Securities Token Or Not? A Case Study – Part III

This is the third part in my three-part series laying out fact patterns and discussing whether a specific digital asset is a security, a utility, currency, commodity or some other digital asset. In Part 1 of the series, I examined a decentralized token that had been issued without any concurrent capital raise and was able to conclude such token was not a security. Part 1 can be read HERE. In Part 2 I examined a token that was issued with the intent of being a utility token, but as a result of the clear speculative motivation for purchasers, and the lack of decentralization, concluded it was a security. Part 2 can be read HERE.

In this Part 3 of the series, I examine the issuance of the Free Token as a dividend and its cousin the Bounty Token. Unlike the prior blogs in this series, which examined the question of whether a particular token is a security, this blog will analyze the definition of a “sale” under Section 2(a)(3) of the Securities Act of 1933, as amended (the “Securities Act”).  As part of this analysis, I will review the SEC action In the Matter of Tomahawk Exploration LLC et al (“Tomahawk Matter”).

The Free Token

Facts

Acme Insurance is building a blockchain-based community for the development of blockchain applications to revolutionize the insurance industry. Acme Insurance intends for the community to ultimately be decentralized and the code to be entirely open-source. Acme Insurance is a regional, top-tier insurance company that hopes to grow in the national marketplace and believes that if it can start and assist in the creation of a community that fosters technological developments in the industry, it will be able to capitalize on those developments to improve its market share. It also fundamentally believes in the improvement and advancement of the industry as a whole, which is defragmented and has a very large incidence of fraud. Prior to launching the Insurance Blockchain, Acme donated 2% of its net profits to educational projects which could benefit the insurance industry and has now committed to donating that 2% to the Insurance Blockchain community.

Acme is launching the Free Token to facilitate its plans. Acme is forming a Foundation to oversee the Insurance Blockchain project. An initial team of international developers is creating the platform. Acme has created 15 million Free Tokens, half of which it will distribute as a dividend to all Acme Insurance shareholders, on a pro rata basis. Acme has 900 shareholders. Acme will not receive any consideration for the issuance. Future Free Tokens will be issued through Proof of Work, and later Proof of Stake, mining efforts and as compensation for website maintenance, code updates, developing and other contributions to the project. All software developments will remain open-source, with no royalty or profit-sharing-type rights.

It is anticipated that the Free Token will trade on cryptocurrency exchanges, and Acme hopes they will increase in value to motivate efforts on the project.

Although Acme believes that ultimately the Free Token would not be considered a security, rather than test its analysis, it intends to sidestep the question and issue the token as a dividend by airdropping the token to all shareholders, without compliance with the registration and exemption requirements of the federal securities laws. Acme has asked me to confirm that it is able to do so.

Legal Analysis

As I’ve written about many times, Section 5 of the Securities Act stipulates that the offering or sale of a security requires registration under the Securities Act and applicable state securities laws, unless it is able to fit within an exemption from registration.  Registration under the Securities Act requires the issuer of the security to file a registration statement or offering circular in the case of Regulation A+ offerings, containing specified disclosure about the issuer, its management and business, including financial information. Likewise, the resale of a security by an existing security holder must either be registered or exempt from registration. The registration statement or offering circular is subject to review by the SEC before it can be used for the offer and sale of a security. The process can be both time-consuming and expensive.

Exemptions from registration under both the Securities Act and applicable state securities laws are generally designed for limited offerings of securities to qualified offerees, such as “accredited investors.” Broad-based solicitation without limits on the number or qualifications of offerees, or value of the offering, would make it difficult, if not impossible, to qualify for an exemption.

The registration requirements, or necessity to utilize an exemption, apply to the “offer” or “sale” of a security. Section 2(a)(3) of the Securities Act defines the terms “sale” and “offer” in pertinent part as:

The term “sale” or “sell” shall include every contract of sale or disposition of a security or interest in a security, for value. The term “offer to sell”, “offer for sale”, or “offer” shall include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value… Any security given or delivered with, or as a bonus on account of, any purchase of securities or any other thing, shall be conclusively presumed to constitute a part of the subject of such purchase and to have been offered and sold for value.

Section 2(a)(3), by its own terms, hinges on the receipt of value. The issuance of a dividend to all shareholders or the issuance of broad-based stock options to all employees has long been viewed as not involving the sale of securities.  This theory is often referred to as the “no sale” theory. In a Letter of General Counsel Discussing Question of Whether a Sale of a Security is Involved in the Payment of a Dividend, Securities Act Release No. 33-929, the SEC stated that the distribution of a cash or stock dividend to an issuer’s existing shareholders does not constitute a “sale” under Section 2(3)(a) of the Securities Act, and therefore such distribution does not require a Securities Act registration statement.  This guidance was issued in 1936 and has been reiterated on multiple occasions ever since.

Question 103.01 of the SEC Division of Corporation Finance’s Compliance and Disclosure Interpretations, published in November, 2008 confirmed the SEC’s long-standing position.  In particular:

Question 103.01

Question: If a company declares a dividend that is payable in either cash or securities at the election of the recipients, does the declaration of the dividend need to be registered under the Securities Act?

Answer: No, as there is no sale of the dividend shares under the Securities Act. [Nov. 26, 2008]

The analysis is based in part on the lack of investment decision by the recipient of the dividend.  If the recipient is not bargaining for the dividend and is not giving up anything of value, there is no risk, and therefore no sale of securities has occurred.

Accordingly, without more, even if the Free Token is a security, Acme Insurance can issue it as a dividend without compliance with the registration or exemption requirements under the federal securities laws.

The Bounty Token

Facts

To increase distribution of the Free Token, Acme will create a bounty program whereby initial users receive Free Tokens for (i) signing up to the Insurance Blockchain project; (ii) sharing certain white papers and other information documents on the project; or (iii) writing and creating educational and informational documents on the project.

Bounty programs are also often referred to as airdrop programs, though an airdrop can be used for a dividend release as well. An airdrop involves a controlled and periodic release of “free” tokens to people that meet a specific set of requirements, such as user ranking or activity. Generally the goal of an airdrop is to promote the new cryptocurrency. Bounty programs are essentially incentivized reward mechanisms offered by companies to individuals in exchange for performing certain tasks. Bounty programs are a means of advertising and have gained in popularity in ICO campaigns. During a bounty program, an issuer provides compensation for designated tasks such as registering at a website, reading and sharing materials, or marketing and making improvements to aspects of the cryptocurrency framework. In an airdrop, however, the issuer does not assign any tasks to the recipients; they need only meet some effortless requirements.  In a bounty program, however, individuals must execute assigned tasks before receiving the tokens.

Legal Analysis

Tokens issued in a bounty program generally involve the sale of securities that must either be registered or exempt from registration. The concept behind a bounty token program is not new. In the Internet bubble of the ’90s, companies were issuing free stock to gain website traffic and the SEC took notice. In a series of no-action letters, the SEC shut down the practice.

In Vanderkam & Sanders (January 27, 1999), an unnamed operator of an Internet-based auto referral service proposed to issue free stock to anyone who registered at the company’s website or who referred others to it. Visitors would complete a simple registration form and would not be required to provide cash, property or services for their shares. The SEC ruled that “the issuance of securities in consideration of a person’s registration on or visit to an issuer’s Internet site would be an event of sale” and would be unlawful unless “the subject of a registration statement or a valid exemption from registration.”

In Simplystocks.com (February 4, 1999), a web-based provider of financial information proposed to distribute free stock from a pool of entrants who logged in to the company’s website and provided their name, address, Social Security number, phone number and email address and then chose a log-in name and password. Visitors would receive one entry in the stock pool for each day they logged in to the website. After 180 days, the stock would be randomly allocated among the entrants in the stock pool. The SEC stated that the Simplystocks.com stock giveaway would be unlawful unless registered or exempt from registration.

In Andrew Jones (June 8, 1999), the promoter proposed to issue free stock to the first one million people who signed up or referred others to sign up. Shares would be claimed either by sending a self-addressed stamped envelope to the company along with the person’s name, address and email address, or by visiting the company’s website and providing the same information. The company said the information provided by shareholders would be used solely for corporate purposes and would not be sold or given to others or used for advertising purposes. The SEC ruled that “the issuance of securities in consideration of a person’s registration with the issuer, whether or not through the issuer’s Internet site, would be an event of sale” and would be unlawful unless registered or exempt from registration.

                In the Matter of Tomahawk Exploration LLC et al (“Tomahawk Matter”)

On August 14, 2018 the SEC obtained a judgment against Tomahawk Exploration LLC and its principal for engaging in a fraudulent ICO.  According to the SEC, Tomahawk attempted to complete an ICO using fraudulent and misleading sales materials. However, the ICO failed to raise any money and so Tomahawk “gave away” its tokens as part of a bounty program involving online promotional services.

The bounty program, like the ICO sales materials, were misleading on their face and clearly an effort to promote the token.  Tomahawk featured the program prominently on its ICO website, offering between 10 and 4,000 tokens for activities such as making requests to list TOM on token trading platforms, promoting tokens on blogs and other online forums, and creating professional picture file designs, YouTube videos or other promotional materials.

