Tag Archives: Blockchain

A Millennial’s Guide to Real Estate Investing Podcast

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On this episode of A Millennial’s Guide to Real Estate Investing, host Antoine Martel sits down with Mark Roderick, a leading crowdfunding, investing and fintech lawyer. They talk about blockchain, crowdfunding, the JOBS act, and how all of these things are going to be changing the real estate industry. Also discussed are the different types of crowdfunding flavors and how each of them work.

Questions? Let me know.

Crowdfunding & Fintech for Real Estate Podcast

CF and Fintech for Real Estate Podcast

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Technology has made it easier to raise capital for real estate deals. Since Crowdfunding has grown exponentially, John Casmon, host of the popular Target Market Insights podcast, invited me on his show to learn more about crowdfunding and fintech (financial technology).  On this episode, I talk about different ways to use the internet to raise money and the impact new technologies will have on the way we buy real estate.

Key Market Insights

  • Crowdfunding is raising money on the internet

  • Two versions – donation based (think Kickstarter) and equity based

  • Crowdfunding is online syndication with 3 flavors: title 2, title 3 and title 4

  • All crowdfunding falls under the JobsAct

  • Title 2 is very similar to 506c for accredited investors

  • Title 3 is very different, can only raise $1MM annually

  • Title 4 can raise $50 million

  • FinTech – any technology disrupting the financial services industry

  • Many believe banks should be a disintermediary

  • Roboadvisor apps are apart of FinTech

  • Online syndication is not more risky than traditional syndication

  • Anytime you take money, you can be sued

  • When done properly, you should not be exposed to any actual liability – even if they lose money

  • Blockchain technology could disrupt the real estate industry

  • Blockchain is a database or ledger that cannot be changed and has no central authority – everyone must consent

  • Title companies and other “middle men” could be pushed away through blockchain

Questions? Let me know.

Amendments and Supplements in a Regulation A Offering

Pigeon Point lighthouse USA, California, Big Sur

Your Offering Statement has been qualified by the SEC. Now something changes. Do you have to file something with the SEC? If so, what and how?

Changes Reported on Form 1-U

Some changes must be reported using Form 1-U:

  • If the issuer has entered into or terminated a material definitive agreement that has resulted in or would reasonably be expected to result in a fundamental change to the nature of its business or plan of operation.
  • The bankruptcy of the issuer or its parent company.
  • A material modification of either (i) the securities that were issued under Regulation A, or (ii) the documents (g., a Certificate of Incorporation) defining the rights of the securities that were issued under Regulation A.
  • A change in the issuer’s auditing firm.
  • A determination that any previous financial statements cannot be relied on.
  • A change in control of the issuer.
  • The departure or termination of the issuer’s principal executive officer, principal financial officer, or principal accounting officer, or a person performing any of those functions even if he or she doesn’t have a title.
  • The sale of securities in an unregistered offering (g., Rule 506(c)).

Form 1-U may be used, at the issuer’s discretion, to disclose any other events or information that the issuer deems of importance to the holders of its securities.

NOTE:  If an event has already been reported on an annual or semi-annual report, the same event does not have to be reported again on Form 1-U.

NOTE:  A report on Form 1-U must be filed even if the Regulation A offering has ended.

Amendments

After the offering is qualified by the SEC, the issuer must file an amendment of its Offering Statement “to reflect any facts or events arising after the qualification date. . . .which, individually or in the aggregate, represent a fundamental change in the information set forth in the offering statement.”

Examples of fundamental changes:

  • A change in the offering price of the security.
  • A change in the focus of the issuer’s business, g., we were going to focus on cryptocurrencies, but now we’re pivoting to blockchain-based financial services.
  • The bankruptcy of the issuer.
  • A change in the type of security offered, g., from preferred stock to common stock or vice versa.

An amendment of an Offering Statement must be approved by the SEC before it becomes effective, which means waiting.

Even more important, depending on the nature of the change, the issuer might be required to stop selling securities or even stop offering securities (i.e., shut down its website and all marketing activities) while the amendment is pending.

Supplements

After the offering is qualified by the SEC, the issuer must file a supplement of its Offering Circular to reflect “information. . . .that constitutes a substantive change from or addition to the information set forth” in the original offering circular.

