As blockchain continues to evolve as a disruptive technology, the regulatory environment surrounding initial coin offerings (ICOs) by companies issuing digital tokens to investors remains uncertain and subject to much debate. As a result, many companies issuing ICOs are shunning US investors altogether to avoid US securities laws. Below, we will discuss the definition of a “US person” under Regulation S of the Securities Act, which effectively determines who can invest in such ICOs and the restrictions placed on such investors. Specifically, under what circumstances, if any, will a cryptocurrency hedge fund affiliated with a US manager be permitted to participate in unregistered ICOs? Further, if allowed to participate in unregistered ICOs, when will a participating cryptocurrency fund be permitted to resell the securities on the secondary market?
Definition of a US Person – Who Can Invest?
Many ICOs restrict their offerings to non-US persons. In doing so, these issuers generally use the Regulation S definition of a “US person” to determine investor eligibility. In most cases, determining whether an investor is a US person is straightforward, as the investor will either be a non-US resident or a company formed outside the US by non-US residents. However, the determination is not as clear when a foreign entity can be traced back to a US person. The definition, provided below, contains a somewhat ambiguous example at the end that, depending on one’s interpretation, could either permit or prohibit US-managed offshore cryptocurrency hedge funds from participating in certain foreign ICOs.
Under Regulation S, a US person is:
(i) Any natural person resident in the United States;
(ii) Any partnership or corporation organized or incorporated under the laws of the United States;
(iii) Any estate of which any executor or administrator is a U.S. person;
(iv) Any trust of which any trustee is a U.S. person;
(v) Any agency or branch of a foreign entity located in the United States;
(vi) Any non-discretionary account or similar account (other than an estate or trust) held by a dealer or other fiduciary for the benefit or account of a U.S. person;
(vii) Any discretionary account or similar account (other than an estate or trust) held by a dealer or other fiduciary organized, incorporated, or (if an individual) resident in the United States; and
(viii) Any partnership or corporation if:
(A) Organized or incorporated under the laws of any foreign jurisdiction; and
(B) Formed by a U.S. person principally for the purpose of investing in securities not registered under the Act, unless it is organized or incorporated, and owned, by accredited investors (as defined in § 230.501(a)) who are not natural persons, estates or trusts.
The last example above is the most relevant to US-based fund managers that sponsor offshore funds to accommodate non-US investors and tax-exempt US investors. The crux of the issue is whether an offshore cryptocurrency hedge fund would qualify as a US person and be prohibited from investing in an ICO limited to non-US persons.
There are two main considerations in determining whether an offshore cryptoccurency fund would qualify as a US person under (viii)(B) above; specifically, whether the offshore fund is formed by a US person or, in the alternative, if the offshore fund is owned by accredited investors who are not natural persons, estates, or trusts.1
Formed by a US Person
Whether an offshore fund is formed by a US person can be tricky. Typically, when sponsoring an offshore fund entity, the US-based manager will instruct its offshore counsel or some other offshore organization to facilitate the process of forming the entity. However, if the ICO looks through the literal formation of the fund and concludes that the fund is effectively formed for the benefit of the US manager, such US manager that established an offshore fund, either standalone or in a master-feeder or mini-master scenario2 , may have to overhaul its overall structure and create a non-US-based management company. Each new offshore management company would itself not be considered a US person and, arguably, could form an offshore hedge fund without concern for the interpretive issue created by (viii)(B)3.
Owned by Accredited Investors who are not Natural Persons
Even if the ICO issuer determines that the offshore fund was formed by a US person, the fund itself may still avoid qualification as a US person if it is owned entirely by accredited investors who are not natural persons.
In the standalone fund context, the fund must simply limit its investor pool to accredited entities. This is mostly impractical in the ICO realm as it may be difficult to entice institutional investors or other hedge funds to invest in a fund that is focused on such a cutting-edge and volatile investment opportunity. Accordingly, other fund structures may provide more favorable conditions.