The SEC Order found that Tomahawk’s issuance of tokens under the Bounty Program constituted an offer and sale of securities because the company provided tokens to investors in exchange for services designed to advance Tomahawk’s economic interests and foster a trading market for its securities. In other words, the services required in the bounty program were a valid consideration. It has long been established that value for securities can be in the form of services, cash, property, or anything that a board of directors reasonably determines as valuable. Tomahawk received value in the form of online marketing and promotion, and by the creation of a secondary public trading market for its token.  In the case of SEC vs. Sierra Brokerage Servs, Inc., the court specifically found that “where a ‘gift’ disperses corporate ownership and thereby helps to create a public trading market it is treated as a sale.”

Although the Insurance Blockchain bounty program does not require outright promotional activity, at this point, I would still recommend that the bounty program be discontinued or comply with the registration or exemption requirements of the federal securities laws.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
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West Palm Beach, FL 33401
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Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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Securities Token Or Not? A Case Study – Part II

This is the second part in my three-part series laying out fact patterns and discussing whether a specific digital asset is a security, a utility, currency, commodity or some other digital asset. Although the first and easy answer is that if a digital asset is being issued today, it is most assuredly a security upon issuance that needs to comply with the federal securities laws, the answer is not always that straightforward for digital assets that have been in the marketplace for a period of time, such as Bitcoin and Ether, or for new digital assets that are carefully being constructed to fall outside the purview of a securitized token.

In the first part of this series, we examined the Oldie Token and, under the fact pattern presented, was able to determine that the Oldie Token was not a security. Part 1 can be read HERE. In this part we will examine the Functional Token, which has not yet been issued. In our fictional fact pattern, Freight Blockchain, Inc. has created what they believe to be a true utility token, the Functional Token that would not need to comply with the federal securities laws. Based on the analysis below, I concluded that Functional Token does indeed need to comply with the federal securities laws.

Sources Applicable to an Analysis of all Digital Assets

In determining whether a digital asset is a security and/or needs to comply with the U.S. federal securities laws in its issuance and distribution, at least the following sources should be reviewed and considered by securities counsel. This is not a comprehensive list as facts and circumstances, and the evolving state of the U.S. and international laws, must also be considered, but it covers the basics.

  1. The Securities Act;
  2. The Exchange Act;
  3. SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (“Howey”);
  4. Reves v. Ernst & Young, 494 U.S. 56 (1990) (“Reves”);
  5. Report of Investigation Pursuant to Section 21(a) of the Exchange Act: The DAO (July 25, 2017)(the “DAO Report”);
  6. In the Matter of Munchee Inc. (“Munchee Order”);
  7. Statement on Cryptocurrencies and Initial Coin Offerings (SEC Chairman Jay Clayton) (December 11, 2017) (“SEC Cryptocurrency Statement”);
  8. Speech by William Hinman, the Director of the SEC Division of Corporation Finance at Yahoo Finance’s All Markets Summit on June 14, 2018;
  9. SEC v. PlexCorps et al., Civil Action No. 17-cv-07007 (E.D. N.Y., filed December 1, 2017) (“PlexCorp Litigation”);
  10. In the Matter of Tomahawk Exploration LLC et al. (“Tomahawk Matter”);
  11. The Bitcoin White Paper;
  12. The Ethereum White Paper;
  13. The MUN Coin White Paper;
  14. The PlexCoin White Paper; and
  15. The White Paper and all relevant documents associated with the particular Digital Asset.

Like the first, this blog and case study is limited to an analysis of the U.S. federal securities laws and does not include any state or international securities laws nor the applicability of any regulations promulgated under or enforced by any other U.S. regulators such as the CFTC, FinCEN or the IRS.

The Functional Token

Facts

Freight Blockchain, Inc. is a software company focused in the logistics and transportation business. They have built a blockchain software application whereby the defragmented small trucking company can have access to the freight and transport needs of customers such as warehouses, stockrooms and shipping and receiving stations, without the use of a freight agent or broker. In addition to allowing for direct communication between trucking companies and potential customers, the Freight Blockchain allows for pre-screened qualified businesses in the logistics industry to advertise their goods and services on its platform. Freight Blockchain’s revenue model is based on transaction fees for the use of the Freight Blockchain.

Freight Blockchain’s idea was well received in the trucking industry and, as a result, they were able to raise funds in traditional debt and equity offerings and through venture capital investors. The Freight Blockchain is fully built out and operational, though as with any application, it is expected that it will need consistent development modifications and improvements as it gains users.

Partially as a result of the marketing angle and to attract users, and partially to encourage developers and the crowd to collaborate on maintenance and improvements to the Freight Blockchain, the company has decided to issue a Functional Token. Freight Blockchain created 10 million Functional Tokens for release with an upper limit of 15 million tokens. The management team of Freight Blockchain each received 100,000 Functional Tokens for deferred compensation, and the company removed the deferred compensation liability from its financial statements.

Freight Blockchain sold the Functional Token to users of the Freight Blockchain in its initial release at $2.00 per token with the Functional Tokens to be used as currency on the Freight Blockchain. Freight Blockchain accounted for the sales as advance transaction fees and purchasers were given a transaction fee credit for the purchase. Freight Blockchain sold 5 million Functional Tokens in its initial launch, all to individuals or entities that they thought to be customers or prospective customers of the Freight Blockchain based on a check-the-box response from purchasers.  Freight Blockchain did not separately advertise the Functional Token, but rather included the offer to prepay transaction fees via the purchase of a Functional Token in its regular Freight Blockchain ads and on its website.

Transaction fees equate to 6% of the transaction value and could vary widely depending on the customer and whether a haul is local or long-range. However, Freight Blockchain did not include either a minimum or maximum on the ability to purchase the Functional Token. A review of purchase records show that the minimum purchase was $500 and the maximum was $50,000. Although it is possible that a large customer could pay $50,000 in transaction fees in a year, it does not appear that the particular purchaser would do so and thus in hindsight, it is likely that person purchased for speculative value.

Users of the Freight Blockchain can opt to be paid in Bitcoin, Ethereum, Functional Token or fiat currency.  Transaction fees are paid to Freight Blockchain in the same currency that the users complete their transaction with.  Following the initial release Freight Blockchain launched the Functional Token open source code on Github and began trading on several cryptocurrency exchanges. Tokens can be earned by miners and are issued as compensation for website maintenance, code updates and other contributions to the Freight Blockchain. The Functional Token works as Proof-of-Stake. Freight Blockchain did not and does not market the Functional Token as an investment opportunity.

All changes to the Freight Blockchain platform must be approved by the Freight Blockchain management team, who maintains ultimate control over the software. No Foundation has been formed.

Functional Token holders do not have rights generally associated with security holders.  In particular, Functional Token holders (i) have no ownership rights in Freight Blockchain; (ii) have no right to share in profits and/or losses of Freight Blockchain; (iii) claims in bankruptcy or similar proceedings with a status of an equity holder; (iv) right to convert or exchange the Functional Token for a security token or other security; or (v) right to purchase a security token.

Legal Analysis

As I’ve written about many times, the offering or sale of a security requires registration under the Securities Act and applicable state securities laws, unless it is able to fit within an exemption from registration. Registration under the Securities Act requires the issuer of the security to file a registration statement or offering circular in the case of Regulation A+ offerings, containing specified disclosure about the issuer, its management and business, including financial information. Likewise, the re-sale of a security by an existing security holder must either be registered or exempt from registration.

Exemptions from registration under both the Securities Act and applicable state securities laws are generally designed for limited offerings of securities to qualified offerees, such as “accredited investors.” Broad-based solicitation without limits on the number or qualifications of offerees, or value of the offering, would make it difficult, if not impossible, to qualify for an exemption.

The registration requirements, or necessity to utilize an exemption, only apply to securities and accordingly, if Functional Token is not a security, it could be issued or resold on a cryptocurrency exchange without compliance with the federal securities laws.

The Securities Act defines the term “security” broadly to include “investment contracts.” Several tests have been used by the SEC and the courts to determine whether an offering involves an investment contract and thus a security, with the most commonly used test being the “Howey test.”  The SEC relied on the Howey test in its DAO Report in determining that certain offerings of tokens may be deemed securities. Another common test is the “Reves Test,” which I will discuss further in this analysis.

As set forth below, I conclude that the Functional Token is a security requiring compliance with the federal securities laws. However, my conclusion is weighed by the lack of legal clarity on tokens in general and my belief that when in doubt, it is a security. Furthermore, I find an analysis of a token with the features of the Functional Token to be more difficult than a decentralized token such as the Oldie Token from Part 1 of this series.

The Howey Test

The US Supreme Court case of SEC v Howey, 328 U.S. 293 (1946) established the test for whether an arrangement involves an investment contract.  An investment contract is a type of security.  In Howey, the Supreme Court noted that the term “investment contract” has been used to classify those instruments that are of a “more variable character” that may be considered a form of “contract, transaction, or scheme whereby an investor lays out money in a way intended to secure income or profit from its employment.” The Howey test can be expressed as three independent elements.  All three elements must be met in order for a token or cryptocurrency to be a security, including (i) an investment of money, (ii) in a common enterprise, (iii) with an expectation of profits predominantly from the efforts of others. For more on the Howey test, see HERE.