Examples of substantive changes or additions:

  • A new Chief Marketing Officer joined the management team.
  • The issuer’s patent application, disclosed in the original Offering Circular, was approved.
  • The issuer moved its principal office.

Unlike amendments, supplements do not require SEC approval and do not require that that the issuer stop selling or issuing securities. Instead, the supplement must be filed with the SEC within five days after it is first used.

Real Estate Supplements

While its offering is live, an issuer in the real estate business — a REIT, for example — must file a supplement “[w]here a reasonable probability that a property will be acquired arises.” Not when the property is purchased, but when there is a “reasonably probability” that it will be purchased.

The SEC doesn’t specify what information to include in these supplements, except to disclose “all compensation and fees received by the General Partner(s) and its affiliates in connection with any such acquisition.” Including a statement of any significant risks associated with the property is a good idea, too.

Having filed a separate supplement for each property, the real estate issuer must then file an amendment at least once every quarter that consolidates the supplements and includes financial statements for the properties. Notwithstanding the general rule for amendments, however, the issuer doesn’t have to stop offering or selling securities pending SEC approval.

Supplement vs. Amendment

An amendment is required for “fundamental changes,” while only a supplement is required for “substantive changes.” Where to draw the line?

There’s a lot at stake. If an issuer uses a supplement where it should have used an amendment, it will be using an Offering Statement that has not been qualified by the SEC. Meaning, the whole offering will be illegal.

The SEC won’t say whether it believes a given change requires a supplement or an amendment, leaving the decision to the issuer and its lawyer. The SEC will, however, allow an issuer to file an amendment even for non-fundament changes, i.e., where a supplement would have done the trick. Filing an amendment takes a little longer, costs a little more, but eliminates the risk of guessing wrong.

Often, however, an issuer wants to make a change but doesn’t want to go through the amendment process. In those cases, the rule of thumb should be as follows:

Would an investor of ordinary prudence want to re-think his investment decision based on the new information?

If the answer to that question is Yes, the new information should be provided via amendment. If the answer is No, it can be provided supplement.

For example, an investor who liked the cryptocurrency space might not be interested in the financial services space, while the addition of a new CMO might be interesting and useful, but unlikely to affect the investment decision.

Contrary to popular belief, the main risk of this or any other violation of the securities laws is not that the SEC will bring your offering to a screeching halt or fine you. Those things are possible, but the SEC has more important things on its plate. The main risk is that an investor will lose money and hire a clever lawyer, who will then seize on your mistake (or your alleged mistake) as grounds to get the investor’s money back.

Supplement vs. Form 1-U

If a change falls within any of the specified categories of Form 1-U, then it should be reported on Form 1-U rather than via supplement.

If the offering has ended, then supplements are no longer relevant and changes should be reported on Form 1-U.

If the offering is still live and the change does not fall within any of the specified categories of Form 1-U, then it can be reported on either Form 1-U or via supplement, take your pick. However, supplements may not be accompanied by exhibits. So if you need to change or add an exhibit (e.g., you’ve modified your Subscription Agreement or entered into a material contract that doesn’t constitute a fundamental change), you should use form 1-U.

Questions? Let me know.

Podcast: The BAD Crypto Podcast – Crowdfunding Law with Mark Roderick

Mark Roderick Crowdfunding Attorney

Recently, BAD Crypto Podcast hosts Joel Comm and Travis Wright were foolish enough to have me on their show, talking about Crowdfunding and Crypto and ICOs and blockchain and French cooking (or was that another podcast?). Click here to listen.

I hope it was informative – it was definitely fun.

Questions? Let me know.

Section 17(b) of the Securities Act in Crowdfunding and Token Sales

Among the tricks of Wall Street bad guys is the fake financial analysis, prepared (and paid for) to promote a particular stock but presented as an objective review. Section 17(b) of the Securities Act of 1933 was written to stop that:

It shall be unlawful for any person. . . . to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof [italics added].

