explain how it determined the value of the exchanged options.

Under current accounting rules, an option exchange is considered a modification of the old option. If there is an increase in value when comparing the new option with the old, then an accounting charge is taken. But if there is a true value-for-value exchange (underwater option is exchanged for option subject to a fewer number of shares), then the exchange is a neutral event with no accounting charge.

One quick tax point that relates to both repricings and exchanges. In either case, it’s critically important to make sure the exercise price of the new options is at or above fair market value at the time of the repricing or exchange. If it isn’t, the new discounted option may be immediately taxable and subject to a 20% penalty and interest under dreaded Section 409A.

Among the many challenges companies are facing during the COVID-19 pandemic is how to conduct their shareholder meetings. Current social distancing requirements are effectively forcing companies to choose between postponing meetings and conducting them virtually. This requires careful attention to state executive orders, the relevant corporate statute, the company’s certificate of incorporation and by-laws, as well as SEC rules and recent guidance in the case of public companies. Several states, including New York and Delaware, have issued executive orders designed to facilitate virtual meetings, and the SEC has issued virtual meeting proxy guidance, including for companies that mailed proxy materials to shareholders but wish to change to virtual meetings because of social distancing concerns.

State Corporate Law

State corporate statutes dictate how shareholder meetings are to be conducted, including whether and to what extent such meetings may be held virtually.

For corporations incorporated in New York, the Business Corporation Law (the “BCL”) requires that shareholder meetings be held at such place fixed by the company’s by-laws. Although the BCL allows remote shareholders to participate electronically (provided reasonable procedures are in place to enable participation and voting), the statute does not explicitly authorize virtual-only meetings and has generally been understood to require a physical location. On March 20, 2020, however, Governor Cuomo issued Executive Order No. 202.8, which among other COVID-19 emergency measures temporarily suspends the BCL’s meeting requirements “to the extent they require meetings of shareholders to be noticed and held at a physical location” through April 19, 2020, subsequently extended by further executive order to May 7, 2020. Essentially, the order temporarily permits New York corporations to hold annual and special shareholder meetings solely by means of remote communication.

For Delaware corporations, if the organizational documents do not require a physical location, the annual meeting may be held virtually (i.e., telephonically or online). However, Delaware law requires reasonable measures to ensure stockholders may meaningfully participate in the virtual meeting through a secure and verifiable process, which focuses on access to the meeting, voting and access to the stockholder list.

SEC Guidance and Delaware Clarification

On March 13, 2020 (updated as of April 7), the SEC’s Division of Corporation Finance issued guidance on holding virtual shareholders meetings, including guidance on transitioning from a previously noticed in-person meeting to a virtual or hybrid (i.e., in-person meeting that permits electronic shareholder participation) annual meeting format. The guidance requires companies planning to conduct a virtual or hybrid meeting to take the following steps:

  • Notify shareholders of such in a timely manner with information on the logistical details of the virtual or hybrid meeting, including how shareholders can remotely access, participate in and vote at the meeting.
  • Companies that haven’t yet filed definitive proxy materials should include the above disclosures in the definitive proxy statement and other soliciting materials.
  • Companies that have already filed and mailed proxy materials and seek to change to a virtual or hybrid meeting should issue a press release announcing the change, file the press release as definitive additional soliciting material on EDGAR and take all reasonable steps necessary to inform other intermediaries in the proxy process (e.g., proxy service providers) and other relevant market participants (e.g., the relevant national securities exchanges) of the change.

The guidance unintentionally gave rise to concern among Delaware corporations that a press release meeting the above SEC guidance would not necessarily qualify as effective notice under Delaware law. Consequently, Delaware Governor John Carney clarified the ambiguity by issuing an executive order on April 6 that a press release announcing a change from an in-person to a virtual or hybrid meeting due to COVID-19 issues and otherwise in compliance with the SEC’s guidance will constitute effective notice under Delaware law, provided it is promptly posted on the company’s website. The order also provides that if alternatively the meeting is adjourned, the company would not be required to call the meeting to order in order to adjourn, but would permit such adjournment to be announced solely by means of the SEC filing and press release.

