Grybniak and the Sword of Damocles
Reg S is supposed to provide peace of mind for firms selling securities outside of the United States. Instead, its availability in the contemporary global economy is increasingly uncertain.
I started Brogan Law to provide top quality legal services to individuals and entities with questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their startup mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz.
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I wrote some op-eds
This week, both Cointelegraph and CoinDesk generously published my thoughts on (i) crypto lobbying and (ii) on-chain securities.
In Cointelegraph, I argued that the optimal amount of spending for crypto-lobbying may be even higher than in 2024. This is because, I argue, the long term surplus generated by the cryptocurrency industry in the United States is likely to be in the trillions of dollars, but the ability to generate that surplus is extremely sensitive to political outcomes. Meaningfully, the last administration came close to contracting the cryptocurrency industry, and another four years of the Biden administration would probably have done permanent damage. These conditions mean that effective political spending, even in the hundred millions or billions of dollars, is a genuine bargain. This argument requires the reader to accept the assumption that the cryptocurrency industry is a net positive when unrestrained, but I do not think that should be controversial here. Check it out here.
In CoinDesk, I discussed Robinhood CEO Vlad Tenev’s recent WaPo op-ed, in which he argued for various policies to liberalize US securities law. Ultimately, Tenev wants the SEC to permit tokenized private securities to “provide an alternative path to the traditional IPO.” Such a regime could fall anywhere along the spectrum of private to public securities, which is why I call it a “third way.” Read my thoughts here.
Regulation S is Broken
The main story today, though, is something completely different. For the past few months, as Donald Trump won the 2024 election and ascended to the Presidency, we’ve mostly covered current events and their implications. Of course, those events are ongoing and, some, like the massive tariffs on Mexico and Canada announced this weekend, are extremely consequential. I want to step back into policy though.
In the past, we’ve discussed different methods of selling securities. The most visible approach is to “go public” or register securities to sell on national exchanges—this is extremely expensive, but for the largest companies it is an opportunity to (i) raise quantities of capital from deep public markets, and (ii) make the formerly illiquid private shares held by founders, employees and investors highly liquid.
But far more sales are private. These rely on exemptions like Reg D, Reg CF, and—the topic today—Reg S.
Regulation S is an exemption from United States securities laws covering foreign transactions. It has some highly specific conditions, which are beyond the scope of this particular article. For more information, I highly recommend James Williams’ Crypto Law Tactics and Observations, which goes deep on the nuance.
In the first instance, foreign transactions may be outside of the SEC’s legal authority. In 2009’s Morrison v. National Bank of Australia, the Supreme Court set legal margins to the extraterritorial scope of U.S. securities laws. However, this scope was subsequently increased in Dodd-Frank in 2010 to follow the “conduct and effects test.” SEC enforcement authority extends to transactions either significantly occurring in the United States (conduct), or having substantial effects on United States markets (effects). This is quite broad, so the legal margins are not so protective.
Filling the gaps, Reg S sets rules to determine which transactions are nonetheless exempt from registration. Different transactions may qualify depending on the circumstances, and so there are three categories related to who is offering the securities and under what conditions. The details of those are available here.
Regardless of the category, however, the exemption is somewhat delicate. While you might expect extraterritoriality to be broadly protective against U.S. laws, the SEC does not treat it that way. If the conditions for compliance with Reg S are not met, then the exemption is unavailable.
For today’s purposes, the most important condition is that a Reg S offering must not involve “directed selling efforts” into the United States. Directed selling efforts means “any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States.”
Crypto Use Cases
Compared to other exemptions like Reg D, Reg A, or Reg CF, Reg S is relatively simple for cryptocurrency firms to use. Depending on which category the firm falls in, compliance requirements fall between none and limited. Regardless of category, no filing like Form D need be made to the SEC.
Because of this, many cryptocurrency firms loosely rely on Reg S to sell cryptocurrency tokens offshore. The sense among these companies is that extraterritorial sales should not be subject to U.S. securities laws, and as long as they enforce lockups and reasonable compliance, they should be in the clear.
Quietly, though, an EDNY case late last year undermined that assumption, and may have closed Reg S to virtually all contemporary cryptocurrency firms. Judge Eric Komitee’s summary judgment order seems to have gone largely under the radar as some, uh, significant political events occurred in autumn of ‘24—but its consequences could be far reaching.