(i) Investment of Money. Under Howey, and case law following it, an investment of money may include not only the provision of capital, assets and cash, but also goods, services or a promissory note. Given the broad definition of investment, Functional Token distributed to developers for mining or other services to the Functional Token project may satisfy this part of the test, but it is also possible that a court might view the individual efforts of the miners or developers differently and conclude that no investment of money has occurred. Furthermore, it is possible that the courts would interpret the initial sale of the Functional Token, even though it was characterized as advance payment for transaction fees, as an investment of money. As part of this analysis, I consider the fact that it is unlikely that a customer would advance any fees associated with the use of the Freight Blockchain but for the potential for receiving value from such advancement in excess of the amount expended.

(ii) Common Enterprise. Different circuits use different tests to analyze whether a common enterprise exists. Three approaches predominate: (a) horizontal; (b) narrow vertical; and (c) broad vertical.

  1. Under the horizontal test, a common enterprise is deemed to exist where multiple investors pool funds into an investment and the profits of each investor equal a prorated portion of the total profits of the pool; see, e.g., Curran v. Merrill Lynch, 622 F.2nd 216 (6th Cir. 1980). Whether funds are pooled appears to be the key question, and thus in cases where there is no sharing of profits or pooling of funds, a common enterprise may not be deemed to exist. For example, a court has found that a discretionary trading account was not an investment contract because there was no pooling of funds.

Under the horizontal test, the Functional Token may be considered a common enterprise — notwithstanding the absence of a pooling of funds — where the reward for work, through mining or the contribution of other services, correlates to the reward received by the miners, developers or other members of the Functional Token platform receiving Functional Token. However, since Freight Blockchain retains control over the platform and there is no sharing of profits or pooling of funds, it is also likely that there is not a common enterprise under the horizontal test.

  1. Under the narrow vertical test, the key is whether the profits of an investor are tied to the promoter. For example, a court has found that the imposition of profit limitations on investors through requiring a promoter to receive an excess return rate tied to the investors return, satisfied this test. This test generally relates to income earned by a promoter from profits derived from participants.
  2. Under the broad vertical test, the critical fact is whether the success of the investor depends on the promoter’s expertise. If there is such a reliance, then a common enterprise is deemed to exist.

In this case, I believe a common enterprise exists in applying the vertical test.  Although miners depend on their own efforts to receive Functional Tokens, the ultimate secondary trading value of the Functional Token is inextricably tied to the success of the Freight Blockchain. Moreover, management of Freight Blockchain has maintained control over the platform and it is their expertise that will drive the success of the enterprise as a whole. If the Freight Blockchain does not gain customers and users, it is unlikely that the Functional Token will have any value to miners or those receiving the Functional Token in exchange for services.  Furthermore, I don’t believe a reasonable argument could be made that the initial purchasers of the Functional Token were purchasing for the purpose of pre-paying transaction fees, but rather were purchasing with the hope of an increased value on secondary markets, which would depend on the success of the Freight Blockchain under the control of its management.

An alternative test, sometimes called the “risk capital test,” focuses on whether the holder of an investment may be deemed passive, and in being passive, relying on the efforts of others.  This test has four parts: (i) are any funds raised for use by a venture or enterprise; (ii) who is the target investor (i.e., is it the public generally, or a group comprised only of those with specialized interest or expertise in the area relating to the investment); (iii) how much influence do investors have on the success of the enterprise; and (iv) is the investor’s investment substantially at risk?  Under the risk capital test, I believe the Functional Token would be a security.  If Freight Blockchain is not successful, then the Functional Tokens will have no value either on a secondary market or to be used against future transaction fees.

(iii) Expectation of Profit from the Efforts of Others.  Under this element of the test, profit refers to the type of return or income an investor seeks on their investment.   This could refer to any type of return or income earned from being the owner of a Functional Token, but for purpose of the Howey test and a securities law analysis would only include profits earned passively from the efforts of others.  In other words, it is the essentially passive nature of the return, utilizing the efforts of others, that results in an “investment contract” and determination of the existence of a security, rather than a simple contract which in itself would not be a security.

As discussed above, the success of the Freight Blockchain and therefore value of the Functional Token depends on the efforts of the Freight Blockchain management and as such, I believe that this part of the Howey test is satisfied.

As with the Oldie Token, the appreciation in the value of the Functional Token after issuance, due to secondary trading, should not affect the analysis of whether a Functional Token is an investment contract and thus a security.  Other rights that are not investment contracts or securities, such as loyalty points, airline points, licenses and franchise rights, can increase in value over time due to the secondary market for those assets.

Reves and the Family Resemblance Test

An analysis of Reves and the “family resemblance test” as formulated by the Supreme Court in Reves v. Ernst & Young, is only appropriate when determining whether a loan is a security under the Securities Laws.  Reves focused on the term “note” rather than the term “investment contract” as such terms are included in the definition of a security under the Securities Laws.  For more on the Reves test, see HERE.

The Functional Token as sold as pre-paid transaction fees and recorded as same on the books and records of the company. Each purchaser received a credit on their account. Accordingly, the funds received from the Functional Token sales are a liability on the books of Freight Blockchain and each purchaser is a creditor. In the event that Freight Blockchain were to fail, the purchasers of the Functional Token with remaining transaction fee credits would be creditors of the company entitled to a distribution of assets, if any.

The first part of an analysis as to whether the Functional Tokens could be a debt security would be to consider the time in which repayment is likely. The Exchange Act and SEC specifically exclude notes with a term of less than nine months, the proceeds of which are used for a current transaction, from the definition of a “security.”  The transaction fee credit associated with Functional Tokens does not have an expiration date and based on the amounts purchased, although some will be used up in nine months, many will take much longer.

A Reves analysis involves four tests: (i) the motivation of the seller and buyer; (ii) the plan of distribution of the instrument; (iii) the reasonable expectations of the investment public; and (iv) the presence of an alternative regulatory regime.

(i) Motivation of the seller and buyer. The first factor is described as the motivation that prompts “a reasonable seller and buyer to enter into” the transaction.  If the seller’s motivation is to raise money for his/her business and the buyer’s motivation is to earn profits, then the note is likely a security.  Even if the note is not necessarily characteristic of a security, if the investor reasonably expected that they were buying a security, and would be protected by the accompanying securities laws, the courts can determine that indeed a security has been sold.  Furthermore, Reves specifically states that if the purpose is, for example, to “facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash flow difficulties, or to advance some other commercial or consumer purpose,” it is unlikely to be deemed a security.

Although the Freight Blockchain management was attempting to motivate users and build the commercial enterprise of the Freight Blockchain by issuing the Functional Token, I think it would be difficult to establish that the motivation of the purchaser was to pre-pay transaction fees.  Transaction fees do not fluctuate and therefore there would be no motivation to pre-pay this expense.  However, the immediate secondary trading of the Functional Token created a motivation to expend risk capital with the hope of a return on such investment.  Moreover, the Freight Blockchain transaction fees could be paid in fiat currency, and thus it would not be necessary to purchase the Functional Token to conduct business on the platform.

(ii) Plan of distribution.  The second factor determines whether the instrument is being distributed for investment or speculation.  If the debt instrument is being offered and sold to a broad segment or the general public for investment purposes, it is a security.  Although the Functional Blockchain was not marketed as an investment, advertisements related to the Freight Blockchain and the availability of the Functional Token were widely disseminated.  Moreover, a Telegram group quickly formed regarding the Functional Token, which appeared to increase sales dramatically.

(iii) Reasonable expectation of investing public.  An instrument will be deemed a security where the reasonable expectation of the investing public is that the securities laws (and accompanying anti-fraud provisions) apply to the investment.  Although the investing public did not believe they were purchasing a security, as described herein, it is likely that the purchase of the Functional Token was motivated by a potential return on investment as opposed to purely commercial uses.

(iv) The presence of alternative regulatory regime.  The fourth factor is a determination whether another regulatory scheme “significantly reduces the risk of the instrument, thereby rendering the application of the Securities Act unnecessary.”  A “utility token” or cryptocurrency remains largely unregulated in the U.S. unless such token is found to be a security under the federal securities laws, or a commodity subject to the Commodity Exchange Act.  The lack of alternative regulatory regime supports the need for protection under the federal securities laws in the issuance and sale of the Functional Token.

Speech by William Hinman

On June 14, 2018, William Hinman, the Director of the SEC Division of Corporation Finance, gave a speech at Yahoo Finance’s All Markets Summit in which he expressed his views on when a cryptocurrency would most assuredly be a security, and laid out some factors to consider in completing an analysis under the securities laws.  An important factor in determining that a token is not, or no longer, a security is the decentralization of the underlying platform.  If a platform is decentralized, purchasers of the token would not reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts, the result of which would increase the value of the token.

When the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.  It is this information asymmetry that I find is key to the analysis of the Functional Token, and why using both Howey’s based-on-the-efforts-of-others test and Reves’ motivation test, the Functional Token is a security.

