Source: Securities and Exchange Commission
As part of an effort to provide greater clarity on the application of the federal securities laws to crypto assets,[1] the Division of Corporation Finance is providing its views[2] on the application of certain disclosure requirements under the federal securities laws to offerings and registrations of securities by issuers of crypto asset exchange-traded products (“crypto asset ETPs”). Crypto asset ETPs are investment products that are listed and traded on national securities exchanges. They are typically structured as trusts that hold assets which consist of spot crypto assets or derivative instruments that reference crypto assets. These trusts are issuers of securities who must register their offerings and classes of securities under the Securities Act of 1933 (“Securities Act”) and Securities Exchange Act of 1934 (“Exchange Act”), respectively. Issuers of crypto asset ETPs[3] are also subject to the anti-fraud provisions of the federal securities laws. However, the crypto asset ETPs addressed in this statement are not registered as investment companies under the Investment Company Act of 1940.[4]
The disclosures required in connection with offerings and registrations under the Securities Act and the Exchange Act protect investors, facilitate capital formation, and promote fair, orderly, and efficient markets. In recent years, issuers have registered offerings of crypto asset ETPs under the Securities Act and registered classes of these securities under the Exchange Act. This statement reflects our observations regarding disclosure practices in our reviews of crypto asset ETP filings. It also addresses our views about certain specific questions that market participants have presented to the staff. While disclosures should be based on an issuer’s specific facts and circumstances, we believe that issuers may benefit from the identification of common issues we have observed during our reviews.
This statement addresses our views about certain disclosure requirements set forth in Regulation S-K and Regulation S-X as they apply to Securities Act registration forms (such as Form S-1). This statement does not address all material disclosure items, and the disclosure topics addressed below may not be relevant for all issuers. Each issuer should consider its own facts and circumstances when preparing its disclosures. Each issuer also should consider whether it is permitted to provide “scaled disclosure” with respect to any applicable disclosure requirements.[5] Moreover, issuers should note that disclosure is not required where a particular disclosure requirement is not applicable.[6]
Cover Page
SEC rules require issuers to provide information on the outside front cover page of the prospectus related to the offering, including the offering price of the securities, the nature of any underwriting arrangements and the name(s) of the underwriter(s).[7] Crypto asset ETPs are required to disclose on the cover page the initial offering price of the securities. We have observed cover page disclosure identifying the initial authorized participant (“AP”)[8] or the initial purchaser as a statutory underwriter.
Prospectus Summary
SEC rules require issuers to provide a summary in plain English of the information in the prospectus where the length or complexity of the prospectus makes a summary useful.[9] In this summary, we have observed issuers that have identified those aspects of the offering that are the most significant and highlighted those points in clear, plain language, avoiding merely repeating the text of the prospectus.[10] Examples of disclosure we have observed in the prospectus summary include:
- An overview of the trust, including a clear description of the investment objective of the trust and the tracking index or benchmark it plans to reference;
- A description of the underlying crypto asset(s) and the associated network(s);
- The issuer’s policies regarding the management of the underlying crypto asset(s), including any limitations on how they are held or used;
- The issuer’s policies regarding any incidental rights associated with the underlying crypto assets(s), including forks, airdrops, or similar events; and
- That the amount of underlying crypto assets per share held by the trust will decline over time as the crypto assets are sold to pay the trust’s fees and expenses.
Risk Factors
SEC rules require a discussion of the material factors that make an investment in the issuer and product speculative or risky.[11] The content and scope of an issuer’s risk disclosure will depend on the nature of the security, the issuer’s business, the underlying crypto asset(s), the tracking index or benchmark, and, if material, may include factors such as the characteristics of the security, limited rights of holders, insurance coverage, valuation and liquidity risks, technological risks, cybersecurity risks, and legal, regulatory and tax risks. Discussion of risks that could apply generically to any issuer is discouraged.[12] The following are examples of risks that have been disclosed:
- Risks related to the underlying crypto asset(s) and crypto asset markets that pose a risk of investor losses, including price volatility, theft of private keys and other hacking incidents, and the risk of price volatility from other parts of the crypto asset markets;
- Risks of fraud, manipulation, front-running, wash-trading, security failures or operational problems on crypto asset trading platforms;
- Risks of attacks on the associated network(s) by malicious actors;
- Risks of concentration of ownership in the underlying crypto asset(s);
- Risks from loss of incentives for miners and validators of the underlying crypto asset(s);
- Risks from other competing products that have already entered the market or that charge lower fees; and
- Risks from APs and other service providers or counterparties providing services for competitors.