Practical Considerations

There are some best practices emerging for conducting a virtual or hybrid annual meeting, including the following:

  • Engaging a remote communication service provider (such as Broadridge or Computershare) to host the virtual or hybrid meeting.
  • Ensuring the remote communication method allows shareholders to vote, make comments, ask questions, hear answers and otherwise exercise all of the rights shareholders have under state law for participation in shareholder meetings.
  • Ensuring the technology platform used to conduct the virtual meeting will accommodate all of the shareholders, board members, members of management, and other persons participating in the meeting.
  • Making shareholders aware of the procedures necessary to access and participate in the virtual meeting.

Venture-backed companies did not receive the relief they had hoped for this past Friday, April 3rd, when the Small Business Administration (“SBA”) issued affiliation rule guidance on the Paycheck Protection Program (“PPP”) created under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The guidance largely affirms existing SBA regulations as they previously applied to SBA 7(a) loans and includes no affiliation rule waiver other than the limited waivers in the CARES Act. The absence of an applicable waiver means most venture-backed companies will need to include employees of other portfolio companies of their VC investors in determining whether they fall below the 500 employee limit for PPP eligibility. Without any further relief, PPP loans will not be extended to venture-backed companies, many of which are vital in the fight against the Coronavirus pandemic.


The CARES Act temporarily adds a new Paycheck Protection Program to the SBA’s 7(a) loan program providing guarantees for forgivable loans of up to $10 million (capped at $349 billion in the aggregate). The PPP is intended to provide economic relief to small businesses adversely impacted by COVID-19. An entity is generally eligible for the PPP if it, combined with its “affiliates”, has 500 or fewer employees whose principal place of residence is in the United States or is a business that operates in a certain industry and meets applicable SBA employee-based size standards for that industry. If two or more companies are deemed affiliates of each other, all employees of each of the affiliated entities are aggregated for the purpose of calculating the 500 employee threshold.

Without a waiver of the SBA affiliation rules, venture backed companies would be deemed affiliates of all other companies in their VC investor’s portfolio and would be required to aggregate employee numbers with those of the other portfolio companies.  Moreover, many venture backed companies have multiple VC investors.  Some receive investment from corporate VCs, where the related corporate entity single-handedly employs more than 500 persons.

On April 3, the SBA issued guidance on application of the SBA’s affiliation rules to the PPP in the form of an interim final rule and a summary of the applicable affiliation tests (together, the “PPP Affiliation Guidance”).  The day before the release of the PPP Affiliation Guidance, House minority leader Kevin McCarthy told the Axios Pro Rata Podcast the waiver would happen: “I just got off the phone with Treasury Secretary Mnuchin and this is going to be solved.” Speaker Nancy Pelosi also pushed for relief.  Nevertheless, the PPP Affiliation Guidance gave venture backed companies no satisfaction.

Determining Affiliate Status

Under the PPP Affiliation Guidance, any of the circumstances described below would be sufficient to establish affiliation for applicants for the Paycheck Protection Program.

  • Affiliation based on ownership. An entity is an affiliate of another entity that owns or has the power to control more than 50 percent of the first entity’s voting equity. If no individual or entity is found to control, the SBA will deem the board of directors or president or chief executive officer (or other officers, managing members, or partners who control the management of the entity) to be in control of the entity. The SBA will deem a minority shareholder to be in control, if that individual or entity has the ability, under the concern’s charter, by-laws or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.
  • Affiliation arising under stock options and convertible securities. In determining size, the SBA considers stock options, convertible securities and agreements to merge (including agreements in principle), to have a present effect on the power to control an entity. The SBA treats such options, convertible securities and agreements as though the rights granted have been exercised. An individual or other entity that controls one or more other entities cannot use options, convertible securities or agreements to appear to terminate such control before actually doing so.  The SBA will not give present effect to an individual’s or entity’s ability to divest all or part of its ownership interest in order to avoid a finding of affiliation.
  • Affiliation based on management. Affiliation arises where the CEO or president (or other officers, managing members or partners who control management) also controls the management of one or more other concerns. Affiliation also arises where a single individual or entity that controls the board or management of one entity also controls the board or management of one of more other entities. It also arises where a single individual or entity controls the management of the applicant entity through a management agreement.
  • Affiliation based on “totality of the circumstances”.       The SBA may consider all connections between the borrower and a possible affiliate and, if no single factor is sufficient to constitute affiliation, the SBA may determine on a case-by-case basis that affiliation exists when there is “clear and convincing evidence” based on the totality of the circumstances.