The Freight Blockchain management team is uniquely positioned to know whether the Freight Blockchain platform is meeting its milestones, successful, and profitable, all of which are necessary for the Functional Token to have value.  To the extent that initial purchasers hold credits for future transaction fees, those credits become worthless if the Freight Blockchain fails.  Furthermore, it is likely that the trading value of the Functional Token is inextricably tied into the success of the Freight Blockchain.  Without meaningful disclosures, such as can be found in a registration statements or proper private placement offering document, the only information that purchasers receive is found on the Freight Blockchain website, press releases and on social media such as the Telegram group.

Moreover, a review of the social media sites, such as Telegram, clearly indicates that some are promoting the Freight Blockchain for the purpose of increasing the value of the Functional Token, presumably because they hold tokens and hope to sell at a profit.  The Functional Token was sold to anyone who sought to purchase which would include those that may not understand the risks associated with the investment, and even those that did, were not provided with any meaningful information on which to assess such risks.

Hinman provided some guidance in determining whether a particular sale involves the sale of a security.  The primary consideration is whether a third party, such as a person, entity, or coordinated group, drives the expectation of a return on investment.  Questions to consider include:

  1. Is there a person or group that has sponsored or promoted the creation and sale of the digital asset, the efforts of whom play a significant role in the development and maintenance of the asset and its potential increase in value?
  2. Has this person or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in value in the digital asset? Would purchasers reasonably believe such efforts will be undertaken and may result in a return on their investment in the digital asset?
  3. Has the promoter raised an amount of funds in excess of what may be needed to establish a functional network, and, if so, has it indicated how those funds may be used to support the value of the tokens or to increase the value of the enterprise? Does the promoter continue to expend funds from proceeds or operations to enhance the functionality and/or value of the system within which the tokens operate?
  4. Are purchasers “investing,” i.e., seeking a return? In that regard, is the instrument marketed and sold to the general public instead of to potential users of the network for a price that reasonably correlates with the market value of the good or service in the network?
  5. Does application of the Securities Act protections make sense? Is there a person or entity others are relying on that plays a key role in the profit-making of the enterprise such that disclosure of their activities and plans would be important to investors? Do informational asymmetries exist between the promoters and potential purchasers/investors in the digital asset?
  6. Do persons or entities other than the promoter exercise governance rights or meaningful influence?

Other than that the Freight Blockchain was built and operational at the time of the issuance of the Functional Token, the answer to all of these questions supports the conclusion that the Functional Token is a security.

License/Contract Right Considerations

Providing access to the open-source Functional Token blockchain can be analogized to the grant of a license.  Because software licenses are typically governed by contract law, one possible analysis would be to focus on the rights associated with the license that are granted by the licensor to the licensee. For example, the licensor’s rights would include the ability to grant or distribute all, some or none of the rights attached to the use of the software code (originally the licensor’s intellectual property), as well as the right to exclude certain parties from using any of those rights.  Thus, the licensee would receive all of these rights, or a portion of these rights depending on what the licensor grants.

In the context of a license of the Functional Token blockchain, if any, Freight Blockchain would act as the licensor of the system, which includes the right to use the Functional Token platform and earn fees for accepted developments, but which does not include most other proprietary rights, including the right to assign or sublicense the Functional Token blockchain or transfer any rights.  There are no voting rights inherent in the Functional Token or provided other members of the Functional Token community.  Of the bundle of rights, the only right is to use the Functional Token blockchain, with the hope that innovations will be rewarded.  This limitation could be used to argue that the right is more analogous to a limited contract right rather than a security.

The DAO Report

The SEC has advised that tokens may be securities in certain circumstances, generally when involving raising capital for the issuer or seller of the tokens.  On July 25, 2017, the SEC issued the DAO Report detailing its investigation into whether the DAO (an unincorporated “decentralized autonomous organization”), Slock.iotUG (“Slock.it”), its co-founders, and intermediaries violated the federal securities laws.  Utilizing the Howey test, the SEC determined that the tokens issued by the DAO are securities under the Securities Laws and advised that those who would use distributed ledger or blockchain-enabled means for capital raising must take appropriate steps to comply with the Securities Laws (e.g., register the offering or qualify for an exemption from registration).

The DAO Report emphasized that whether a particular investment transaction involves the offer or sale of security is not dependent on the terminology used, but rather on the facts and circumstances, including the economic realities of the transaction. For more on the DAO Report, see HERE.

As detailed in the DAO Report, the concept of the DAO was memorialized in a white paper (the “DAO White Paper”) authored by the Chief Technology Officer of Slock.it.  In the DAO White Paper Slock.it proposed an entity (a DAO entity) that would use smart contracts to attempt to solve governance issues it describes as inherent in traditional corporations. Slock.it organized a DAO as a crowdfunding contract to raise funds to grow a company in the crypto space. The DAO was a for-profit entity where participants would send ETH to the DAO to purchase DAO tokens, which would permit the participant to vote and entitle the participant to “rewards.” The White Paper described this as similar to “buying shares in a company and getting . . . dividends.”  The DAO was to be “decentralized” in that it would allow for voting by investors holding DAO tokens.  All funds raised were to be held at an Ethereum blockchain “address” associated with the DAO, and the DAO token holders were to vote on contract proposals, including proposals to the DAO to fund projects. Based on the vote of the DAO token holders, the DAO would use any “rewards” from the projects it funded to either fund new projects or distribute them to the DAO token holders. The DAO was intended to be “autonomous” in that project proposals were in the form of smart contracts that exist on the Ethereum blockchain and the votes were administered by the code of the DAO.

In applying the Howey test, the SEC found that the DAO’s investors relied on the managerial and entrepreneurial efforts of Slock.it, its co-founders, and the DAO’s curators to manage the DAO and generate profits.

The Freight Blockchain project is an actual for-profit corporation under the control of a standard board of directors and officers.   Under this analysis the Freight Blockchain management acted as promoters of the Functional Token, and continue to be motivated to increase its value, as each received Functional Tokens as compensation. Moreover, although the Functional Token can be used as currency on the Freight Blockchain, its real value is in the secondary trading market, which depends on the success of the underlying platform. Applying the Howey test and principles in the DAO Report, it is difficult to argue that the Functional Token is not a security.

The Munchee Order

On December 11, 2017, the SEC issued a cease-and-desist order against Munchee, Inc. (“Munchee”) to stop Munchee’s ICO and require it to return to investors the funds it collected through the sale of its MUN token. The SEC found that Munchee’s token sale constituted an offering of securities in violation of the Securities Laws.

In applying the Howey test to the offering of the MUN token, the SEC gave little weight to the fact that Munchee characterized the MUN token as a “utility” token because of their functional use in connection with the business model of Munchee.  Instead, the SEC focused on the manner in which the offering of the MUN token was marketed.  In connection with the ICO, Munchee described how MUN tokens were expected to increase in value, especially as the result of Munchee’s future efforts. The SEC noted that Munchee made statements in its White Paper, on blogs, podcast and Facebook posts that suggested that investors would profit from purchasing MUN tokens.  In addition, Munchee endorsed statements made by other commentators that highlighted the opportunity for profit through the purchase of MUN tokens, including, for example, by linking their public post on their Facebook page about the offering (“199% GAINS on MUN token at ICO price!”) to a YouTube video in which the person featured claimed that if investors got in early enough on ICOs, they would make a profit.  Munchee also stated in a blog post that investors could count on the burning of MUN tokens by Munchee from time to time to increase value.

In the Munchee Order, the SEC noted that in its White Paper, Munchee said that they would work to cause MUN tokens to be listed on various exchanges to ensure that a secondary trading market would exist for MUN tokens. The SEC viewed such statements as priming “purchasers’ reasonable expectations of profit” and that “[p]urchasers would reasonably believe that they could profit by holding or trading MUN tokens, whether or not they ever used the Munchee App or otherwise participated in the MUM ‘ecosystem,’ based on Munchee’s statements in its MUN White Paper and other materials.”

In addition to concluding that purchasers of MUN tokens would have a reasonable expectation of profits based on Munchee’s states, the SEC concluded that those profits would be based primarily on the future efforts of Munchee.  In the Munchee Order, the SEC said:

The proceeds of the MUN token offering were intended to be used by Munchee to build an “ecosystem” that would create demand for MUN tokens and make MUN tokens more valuable. Munchee was to revise the Munchee App so that people could buy and sell services using MUN tokens and was to recruit “partners” such as restaurants willing to sell meals for MUN tokens. The investors reasonably expected they would profit from any rise in the value of the MUN tokens created by the revised Munchee App and by Munchee’s ability to create an “ecosystem” – for example, the system described in the offering where restaurants would want to use MUN tokens to buy advertising from Munchee or to pay rewards to app users, and where app users would want to use MUN tokens to pay for restaurant meals and would want to write reviews to obtain MUN tokens.

The SEC focused on the ongoing efforts by Munchee after the token sale. However, in most cases token issuers intend to use at least a portion of the proceeds from the sale to further develop the token ecosystem. In the Functional Token context, the work done by developers, miners and other contributors to the Functional Token project is rewarded with Functional Tokens.