SEC v. Grybniak
From 2017 to 2018, the firm Opporty and its founder Sergii "Bergey" Grybniak sold $600,000 of “OPP” tokens. These tokens were sold using typical Simple Agreement for Future Token (SAFT) agreements to approximately 200 investors in the United States and abroad. The firm verified the accredited investor status of the six investors located in the United States and filed a Form D to avail itself of the Reg D exemption. it stated on that Form D that certain of the sales were made under Reg S—presumably all the ones not covered by Reg D. During this period, the firm also made a number of allegedly fraudulent statements about their business and regulatory status.
By 2020, the SEC had taken notice and filed charges alleging that Mr. Grybniak and Opporty violated a number of securities laws including unregistered offer and sales of securities under Section 5 of the Securities Act of 1933. In doing so, the SEC implicitly relied on a legal doctrine known as “integration.”
Integration, governed by USC § 230.152, specifies that “two or more offerings are to be treated as one for the purpose of registration or qualifying for an exemption from registration” under certain conditions. The rules around this have changed a little over the years, but presently they are governed by the “general principle” that “offerings of securities will avoid integration only if the issuer establishes that each offering—based on its particular facts and circumstances—either (1) complies with the registration requirements of the Securities Act or (2) is exempt from registration.”
The effect of integration, practically, is that the various exempt offerings are then treated as a “single plan of financing”, which, because it was designed to fit within various different exemptions, will, when combined, not qualify for any exemption. This means, in general, the integrated offering will constitute a single unregistered offering that is illegal under Section 5.
That’s a problem for anyone attempting to sell securities under multiple exemptions, however, there are a number of safe harbors—statutory exceptions to integration that provide a path to make multiple exempt offerings at once. One of these safe harbors, crucially, is 152(b)(2), which states that compliant Reg S offerings will not be integrated.
Good for Grybniak, right? Wrong.
Mr. Grybniak argued that his offering was “exempt because it satisfied two exemptions” Reg D and Reg S, which would place it squarely within the 152(b)(2) safe harbor and leave it immune to integration. In September, however, Judge Komitee ruled against him on summary judgement. The reason why is what makes this case so interesting.
While acknowledging the general availability of the 152(b)(2) safe harbor, the court found that Mr. Grybniak was unable to satisfy the conditions of Reg S because there was “no genuine dispute” that he engaged in directed selling efforts into the United States:
As discussed above, the defendants made Opporty's offering materials, including the White Paper, PPM, and SAFT, publicly available on the company's website. Opporty discussed the ICO on social media platforms (including Facebook, Twitter, and YouTube) and other online forums. Grybniak touted the ICO at digital asset conferences in the United States, including in San Francisco and Miami in January 2018. The defendants paid digital asset “advisors” located in the U.S. to promote the OPP Tokens. Through the efforts of these advisors and the company itself, the Opporty ICO was discussed in “sponsored” press releases, articles, and other content published on third-party websites. All this online content was accessible in the United States; at no time prior to the ICO pre-sale did Opporty attempt to differentiate between U.S. and foreign investors, or otherwise limit the reach of any offshore component of its ICO to only non-U.S. persons. At the very least, these efforts “could reasonably [have been] expected to have the effect” of “conditioning” the U.S. market for the sale of the OPP Tokens. Given that reasonable expectation, the Regulation S exemption is unavailable.
This fact pattern should be alarming to any project issuing tokens premised on the availability of a Reg S exemption. Most of the activities identified by Judge Komitee as constituting “conditioning the market” are typical of essentially all cryptocurrency projects. Things like (i) discussing products on social media, (ii) attending conferences in the United States, and (iii) placing press releases on third party websites are all relatively standard practice that would be extremely difficult to segregate between US and non-US buyers. While the court does not identify the minimum quantum of these activities which would have been sufficient to make Reg S unavailable, there is no legal reason it could not have been any of them alone.
Extrapolating this out, it is possible therefore that Reg S is unavailable to any project that has engaged in any of the covered activities such as participating in a YouTube interview or attending a conference in the United States. Given the realities of contemporary cryptocurrency firms, this suggests, broadly, that Reg S may be unavailable to any project in cryptocurrency, period.
Implications
The analysis in Grybniak applies to integration, not an SEC challenge of a Reg S offering on its own. Indeed, at the time of writing, to my knowledge, the SEC has never challenged a crypto Reg S offering on its own. Well known cases of the SEC challenging exempt offerings like SEC v. Telegram have, so far, always involved both domestic and offshore sales.
