1/n
Grey area in securities regulation @SECGov has birthed a new phenomenon: bearer security tokens

Investors aren't aware of the risks associated w/ these assets so I wrote an article to share👇

Buyers Beware: Introducing Bearer Security Tokens👀

Link: blog.stomarket.com/buyers-beware-… Image
2/n
Security tokens are digital assets that comply w/ government securities regulations & automatically enforce rules, guidelines & parameters given a security

The @STOmarket secondary market capitalization has exploded more than 10x from last year to today & now sits @ $15B 🌴
3/n
#Realestate has been cementing its place in the security token industry as a beneficiary of the technology since 2018 and 2019.🏚

We have seen a multitude of real estate security token offerings. According to the STM Real Estate Intelligence Report, by @pgaff_digital
4/n
...over 40% of the current #securitytoken primary issuance pipeline consists of real estate investments.🏡

Given this, it is also not surprising that the vast majority of security tokens trading on STM.co represent equity shares in real estate properties.
5/n
The Ground Rules

As more real estate security tokens are unlocked and begin trading on secondary markets, it is essential to ensure you, as the investor, are protected.⛑
6/n
Most countries have expansive #securities laws protecting investors from theft, loss, fraud, and other events that hurt the investor. 🧑‍⚖️

In addition, investor protections are created and enforced by a country's respective government or security oversight body,...
7/n
...such as the Securities and Exchange Commission (#SEC) in the United States. Specifically, existing securities laws require companies to register with the SEC when raising capital from investors unless that company files a private exemption.
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Common exemptions used by real estate security #token issuers are outlined by @UpCounsel as follows:
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Rule 5️⃣0️⃣6️⃣ (b) of Regulation D: Under this #exemption, a company can raise money from an unlimited number of accredited investors and up to 35 “sophisticated but non-accredited investors in a 90 day period.” The company cannot advertise the offering.💰
10/n
Rule 5️⃣0️⃣6️⃣(c) of Regulation D: Under this exemption, a company can raise money from an unlimited number of accredited investors and must take “reasonable steps” to ensure that all investors are accredited. The company can advertise the offering.💸
11/n
Regulation A: Tier 1️⃣: Under this exemption, a company can raise up to $20 million from any #investors. “Testing-the-waters” through advertising and general solicitation is permitted.💰
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Regulation A: Tier 2️⃣: Under this exemption, a company can raise up to $75 million from any investors, but non-accredited investors are subject to investment limits. “Testing-the-waters” through advertising and general solicitation is permitted.💸
13/n
If a company doesn't register w/ the SEC or file a exemption, it may be committing securities violations that many #ICOs have been targeted for by the SEC in the past🧑‍⚖️ (Example #1 sec.gov/news/press-rel…, Example #2, sec.gov/news/press-rel…)
14/n
Without an issuer filing their security token offering with their respective government or securities commission, issuers are essentially offering what I call 'bearer security tokens'.⚠️
15/n
The term '#bearer security token' is derived from the term in traditional financial markets that is a bearer instrument. A bearer asset has been defined by @Investopedia as,📚
16/n
“A bearer instrument, or bearer #bond, is a type of fixed-income security in which no ownership information is recorded and the security is issued in physical form to the purchaser.
17/n
The holder of a bearer instrument is presumed to be the owner, and whoever is in possession of the physical bond is entitled to the coupon payments.”
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The first bearer instrument came about as paper shares from John Law and the Banque Générale in France in 1717. Law used bearer instrument bank notes to raise money for his joint-stock company.🇫🇷 Image
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Law's company thrived until the French government was forced to admit that the number of paper notes issued exceeded the value the bank held.😬

Despite the rocky first experience with bearer instruments, this form of investing in a company became widespread in Europe and...
20/n
This is due to their potential use for abuse, such as tax evasion, illegal movement of funds, and money laundering, not to mention the security risk of holding such an asset🥷