It’s no joke. For example, in April 2017 the SEC brought an enforcement action charging 28 businesses and individuals for participating in a scheme to generate bullish articles on investment websites like SeekingAlpha.com, Benzinga.com, and SmallCapNetwork.com while concealing the compensation.  See Press Release, SEC: Payments for Bullish Articles on Stocks Must Be Disclosed to Investors, Rel. No. 2017-79 (Apr. 10, 2017).

Hypothetical examples in the Crowdfunding and token world:

  • NewCo pays an industry periodical to publish an article written by NewCo that purports to objectively rate the “Top 10 ICOs of 2018” and happens to list NewCo’s ICO as #1. Section 17(b) doesn’t make the article illegal, it just says the periodical has to disclose both the fact that it’s being paid and the amount of the payment.
  • If NewCo paid me to highlight its ICO on this blog, I’d have to report the compensation.
  • A real estate Crowdfunding platform sends an email promoting an offering, or a group of offerings, on its platform. That email is not covered by section 17(b) because of the italicized language above, i.e., it’s clear that the email is an offer of securities (which raises its own issues, separate from section 17(b)).
  • An investor relations firm places favorable articles about NewCo in trade publications while NewCo’s ICO is live. Those articles are covered by section 17(b).
  • A live event called “ICO Summit World” purports to highlight “The Most Promising ICOs of 2018,” but presents only companies that pay to play. Definitely covered by section 17(b).

My sense is that in the Crowdfunding world, and especially in the token world, there’s a lot of paid promotional activity going on without the disclosure required by section 17(b). The securities laws don’t apply to tokens, right?

Questions? Let me know.

The Bad News About ICOs Is Good News

Every day brings more bad news about ICOs: another class action lawsuit, another subpoena by the SEC, another “request for information” by a state Attorney General, another country that outlawed ICOs altogether.

The bad news is probably hurting the industry’s reputation and driving away investors in the short term. But from my perspective the bad news is, on balance, actually good.

The ICO market was crazy in 2017. Lawyers were giving questionable advice, investors were buying anything called a token, and the billions of dollars sloshing around attracted bad actors and instant-millionaires. People convinced themselves this was normal and justified, as they did with tulip bulbs in 1636.

From my perspective, the bad news in today’s headlines shows that the fog is clearing. Among the lessons learned:

  • ICOs were not, after all, a law unto themselves.
  • It’s easier to describe a network than to build one.
  • Some smart contracts are dumb.
  • Honesty is still the best policy with investors.
  • An honest cop is good for the neighborhood.
  • The laws of economics have not been repealed.

Most important, it turns out that there really is value in blockchain, even without the hype, and that real entrepreneurs are building serious value and finding it easier to connect with investors as the fog clears. Your Uber driver is no longer offering tips on Bitcoin, but you can do a legal ICO, there really is such thing as a utility token, and there are a lot of really smart folks building real companies that are going to disrupt and transform a lot of industries.

We’re going through a much-needed adjustment right now. It’s all good, as we young people say.

Questions? Let me know.

Blockchain Is A Technology, Not A Philosophy

John Barlow died last Wednesday. Mr. Barlow wrote lyrics for the Grateful Dead, dabbled in Republican politics in Wyoming, and, more famously, had big dreams for the internet. He referred to the internet as “the new home of the mind” and demanded of governments, “I declare the global social space we are building to be naturally independent of the tyrannies you seek to impose on us.”

Good things have come from the internet, no question, but for the most part Mr. Barlow’s dreams have not materialized. Twenty five years later, the internet means mainly Facebook and Google for most people, along with a loss of privacy, e.g., Equifax. The internet has made it easier to work from home and collaborate and start social movements like #MeToo and #TeaParty, but also allows Russia to interfere with our elections. We’re connected all the time, yet somehow feel more lonely. And all the information circling the globe leaves us with a citizenry somehow less informed than when television came in three black and white channels.

Mixed results are not unique to the internet. Pick any technology – electricity, automobiles, television, nuclear power – and you’ll find the same story of idealistic dreams transformed or broken on the shoals of the real world. We imperfect human beings keep asking technology to save us from ourselves, and it never can.

Which brings us to blockchain.

