Since a few weeks the German crypto community celebrates the first BaFin approved securities prospectus, being fully compliant with German regulatory laws and statues. With this approval BaFin really displayed an innovative and progressive attitude towards blockchain based funding methods. At least three more STO prospectuses are currently awaiting BaFin’s approval and more will follow. The security token now being offered through the first approved STO prospectus is legally designed as a registered bond and therefore, according to German capital markets regulatory law as an asset investment. Nevertheless, BaFin categorizes the token as a security and not as an asset investment. This stems from the legal view of the BaFin that because the registered bond is embodied in the (transferable) token it is tradable just like a security. But what should be the legal design of a security token from the issuer’s perspective so that the Security Token Offering can be conducted without any problems?
The Administrative Practice of BaFin Regarding Blockchain Tokens.
On the 20st of February 2018 BaFin pointed out that tokens having been issued via an Initial Coin Offering, depending on the actual token design, may classify as either securities as defined in the German Securities Trading Act (WpHG) or an asset investment as defined in the German Asset Investment Act (VermAnlG) or even as shares of a investment fund as defined in the German Capital Investment Code (KAGB). According to BaFin, this regulatory qualification cannot be generalized but instead has to be considered on a case to case basis. For a token’s classification as security the following four criteria have to be fulfilled: (1) The token is not meant to be a mere means of payment, (2) it embodies corporate and/or participation rights, (3) it must be transferable and (4) it must be tradable on the financial or capital markets. BaFin actually considers crypto exchanges as financial markets in this sense. A token can be classified as a share of an investment fund as defined in the KAGB if it represents a share of an entity that makes collective investments for a number of investors. If a token neither qualifies as a security nor as a share of an investment fund while granting patrimonial rights to the investor it will most likely be classified as an asset investment. In 2012 the German legislator passed the Asset Investment Act with the intention to regulate those capital market products that where neither a security nor a share of an investment fund and therefore were at that time unregulated. All three of those regulatory regimes differ from each other and the creation and approval processes for creating prospectuses and further legal documents for their public offering have different prerequisites.
Security Tokens have to be Designed Coherently in regards to Supervisory Law as well as Private Law
A risk for emitters of security tokens lies in the fact that the approval of the prospectus is granted by BaFin, being an administrative authority while claims that arise from a missing or wrong prospectus in the form of prospectus liabilities are decided by civil courts. Due to the principal of separation of powers the civil courts are not legally bound to the classification decision of BaFin regarding the legal nature of a token. They will assess if a token is a security, an asset investment or a share of a capital fund themselves on basis of the law. It therefore is possible that a civil court might qualify a token as an asset investment while BaFin qualified the same token as a security. That might lead the deciding court to the conclusion that a required asset investment prospectus has not been published by the emitter. For the issuer of an STO this poses a major liability risk. The consequences of a missing prospectus are usually that the emitter has to refund the original investment to the investor plus any transaction fees. In return the emitter will get back the tokens . The legal conception of a security token therefore must be designed with the highest diligence and professional competence. FIN LAW specializes in the legal conception of Security Token Offerings and offers its clients the highest advisory quality in all relevant legal aspects.
Attorney Lutz Auffenberg, LL.M. (London)