ICO Regulation in the USA: Legal Risks for Startups and Investors

Initial Coin Offering or ICO in the United States carries certain legal responsibilities to the project teams that organize it. In particular, after the boom in this crowdfunding type in 2017-2018 and related scams, government regulators had to tighten control over cryptocurrency sales. For example, in the US, projects launching ICOs have to ensure careful compliance with the SEC and other regulatory bodies. In this guide, we will consider legal specifications about the ICOs in the US.

What Is an ICO and Why Is It Regulated?

ICO is a way for startups to raise funding through the sale of tokens, i.e. virtual assets, with pre-agreed areas use and rules of getting profit. ICO has become an alternative to venture financing and helped teams that were developing their projects on the blockchain to sell tokens to investors before the full-fledged product was released.

The peak of ICOs occurred in 2017-2018: projects raised hundreds of millions of dollars in a matter of days, however, with the growing number of fraud cases (including the hyped blockchains like FAROL, PlexCoin, and Confido), when project teams suddenly disappeared along with investors' money, ICOs attracted the attention of the SEC. In particular, the legislation of that time allowed this US commission to perceive such precedents as unfulfilled obligations classified as securities. Since then, a number of new ICO laws have emerged to ensure more stringent control over ICOs and thereby reduce the risks for crypto investors.

The Legal Status of ICOs in the United States

The main authority for ICOs regulation in the USA is the U.S. Securities and Exchange Commission (SEC)

• Legality of the way to attract investments;
• General transparency of business activities;
• Realistic expectations of profit;
• Dependence of profit on the internal efforts of the team and on third parties.

If all four conditions are met, from this moment, the ICO begins to be perceived as a sale of securities, and Section 5 of the Securities Act of 1933 and the Exchange Act can cover it. Accordingly, United States ICOs are required to be registered officially or work under one of the exceptions (Reg D, Reg S, or Reg A+).

As for investors, they must first understand the type of tokens they are going to buy on the US ICO. This can be:

• Utility token, which is needed to access the service within the project (most often, they are not considered securities at the regulatory level);
• A security token that promises a share of profits and dividends to its holders (in the US, they require registration, full compliance with the law, and public disclosure of information).

Key ICO Laws and Regulations You Need to Know

To launch an ICO in the US, projects need to ensure full compliance with the Securities Act (1933), which defines the rules for the issue and sale of securities, and the Securities Exchange Act (1934), which is aimed at regulation of the secondary market.

It is also important to act in accordance with the following ICO regulation exemptions:

• Regulation D, which requires registration for a limited number of accredited investors (usually up to 50 adult individuals);
• Regulation S, which exempts from the obligation to publicly listed tokens outside the US;
• Regulation A+, which applies to “mini-IPOs” up to 50 million USD per year;
• Bank Secrecy Act and Anti-Money Laundering (AML), which requires crypto companies to conduct KYC/AML checks and report suspicious transactions.

Finally, before launching a USA ICO, crypto projects should also take into account potential civil penalties, which may result in forced lawsuits and bans on further activities.

Recent SEC Actions Against ICOs

Based on the SEC's previous actions regarding ICOs, it can be concluded that the attitude of this commission is extremely picky and negative. This is evidenced by precedents with Telegram Open Network (in 2020, the SEC succeeded in blocking $1.2 billion of the Gram issue, demanding a refund to investors) and Ripple Labs (since 2020, the SEC has considered XRP as a security, and the company has to file regular appeals in order not to cease its activities).

Therefore, public offerings of even large projects can be assessed and registered as “illegal sales of tokens” – simply because they have not received SEC permission. Therefore, if you are going to launch an ICO in the USA, be ready to cooperate with lawyers who are well-versed in local legislation from the very beginning.

Legal Considerations for Startups and Investors

Both crypto startups and potential token holders should consider the following aspects before organizing/participating in an ICO:

• Token classification and legal risks. If the token is classified as a utility, there will be fewer risks of non-compliance with the current ICO law. And vice versa, if it is a security token, projects are required to register the emission or use Reg D. In this case, an error or neglecting this step will lead to fines.
• Information disclosure. In essence, this is a document that must include the main risks, the description of an economic model, the emission structure, and buyback mechanisms. The more detailed it is, the more transparent the conditions for the investor, and the lower the risk of non-compliance with SEC requirements.
• AML/KYC. Project teams are required to identify investors, especially in Reg D or Tier 2 Reg A+. Violations will result in increased scrutiny and fines from FinCEN.
• Legal expenses. The SEC files lawsuits when violations are found, so startups should prepare their budgets in advance for dispute resolution.