Speaking at a crypto-conference in New York the day Mr. Barlow died, I heard a speaker predict that blockchain would replace the banking system, that cryptocurrency would eliminate national currencies, that we are about to witness a fundamental change (for the good) in the human condition. You can read articles in serious business publications about the “ethos” of blockchain, how the technology will replace our broken trust in private and government institutions.

In my opinion that thinking isn’t just wrong but dangerous. Blockchain is not going to replace the banking system, and shouldn’t. Cryptocurrencies will replace fiat currencies only in countries without a functioning currency of their own. If you see a country where Bitcoin is the currency of choice, it’s like seeing a guy on the subway with an IV in his arm:  you’re not sure what’s wrong, but you know he’s sick.

If you think blockchain has an ethos, you’ll sell tokens without bothering about securities laws. You’ll encourage wage-earners to invest their savings in a cryptocurrency whose price chart makes Pets.com look stable, having decided that it’s not so much a “currency” as a “store of value.” Most dangerous, you’ll convince yourself that technology is a substitute for morality.

Like every technology, starting with fire, blockchain can improve the human condition only if we tether it to our needs.

Fortunately, based on what I saw at the conference on Wednesday, there’s a lot of tethering along with the hype. Among other things, we heard from entrepreneurs using blockchain technology to:

  • Improve healthcare outcomes
  • Give consumers control over their financial records
  • Facilitate business and consumer payments
  • Reduce fraud in the financial markets
  • Make sense of our antiquated system of property ownership

With the grandiose predictions and the mystification and, frankly, some wishful thinking by lawyers, the blockchain industry has earned a black eye in the minds of many, including government regulators. Even so, light shines through. As an industry, let’s dedicate ourselves to using the technology wisely, making it work for ordinary people, being more transparent than the law requires, thinking long-term, and above all, remembering that how blockchain is viewed 25 years from now depends not on technology, but on imperfect human beings like us.

Questions? Let me know.

Cryptocurrencies: There’s Nothing New Under The Sun

Blockchain technology is revolutionary, promising to disrupt many of today’s industries. In contrast, the cryptocurrencies that live on the blockchain – to avoid confusion, I’m going to refer to cryptocurrencies as “tokens” – are really just high-tech manifestations of traditional ideas.

Broadly speaking, there are three kinds of tokens today:

  • Tokens like Bitcoin that are intended to function as currencies
  • Tokens that represent economic interests in businesses, e., securities
  • Tokens that give the holder some kind of contract right in the business conducted by the issuer, g., a distributed storage network

Tokens that are intended to function as currencies are like, well, they’re like currencies. They’re secure, they’re anonymous (maybe), they’re decentralized, but fundamentally they’re like paper money. The idea of paper money was revolutionary, rendering the barter economy obsolete. A digital representation of paper money is incrementally better, but not revolutionary.

Tokens that are securities – digital stock certificates – are helpful and better than paper or Excel spreadsheets but obviously not revolutionary.

The most interesting kind of tokens are the third:  tokens that give the holder the right to participate in a business.

Imagine you’re Henry Ford designing an automobile. You need a lot of capital. Your investment banker suggests you sell stock on Wall Street, but someone else suggests a different approach. You publish design specifications for your new automobile in something you happen to call a “Whitepaper,” and you sell to the public a limited number of licenses giving the holder the right to manufacture tires (or oil filters, or whatever) based on those specifications.

You just sold tokens, even though the blockchain doesn’t exist and you keep track of the sales in a red leather book.

Financially, you’ve pre-sold licensing rights. Some pros and cons versus selling stock:

  • On the plus side, you still own 100% of your company.
  • On the minus side, you have reduced or eliminated a future revenue stream for the company, e., licensing revenue.
  • On the plus side, because the tokens weren’t a security, you didn’t incur all that time and cost.
  • On the minus side, you really, really care about the quality of your cars – the whole future of your business depends on it – but the tokens might not end up in the hands of the highest-quality suppliers. That’s especially true in a market frenzy that reminds you of Tulip Mania in 1637, where many buyers are low-information speculators.
  • On the plus side, if raising money by pre-selling licensing rights happens to be a super-cool thing, the token sale might raise a lot more money than the licensing rights are actually worth.
  • On the minus side, you didn’t get to deal with securities lawyers.