Today, the main use of bearer instruments is in offshore financial centers to hide information...
21/n
...about the instrument's real owner. In the same sense that a bearer instrument today is an illegal security as it lacks investor protections, so should be 'bearer security tokens.'
22/n
In the last year, the security token industry has seen companies rushing to get their products to market and opting out of registering for an exemption or securities offering. 🤔
23/n
Companies that choose to do this are doing so at their investors' expense by exposing them to possibly losing their #assets with no avenues for remediation.👎
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'Bearer security tokens' most often take the form of #fractionalized LLC's which are then never registered for a securities offering.🚩

Given our definition of a bearer instrument, a 'bearer security token' would be defined as follows:
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“A bearer security token is a blockchain-based #digitalasset in which there is no registered exemption or securities offering issued to investors. Ownership information is automatically issued, transferred, and collected via the #blockchain ...
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...The holder of a bearer security token is presumed to be the owner, and whoever is in possession of the security token is entitled to the underlying asset and its distributions.”
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Registering with the local securities oversight authority can be time-consuming and more costly than just creating a cryptocurrency, but is required to offer the sale of any security.☑️
28/n
Despite being required, #enforcement of securities laws has trailed behind the lightning-fast innovation of the blockchain industry.⚡️

This has allowed companies to issue 'bearer security tokens' without immediate consequences or oversight.
29/n
The Grey Area

An example of a company that may have issued 'bearer security tokens' is @lofty_ai (lofty.ai)

This company offers fractionalized real estate investing to ANY US investor for ~$50.🤔
30/n
They create Wyoming-based #DAOs to acquire, securitize, and fractionalize equity in individual real estate properties. 🤝

The sale of these fractional shares are fully open to non-accredited (#retail) investors on their site...
31/n
...which would lead one to expect that the sale of these investments would be conducted via a Regulation A or CF Exemption.💡

Despite extensive investigation, this does not seem to be the case. ☹️

Lofty.Ai Home Page
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While the #JOBSAct does provide avenues that would allow for compliant registered security tokens for non-accredited investors to trade through Regulation Exemptions A and CF, we have not seen a blockchain-based platform to date...
33/n
...that allows non-accredited US investors to invest & trade fractional real estate w/ proper investor protections.

Instead, we have seen companies such as LoftyAi opt to offer what seem to be 'bearer security tokens', where the investor has no tangible investor protection
34/n
Investor protections include regulation adherence, filing, and other processes that mitigate malpractice/mistakes of intermediaries. 👍

Investor protections are essential for asset health and long-term appreciation; The World Bank outlines tangible benefits of investor...
35/n
...protections as follows: “Research on 539 large firms in 27 economies shows that firm valuation is higher in economies with good investor protections than in those with poor protections.
36/n
Other research shows that corporate risk-taking and firm growth rates are positively related to the quality of the system of investor protections.

Better systems may lead corporations to undertake riskier but value-enhancing investments”📈
37/n
After conducting my research, it seems LoftyAi, and similar platforms act as their #unregistered transfer agents, facilitating cap table management, share transfers, and distributions while letting the blockchain act as the broker that facilitates the transactions. Image
38/n
While this is a noble cause, current investment frameworks prohibit this. #Transferagents and #brokers are required to register with the @SECGov, which LoftyAi and the blockchain protocols they are using do not seem to comply with these requirements.
39/n
In addition to allowing blockchain to be the broker as intended with security tokens, it is essential to have a registered transfer agent overseeing the security.
40/n
In the event of a hack, a 'bearer security token' issuer may be left with a multitude of issues to work through for its users, resulting in significant asset risk, which may not be accounted for in an investor's decision to participate.
41/n
For example, if a user's security token was stolen, the transfer agent is responsible for verifying that the hacked user was the true initial owner while confirming that the token was indeed stolen and executing the means of reconciling the situation.
42/n
Transfer agents have guidance from the SEC on handling these situations and their own internal experiences from similar situations in traditional financial markets.
43/n
A thief of a bearer security token may collect rental income on the stolen token for as long as it takes the compromised firm to determine the token was stolen, while its rightful owner misses their distributions.
44/n
As many of these bearer security token issuers serve as their own transfer agents, nothing is stopping them from erroneously displaying false information on the user dashboard in the event of a hack to misconstrue the situation.
45/n
Users that do not self custody of their assets may not receive distributions each day which presents perverse incentives for bad actors to falsely present their user's information, which is the opposite of the transparency we strive for in the tokenization industry.
46/n
A high-level comparison between the traditional security token issuance process and LoftyAi's issuance process

Some experts are warning that the SEC won't be silent for long. "In my experience, it's only a matter of time before the SEC gets involved," says @YoAdrian305
47/n
an attorney and founder of both @GetInvestReady, which verifies accredited investors for issuers of Reg D 506(c) exempt offerings, and @DASAdvisors, a digital asset securities advisory firm.