The Freight Blockchain management team believed that because the Freight Blockchain was built and operational at the time of issuance of the Functional Token, and because they did not tout the potential increase in value, it would not be a security. However, I believe that, because the Functional Token immediately began to trade in a secondary market, despite how it was marketed, its purchase would logically be to realize an increase in value and because the Functional Token is not a requirement to use the Freight Blockchain, it is a security.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a Bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC’s and NASAA’s statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal’s op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC’s role and position on cryptocurrencies, see HERE

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and need for even further guidance in this space, see HERE.

For a discussion of William Hinman’s speech related to Ether and Bitcoin and guidance on cryptocurrencies in general, see HERE.

For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.

For a review of Wyoming’s blockchain legislation, see HERE.

For a review of FINRA’s Special Notice seeking public comments on how FINRA can support fintech developments including those related to data aggregation services, supervisory processes, including with the use of artificial intelligence, and the development of a taxonomy-based, machine-readable rulebook and FINRA regulatory Notice 18-20 related to member firms’ digital asset activities, see HERE.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
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Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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Security or Utility Token? A Case Study – Part I

Is it a security or is it a utility, currency, commodity or some other digital asset? That question has been continuously raised by those working with digital assets such as cryptocurrencies, virtual coins and tokens, including by digital asset issuers and companies that run platforms for the issuance or trading of such digital assets. Although the first and easy answer is that if a digital asset is being issued today, it is most assuredly a security upon issuance that needs to comply with the federal securities laws, the answer is not always that straightforward for digital assets that have been in the marketplace for a period of time, such as bitcoin and ether, or for new digital assets that are carefully being constructed to fall outside the purview of a securitized token.

The “STO” standing for security token offering has quickly gained favor alongside “ICO” with an industry-understood distinction. An STO is designed to be a security or financial instrument offering usually backed by stock, assets, revenues or profits in a company. An ICO may or may not be designed to be a security or financial instrument upon issuance, has utility or commodity attributes, and often involves a token offering entirely outside of the United States precluding US investors (some doing so more successfully than others, but that is another topic).

In this three-part blog, I will lay out fact patterns and analyze whether a digital asset is a security including (i) the issued- and trading-for-years Oldie Token; (ii) the about-to-be-issued Functional Token; and (iii) the newly-issued-as-a-dividend Free Token including a discussion of the definition of a “sale” under the Securities Act and its cousin, the Bounty Token.

Sources Applicable to an Analysis of all Digital Assets

In determining whether a digital asset is a security and/or needs to comply with the U.S. federal securities laws in its issuance and distribution, at least the following sources should be reviewed and considered by securities counsel. This is not a comprehensive list of facts and circumstances, and the evolving state of the U.S. and international laws must also be considered, but it covers the basics.

  1. The Securities Act;
  2. The Exchange Act;
  3. SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (“Howey”);
  4. Reves v. Ernst & Young, 494 U.S. 56 (1990) (“Reves”);
  5. Report of Investigation Pursuant to Section 21(a) of the Exchange Act: The DAO (July 25, 2017)(the “DAO Report”);
  6. In the Matter of Munchee Inc. (“Munchee Order”);
  7. Statement on Cryptocurrencies and Initial Coin Offerings (SEC Chairman Jay Clayton) (December 11, 2017) (“SEC Cryptocurrency Statement”);
  8. Speech by William Hinman, the Director of the SEC Division of Corporation Finance at Yahoo Finance’s All Markets Summit on June 14, 2018;
  9. SEC v. PlexCorps et al., Civil Action No. 17-cv-07007 (E.D. N.Y., filed December 1, 2017) (“PlexCorp Litigation”);
  10. In the Matter of Tomahawk Exploration LLC et al (“Tomahawk Matter”);
  11. The Bitcoin White Paper;
  12. The Ethereum White Paper;
  13. The MUN Coin White Paper;
  14. The PlexCoin White Paper;
  15. Any and all recent statements, speeches or enforcement proceedings by the SEC; and
  16. The White Paper and all relevant documents associated with the particular Digital Asset.

This blog and case study is limited to an analysis of the U.S. federal securities laws and does not include any state or international securities laws nor the applicability of any regulations promulgated under or enforced by any other U.S. regulators such as the CFTC, FinCEN or the IRS.

The Oldie Token

Facts

The Oldie Token was a fair launch without any presale, ICO, pre-mine or distribution to the Oldie Token Team. No central company or entity was in charge of the initial launch. An international group of developers, building on the idea of John Doe, the founder of the idea on which Oldie Token is based (the “Initial Founders”), created the core code for the Oldie Token. Members of the developer community donated bitcoin, fiat currencies, coin and their time in a collaborative effort to launch, develop and maintain the Oldie Token.

The Oldie Token Team released 10 million coins during its Proof-of-Work phase and has a total upper limit of 15 million coins. Following the initial release, a team of developers and hundreds of contributors launched the Oldie Token open-source code on Github, the Oldie Token switched from Proof-of-Work to Proof-of-Stake and began trading on several cryptocurrency exchanges. Tokens continue to be issued via mining and as compensation for on initial graphical works, website maintenance, code updates and other contributions to the Oldie Token project.

A few years after the initial issuance of the Oldie Token, the Initial Founders formed a Foundation to direct the continued development of the Oldie Token on open source blockchain. Over time developers have made changes and upgrades to the Oldie Token code including to the wallet, programming which enables user to register names on a server linked to the blockchain and send and receive Oldie Token, data storage and messaging. The Foundation also solicits donations to spend on further development on the open sourced Oldie Token blockchain. The Foundation is based in Switzerland.

Legal Analysis

As I’ve written about many times, the offering or sale of a security requires registration under the Securities Act and applicable state securities laws, unless it is able to fit within an exemption from registration. Registration under the Securities Act requires the issuer of the security to file a registration statement or offering circular in the case of Regulation A+ offerings, containing specified disclosure about the issuer, its management and business, including financial information. Likewise, the resale of a security by an existing security holder must either be registered or exempt from registration. The registration statement or offering circular is subject to review by the SEC before it can be used for the offer and sale of a security. The process can be both time-consuming and expensive.

Exemptions from registration under both the Securities Act and applicable state securities laws are generally designed for limited offerings of securities to qualified offerees, such as “accredited investors.” Broad-based solicitation without limits on the number or qualifications of offerees, or value of the offering, would make it difficult, if not impossible, to qualify for an exemption.

The registration requirements, or necessity to utilize an exemption, only apply to securities and accordingly, if Oldie Token is not a security, it could be issued or resold without compliance with the federal securities laws.

The Securities Act defines the term “security” broadly to include “investment contracts.” Several tests have been used by the SEC and the courts to determine whether an offering involves an investment contract and thus a security, with the most commonly used test being the “Howey test.” The SEC relied on the Howey test in its DAO Report in determining that certain offerings of tokens may be deemed securities.

As set forth below, I conclude that the Oldie Token is not a security requiring compliance with the federal securities laws.

The Howey Test

The US Supreme Court case of SEC v Howey, 328 U.S. 293 (1946) established the test for whether an arrangement involves an investment contract. An investment contract is a type of security. In Howey, the Supreme Court noted that the term “investment contract” has been used to classify those instruments that are of a “more variable character” that may be considered a form of “contract, transaction, or scheme whereby an investor lays out money in a way intended to secure income or profit from its employment.” The Howey test can be expressed as three independent elements (the third element encompasses both the third and fourth prongs of the traditional Howey test). All three elements must be met in order for a token or cryptocurrency to be a security, including (i) An investment of money, (ii) in a common enterprise, (iii) with an expectation of profits predominantly from the efforts of others. For more on the Howey test, see HERE.

(i) Investment of Money. Under Howey, and case law following it, an investment of money may include not only the provision of capital, assets and cash, but also goods, services or a promissory note. Given the broad definition of investment, Oldie Token distributed to developers for mining or other services to the Oldie Token Project may satisfy this part of the test, but it is also possible that a court might view the individual efforts of the miners or developers differently and conclude that no investment of money has occurred.

(ii) Common Enterprise. Different circuits use different tests to analyze whether a common enterprise exists. Three approaches predominate: (a) horizontal; (b) narrow vertical; and (c) broad vertical.

  1. Under the horizontal test, a common enterprise is deemed to exist where multiple investors pool funds into an investment and the profits of each investor equal a prorated portion of the total profits of the pool. See, e.g., Curran v. Merrill Lynch, 622 F.2nd 216 (6th Cir. 1980). Whether funds are pooled appears to be the key question, and thus in cases where there is no sharing of profits or pooling of funds, a common enterprise may not be deemed to exist. For example, a court has found that a discretionary trading account was not an investment contract because there was no pooling of funds.

Under the horizontal test, the Oldie Token may be considered a common enterprise — notwithstanding the absence of a pooling of funds — where the reward for work, through mining or the contribution of other services, correlates to the reward received by the miners, developers or other members of the Oldie Token community receiving Oldie Token. Thus, although the Foundation has some control over the protocol, the rewards in the form of Oldie Token would likely be correlated.