How to Launch a Legal ICO in the U.S.

So, let’s find out – how to make ICO legal?

1. Conduct a legal audit of the token. Before the ICO, it is important to determine whether your token is a utility or a security. We recommend hiring a law firm with experience in working with the SEC to analyze the legal structure of the token, ensure that its features are consistent with business goals, and get suggestions on optimizing the corporate architecture (LLC, C-Corp, or trust). It is also crucial to outline how the tokens will be distributed among the team and investors, as well as determine the vesting and repurchase mechanisms.
2. Choose an emission strategy. Now, you have to choose an optimal path – registration with the SEC or using exemptions. For example, registration via Form S-1 makes a public sale possible with disclosure but requires the expenses of a third-party audit. Simplified schemes are Reg D (only for accredited investors) and Reg S (for token sales outside the US), but they both require confirmation of the investor's status.
3. Create a detailed whitepaper and prospectus. These documents should be written in collaboration with lawyers and financial advisors. They include a project overview, market analysis, technical section, description of tokenomics, and roadmap. You will need to pay special attention to the “Investment risks” section and the description of revenue-sharing mechanisms and expected ROI.
4. Ensure AML/KYC compliance. Once the ICO has started, you will need to communicate with KYC/AML providers (usually, Jumio, Onfido, or Shufti Pro, as they comply with FinCEN user identification requirements). This will allow you to analyze investors for sanctions lists, age, and country of residence.
5. Start the emission and start marketing. According to the US law concerning ICO, you must comply with the offer timeline (for example, do not start the emission until the official whitepaper release). As for marketing, it must be well-thought-out – you cannot guarantee profitability or refer to real income without legal support.
6. Start listing the tokens on crypto exchanges. After the emission, you should make a request to platforms that take into account American regulation of ICO – these are primarily Kraken, Gemini, and Substratum. It is also important to be prepared for delays due to SEC monitoring. Also, you must provide transparent reporting (including financial results, progress on the roadmap, budgets, etc.) and ensure interaction with investors.

Global Comparison: ICO Regulation in the USA vs EU

In the EU, there is the MiCA Regulation, a system tailored to three types of digital assets: utility, e-money, and asset reference. All of them are regulated through licensing, mandatory openness of projects, and audit requirements.

In the US, the approach to determining the ICO legality is more precedent-based (whether a token belongs to a security or utility type is determined by the Howey Test) and decisions are made during lawsuits and claims involving the SEC. For instance, currently, project openness is required at the registration stage through Reg A+ or Reg S, and to move on to the listing stage, the project teams need to pass an audit on a specific exchange.

For a more clear understanding of the differences in the US vs EU ICO regulation, please, check this table.

As we can see, for now, the EU ensures a more structured ICO accounting approach while the US continues to demonstrate uncertainty.

The Future of ICO Regulation

In the near future, the US may adopt a number of laws concerning the ICO regulations not tokens only but stablecoins as well (perhaps they will require a backup in a state bank or mandatory financial reserve) and expand requirements for tokens through ESG (including ecotrack, anti-money laundering, and truthfulness the whitepaper). Also, a regulated ICO act is being prepared for release, allowing the official launch of tokens with a total value of up to $100 million with a limitation of shares.

For crypto startups, this means that the regulation of ICO is about to become both stricter and more transparent. This will allow them to invest less in marketing (due to the transparency of their actions, which is guaranteed by the state a priori) and attract investors faster. On the other hand, these regulating ICO incentives will also raise the entry threshold for projects – they may be honest and transparent but still not have sufficient qualifications and resources to reach legal ICO. Therefore, those who invest today, can catch the wave of new projects and join them before the accounting for ICO becomes too strict.

FAQs on ICO Regulation

Is ICO legal in the USA?

Yes, but only in strict compliance with the SEC and other US authorities. In particular, project teams need to conduct a legal audit of their token, determine its status (utility or security), as well as register the emission or use Reg D/S/A+.

What laws govern ICO?

Current laws governing USA ICOs include the 1933 Securities Act, the 1934 Exchange Act, the Bank Secrecy Act (AML/KYC), and Reg D/S/A+. Future amendments may also affect stablecoins and ESG.