Alvarez continues: "I warned @BlockFi a year before they were fined $100M that...
48/n
...they were violating securities law because we had a customer,

Mercedes-Benz Financial Services, essentially doing the same thing but actually registering and admitting that their products were securities.
49/n
If BlockFi had listened, then, they may have saved themselves from their recent financial troubles and bankruptcy after the #ftxscandal. The SEC is coming, and it's just a matter of time."
50/n
I reached out to LoftyAi regarding their status as an unregistered transfer agent, broker-dealer, and marketplace and their choice not to file for securities regulation exemptions for their security token offerings and was able to gain insights.
51/n
I suspect that they are currently operating without any of the following: (1) a transfer agent license, (2) a broker-dealer license, (3) an alternative trading system license (ATS), or (4) are filing the right exemptions for their security token offerings.😧
52/n
Secondly, LoftyAi shared details that helped explain why they are operating this way currently.

LoftyAi believes that they are simply a technology provider & therefore do not need the licenses stated. LoftyAi creates Wyoming-based DAOs for private buyers to pool money...
53/n
...have decentralized governance, and ultimately buy real estate properties.🏡

When the private buyers deposit money into the DAO's treasury, they are then "airdropped" DAO tokens.
54/n
The treasury is then used to purchase real estate from private sellers, while the tokens are used to fractionalize ownership, decentralize governance, and distribute rental dividends to owners.🤝

In LoftyAi's opinion, DAO tokens are not securities.
55/n
@lofty_ai's CEO, Jerry Chu , responded to the following questions with the answers given below: Image
56/n
The Case Law

Currently, securities precedent was set in the case SEC v. W. J. Howey Co. in 1946, which established The Howey Test. The Howey Test is a legal test used to determine whether a transaction is an investment contract and therefore subject to securities regulation
57/n
The test has four criteria:
1️⃣ there is an investment of money,
2️⃣ there is an expectation of profits from the investment,
3️⃣ the investment is in a common enterprise, and
4️⃣ any profit that comes from the efforts of a third party.
58/n
The transaction is considered an investment contract if all four criteria are met and then are subject to securities regulation.

The Howey Test would be used in the context of decentralized autonomous organizations (DAOs) to determine whether their tokens are securities.
59/n
In general, DAO tokens would be found to meet the criteria of the Howey Test and are, therefore, considered securities.

However, it could be argued that DAO tokens do not meet the 4️⃣th prong of The Howey Test, "any profit that comes from the efforts of a third party."
60/n
DAO token holders have proportional say in governance to the money they send to the treasury, so it may be argued that they are not relying on the efforts of others.🤷‍♂️
61/n
In the case of LoftyAi, per their website, they plan to launch the next iteration of their governance protocol which will allow token holders to vote on-chain and propose new governance votes within their Lofty dashboard. 👨‍⚖️
62/n
Currently, token holders vote via email-based surveys and cannot make new proposals themselves.

Additionally, there has been a precedent set in Gary Plastic Packaging v. Merrill Lynch, which makes DAO tokens more likely to be deemed securities.🏪
63/n
Merrill Lynch marketed insured credit defaults they had purchased from other banks and promised to create and maintain a secondary market for their liquidity. 💦

In 1985, it was deemed that these credit defaults were securities due to the secondary marketplace being a...
64/n
...critical part of its marketing efforts, and the same marketing efforts permitted investors to make a profit. @lexology describes this decision as follows:
65/n
"Due to the fact that the broker’s creation & maintenance of a secondary market was a critical part of its marketing efforts, & the marketing was designed to enable investors to profit from these investments the additional protection of the Security Act was appropriate"
66/n
Lexology does, however point out that,

“In addition, in June 2018, Director William Hinman, of the SEC’s Division of Corporation Finance delivered a speech at the Yahoo Finance All Markets Summit: Crypto
67/n
In fact, the title of the speech included a specific reference to the Gary Plastics case, and was entitled: “Digital Asset Transactions: When Howey Met Gary (Plastic).”