  1. Under the narrow vertical test, the key is whether the profits of an investor are tied to the promoter. For example, a court has found that the imposition of profit limitations on investors through requiring a promoter to receive an excess return rate tied to the investors return, satisfied this test. This test generally relates to income earned by a promoter from profits derived from participants.
  2. Under the broad vertical test, the critical fact is whether the success of the investor depends on the promoter’s expertise. If there is such a reliance, then a common enterprise is deemed to exist.

Under either of the vertical approaches, however, a common enterprise may not exist given the decentralized nature of the Oldie Token blockchain framework. This is because those who receive Oldie Tokens depend on their own efforts (mining or otherwise), rather than on any expertise of the Foundation or the Oldie Token Team (even though the Foundation may in some cases control or influence technical permission or changes to the protocol). The key is the degree of control exerted by the Foundation; where there is less reliance on the Foundation’s expertise, there is less likelihood that the Oldie Token blockchain would be viewed as being part of a common enterprise.

The law on what constitutes a “common enterprise” is unclear and a definitive conclusion is not possible. Nevertheless, given that at no time has the Oldie Project received any funds from the issuance of the Oldie Token, and instead relies on donations, including donations made to the Foundation, to create, support and maintain the Oldie Token blockchain, a court would not be likely to find that the common enterprise element is satisfied. This is all the more the case since there was no presale of the Oldie Token or distribution to members of the Oldie Team.

An alternative test, sometimes called the “risk capital test,” focuses on whether the holder of an investment may be deemed passive, and in being passive, relying on the efforts of others. This test has four parts: (i) are any funds raised for use by a venture or enterprise; (ii) who is the target investor (i.e., is it the public generally, or a group comprised only of those with specialized interest or expertise in the area relating to the investment); (iii) how much influence do investors have on the success of the enterprise; and (iv) is the investor’s investment substantially at risk? The risk capital test does not seem applicable to the facts and circumstances of the Oldie Token distribution since it generally applies only in a limited number of jurisdictions, and typically is applied only in the context of “startup” capitalization for a business. Cases relating to the risk capital test generally relate to memberships in a club-like organization that does not allow commercial exploitation for profit, but only create a right of personal use.  To the contrary, our fictional Oldie Token blockchain is an open-source system which allows for exploitation of the system by the Oldie Token owner. The Oldie Token Project does not receive funds from the issuance of Oldie Token.  Moreover, the target investor in Oldie Token is the Oldie Token developer community, rather than the general investor class.

(iii) Expectation of Profit from the Efforts of Others. Under this element of the test, profit refers to the type of return or income an investor seeks on their investment (rather than the profits that might be earned from using the Oldie Token blockchain). This could refer to any type of return or income earned from being the owner of an Oldie Token, but for purpose of the Howey test and a securities law analysis would only include profits earned passively from the efforts of others. In other words, it is the essentially passive nature of the return, utilizing the efforts of others, that results in an “investment contract” and determination of the existence of a security, rather than a simple contract which in itself would not be a security.

In determining whether profits arise from the efforts of others, courts have been flexible including situations where there is significant or essential managerial or other efforts necessary to the success of the investment. An expectation of profits resulting from receipt of an Oldie Token primarily relates to whether the holder receives (i) rights or (ii) investment interests. While the holder of an Oldie Token may receive some form of financial incentive inherent in the Oldie Token’s current and potential value, these incentives are primarily derived through the efforts of the holder of the Oldie Token, whether obtained by mining or by providing other services, or whether developed outside of the open-source blockchain protocol.

That is, owners of an Oldie Token can utilize, contribute to or even license their own contribution to the Oldie Token blockchain in various ways, none of which would be considered a passive investment. Owners of Oldie Token received by mining or for services would be better viewed as active participants, like franchisees or licensees. Although the Foundation may have some managerial oversight over the Oldie Token blockchain, including the distribution of the Oldie Token, the Foundation seeks the consensus of the Oldie Token community to make changes to the protocol, again making the owners active participants.

The appreciation in the value of the Oldie Token after issuance, due to secondary trading, should not affect the analysis of whether an Oldie Token is an investment contract and thus a security. Other rights that are not investment contracts or securities, such as loyalty points, airline points, licenses and franchise rights, can increase in value over time due to the secondary market for those assets.

The manner in which the Oldie Token is distributed to developers and miners, particularly the promotion and marketing, likely affects the “expectation of profits” analysis.  For example, we assume that since the Oldie Project’s public statements do not include words like “returns” or “profits” derived from the Oldie Token.

Reves and the Family Resemblance Test

An analysis of Reves and the “family resemblance test” as formulated by the Supreme Court in Reves v. Ernst & Young is only appropriate when determining whether a loan is a security under the Securities Laws. Reves focused on the term “note” rather than the term “investment contract” as such terms are included in the definition of a security under the Securities Laws. There is nothing about the Oldie Token that suggests it could be a debt obligation or that any party has an obligation of repayment. That is also generally the case with any token or coin.  For more on the Reves test, see HERE.

License/Contract Right Considerations

Providing access to the open-source Oldie Token blockchain can be analogized to the grant of a license. Because software licenses are typically governed by contract law, one possible analysis would be to focus on the rights associated with the license that are granted by the licensor to the licensee. For example, the licensor’s rights would include the ability to grant or distribute all, some or none of the rights attached to the use of the software code (originally the licensor’s intellectual property), as well as the right to exclude certain parties from using any of those rights. Thus, the licensee would receive all of these rights, or a portion of these rights depending on what the licensor grants.

In the context of a license of the Oldie Token blockchain, if any, the Foundation would act as the licensor of the system, which includes the right to use the Oldie Token blockchain, but which does not include most other proprietary rights, including the right to assign or sublicense the Oldie Token blockchain or transfer any rights, other than those created by the developer/miner (licensee) by its independent contribution to a side blockchain, albeit one which builds on the public open-source Oldie Token blockchain. There are no voting rights inherent in the Oldie Token or provided to donors or other members of the Oldie Token community (other than, of course, the Board of the Foundation); at best there is an expectation that decisions will be made by consensus, and that users may use the Oldie Token blockchain for their own purposes, independent of the Foundation. Thus, of the bundle of rights, the only right is to use the Oldie Token blockchain, like any other open-source code. This limitation could be used to argue that the right is more analogous to a limited contract right rather than a security.

The DAO Report

The SEC has advised that tokens may be securities in certain circumstances, generally when involving raising capital for the issuer or seller of the tokens. On July 25, 2017, the SEC issued the DAO Report detailing its investigation into whether the DAO (an unincorporated “decentralized autonomous organization”), Slock.iotUG (“Slock.it”), its co-founders, and intermediaries violated the federal securities laws. Utilizing the Howey test, the SEC determined that the tokens issued by the DAO are securities under the Securities Laws and advised that those who would use distributed ledger or blockchain-enabled means for capital raising must take appropriate steps to comply with the Securities Laws (e.g., register the offering or qualify for an exemption from registration).

The DAO Report emphasized that whether a particular investment transaction involves the offer or sale of security is not dependent on the terminology used, but rather on the facts and circumstances, including the economic realities of the transaction. For more on the DAO Report, see HERE.

As detailed in the DAO Report, the concept of the DAO was memorialized in a white paper (the “DAO White Paper”) authored by the Chief Technology Officer of Slock.it.  In the DAO White Paper Slock.it proposed an entity (a DAO entity) that would use smart contracts to attempt to solve governance issues it describes as inherent in traditional corporations. Slock.it organized a DAO as a crowdfunding contract to raise funds to grow a company in the crypto space. The DAO was a for-profit entity where participants would send ETH to the DAO to purchase DAO tokens, which would permit the participant to vote and entitle the participant to “rewards.” The White Paper described this as similar to “buying shares in a company and getting . . . dividends.”  The DAO was to be “decentralized” in that it would allow for voting by investors holding DAO tokens. All funds raised were to be held at an Ethereum Blockchain “address” associated with the DAO and the DAO token holders were to vote on contract proposals, including proposals to the DAO to fund projects. Based on the vote of the DAO token holders, the DAO would use any “rewards” from the projects it funded to either fund new projects or distribute them to the DAO token holders. The DAO was intended to be “autonomous” in that project proposals were in the form of smart contracts that exist on the Ethereum blockchain and the votes were administered by the code of the DAO.

As described in the DAO Report, Slock.it was the promoter of the DAO and its tokens because it launched a website to describe and facilitate the DAO token sale, solicited media attention by posting updates on websites and online forums, communicated to the public about how to participate in the DAO token sale and retained the right to choose the “curators” that would determine what proposals to put to a vote by DAO token holders.

In applying the Howey test, the SEC found that the DAO’s investors relied on the managerial and entrepreneurial efforts of Slock.it, its co-founders, and the DAO’s curators to manage the DAO and generate profits.