Description of Business
The Trust, Crypto Asset Prices, and Calculation of NAV
SEC rules require issuers to provide a narrative description of the material aspects of their business.[13] Crypto asset ETPs generally provide disclosure regarding the trust’s assets, including the characteristics of the underlying crypto asset(s), and describe the applicable index or benchmark methodology, as well as the methodology to calculate net asset value (“NAV”).[14] Disclosure should be presented in clear, concise, and understandable language, without overly relying on technical terminology or jargon.[15] For example, to the extent applicable, we have observed disclosure that:
Underlying Crypto Asset(s) and Associated Network(s)
- Provides material information about the underlying crypto asset(s) and associated network(s), including information about the launch of the crypto asset(s) and the initial development team, the method of generating, minting or mining the crypto asset(s), the process for staking, locking and burning the crypto asset(s), the process for validating transactions, the consensus mechanism, use cases, and any fees associated with use of the crypto network(s) or applications;
- Includes a discussion regarding the total supply of the underlying crypto asset(s) covering the amounts outstanding, issued and burned, the market capitalization for the crypto asset(s), whether there is a cap on supply and what the minting and burning schedule is, as well as material events impacting the supply of the crypto asset(s), such as halving events, modifications to the protocol, and any recent or planned forks; and
- Describes the spot and/or futures markets for the underlying crypto asset(s), including how those markets are regulated.
Index or Benchmark
- Identifies and provides tabular disclosure for each constituent trading platform used to calculate the index or benchmark price, including market share and volume information;
- Describes how the constituent trading platforms are selected and how the index or benchmark price is calculated;
- Includes the composition and operation of any oversight committee; and
- Specifies whether the sponsor has discretion to select a different index or benchmark and discusses whether and how the sponsor will notify investors of material changes to the index or benchmark.
Calculation of NAV
- Describes the methodology the trust will use to calculate NAV and the policies and procedures if the index or benchmark is unavailable or the sponsor elects not to rely on it;
- If the methodology used to calculate NAV differs from the methodology used to determine the fair value of crypto asset holdings for GAAP purposes, provides a discussion of the differences between the two methodologies; and
- Discloses whether the sponsor has agreements with any third parties for use of their valuation methodologies and whether the sponsor has a license to use a secondary index or benchmark.
The Trust’s Service Providers, Custody of the Trust’s Assets, and Fees and Expenses
SEC rules require disclosure of information material to an understanding of the issuer’s business,[16] which may include the extent to which the issuer’s business is materially reliant on third parties. Issuers generally rely on the services of a sponsor and several third-party service providers, including one or more crypto asset custodians. Issuers generally pay a fee to the sponsor of the trust that typically covers the issuer’s operating expenses. Issuers generally disclose the various fees and expenses payable to the sponsor and third-party service providers. Additionally, issuers are required to file as exhibits to the registration statement material contracts not made in the ordinary course of their business, or in the case of ordinary course contracts, those on which they are substantially dependent, except where immaterial in amount or significance.[17] In this regard, we have observed issuers providing the following to the extent applicable:
The Trust’s Service Providers
- Identifying the APs, describing the material terms of the AP agreement, and filing the agreement as an exhibit to the registration statement;
- Identifying any counterparties contracted to assist in the purchase and sale of the underlying crypto asset(s), describing the material terms of any agreement with such parties, disclosing the extent of any affiliations or material relationships between the counterparties and the APs, discussing the criteria for engaging the counterparties, and filing any material agreements as exhibits to the registration statement; and
- To the extent the trust has an agreement with a counterparty to provide financing for purchases and sales of the underlying crypto asset(s), disclosing the material terms of that arrangement, including the rate of interest, describing the mechanics of financing in connection with creation and redemption orders, and filing any material agreements as exhibits to the registration statement.