In a mini-master structure, the feeder fund, as the non-US entity in the structure, would similarly have to prohibit individuals from investing in it. This presents the same problem as the standalone fund in that it may be impractical to limit a fund of this type to entity investors.
In a master-feeder structure, the two feeder funds are technically the only investors in the master fund. If the master fund is deemed to be formed by a US person, each feeder fund would have to be an accredited investor for the master fund to not be considered a US person. Each feeder fund may meet the requirements of an accredited investor by limiting its own investors to only accredited investors. In that case, since the master fund’s investor pool only consists of the feeder investors, each investor in the master fund would be an accredited investor that is not a natural person. Notwithstanding the foregoing, many ICOs contain additional verbiage prohibiting participation by entities that are US persons or that are beneficially owned by any US persons (the latter of which would be problematic for master-feeder structures regardless of accredited investor requirements). Fund managers will therefore need to read the ICO offering details closely to confirm whether a master-feeder structure limited to accredited investors is a viable option.
Restrictions Placed on Investors
Even if an investor qualifies as a non-US person under Regulation S and can participate in the ICO, it may still be subject to additional restrictions.
Regulation S provides a safe harbor for securities offerings that take place outside of the United States. Securities that rely on the safe harbor are exempted from US securities registration requirements. To qualify for the exemption, the securities must be offered in an offshore transaction and the issuer must make no directed selling efforts in the United States. Both requirements apply to all issuers seeking safe harbor under the regulation. However additional requirements may apply depending on the type of security being offered and the equivalent category the security falls under.
Under Regulation S, securities are split into 3 categories, each with its own set of limitations.
Category 1 securities must be offered in a foreign offering and issued by non-US issuers who believe that no substantial US market interests exist for their securities. No additional restrictions are placed on Category 1 securities.
Category 2 securities include equity securities of a reporting foreign issuer and debt securities of a reporting or a non-reporting foreign issuer. Category 2 securities are subject to a 40-day distribution compliance period.
Category 3 securities are securities that do not fall into either Category 1 or Category 2.
An offshore ICO would not fall under Category 1 because a substantial US interest most likely exists for the corresponding coin4. Further, the ICO would not fall under Category 2 as the issuer of the ICO is likely not a reporting issuer and the security is not a debt security. Consequently, an offshore ICO would typically fall under Category 3 of Regulation S and carry the corresponding restrictions.
The Category 3 restrictions most relevant to investors in ICOs are the resell restrictions. A non-reporting issuer of Category 3 securities must restrict its offering for a one-year distribution compliance period that generally begins at closing. Resales of these securities are also subject to the distribution compliance period. During the compliance period, no securities can be sold/resold to US persons or to a non-US person for the benefit of a US person. Therefore, investors in the ICO may only resell their security to non-US persons for one year from closing and can resell their security to US-persons after that one-year period ends.
As a novel instrument, ICOs provide fund managers with unique investment opportunities. However, ICOs present equally unique challenges to fund managers due to the unsettled regulatory environment surrounding them. As such, US fund managers should take care to consult qualified legal counsel early during the fund launch process and for ongoing help with evaluating eligibility to invest in certain ICOs.
 If the fund is an offshore fund, it automatically meets the requirement of (viii)(A).
 US based managers typically use either a master-feeder or a mini-master structure. The master-feeder structure involves two feeder funds, one based in the US and one based outside of the US, that both invest all their capital in a master fund that is also based outside the US. The mini-master structure involves an offshore feeder fund that invests solely in a US master fund.
 However, this assumes that the ICO only looks through to the management company of the fund investing in the ICO and not to the US-based, affiliated management companies and/or principals of those companies.
 A substantial US market interests exists “where (i) U.S. securities exchanges and NASDAQ in the aggregate constituted the single largest market for such class of securities in the issuer’s prior fiscal year, or (ii) 20% or more of trading in the class of equity securities during such period occurred in such U.S. markets and less than 55% of trading in such securities took place during that period through the facilities of the securities markets or a single foreign country (17 CFR 230.902).” An offshore ICO would generally qualify for (ii) in the preceding definition as a significant portion of trading in the asset class takes place in the US.