Generally, the Oldie Project has a substantially different focus than that of the DAO. The DAO was focused on providing incentives for investment and promoting sales of the DAO token. Slock.it did this by emphasizing the DAO token’s potential for profits by distributions/dividends and appreciation in value. Oldie Tokens are not sold for other currency, fiat or virtual, but are issued for the contributions made by the miners/developers to the Oldie Token blockchain from which they benefit themselves. Moreover, the role of the Oldie Team and the Foundation is different from that of Slock.it, primarily in that, unlike Slock.it, neither the Oldie Team or the Foundation receive payment for their role and neither actively promotes the Oldie Token as an investment.

The Munchee Order

On December 11, 2017, the SEC issued a cease-and-desist order against Munchee, Inc. (“Munchee”) to stop Munchee’s ICO and require it to return to investors the funds it collected through the sale of its MUN token.  The SEC found that Munchee’s token sale constituted an offering of securities in violation of the Securities Laws.

In applying the Howey test to the offering of the MUN token, the SEC gave little weight to the fact that Munchee characterized the MUN token as a “utility” token because of their functional use in connection with the business model of Munchee.  Instead, the SEC focused on the manner in which the offering of the MUN token was marketed. In connection with the ICO, Munchee described how MUN tokens were expected to increase in value, especially as the result of Munchee’s future efforts. The SEC noted that Munchee made statements in its White Paper, on blogs, podcast and Facebook posts that suggested that investors would profit from purchasing MUN tokens. In addition, Munchee endorsed statements made by other commentators that highlighted the opportunity for profit through the purchase of MUN tokens, including, for example, by linking their public post on their Facebook page about the offering (“199% GAINS on MUN token at ICO price!”) to a YouTube video in which the person featured claimed that if investors got in early enough on ICOs they would make a profit. Munchee also stated in a blog post that investors could count on the burning of MUN tokens by Munchee from time to time to increase value.

In the Munchee Order the SEC noted that in its White Paper, Munchee said that they would work to cause MUN tokens to be listed on various exchanges to ensure that a secondary trading market would exist for MUN tokens.  The SEC viewed such statements as priming “purchasers’ reasonable expectations of profit” and that “[p]urchasers would reasonably believe that they could profit by holding or trading MUN tokens, whether or not they ever used the Munchee App or otherwise participated in the MUM ‘ecosystem,’ based on Munchee’s statements in its MUN White Paper and other materials.”

In addition to concluding that purchasers of MUN tokens would have a reasonable expectation of profits based on Munchee’s states, the SEC concluded that those profits would be based primarily on the future efforts of Munchee.  In the Munchee Order, the SEC said:

The proceeds of the MUN token offering were intended to be used by Munchee to build an “ecosystem” that would create demand for MUN tokens and make MUN tokens more valuable.  Munchee was to revise the Munchee App so that people could buy and sell services using MUN tokens and was to recruit “partners” such as restaurants willing to sell meals for MUN tokens. The investors reasonably expected they would profit from any rise in the value of the MUN tokens created by the revised Munchee App and by Munchee’s ability to create an “ecosystem” – for example, the system described in the offering where restaurants would want to use MUN tokens to buy advertising from Munchee or to pay rewards to app users, and where app users would want to use MUN tokens to pay for restaurant meals and would want to write reviews to obtain MUN tokens.

The SEC focused on the ongoing efforts by Munchee after the token sale.  However, in most cases token issuers intend to use at least a portion of the proceeds from the sale to further develop the token ecosystem. In the Oldie Token context, the work done by developers and miners, and other contributors to the Oldie Token project is rewarded with Oldie Tokens. I do not think that the SEC intended by its statements in the Munchee Order to require an issuer of cryptocurrencies to refrain from any ongoing development and promotional activities for its blockchain once it issues a cryptocurrency coin.

I believe that had the Munchee ecosystem been built and usable at the time of sale and had Munchee not marketed and promoted the MUN tokens in a manner that focused on the future profit and investment potential of MUN tokens and had instead focused on how the MUN token would be used in Munchee’s ecosystem and why the token was an important component of using and accessing the ecosystem, the SEC may not have found the token to be a security.

The SEC noted that Munchee focused on people interested in investing and making profits, not current users of the Munchee app or “people who, for example, might have wanted MUN tokens to buy advertising or increase their ‘tier’ as a reviewer on the Munchee App.” This is different from the Oldie Team and Foundation’s focus on miners/developers and members of the Oldie Token community who can contribute to the development of the Oldie Project (ecosystem) and not on the profits that may be derived from holding and investing in Oldie Token.

Realistically, in most cases, the developers and team involved in the creation of the cryptocurrency coin, such as is the case  for the Oldie Team, will continue to play some form of role in supporting and developing the blockchain. This, in and of itself, is not a fatal fact. However, if the cryptocurrency has little or no functionality at the time of sale, as was the case with Munchee, the SEC may view this as indicative that the initial purchasers are passive investors hoping to make a profit as opposed to those desiring to participate in the development of the blockchain or to gain access to the products or services that will ultimately be provided through the blockchain’s ecosystem.

SEC Cryptocurrency Statement

Concurrently with the release of the Munchee Order, the SEC’s Chairman, Jay Clayton, released a statement on cryptocurrencies and ICOs that provides some additional insights into the SEC’s mindset in reviewing cryptocurrencies. He stated that “I believe that initial coin offerings – whether they represent offerings of securities or not – can be effective ways for entrepreneurs and others to raise funding, including for innovative projects.” He also reemphasized in his statement that “replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a block chain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.”

            SEC v. PlexCorps

On December 1, 2017, the SEC’s newly created Cyber Unit filed a civil enforcement action in federal court against PlexCorps in connection with its ICO or the cryptocurrency “PlexCoin.” On December 4, 2017, the court granted the SEC’s request for an emergency freeze on PlexCorps assets. The PlexCoin White Paper written by PlexCorp characterizes PlexCoin as “the new Bitcoin.” It states that it is comparable to bitcoin but with faster confirmation speeds. However, in the PlexCorps White Paper, PlexCoin promised an investment return of 1,354% for presale purchasers. The SEC viewed these as fraudulent misrepresentations designed to promote the purchase of over $15 million in PlexCoins.

Although the PlexCorp litigation and the facts of the case have some similarities with that of the Oldie Token Project, there are significant differences, most notably the manner in which Oldie Token has been promoted, as a tool for the developer community and those who use the Oldie Token blockchain for their own business purposes, apart from the Oldie Team and the Foundation. I do not think this changes the analysis or warrants the finding that the Oldie Token blockchain as directed by the Oldie Team and the Foundation would be deemed a security.

Conclusion

Based on this analysis, I would be comfortable concluding that the Oldie Token is not a security requiring compliance with the federal securities laws. In the next chapter in this three-part blog series, I will set forth facts and analyze how a new token could be created and issued without being a security, and facts and circumstances which sway the argument in the other direction.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
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Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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FINRA Examines Fintech Including Blockchain

On July 30, 2018, the Financial Industry Regulatory Authority (FINRA) published a Special Notice seeking public comments on how FINRA can support fintech developments including those related to data aggregation services, supervisory processes, including with the use of artificial intelligence, and the development of a taxonomy-based, machine-readable rulebook. The Special Notice, and fintech in general, necessarily includes blockchain technology, a topic FINRA has been examining for a few years now. Last July, FINRA held a Blockchain Symposium to assess the use of distributed ledger technology (DLT) in the financial industry, and earlier in January 2017 FINRA issued a report entitled “Distributed Ledger Technology: Implications of Blockchain for the Securities Industry” on the topic (see HERE).

Also, on July 6, 2018, FINRA sent Regulatory Notice 18-20 to its members asking all FINRA member firms to notify FINRA if they engage in activities related to digital assets such as cryptocurrencies, virtual coins and tokens. FINRA informs members that it is monitoring the digital asset marketplace and as part of its efforts and wants all firms to notify FINRA if it or its associated persons engage in any activities related to digital assets. FINRA has requested that it be kept updated on firms’ digital asset matters through July 31, 2019.

FINRA Special Notice on Financial Technology Innovation

Clearly financial technology innovation (“fintech”) offers benefits to investors and the financial marketplace as a whole, but also creates challenges for regulators to adapt rules and supervision that support the innovations while continuing to satisfy their goals of investor protection. In addition to blockchain, technological advances have been affecting how financial service providers conduct their business and interact with clients for years. For example, fintech applications related to digital advice including robo-advisors and algorithmic trading platforms, and the use of social media in wealth management, have been hot topics of several years now. Furthermore, the use of artificial intelligence, natural language processing and social media have impacted market research and analytical coverage on a wide scale.

FINRA’s special notice provides a succinct summary of the actions FINRA has taken to date involving fintech developments, including:

  • Created an external website dedicated to fintech-related matters (see HERE).
  • Formed Fintech Industry Committee with large and small member firms, non-member fintech service providers and SEC and NASAA representation. Topics of focus for the committee include: (i) the potential impact of innovation on FINRA’s investor protection and market integrity objectives; (ii) challenges to the adoption of fintech-based products or services; (iii) opportunities to improve interactions with FINRA; and (iv) FINRA fintech-related initiatives.
  • Have held 4 blockchain and/or fintech symposiums;
  • Fintech representation at the annual FINRA conference;
  • Issued reports and investor alerts related to blockchain, cryptocurrencies digital investment advice and other fintech matters;
  • Working with other domestic and foreign regulators to share insights and address fintech-related issues.