Who’s in Control?

VC funds typically own less than 50% of the voting securities of their portfolio companies, primarily to preserve proper management incentives, and compensate for its minority position by negotiating for certain control rights. In the VC context, affiliation typically comes down to an analysis of those control rights. Because SBA affiliation rules do not specify the exact control rights that will or will not trigger affiliate status, determinations must be made on a case-by-case analysis of relevant administrative case law guidance to determine loan eligibility.

Based on a review of SBA Office of Hearings and Appeals (the “OHA”) case law, the National Venture Capital Association put together a handy list of block rights which would constitute the type of control sufficient to trigger affiliate status.

In Control

The existence of a block right by a VC fund, exercisable either by the fund itself at the stockholder level or by its designee(s) at the board level, over any of the following actions would likely constitute the type of control that triggers affiliate status for PPP eligibility purposes:

  • Making, declaring, or paying distributions or dividends other than tax distributions.
  • Establishing a quorum at a meeting of stockholders (and likely, by extension, at a meeting of the board).
  • Approving or making changes to the company’s budget or approving capital expenditures outside the budget.
  • Determining employee compensation.
  • Hiring and firing officers and executives.
  • Changes in the company’s strategic direction.
  • Establishing or amending an incentive or employee stock ownership plan.
  • Incurring or guaranteeing debts or obligations.
  • Initiating or defending a lawsuit.
  • Entering into contracts or joint ventures.
  • Amending or terminating leases.

Out of Control

By contrast, the NVCA’s review of OHA case law shows that VC funds may have block rights over the following extraordinary decisions without triggering affiliate status:

  • Selling all or substantially all of the company’s assets.
  • Placing an encumbrance or lien on all or substantially all of the company’s assets.
  • Engaging in any action that could result in a change in the amount or character of a company’s capital contributions.
  • Changing the company’s line of business.
  • Engaging in a merger transaction.
  • Issuing additional stock/equity.
  • Amending the organizational documents of a company.
  • Filing for bankruptcy.
  • Amending the governing documents to materially alter the rights of the existing owners.
  • Dissolving the company.
  • Increasing, decreasing, or reclassifying the authorized capital of the company.
  • Increasing or decreasing the size of the board.
  • Entering into a confession of judgment.
  • Disposing of the goodwill of the company.
  • Committing to take any action that would make it impossible for the company to carry on its ordinary course of business.


As of now, many of the companies that would be excluded from PPP loan eligibility by a strict read of the SBA’s affiliation rules are precisely the innovative emerging companies vital to the fight against the new Coronavirus, namely biotechs developing vaccines and therapies, technology companies developing testing solutions, medical device companies and PPE companies. For that reason, it is expected that there will be continuing pressure for a regulatory or legislative fix for the affiliation rule problem as it would impact venture-backed companies. Whether the fix arrives in time is anyone’s guess. The PPP will be open only until the earlier of either June 30, 2020 or when the $349 billion cap in funding is exhausted.

Public companies stressing over how to meet filing deadlines during the COVID-19 crisis and what to say about the pandemic’s impact just received a filing reprieve and disclosure guidance from the SEC. The Securities and Exchange Commission issued an order on March 25, 2020 conditionally extending the deadlines for certain public company filings under the federal securities laws. On the same day, the staff of the SEC’s Division of Corporation Finance issued guidance on disclosure considerations and other securities law matters related to COVID-19.

Filing Extensions

Subject to certain conditions summarized below, SEC filers will have a 45-day extension to file certain disclosure reports that would otherwise have been due between March 1 and July 1, 2020. For example, a smaller reporting company with a normal filing deadline of March 30, 2020 for its Annual Report on Form 10-K will now have an extended deadline of May 14, 2020.