What about the pros and cons to token buyers?

  • On the minus side, you have far less legal protection, as a buyer and owner of the token, than you would as the buyer and owner of securities in a public company.
  • On the plus side, your specialized expertise as a parts designer or manufacturer might give you a unique ability to increase the value of Ford, and therefore the value of your token.
  • On the minus side, while you know a lot about your own abilities, and might know a lot about Henry Ford and his team, you know nothing at all about the other token buyers. If they turn out to be lousy parts designers and manufacturers, you lose.
  • On the plus side, if you think Ford Motor Company is going to be hugely successful and tokens are the only thing they’re selling, you have no choice.
  • On the minus side, the token probably gives you the right to benefit from only one aspect of the company’s business, g., parts for the the Model T. If the company pivots or expands, you might find yourself left behind.
  • On the plus side, if you’re in a Tulip Mania market, maybe you’ll buy the token today and next week you can double your money selling it to someone else.
  • On the minus side, if we look hard at Ford’s Whitepaper we realize it’s very ambiguous. Do I or Ford really know what I’m getting? Or is this going to end up in litigation?

Who knows where the pros and cons come out. Someday economists will explain whether and in what circumstances a token is more economically efficient than a traditional security.

I feel quite sure that tokens that are currencies and tokens that are digital stock certificates are here to stay, because while not revolutionary, each represents an undeniable, if incremental, improvement over today’s technology. I’m not so sure about tokens that represent prepaid products or services. Until we hear from the economists, the jury is still out.

Questions? Let me know.

CROWDFUNDING AND CRYPTOCURRENCIES

bitcoin-1813503_1920

Cryptocurrencies are hot. And often the sale of cryptocurrencies is referred to as Crowdfunding. Unfortunately, the use of “cryptocurrencies” and “Crowdfunding” together creates confusion about both, along with some pretty serious legal risks.

We use “Crowdfunding” to mean raising money for a business or other venture online. We say “donation-based Crowdfunding” when we’re talking about Kickstarter, where people ask for donations. We say “equity-based Crowdfunding” when we’re talking about raising money from investors, who receive a stock certificate or some other security.

A cryptocurrency is, well, hard to pin down. It’s a transaction registered in a distributed, secure database. Because it exists in limited quantities and is secure, it has value. Like anything of value, it can be used as a currency. For purposes of this post, the key feature of a true cryptocurrency is that is has value of itself, like a nugget of gold.

You use Crowdfunding to sell shares of stock. Obviously, the paper certificates representing the shares of stock have no value by themselves, they have value only to evidence ownership in the business that issued the certificates or, more exactly, in the cash flow the business is expected to generate. So it wouldn’t make sense to say “I’m selling nuggets of gold using Crowdfunding.” The nuggets of gold have an intrinsic value without reference to the cash flow of anything else, or at least you hope they do. I can go shopping with a cryptocurrency like Bitcoin or Ethereum, just as I can shop with US dollars or, historically, with gold.

This is where things get tricky and words matter. The blockchain – the technology underlying all cryptocurrencies – can be used for a lot of things other than cryptocurrencies. As it happens, one of the things the blockchain can be used for is to keep track of stock certificates. In fact, the blockchain works so well keeping track of stock certificates that it will undoubtedly be used by (or replace) all public stock transfer agents within the next five years.

What’s happening today is that companies are selling what they call “cryptocurrencies” that are really just interests in the future operations of a business, i.e., really just hi-tech stock certificates. Cool, they’re using blockchain technology to keep track of who owns the company! But that doesn’t mean what you’re buying is really a cryptocurrency and that you’re going to get rich like the early buyers of Ethereum.

Words are powerful, and the confusion around cryptocurrencies is deepened by the nomenclature. Sales of cryptocurrencies are often referred to as “initial coin offerings,” or ICOs, which implies a similarity to “initial public offerings,” or IPOs. Yet if we’re being careful, the two have nothing in common. In an IPO a company sells its own securities, which have value only based on the success of the company. In an ICO somebody sells a product that has intrinsic value of itself.