In the speech, Director Hinman noted that a digital asset, in and of itself, may not be a security. 🤷‍♂️
68/n
However, depending upon the manner in which it is sold, and the expectations of the investors, an asset of this kind can become an investment contract, and therefore be within the scope of the securities laws and the SEC’s jurisdiction.📝
69/n
In a case of this kind, the purchaser’s ability to realize a profit depends on the success of the enterprise and the ability to realize a profit on the investment turns on the efforts of a third party.”💰
70/n
The Right Way

An example of a company that appears to have followed compliance standards properly is @RealTPlatform ( realt.co )✅ Image
71/n
The Boca Raton-based firm is a real estate tokenization company that has been compliantly tokenizing millions of dollars worth of Affordable Housing in the United States by utilizing Regulation D 506(c) since 2019.🌴
72/n
By utilizing smart contracts to automate compliance across jurisdictions and registering the securities with the SEC, @RealTPlatform has opened US real estate investment to domestic and international investment for a fragment of the price.👀
73/n
@RealTPlatform has seen astronomical demand for its tokens which translates to property appreciation.

RealT has issued 300+ real estate security tokens, all via Regulation D 506(c) and S, they have averaged a yield of 10%+ per property from rental income...📈
74/n
...& 97% of the tokens trading on secondary markets are trading at prices higher than their issuance price.💰

I was able to catch up with @RealTPlatform’s CEO, @JacobsonRemy and get his opinion on why compliance is not only important but becoming easier to achieve. He said
75/n
...“@RealTPlatform we prioritize compliance and security in our real estate tokenization platform. We have always emphasized making our platform compliant with all relevant regulations and easy to use. Compliance is crucial for providing investors with trust in the assets...
76/n
...they’re investing in & the companies they’re investing with. However, for young companies, doing tokenized offerings the right way can be difficult; that’s why in 2023,...
77/n
...we will be open to partnering with companies looking to enter the space and allow them to use the RealT infrastructure.”🤝

By allowing others to utilize the infrastructure they’ve created, they not only have paved the way for new tokenizers, but will actually...
78/n
be opening their doors to those looking to get involved the right way.👫

Many of the platforms in this growing industry have done a fantastic job building their companies, investment opportunities, and platforms, but sadly,...
79/n
some have opted out of the most important step in the process: ensuring their investors are protected.🛡

Investor protections found in compliant security tokens will foster a stronger feeling of legitimacy in the industry while accelerating adoption of security tokens.
80/n
Companies like RealT opening their doors and allowing other to build on the infrastructure they’ve created will only speed this up. ⏩

Blockchain technology is changing behavior in investments by opening investments to global investor bases;
81/n
...investor protections will be a crucial component for the growth, stability, and trust associated with security tokens and, specifically, tokenized real estate.

This year alone, there has been more than $3B in digital assets (editor's note: non-securities!) stolen,...
82/n
...which has continued to rise yearly. Registering your security token will help reduce the pain felt by investors from this astounding figure.
83/n
For adoption to reach peak velocity, we need to have the rules and safeguards in place to prevent bad actors from giving the industry a bad reputation. 📖

Even w/ the grey area, we still see a thriving tokenized real estate industry following the rules and filing exemptions
...for their offerings. RealT realt.co has launched 300+ tokenized properties to investors using Regulation S and, on occasion, Regulation D. 🏡
85/n
@aspen_digital and @LibertyFundRE also used a Regulation D filing, and we've even seen non-tokenized offerings leverage Regulation Crowdfunding to access retail investors.

@HomebaseDAO is bringing its 1st compliant real estate security token offering to life next month!🏡
86/n
There’s lots of exciting stuff going on in the security token industry and we at @stomark are dedicated to providing you the clarity demanded to invest in novel products.

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