To qualify for the filing extension under the order, a filer must (i) be unable to meet a filing deadline due to circumstances related to COVID-19 and (ii) file a Current Report on Form 8-K (or Form 6-K) for each delayed filing by the later of March 16, 2020 or the original filing deadline of the report stating:

  • that it is relying on the order;
  • a brief description of the reasons why it could not file the report, schedule or form on a timely basis;
  • the estimated date by which the report, schedule, or form is expected to be filed; and
  • company-specific risk factors explaining the impact, if material, of COVID-19 on its business, which may be subject to the protections of the statutory safe harbor for forward-looking statements.

If the reason the report cannot be filed timely relates to the inability of any person, other than the company, to furnish any required opinion, report or certification, the Form 8-K (or Form 6-K) must attach as an exhibit a statement signed by that person stating the specific reasons why that person is unable to furnish the required opinion, report or certification on or before the date the report must be filed.

A registrant relying on the order would not need to file a Form 12b-25 so long as the report, schedule or form is filed within the time period prescribed by the order. The SEC order does not apply to Schedule 13D filings or amendments to a previously-filed Schedule 13D. Finally, the SEC order also does not apply to Section 16 beneficial ownership reports on Forms 3, 4 and 5.

COVID-19 Disclosure Guidance

Also on March 25, 2020, the staff of the SEC’s Division of Corporation Finance provided guidance on disclosure and other securities law obligations relating to COVID-19. The guidance provides a series of factors for companies to consider when drafting COVID-19 disclosure, including the following:

  • COVID-19’s impact on financial condition and results of operations, future operating results and near-and-long-term financial condition.
  • COVID-19’s impact on capital and financial resources, including overall liquidity position and outlook, cost of or access to capital and funding sources.
  • Material uncertainty about ongoing ability to meet credit agreements covenants because of the impact.
  • Course of action taken or proposed to be taken to remedy any material liquidity deficiency.
  • COVID-19’s effect on the company’s balance sheet and the company’s ability to account timely for those assets.
  • Anticipation for any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on the financial statements.
  • Adverse impact of any COVID-19-related circumstances such as remote work arrangements on the company’s ability to maintain operations, including financial reporting systems, internal control over financial reporting and disclosure controls and procedures.
  • Any expectation that COVID-19 will materially affect the demand for the company’s products or services.
  • Whether the company anticipates a material adverse impact of COVID-19 on supply chain or methods used to distribute products or services.
  • Whether operations will be materially impacted by any constraints or other impacts on human capital resources and productivity.
  • Whether travel restrictions and border closures are expected to have a material impact on ability to operate and achieve business goals.

The guidance also confirmed the need for companies and insiders to refrain from trading in the company’s securities prior to dissemination of material non-public information. For example, where COVID-19 has affected a company in a way that would be material to investors or where a company has become aware of a risk related to COVID-19 that would be material to investors, the company, its directors and officers, and other corporate insiders who are aware of these matters should refrain from trading in the company’s securities until such information is disclosed to the public.

It’s not often that an SEC Commissioner quotes Bruce Springsteen – not once, but twice – in a speech on securities regulation. But SEC Commissioner Hester Peirce did just that in a February 6, 2020 speech in which she unveiled her novel proposal for a digital asset safe harbor. The proposal would create a three-year securities regulatory grace period during which digital network developers could distribute digital tokens while building a decentralized or functional network, provided they engage in good faith efforts to achieve decentralization or functionality within three years, fulfill disclosure obligations, sell the tokens with a purpose of facilitating network access, participation or development, undertake reasonable efforts to create token liquidity and file a reliance notice with the SEC.

Commissioner Pierce’s proposal may be the most significant since Commissioner William Hinman’s speech at the June 14, 2018 Yahoo Finance Conference in which he set forth the now generally accepted proposition that a digital asset originally offered in a securities offering could later be sold in a manner that does not constitute an offering of a security, where there is no longer any central enterprise being invested in or where the digital asset is sold only to be used to purchase a good or service available through the network on which it was created, i.e., where the network is either decentralized or functional.