Custody of the Trust’s Assets
- Identifying and describing the material terms of their agreement(s) with the custodian(s);
- Storage policies for private keys, including the use of cold, warm or hot storage, whether the issuer’s crypto assets are commingled or held in wallets with assets of other customers, and how transfers of crypto assets from cold, warm or hot storage occur;
- Who will have access to the private key information and whether any entity will be responsible for verifying the existence of the crypto assets; and
- Whether and to what extent the custodian carries insurance for any losses of the crypto asset(s) that it custodies for the issuer and to what extent insurance coverage is shared among the custodian’s customers and not specific to the issuer.
Fees and Expenses
- How the sponsor fee is calculated, which fees and expenses are assumed by the sponsor, and which fees are capped or otherwise not assumed by the sponsor;
- The fee arrangements with third parties, including transaction fees and other expenses; and
- Any arrangements for the sponsor fee or other fees to be paid using the trust’s underlying crypto asset holdings.
Description of Securities
SEC rules require a description of the issuer’s securities.[18] In describing the securities offered by the trust, issuers are required to disclose the circumstances under which shareholders have voting rights.[19] Examples of disclosure we have observed in this context include the following:
- Any limitations or restrictions on voting rights;
- Whether the rights of holders may be modified other than by a vote of a majority or more of the shares outstanding; and
- How shareholders will be notified of material amendments to or termination of the trust agreement.
Plan of Distribution
SEC rules require disclosure of the plan of distribution of securities offered and sold in a registered offering.[20] Additionally, issuers conducting delayed or continuous offerings under Securities Act Rule 415 undertake to include in a post-effective amendment to the registration statement material information with respect to the plan of distribution not previously disclosed or any material change to that information included in the effective registration statement.[21] Among other information, issuers have provided the following information regarding the plan of distribution:
- The mechanics of the creation and redemption process between the trust, the APs, the custodian(s), and any other third-party service providers, whether and to what extent creation and redemption orders will be settled onchain or offchain, and any risks associated with the settlement process;
- The potential impact on the arbitrage mechanism from price volatility, trading volume, and price differentials across crypto asset trading platforms, and in the event crypto asset trading platforms are closed or otherwise unavailable; and
- Whether and under what circumstances the sponsor may suspend creation and redemption orders and how the trust will notify shareholders if it has suspended creation and redemption orders.
Directors, Executive Officers, and Significant Employees
Management
SEC rules require disclosure of information relating to the identity and experience of those entrusted with the management of the issuer, including executive officers, directors, and certain significant employees who make (or are expected to make) a significant contribution to the issuer’s business.[22] SEC rules also require such disclosure for persons who do not hold formal titles or positions as executive officers or directors but who perform policy-making functions typically performed by executive officers or perform similar functions as directors.[23] Crypto asset ETPs typically have a sponsor whose directors and executive officers perform functions similar to a board of directors and executive officers for the trust. To the extent that a sponsor performs policy-making functions, disclosure has been provided with respect to the directors, executive officers, or other employees of the sponsor performing such functions. Although disclosure regarding executive compensation of the issuer would not be applicable in this situation,[24] we have observed disclosure of the fees paid to the sponsor or third party for performing such functions, as discussed in “The Trust’s Service Providers, Custody of the Trust’s Assets, and Fees and Expenses” above.[25]
Conflicts of Interest
SEC rules require disclosure of material information about transactions with related persons and policies and procedures related to the review, approval, or ratification of transactions with related persons.[26] Issuers have disclosed existing and potential conflicts of interest between the sponsor and its affiliates and the trust, including the following:
- Whether the sponsor or any insiders hold the underlying crypto asset(s) or have crypto asset-related exposure that could create conflicts of interest;
- Whether the trust has a code of conduct or other requirements for pre-clearance of transactions in the underlying crypto asset(s) that apply to its employees, the sponsor, or any of its affiliates; and
- The sponsor’s experience sponsoring other exchange-traded products and its specific experience in crypto asset markets.
Financial Statements
We have observed that some issuers are organized as statutory trusts or limited partnerships that are registering the offer and sale of beneficial units or limited partnership interests in multiple series. In these instances, for purposes of SEC reporting, the staff has taken the position that the trust or partnership should be treated as the sole registrant, not the individual series.[27] However, the staff has also taken the position that in addition to providing financial statements of the trust or partnership, issuers should provide separate financial statements of each individual series. Issuers have separately provided, prepared, or evaluated, as applicable, the following for the sole registrant and for each series:
- Separate financial statements and audit reports;
- Separate interim financial statements; and
- Separate assessments of materiality for Regulation S-K and Regulation S-X purposes, including Regulation S-X Rules 3-05, 3-09 and 4-08.
