SEC v Heart Dismissal: Takeaways for Structuring Offshore Token Offerings

Background

The dismissal of the SEC’s case against Richard Heart, Hex, PulseChain and PulseX was based on lack of personal jurisdiction. The court went further, however, and stated that even if it had personal jurisdiction over defendants, the transactions were not sufficiently domestic to implicate Section 5 of the ‘33 Act .

US jurisdiction minimization and Regulation S are interconnected, and sometimes overlapping, concepts. For deeper discussion on the interconnection, see my prior post, here. To briefly recap, practitioners responsible for designing offshore token offerings that fall into Category 1 of Reg S should generally aim for jurisdictional minimization in parallel. Offerings that result in Category 3 (or the very rare Category 2) may be unable to negate personal jurisdiction given that the issuer will be a domestic or a US person-controlled offshore entity, but these offerings can, under certain circumstances, be designed to minimize the application of the extraterritorial application of the Securities Acts.

Note re interplay of jurisdiction minimization and Reg S. Lawyers are likely to be most familiar with jurisdictional work in the context of litigation. The concept of jurisdiction minimization as an affirmative advisory objective is far less often discussed, but where it is determined that Reg S is appropriate and it is the client’s intent to conduct an offering outside the application of US law , then counsel should, at minimum, ensure the offering comports with the safe harbor requirements, but ideally counsel’s advice should seek to incorporate offering mitigants and communications protocols that minimize US jurisdiction potential, generally, especially since the two areas of advice are not always mutual inclusive.

Further note re nature of guidance. This is a district court opinion subject to appeal. It may be overturned and, even if it is not, there is no guarantee the opinion will be accepted nationally. Having said this, it is our duty, as TGE advisors, to make use of what guidance we are provided.

Takeaways

Issuers with no/minimal US infrastructure and who are actively regulated in a foreign jurisdiction may be outside the reach of the ‘33 Act, even where US residents participated in an offering

Irrespective of whether personal jurisdiction exists with respect to an issuer, the court noted that US legislation “is meant to only apply within the territorial jurisdiction of the United States.” Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247, 255 (2010).

In Morrison the court held that the Exchange Act only applied to securities that: (i) traded on US exchanges or (ii) otherwise were involved in “domestic” transactions. As was the case with Hex et al, Reg S token will never be traded on a US securities exchange. Therefore, the critical question begged was under what circumstances is a crypto asset issuance sufficiently domestic to trigger Section 5(a)?

In answer, the court laid out the “irrevocable liability” requirement, as set forth in Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 68 (2d Cir. 2012). Quoting Absolute: “[I]rrevocable liability can be used to determine the locus of a securities purchase or sale…” with key facts “including, but not limited to, facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.” Id at 70. To the extent any of the foregoing occurs in the US, the issuer/purchaser may become irrevocably bound within the US.

The SEC argued that irrevocable liability existed in the US based on the authority set forth in Williams v Binance, which found irrevocable liability based in the US on two inter-connected facts: (i) extensive infrastructure located in the US and (ii) the need to focus on where buy orders originated (rather than where executed/fulfilled) because Binance “disclaimed having any physical location or being subject to any country’s securities regulation.”

Here, the court found no irrevocable liability in the US because Heart/Hex had no significant US-based infrastructure and Heart claimed Finish residency (and Finland did not disclaim regulatory responsibility over Heart as Malta did over Binance in Williams). This line of reasoning suggests jurisdictional defenses may backstop a technical failure of the offshore transaction condition of Reg S where:

• the issuer is subject to a foreign regulator (BMA in Bermuda, MAS in Singapore, FSRA, in Abu Dhabi, etc); and
• the issuer has no (or minimal) infrastructure/assets/personnel in the US and
• the token is not listed on a central exchange in the US.

What is not clear is whether incorporation/organization in a jurisdiction where token issuance is generally not a regulated activity (e.g. BVI and Panama) suffices. Generally, financialized, securities-like products that will continue to require Reg S protection are not launched from BVI (but Panama continues to be an option for projects with tokens that present heightened regulatory challenges in other jurisdictions).

Social media posts published outside of the US that do not specifically target the US, may not be sufficiently domestic offers to implicate Section 5(c).

In addition to liability for unregistered “sales” under 5(a), the SEC also alleged Heart “offered” for sale unregistered securities in violation of Section 5(c). Unsurprisingly, Heart argued the locus of the offeror controlled, in determining whether the offer was sufficiently domestic to be charged under Section 5. The SEC argued the place of the offeree (with respect to the US purchasers) controlled.

The court cited SEC v. Goldman Sachs & Co. holding that for an offer to be deemed domestic under the Securities Act required that “a person or entity must (1) attempt or offer, in the United States, to dispose of securities or (2) solicit, in the United States, an offer to buy securities.” 790 F. Supp. 2d 147, 165 (S.D.N.Y. 2011)

The court found that Heart published tweets and other social media posts (from outside of the US) without specifically mentioning/targeting the US. “In sum, the relevant online communications described in the Complaint during the offer periods consist of untargeted, globally available information” (the court specifically distinguished Hardin v. TRON where social media post published outside the US were domestic because they specifically mentioned the US).

This holding can be situationally at odds with the SEC guidance on use of websites to solicit offshore securities transactions (1998) so I suggest that best practices continue to include US disclaimers on social media posts. But again, we have a potential liability backstop in the event there is a lapse (or a designed deviation) from prescribed communications protocols.

US-based issuer activity post-TGE may be ok (but beware in continuous offering scenarios)

The SEC alleged that Heart’s: (i) virtual appearance at various US conferences and (ii) an in-person interview in Miami were sufficient contacts with the US to create specific personal jurisdiction. The court disagreed, noting that the US-based conduct occurred after the offering and such US contacts could not have influenced the offering, itself.

Note that while this is a welcomed outcome for issuers, it creates additional potential complexity for lawyers. First, where US-based activity occurs post-TGE but where the offering is deemed to be continuous (see my posts re continuous offerings as defined under Reg S), it is unclear whether this holding would apply. Second, there are potential scenarios where US-based activity (such as interviews or conference attendance) may be executed in a way that is compliant with the US directed selling efforts prohibition of Reg S. In other words, there will be times that call for the most cautious approach, curtailing all US-based activity. But there may also be times where the strategic value of a particular US contact justifies the effort, assuming the contact can be executed in compliance with Reg S. But doing so, especially if pre-TGE, may compromise jurisdiction minimization efforts. The point is that counsel should be cognizant of potential risk/reward tradeoffs and clients should be fully informed of the same.

In closing…

The change in regulatory tenor we are now experiencing will likely result in a (potentially significant) drop in prudential Reg S offerings for many utility and protocol tokens. At the same time, however, we are seeing an acceleration in sophisticated onchain products that clearly are securities (both in defi and permissioned flavors). Given that Reg S is not tailored for crypto assets and many Reg S token offerings face technical challenges with compliance, jurisdiction minimization and offering mitigants designed to render sales and offers non-domestic should continue to play a significant role in TGE structuring.