Commissioner Peirce opened her speech (after quoting the Boss) by describing what she referred to as a regulatory Catch 22. Digital token network developers fear distributing tokens until the network is either decentralized or fully functional because doing so would violate the Securities Act. But they can’t develop a centralized or fully functional network unless they widely distribute the tokens to many people. Developers’ enforcement concerns are well founded given the Commission’s digital token offering enforcement campaign over the last two years, and I’ve blogged about it extensively. See, for example, here, here, here and here for my most recent posts on digital token sale enforcement.

Commissioner Peirce’s proposal seeks to resolve the regulatory Catch 22 by bridging the gap between a blockchain network’s initial centralized phase (when the tokens would be deemed to be securities) and its hoped-for decentralized or fully functional stage. The safe harbor would provide network developers a three-year grace period to facilitate development of and participation in a decentralized network by exempting (i) the offer and sale of tokens from the provisions of the Securities Act of 1933, (ii) the tokens from registration under the Securities Exchange Act of 1934 (the “Exchange Act”), and (iii) persons engaged in certain token transactions from the definitions of “exchange,” “broker,” and “dealer” under the Exchange Act.

To qualify for the proposed safe harbor, digital token network developers would have to meet the following five conditions:

  1. Reasonable Development Efforts: The development team must intend for the network to reach network maturity, defined as either decentralization or token functionality, within three years of the date of the first token sale and undertake good faith and reasonable efforts to achieve that goal.
  2. Disclosure. Disclosure of material information on a freely accessible public website, including source code and transaction history, description of the purpose, protocol and operations of the network, plan of development, prior token sales, initial development team and certain token holders, any secondary trading platforms on which the token trades and any member token sales of five percent or more.
  3. Purpose of Token Sales. The tokens must be offered and sold for the purpose of facilitating access to, participation on or the development of the network. This condition is intended to clarify that the safe harbor is not appropriate for debt or equity securities masquerading as tokens.
  4. Token Liquidity. The development team must undertake good faith and reasonable efforts to create liquidity for token holders.
  5. Notice of Reliance. The development team must file a notice of reliance on EDGAR within 15 days following the date of the first token sale in reliance on the safe harbor.

The safe harbor is not intended to provide immunity from fraud and is subject to bad actor disqualification under the securities laws.

Previously, compliant token offerings have been conducted pursuant to offering exemptions under Rule 506(c) of Regulation D or under Regulation A+. As Commissioner Peirce notes, however, because Rule 506(c) requires that sales be made only to accredited investors and there aren’t enough accredited investors to go around, this poses a built-in impediment to building a decentralized network. As to the alternative, Regulation A+, Commissioner Peirce observes the costs of conducting such a “mini-IPO” can be prohibitive. And even if a development team has the financial resources to do so, once the token is a security it must trade as a security while a core benefit of a token network is its non-reliance on intermediaries — people transact directly with one another. Having to buy or sell tokens through a registered broker-dealer or on a registered exchange would impede the development of a thriving, decentralized crypto network.

Finally, the condition that the development team promote liquidity in the tokens may seem antithetical to the securities offering law doctrine that generally holds that attempts to facilitate secondary trading is one indicator of a securities offering. Commissioner Peirce recognizes this, but seeks to reconcile the apparent contradiction by positing that in the context of the safe harbor, secondary trading is necessary both to get tokens into the hands of people who will use them and to offer developers and network service providers a way to exchange their tokens for fiat or crypto currency.

The Securities and Exchange Commission is proposing to expand the definition of “accredited investor” to include additional entities that could bear the economic risks of investment and certain financially sophisticated persons irrespective of income or wealth. The Commission’s main objective is to identify more effectively institutional and individual investors that have the knowledge and expertise to participate in private capital markets and thus do not need the protections of registration.  If adopted, the proposed expansion would significantly benefit issuers and investors alike.