Ignoring the difference is going to land someone in hot water, probably sooner rather than later. A company that sells something it calls a cryptocurrency but is really just a share of stock is selling a security, even if that company has an address near Palo Alto. And a company that sells a security is subject to all those pesky laws from the 1930s. If you sell a cryptocurrency that is really just a hi-tech stock certificate, then not only do you risk penalties from the SEC and state securities regulators, you’ll also face lawsuits from your investors if things don’t go as planned.

How to know whether you’re selling a true cryptocurrency or a hi-tech stock certificate? Here are some tips:

  • If the value of the cryptocurrency depends on the success of the business, it’s a security.
  • If the value of the cryptocurrency depends on, or is backed by, real estate or other property, it’s a security.
  • If the cryptocurrency is marketed as an investment, it’s probably a security.
  • If the value of the cryptocurrency depends what the buyer does with it, rather than the success of the business, it’s probably not a security.
  • If the cryptocurrency merely gives the holder the right to participate in a group effort (g., the development of software), it’s probably not a security.
  • If you’re selling the cryptocurrency in lieu of issuing stock, it’s probably a security.

Using Blockchain Technology in Crowdfunding

Guest Co-Author: Benjamin L. Roderick

What Is Blockchain?

Blockchain is the term given to a highly sophisticated database tool that allows “distributed verification.” Most of us heard about blockchain because it is the technological backbone of Bitcoin, the alternative currency, but the possible applications go far beyond that.

To understand what “distributed verification” means, let’s look at a typical Bitcoin transaction, where Franchesca uses her Bitcoin currency to buy a TV from Herb.

On the surface, the transaction is simple: Herb gives Franchesca his TV and Franchesca gives Herb some Bitcoin. But how does Herb know that Franchesca actually owns Bitcoin? And how does he get it from her?  The answer is the blockchain. Distributed all over the world, the blockchain verifies that Franchesca owns Bitcoin, and then records the transfer from Franchesca to Herb, so Herb can use the Bitcoin to buy groceries from Janet.

Benefits of Blockchain

The primary benefits of the blockchain are:

  • It’s secure
  • It provides universal authentication
  • It provides trust for trust-less networks
  • It’s automated
  • It’s almost friction-free, drastically lowering transaction costs
  • It’s easy to audit
  • It’s decentralized
  • It can be (but doesn’t have to be) anonymous.

Here’s a table illustrating where and how blockchain technology can add value:

Ben Roderick Guest Blog Post image

Blockchain technology isn’t perfect yet; some might say it’s not even ready for prime time. Today, the primary drawback is how long it takes to authenticate transactions. A transaction today in Bitcoin takes about 10 minutes to clear, and Bitcoin is a microscopic market compared to, say, credit card transactions. Indeed, the Bitcoin community is engaged in a civil war as to how, or even whether, to change the technology to speed up transactions.

Application of Blockchain Technology

But you can understand why blockchain technology is attracting so much interest from government and private industry. For example, the music industry is plagued by uncertainty over ownership of rights. The title industry exists because of uncertainty as to the ownership of real estate. Credit card issuers spend tens (hundreds?) of millions of dollars processing and authenticating transactions. Airlines have yet to find a way to ensure that every plane is late.

Everyone wants a secure, decentralized, efficient network that can authenticate transactions or information, as long as the FBI gets a back door (no joke).

Here are some possible applications in the Crowdfunding industry:

  • In Title III, we need a centralized system that knows how much an investor has invested in Title III deals.
  • In Title III and Title IV, we need a way to verify the income and net worth of investors.
  • In Title II and Title IV, we could certainly use a way to verify that investors are accredited in some centralized way.
  • A blockchain: the ultimate aggregator and verifier of Crowdfunding deals.

Crowdfunding and blockchain are both pieces of the FinTech industry. We’re going to see blockchain startups raising money using Crowdfunding, and we’re going to see Crowdfunding companies using blockchain technology. A blockchain startup using a Crowdfunding company that uses blockchain technology – that’s not far down the road.

Ben Roderick is currently working on blockchain applications for his MBA Capstone project at Carnegie Mellon University, graduating in May 2016. His email address:  Broderic@tepper.cmu.edu.

Questions? Let me know.

 

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