None of the analysis in Grybniak is specific to integration, though. On the contrary, all of Judge Komitee’s reasoning should apply with equal force to any other Reg S offering, integrated or not. Since it is impossible to disaggregate the various conditioning activities from one another, it is also impossible to definitively say that any Reg S offering by a firm participating in any of these common activities is compliant.
This creates an incredibly narrow window to confidently rely on Reg S for risk-adverse firms. Here are the paths as I see them:
Attempt to extrapolate a rule from Grybniak and tailor public communications to avoid identified activities. In this path, firms should refrain from making any online public comment about tokens that they seek to sell under the Reg S exemption. To the extent that they take interviews or produce content for social media platforms, they should avoid mentioning the token, or, to the extent they must, they should avoid discussing tokenomics or the terms of distribution or sale of the token. They should also geofence the United States from accessing any portion of their website that mentions their token or the terms of token sales. To the extent they wish to make a Reg D offering alongside their Reg S sales, they should carefully evaluate all marketing of the Reg D sales to ensure it is wholly differentiated from Reg S sales, and consider making sales under different terms in the US and abroad. Since “conditioning the market” is indeterminately broad, this approach does not guarantee compliance with Reg S, but it makes a good faith attempt to comply with the rule as articulated.
Projects could also attempt to sit outside of the jurisdictional margins of US securities laws. Even post Dodd-Frank, the conduct and effects test still has limits. By sitting outside those margins, token sellers can be sure to avoid U.S. enforcement. To do so, an offering might be structured to be wholly foreign, geofencing U.S. purchasers from even seeing that the offering is being made, refraining from soliciting sales on social media which might be visible in the United States. The issuer in this case should also involve no U.S. intermediaries or underwriters who might resell tokens into the United States at a later date. This strategy is relatively low risk (at least, with respect to U.S. law) to the extent firms are able to follow it, but it is also profoundly limiting in a global economy.
Finally, Projects could say “screw it” and assume that the SEC will not pursue foreign issuers even where they arguably could, provided the firm and offering remain directed at foreign markets. Applying this strategy, a firm might avoid the U.S. market enough to feel relatively comfortable, but not take such rigorous steps to be legally extraterritorial as in Option 2. This is probably the most common approach, and is weakly supported by the lack of SEC action against foreign token issuers who nonetheless participate in social media and attend crypto conferences in the United States. Despite this practical support, though, this approach is legally difficult to endorse. One can easily construct a story where the SEC only pursues token issuers when they actually sell into the United States, and chooses to ignore other issuers that it could legally pursue for a host of reasons, but the spectre of enforcement will nonetheless continuously hang over this arguably non-compliant category like the sword of Damocles.
Obviously, many firms choose to operate outside of the realm of strict compliance—and with chaos reigning in Washington, it is hard to say this won’t be an optimal strategy for the next four years. Nonetheless, it is a real problem to have an incoherent Reg S exemption regime.
To begin, Rule 152 makes no sense. It applies in situations where two or more exempt offerings occur concurrently, and integration is restricted to situations in which at least one of the offerings does not comply with an exemption from registration. But then, in the same breath, it creates a safe harbor from integration of compliant Reg S offerings—those scenarios should already be excluded from integration! This leaves the 152(b)(2) safe harbor as a meaningless rump rule, something courts are famously loath to read into law. Then, to make matters worse, in nearly all situations where a domestic exemption is combined with a concurrent Reg S offering, the Reg S offering would be non-compliant because marketing for the domestic exempt sales would constitute directed selling efforts and compromise the Reg S exemption. This makes 152(b)(2) doubly meaningless!
Even beyond this technical and aesthetic complaint, a Reg S regime that can be defeated by commonplace global marketing channels like YouTube, X, or a website undermines the whole point of the rule—to permit foreign security sales to operate outside of U.S. law. Yes, the SEC doesn’t seem to actively pursue these cases with any regularity, but retaining plenary authority against foreign issuers is certainly market chilling. If a rule exists to create channels for economic activity outside of U.S. regulation, then it should actually do that.
Maybe this won’t matter in the next four years, but with any luck a fifth year will follow, and I would like to see more avenues to legally offer tokens available by then. Now, maybe that will be because cryptocurrency tokens are recognized as non-securities by then, or maybe we’ll follow Mr. Tenev’s lead and create a regulatory third way, but the status quo is unsatisfactory.
Until next week.
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