Regulation D and Current Accredited Investor Definition

Private offerings conducted under Rule 506 of Regulation D play a significant role in capital formation in the United States. In 2018, an estimated $1.7 trillion was raised in Rule 506 offerings, as compared with $1.4 trillion raised in registered offerings. Of the $1.7 trillion raised in private offerings, $1.5 trillion went to investment funds and $228 billion to operating issuers.

Rule 506 allows an issuer to sell shares to an unlimited number of “accredited investors” and up to 35 non-accredited investors. As a practical matter, however, the vast majority of issuers in Rule 506 offerings offer and sell the offered securities only to accredited investors. The reason for this is a built-in disclosure bias in favor of accredited investor-only offerings: if you sell only to accredited investors, you do not have to satisfy the specific, mandated and rather onerous disclosure requirements set forth in Regulation D. Instead, an issuer selling only to accredited investors may determine for itself what is material and what is not, and satisfy its disclosure obligation through the concept of “access”, whereby the investors are given access to information offered to or requested by the investors and an opportunity to ask questions directly. The theory here is that an accredited investor is able to fend for himself and has the leverage to extract information.

Currently, the term “accredited investor” means anyone who fits any of the following categories:

  • banks, registered broker-dealers, certain insurance companies and certain employee benefit plans with more than $5 million in assets;
  • private business development companies;
  • 501(c)(3) companies, corporations, business trusts and partnerships, in each case exceeding $5 million in assets and not formed to acquire the offered securities;
  • directors, executive officers and general partners of the issuer of the securities, or any director, executive officer or general partner of a general partner of that issuer;
  • individuals with net worth, or joint net worth with spouse, exceeding $1 million;
  • individuals with income of over $200,000 (or $300,000 with spouse) in each of two most recent years, with reasonable expectation of earning at least same in current year;
  • trusts with assets exceeding $5 million not formed to acquire the offered securities, whose purchase is directed by a sophisticated person; or
  • entities in which all of the equity owners are accredited investors.

In June 2019, the Commission issued a concept release that solicited public comment on ways to simplify and improve the exempt offering framework to promote capital formation and expand investment opportunities while still maintaining appropriate investor protections. In the concept release, the Commission requested comments on possible approaches to amending the definition of “accredited investor” in Rule 501(a) of Regulation D.

Historically, the accredited investor definition used income level and wealth as a proxy for both capacity to sustain investment loss and for financial sophistication. The problem with the old approach is that it excluded investors who are financially sophisticated but do not meet the income and wealth criteria. In this regard, the concept release requested comment on the use of sophistication measures other than income and net worth to expand the universe of accredited investors.

Proposal to Expand Accredited Investor Definition

The Commission’s current proposal to expand the accredited investor definition was presented in its release dated December 18, 2019 entitled Amending the “Accredited Investor” Definition (the “Release”). The Release is premised on the Commission’s stated belief that wealth and income should not be the sole means of establishing financial sophistication for purposes of the accredited investor definition. Accordingly, it seeks to create new categories of individuals who would qualify as accredited investors irrespective of wealth and income on the basis that such investors have the requisite financial sophistication to assess an investment opportunity. It also seeks to add new categories and add to existing categories of entities that can fend for themselves as a result of asset ownership or investment in securities.

The proposed revised definition would add the following categories of individuals and entities as “accredited investors”:

  • individuals with a license as a general securities representative (Series 7), investment adviser representative (Series 65) or private securities offerings representative (Series 82);
  • “knowledgeable employees” of a private fund, as to investments in that fund;
  • registered investment advisers (but not “exempt reporting advisers” relying on the venture capital adviser exemption or private funds adviser exemption);
  • “family offices” with at least $5 million in assets under management, directed by a sophisticated person and not formed to invest in the offered securities, as well as their “family clients”;
  • entities owning “investments” of more than $5 million, so long as the “investments” fall within Rule 2a51-1(b) of the Investment Company Act and so long as the entity was not formed for the specific purpose of investing in the offered securities;
  • limited liability companies exceeding $5 million in assets not formed to acquire the offered securities; and
  • rural business investment companies.