Filing Fee Tables
Issuers electing to register the offering of an indeterminate number of exchange-traded vehicle securities[28] in reliance on Securities Act Rules 456(d) and 457(u) should be aware that the EDGAR fee tag for “Type of payment” is “2” and the EDGAR “Security type” is “Exchange-Traded Vehicle Securities.” Failure to include these tags may prevent the issuer from being able to file a form of prospectus under Securities Act Rule 424(i) and pay its registration fee not later than 90 days after the end of any fiscal year during which it has publicly offered securities.
Contacting the Division
The Division welcomes questions about the application of the SEC’s disclosure rules to offerings and registrations of crypto asset ETPs, as well as any ongoing reporting obligations. We also welcome requests for other assistance (including requests for interpretive or no-action letters) relating to these issues and questions. Information about how to contact the Division is available on our website.[29]
[1] For purposes of this statement, a “crypto asset” is an asset that is generated, issued, and/or transferred using a blockchain or similar distributed ledger technology network (“crypto network”), including, but not limited to, assets known as “tokens,” “digital assets,” “virtual currencies,” and “coins,” and that relies on cryptographic protocols. References in this statement to “network” refer to a crypto network, and references to “application” refer to an application running on such a crypto network.
[2] This statement represents the views of the staff of the Division of Corporation Finance (the “Division”). It is not a rule, regulation, exemption, guidance, or statement of the U.S. Securities and Exchange Commission (“Commission” or “SEC”), and the Commission has neither approved nor disapproved its content. This statement, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.
[3] For brevity, we refer to crypto asset ETP issuers as “issuers” in this statement.
[4] As a result, these crypto asset ETPs are not subject to the requirements of the Investment Company Act of 1940, such as the legal requirements related to valuation and custody of fund assets.
[5] Scaled disclosure refers to disclosure accommodations that the federal securities laws sometimes provide for smaller or newly public companies, such as smaller reporting companies, non-accelerated filers, or emerging growth companies. These accommodations apply to a qualifying company’s registered offerings and its ongoing public company reporting. Scaled disclosure permits these companies to provide less extensive disclosure than other companies.
[6] See, e.g., Rule 404(c) under the Securities Act and General Instruction II.B. of Form S-1. For example, disclosure regarding properties only is required where issuers have material physical properties. See Item 102 of Regulation S-K.
[7] See Item 501(b) of Regulation S-K.
[8] APs are financial intermediaries that provide liquidity for crypto asset ETPs by facilitating the creation and redemption of shares (often referred to as creation and redemption units or creation and redemption baskets). APs place orders to create and redeem baskets.
[9] See Item 503 of Regulation S-K.
[10] See Instruction to paragraph 503(a) of Item 503 of Regulation S-K.
[11] See Item 105 of Regulation S-K.
[13] See Item 101 of Regulation S-K.
[14] NAV of a crypto asset ETP is the trust’s total assets minus its total liabilities.
[15] See Securities Act Rule 421(b).
[16] See, e.g., Items 101(c) and 101(h) of Regulation S-K.
[17] See Item 601(b)(10) of Regulation S-K.
[18] See Item 202 of Regulation S-K.
[19] See Item 202(d) of Regulation S-K.
[20] See Item 508 of Regulation S-K.
[21] See Securities Act Rule 415(a)(3); Item 512(a)(1) of Regulation S-K; and Part II, Item 17 to Form S-1 and Part II, Item 17 to Form S-3.
[22] See Item 401 of Regulation S-K.
[23] See Securities Act Rule 405. Disclosure is not required where a particular disclosure requirement is not applicable, or the issuer otherwise does not have responsive information. For example, crypto asset ETPs do not have a board of directors and, therefore, do not provide disclosure regarding members of a board of directors.
[24] See Item 402 of Regulation S-K.
[25] See Item 404 of Regulation S-K.
[26] See Item 404 of Regulation S-K.
[27] See Securities Act Sections Compliance and Disclosure Interpretations, Question 104.01. Compliance and disclosure interpretations reflect the views of the staff of the Division of Corporation Finance. They are not rules, regulations, or statements of the Commission. The Commission has neither approved nor disapproved these interpretations.
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