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How to set up an ICO – Part 4: The Token Sale (KYC, Terms & Conditions and Marketing)

Flag Theory Weekly Letter – Friday, June 8th, 2018

During these last weeks, we have been reviewing the process of how to set up an ICO, the fundamental aspects, and the corporate structure. Then we reviewed in more detail the vehicle established to carry out the token issuance.

Today we’ll go into the Token Sale itself and the aspects that you must take into account from a legal standpoint when marketing and selling your tokens.

Token Sale KYC / AML & CTF

Although ICOs strictly issuing a utility token (as opposed to a currency or a security token) are generally falling in an unregulated space, it is still highly advisable to conduct the appropriate compliance checks to identify and screen participants of a Token Sale.

There are many reasons for this, one being to screen out individuals in countries where even utility token sales to the general public are prohibited (for instance PRC, at the time of writing). Speaking broadly, KYC is an essential part of any token sale.

Another reason for performing KYC is to identify and screen sanctioned individuals and companies. It is essential to establish mechanisms to identify them, as well as their shareholders/members and ultimate beneficial owners (UBO).

Otherwise, you could be considered an accomplice to money laundering, terrorist financing, or worse – and all the associated liability therein. By accepting payments from individuals or businesses, you are responsible for ascertaining their name and personal/company details and conducting the appropriate checks to ensure that they are not sanctioned persons.

If you do distribute tokens to known terrorists or members who are on a list of economic or commercial sanctions (eg. OFAC, UN, Interpol, EEAS, etc.) you may unknowingly be committing a crime and the penalties are severe.

Bear in mind that compliance requirements vary between jurisdictions. There are jurisdictions that require collecting more due diligence documents than others. This requirement can also vary depending on the transaction amount.

Normally, for individuals, you should at least identify them by a proof of identities such as a copy of a passport or ID card and proof of its ownership, such as a selfie with the document or a live video and then use the appropriate technology to verify the veracity of the said document. Further checks for tampering and fraud could also be conducted at this stage.

For legal entities, you may have to request the incorporation documents such as Certificate of Incorporation, Memorandum, and Articles of Association, Register of Directors, etc. and proof of identity and address for each of the shareholders, directors and UBOs.

If the amount transferred exceeds certain minimum thresholds, you may need to obtain a proof of address the copies which should be certified by a qualified notary, attorney, accountant or consulate. You may even have to collect and save hard copies of those documents.

After that, you must perform the appropriate AML checks to ensure that your Token Sale is not being used for money laundering and that you are not having commercial relations with sanctioned persons. Most KYC laws mandate that KYC is conducted from a risk-based approach as well, with different tiers of customer due diligence based on the risk scoring. Those who are politically exposed persons (PEP’s) should generally undergo additional enhanced due diligence (EDD) to prevent things like corruption and bribery.

Nowadays there are a variety of programs that help you collect documents, identify and screen customers in an easy and painless manner for both the user and the compliance staff.

At Flag Theory, we offer, through our partner KYC-Chain, the necessary tools to meet the highest compliance standards.

As we discussed in a previous article, when it comes to opening bank accounts for an ICO, what the bank cares about most is the source of funds. This means they will not only be needing to do KYC on you – but they will also need to know that their customer’s customers (your ICO participants) source of funds has been vetted.

As a final point – if you do not perform KYC, in addition to all the potential legal issues, it will likely be impossible to open a bank account. This is because you will not be able to properly articulate or prove to a bank the source of funds. It should be clear at this point – that performing KYC on your participants is not an option, it is mandatory.

Terms and Conditions of the Token Sale

The Terms and Conditions of the sale are the most important documents of your token sale.

It is the legal communication between the issuer and the public, the token purchasers. It is the document that governs your commercial relationship with them.

Without going into much detail, the T&Cs must reflect the nature of the product (your token) you are selling, its price, payment methods, how, when and how many will be generated, under what conditions, and what will be the tokens used for.

It must determine the period of the sale and who can participate in it. You may want to exclude residents of countries where your token may fall under certain regulations such as securities laws.

Your T&Cs must declare a jurisdiction for dispute resolution and expose risks, warranties, liability, and other basic legal issues.

Laying out clear T&Cs is crucial and it must be written by qualified lawyers with experience in ICOs.

ICO Marketing and Communications

If you are selling any type of product, Terms and conditions are important. stating in the T&Cs the risks of purchasing tokens or that your token is not a financial instrument, and it only has utility within an application, is paramount.

But it is equally or more important than the communication and marketing are in line with these T&Cs, otherwise, the T&Cs  might be a moot point.

If you are promising returns to your potential purchasers or promoting the listing of your token in secondary markets, this can and will alert regulators.

Not only is important to conceive your token as a utility token, (a consumer product and not a financial instrument) it is also very important how you sell it.

A consumer product does not offer a return on investment or guaranteed (or non-guaranteed) profits, so you should not sell it as such.

Generally, a good approach when it comes to marketing and communicating your token sale includes:

Do not call the event an ICO, the term is easily associated with IPO, initial public offering, raising capital or selling shares or securities. Instead, you should call it a Token Sale, or Token Generation Event or Token Distribution Event.

Do not talk about investment or investor, instead, call them purchasers or participants. Don’t talk about any future appreciation or make any forward-looking statement about the performance of the token.

And do not publicly imply that the company will make efforts to list the token in an exchange platform. You are not selling any financial instrument to be traded in secondary markets. If an Exchange decides to list the token, it should be its own decision.

In summary, communication and marketing must be in line with what you are selling: a utility token.

If you are planning to launch an ICO, we can help you. We assemble lean teams of experts to bring success to your project. From drafting the whitepaper to your corporate structure to converting your tokens to fiat all while helping with all of the legal, tax, compliance and banking issues you need to be aware of for both your company and its officers.

In the next chapter of How to structure your ICO, we will go into the post-ICO and how the management of proceeds collected should be handled.

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