Benefit to Issuers and Investors

The proposed amendment to the accredited investor definition could prove enormously advantageous to issuers and investors beyond the obvious expansion of the universe of accredited investors who supply the vast majority of private capital in the U.S.  The benefit of an expanded accredited investor definition to Regulation A issuers is that accredited investors are not subject to the Tier 2 investment cap.  In Regulation Crowdfunding offerings, the expanded definition would mean enhanced resale opportunities inasmuch as securities purchased in a Regulation CF offering may not be resold for a one year period other than to accredited investors, the issuer or family members (or in a registered sale).  The reasonable verification requirement has been identified as an impediment to Rule 506(c) offerings, and the expansion of the definition to include those with professional certifications would provide issuers with more palatable methods to verify status. For holders of restricted securities, an expanded accredited investor pool would make it easier to conduct a private resale under Rule 4(a)(7) which requires that the purchaser be an accredited investor.  If the proposed rules indeed make it easier to conduct private resales of restricted securities, this could lead to lower liquidity discounts and thus higher prices.

Finally, the Release also proposes to amend the definition of “qualified institutional buyer” for purposes of the resale exemption under Rule 144A to include additional entity types that meet the $100 million threshold to avoid inconsistencies between the types of entities that are eligible for accredited investor status and those that are eligible for qualified institutional buyer status under Rule 144A.

The Commission is seeking input on its proposed amendments to the accredited investor definition, and comments may be communicated using the Commission’s internet comment form, by email to or by mail to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. Published comment letters, including your humble blogger’s January 13, 2020 comment letter regarding inclusion as accredited investors limited liability companies with more than $5 million in assets not formed to invest in the offering, as well as managers of manager-managed LLCs, could be found here. Comments need to be received by the Commission not later than March 15, 2020 (60 days after the Release’s January 15, 2020 publication in the Federal Register).

On September 30, 2019, the Securities and Exchange Commission announced that blockchain developer had agreed to pay a $24 million fine to settle charges that it had engaged in an unregistered offering of securities in violation of Section 5 of the Securities Act.  The announcement set off a mini-firestorm of criticism in the crypto community because the $24 million penalty seemed disproportionately small relative to the $4 billion it raised in its ICO and relative to the penalties imposed on other ICO issuers targeted by the Commission in similar cases not involving fraud.  Moreover, was not hit with any of the non-monetary sanctions imposed in the other cases, namely rescission, registration and bad actor disqualification. The apparent enforcement disconnect has resulted in confusion among ICO issuers, exchanges, lawyers and other players in the space, along with demands for an explanation from the Commission and predictions that the case signals a relaxation of enforcement policy. A closer look at the circumstances of’s ICO, however, suggests another possibility.

Rescission, Registration and Bad-Actor Disqualification

Before, Commission sanctions in unregistered offering cases not involving fraud allegations such as Airfox and ParagonCoin included rescission, registration and bad-actor disqualification.

Rescission refers to the process of remedying a securities violation by offering investors the right to rescind their purchase of securities and receive a repayment of their investment. Purchasers who reject the offer lose the right to bring a private action under state securities law, but it is unclear whether federal claims are barred as well. The Commission has taken the position through no-action letters that rescission offers don’t eliminate Federal securities liability to those rejecting the offer, but Federal courts have held the opposite.

The mechanics of the rescission obligation under previous settlement orders begin with the requirement to issue a press release within a certain number of days following the settlement order.  The press release notifies the public of the order and links to the rescission claim form, which also must be posted on the issuer’s website.  The claim form along with a notice is then delivered to all potential claimants informing them of their rescission rights and the deadline for filing the claim form. The issuer then is required to make payments to all claimants properly delivering claim forms, and to provide updates to the Commission to enable the Commission to monitor the rescission process.

