STO’s vs Rule 12g of the Securities Exchange Act of 1934

Lanli Pham
Lanli Pham

By tokenizing securities on a blockchain, combined with writing appropriate rules and restrictions into the smart contracts, they can now effectively trade on any of the hundreds of token exchanges globally. Thus potentially unleashing trillions of dollars in pent-up supply and demand to distribute and build wealth in private businesses, real estate, and every asset imaginable. One big wrinkle in all of this is Rule 12g of the Securities Exchange Act of 1934.

People involved with securities tokens offerings (“STO’s,” aka “Smart Securities”) need to be aware of and plan for compliance with Rule 12g of the Securities Exchange Act of 1934. This is true for issuers, as well as their lawyers, brokers, exchanges and other professional advisors.

What is Rule 12g of the Securities Exchange Act of 1934?

Rule 12g & SECSection 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”) establishes the thresholds at which an issuer is required to register a class of securities with the Securities and Exchange Commission (the “SEC”).  

On May 3, 2016, the SEC approved amendments to Implement Title V and Title VI of the Jumpstart Our Business Startups Act (the (“JOBS Act”) and Title LXXXV of the Fixing America’s Surface Transportation Act (the “FAST Act”).

These amendments included raising the thresholds for registration and termination of registration for a class of equity securities under Exchange Act Section 12(g) and changing the definition of “held of record.”  

As a result of these amendments, an issuer that is not a bank, bank holding company or savings and loan holding company is required to register a class of equity securities under the Exchange Act if:

  • it has more than $10 million of total assets; and
  • the securities are “held of record” by either 2,000 persons, or 500 persons who are not accredited investors.

Registering Securities

If you fall within the 12(g) rules, you must register as a publicly reporting company. 

What’s involved with that?

It generally means;

  • for equity securities and for asset-backed securities (including real estate), filing Form 10 with the SEC.


In complying with Section 12(g) of the Exchange Act, a company becomes subject to the periodic and current reporting requirements of Section 13(a) of the Exchange Act. Reporting companies must
file quarterly reports on Form 10-Q, annual reports on Form 10-K, and current reports on Form 8-K as well as certain director and shareholder reporting (Forms 3, 4, 5 and Schedules 13D/G ) and proxy statements for voting on matters which require shareholder approval. Reporting companies that fail to file Forms 10-Q or 10-K are subject to liability under Section 10 of the Exchange Act and Rule 10b-5 thereunder for failure to disclose material information or for any omissions.

Amendments to Rule 12g5-1 Definition of “Held of Record” to Exclude Certain Employee Compensation Plan Securities

Rule12g and the JOBS ActThe JOBS Act directed the Commission to revise the definition of “held of record.” The Commission adopted amendments to Exchange Act Rule 12g5-1 to implement the changes from Section 502 of the JOBS Act.

The definition of “held of record” was amended to provide that, when determining whether an issuer is required to register a class of equity securities with the Commission pursuant to Exchange Act Section 12(g)(1), an issuer may exclude securities that are:

  • held by persons who received them under an employee compensation plan in transactions exempt from, or not subject to, the registration requirements of Section 5 of the Securities Act and in certain circumstances, held by persons who received them in exchange for securities received under an employee compensation plan.

Additionally, the amendments to Rule 12g5-1 added a non-exclusive safe harbor for determining the holders of record. 

Why is this important?

Historically, since private securities were pretty much illiquid and impossible to trade, there was little risk of having more than 500 non-accredited investors (or 2,000 total investors) of record. However, if Reg A+, Reg D, S or CF securities are tokenized, then it makes them a lot more likely to trade. So if the securities start trading, then hitting 12g is much more of a risk.

Does it apply to me?

If the tokens are considered equity securities or asset-backed securities, then 12g applies.

Okay, but I’m not issuing equity or asset-backed securities.

Think again. 

240.3a11-1 of the Securities Exchange Act of 1934 reads:

The term ‘‘equity security’’ means any stock or similar security; or any security future on any such security; or any security convertible, with or without consideration, into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any other security which the Commission shall deem to be of similar nature and consider necessary or appropriate, by such rules and regulations as it may prescribe in the public interest or for the protection of investors, to treat as an equity security. 

This language is broad and can be interpreted by the SEC in potentially surprising (and costly) ways.

Conclusion

For all the opportunities that tokenization of securities brings issuers, investors, and the markets, it is critical to remain aware and respectful of the rules. Some regulations provide an opportunity to get funded, create wealth, and build businesses. Others present a genuine threat, potentially to the very existence of the company. Rule 12g and the costs associated with registration and reporting requirements present such a threat. Offerings and secondary trading must be constructed and conducted with this in mind.

These issues are INCREDIBLY complicated matters of law. You absolutely must engage and rely only on the advice of qualified securities attorneys before taking any action. Countless books can be and have been written on each of the many parts of these regulations. I am not an attorney, so this article is not intended to be a guide, a recommendation, advice, or an exhaustive presentation of all the applicable information.

Editor’s Note: A version of this article was first published on the Prime Trust blog by Scott Purcell, CEO and Chief Trust Officer of Prime Trust.

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