A rescission offer is deemed a separate offer of securities which must either be registered or qualify for an offering exemption. This is to ensure that those receiving the offer have sufficient meaningful information on which to base a decision on whether or not to accept the offer. Consequently, the aforementioned settlement cases also obligate the issuer to register the ICO tokens with the Commission. Specifically, the issuers in the subject settlements were required to register the tokens on Form 10 under the Securities Exchange Act of 1934. See for example ParagonCoin’s Form 10 here. The filing of a Form 10 also triggers the periodic reporting requirements of the Exchange Act, obligating the issuer to file annual reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

Finally, the settlements also include bad actor disqualification from future utilization of the exemptions provided in Regulation A, Regulation CF (crowdfunding) and Regulation D.  Although the settlement orders don’t explicitly provide as much, the disqualification applies because the order requires the issuer to cease and desist from committing or causing any future violations of Section 5 of the Securities Act, and a Commission order to cease and desist from future violations of Section 5 of the Securities Act is one of the disqualifying events under the Commission’s bad actor rules.

Why the Enforcement Disparity?

So what explains the apparent enforcement disparity between, which involved only a relatively insignificant monetary penalty, and previous non-fraud unregistered offering cases which included rescission, registration, bad-actor disqualification and relatively more significant penalties relative to offering proceeds? Some have suggested that the settlement order signals a relaxation of enforcement in these cases. Others have justifiably called for the Commission to provide more detail and explain the disparate treatment.

It would certainly be helpful to ICO issuers, exchanges, lawyers and other market participants for the Commission to provide further detail explaining the apparent disparity. In the meantime, some of the details of how the ICO was conducted may suggest an explanation. The order states that implemented certain measures to prohibit U.S. persons from participating in the ICO.  First,’s offering website included certain measures intended to block U.S.-based purchasers from buying the offered digital tokens, including by blocking U.S.-based IP addresses from accessing the website token sale page. Second, required all token purchasers to sign a token purchase agreement which provided that U.S. persons were prohibited from purchasing the tokens and that any purchase by a U.S. person was unlawful and rendered the token purchase agreement null and void.

So if took steps to ensure offers and sales were not made to U.S. persons, why was the ICO of any concern to the Commission? Despite the aforementioned efforts to exclude U.S. persons from purchasing tokens in the ICO, the settlement order implies that some portion of the multi-billion dollar proceeds was raised from U.S. persons. The Commission also implies in the order that whatever U.S. sales did occur may not have been purely accidental. The order states that did not ascertain from purchasers whether they were in fact U.S.-based persons. Also, a number of U.S. based persons apparently purchased tokens directly through’s offering website, and received information through that site and various social media and forum posts. Further, the order states that undertook efforts for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the U.S. for the tokens, including by engaging in directed selling efforts. Among other things, was said to have participated in blockchain conferences in the U.S. where it promoted its ICO.  Its offering website, white paper and other promotional statements were accessible to potential U.S. purchasers. Finally, the order states that the tokens were traded and widely available for purchase on numerous online trading platforms open to U.S.-based purchasers throughout the duration of the ICO, and that didn’t take any steps to prevent the tokens from being immediately resold to U.S.-based purchasers in secondary market trades.

So in the final analysis, the Commission may have been worried about’s selling efforts in the U.S. despite the tangible and seemingly reasonable safeguards implemented by it to ensure no sales were made to U.S. persons. But perhaps because the Commission was not ultimately able to prove how much of the offering proceeds were in fact generated in the U.S., and because of the difficulty of ever being able to make such a determination, the Commission may have tried to split the baby by settling with under terms more relaxed than in previous enforcement actions.

Key Takeaway

The key takeaway here is that ICO issuers that believe they can conduct a successful offering outside the U.S. should implement the safeguards employed by while avoiding the offering pitfalls that may have undercut its efforts to exclude U.S. persons.  That means blocking U.S.-based IP addresses from accessing the offering website, requiring that all token purchasers sign token purchase agreements prohibiting U.S. persons from purchasing tokens and providing that any purchase by a U.S. person is unlawful and renders the token purchase agreement null and void.  It also means obtaining written representations from purchasers that they are not U.S.-based persons.  It also means refraining from any efforts that could reasonably be expected to have the effect of conditioning the market in the U.S. for tokens, including by engaging in directed selling efforts such as promoting the ICO in U.S. blockchain conferences. Issuers should ensure that their offering website, white paper and other promotional statements are not accessible to potential U.S. purchasers, and that their digital tokens are not available for purchase on online trading platforms open to U.S.-based purchasers.