The special report generally seeks comments that can help identify FINRA rules or administrative processes that could be modified or improved to support fintech innovation while still protecting investors and market integrity. In addition to the general request for comments, FINRA specifically requests comments on (i) the provision of data aggregation services through compiling information from different financial accounts into a single place for investors; (ii) supervisory processes concerning the use of artificial intelligence; and (iii) the development of a taxonomy-based, machine-readable rulebook.

Data Aggregation

Many investors have started using data aggregation services that compile their financial data from different financial institutions, including broker-dealers, into one place, often using a dashboard on an Internet-based platform, in order to offer a variety of services such as financial planning, portfolio analysis, budgeting, and other types of financial analysis or advice. In order to compile the data, personal information, including passwords, must be provided to these service providers. Generally, the system is automated such that a program or computer code utilizes the passwords to access various financial institutions and obtain data that is then presented to the investor. In this case the aggregation service provider and financial institution to not have a contractual relationship.

As an alternative, some financial institutions now offer services called “application programming interface” (API) in which there is a direct transfer of data from the financial institution to the aggregator. The consumer client sets the access authorization and level. In this case there is a contract between the aggregator and the financial institution including provisions related to responsibilities and technical requirements to safeguard data and privacy.

Broker-dealers can be on both sides of these transactions. That is, the broker-dealer may be one of the financial institutions from which data is being aggregated and broker-dealers can act as the aggregation service provider as well. FINRA is exploring ways to address this increasing consumer option including through the development of standards and protocols. FINRA has provided a notice to members with some guidance on data aggregation services, including that consolidated reports are communications with the public subject to anti-fraud parameters. FINRA also provided some guidance on supervisory and internal control systems; however, with the increase use of these services, more robust rules and guidance may be necessary. Blockchain, including the use of smart contracts, could be utilized in data aggregation services.

Supervision Related to Artificial Intelligence

There is a growing interest in applying artificial intelligence, including machine learning and natural language processing, to financial markets and broker-dealer processes and services. Artificial intelligence is used in areas such as anti-money laundering/know-your-customer compliance, trading, data management and customer service.

With the growth of artificial intelligence comes concerns about how the processes fit within existing FINRA regulations, and the need for new regulations. For example, FINRA is examining how a firm can adequately supervise algorithmic trading, including suitability requirements for specific customer transactions. However, more information is needed and the Special Report indicates that FINRA needs to develop a better understanding of artificial intelligence applications in the industry.  Smart contracts built on the blockchain are a form of artificial intelligence.

FINRA specifically requests comments on the following:

  • For what purposes are members using, or considering, artificial intelligence tools—including chat bots and robotic process automation (RPA) tools—in their brokerage businesses and what benefits will it serve?
  • Do firms’ governance practices for the development and ongoing operation of artificial intelligence tools differ from those used for tools or processes that use more conventional operational techniques?
  • What forms of quality assurance do firms use in developing artificial intelligence?
  • What are the greatest regulatory challenges in adapting artificial intelligence, including those related to supervision?
  • Are there specific regulatory issues that the use of artificial intelligence tools in the context of algorithmic trading strategies raises?

Development of Taxonomy-based, Machine-readable Rulebook

The UK Financial Conduct Authority (FCA) and the Bank of England (BoE) have launched an initiative to examine how to simplify regulatory compliance through the digitization of rulebooks, making them “machine-readable” – in other words, the creation of a rulebook that is structured in such a way as to make it more easily processed by a computer such as a rulebook built on the blockchain using smart contracts. FINRA is reviewing the possibility of machine-readable rulebooks for compliance policies, procedures and transaction databases.

According to the FCA and BoE, such efforts have the potential to “fundamentally change how the financial services industry understands, interprets, and then reports regulatory information,” through the mapping of regulatory obligations. The reduction of compliance costs and elimination of human error would benefit both firms and regulators.

Obviously, such a dramatic change in the industry will not happen overnight, but as FINRA indicates, it has to start with a first step. As such, FINRA is considering the feasibility and desirability of developing a type of machine-readable rulebook through the creation of an embedded taxonomy (i.e., a method for classification and categorization) within its rules.

FINRA specifically seeks comments on:

  • Who will benefit the most and who will utilize a machine-readable rulebook?
  • In what way will it make compliance more efficient and effective?
  • Is there a risk of “over-reliance”?
  • What are the benefits of developing machine-readable rulebooks that interact with other US-based and foreign regulators’ machine-readable rulebooks?
  • What role should vendors and regulated firms play in the adoption, development and ongoing taxonomy maintenance?

Regulatory Notice 18-20

The market for digital assets such as cryptocurrencies, tokens and coins continues to grow significantly and as such, fraud in their issuance and secondary trading continues to be a focus for regulators including FINRA. On July 6, 2018, FINRA sent Regulatory Notice 18-20 to its members asking all FINRA member firms to notify FINRA if they engage in activities related to digital assets such as cryptocurrencies, virtual coins and tokens and to continue to update FINRA on such activities through July 31, 2019. FINRA informed members that it is monitoring the digital asset marketplace and, as part of its efforts, wants all firms to advise FINRA if it or its associated persons engage in any activities related to digital assets.

Member firms are specifically requested to notify FINRA of any of the following activities:

  • Purchases, sales or execution of transactions in digital assets;
  • Purchases, sales or execution of transactions in a pooled fund investing in digital assets;
  • The creation of, management of, or provision of advisory services for a pooled fund investing in digital assets;
  • Purchases, sales or execution of transaction in derivatives tied to digital assets;
  • Participation in an initial or secondary offering of digital assets including ICOs and pre-ICOs;
  • Creation or management of a platform for the secondary trading of digital assets;
  • Custody or similar arrangement involving digital assets;
  • Acceptance of cryptocurrencies from a customer;
  • Mining of cryptocurrencies;
  • Recommending, soliciting or accepting orders in cryptocurrencies or any digital assets;
  • Displaying indications of interest or quotations in cryptocurrencies or any digital assets;
  • Providing or facilitating clearance and settlement services for cryptocurrencies or any digital assets;
  • Recording cryptocurrencies or any digital assets using distributed ledger technology; or
  • Any use of blockchain technology.

The Regulatory Notice also explicitly reminds member firms to be cognizant of all applicable federal and state laws, rules and regulations, including FINRA and SEC rules and regulations. Furthermore, any material change in the business operations of a member firm requires the submittal of a CMA.  Involvement in cryptocurrencies, digital assets or blockchain would be considered a material change.

FinCEN and the SEC Weigh In

In a speech at a blockchain conference on August 9, 2018, FinCEN director Kenneth A. Blanco was less than positive on the state of compliance of money transmitter businesses such as cryptocurrency exchanges. For more information on FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.  In particular, Blanco states that the industry lacks adequate anti-money laundering (AML) controls and that most businesses do not even attempt to put better measures into place until after they are reviewed or investigated by a regulatory authority. Furthermore, the victims of improper AML procedures are not investors with money to lose, but rather families who lose loved ones to opioid addictions or terrorist acts, as both of these utilize cryptocurrencies in their operations.

Mr. Blanco’s remarks follow similar comments by SEC assistant director Amy Hartman, who also advised companies planning on an ICO to engage competent securities counsel.

 

Wyoming’s Blockchain Legislation

Wyoming continues to position itself as a business-friendly state most recently by passing groundbreaking blockchain legislation defining cryptocurrency coins or tokens as a whole new asset class separate from securities and commodities.  While it is unlikely that Wyoming’s new statutes will impact the SEC’s view that most, if not all, cryptocurrencies, or at least those issued to investors or used for capital raising, are securities, or the CFTC’s view that cryptocurrencies that are used as a medium of exchange, are a commodity, Wyoming has done what federal lawmakers have not yet endeavored – created comprehensive blockchain legislation.

In March 2018, Wyoming passed five separate bills addressing securities, corporate, banking and tax matters which could entice cryptocurrency and blockchain businesses to locate within the state. The statutes are part of an initiative in Wyoming called ENDOW – Economically Needed Diversity Options for Wyoming.

HB 19

Wyoming House Bill 19 provides an exemption for virtual currency, including bitcoin and ethereum, used within Wyoming from money transmitter laws and regulations subject to providing certain specified verification authority to the Wyoming Secretary of State and Wyoming Banking Commissioner.  The specified verification authority includes representations, warranties and undertakings by the issuer of “utility tokens” to confirm beneficial ownership of the token and to prevent unauthorized or fraudulent duplication of the token by third parties.

HB 19 defines a “virtual currency” as “any type of digital representation of value that: (i) is used as a medium of exchange, unit of account or store of value; and (ii) is not recognized as legal tender by the United States government.”

As a reminder, the CFTC has regulatory oversight over futures, options, and derivatives contracts on virtual currencies and has oversight to pursue claims of fraud or manipulation involving a virtual currency traded in interstate commerce.  Beyond instances of fraud or manipulation, the CFTC generally does not oversee “spot” or cash market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing.  Rather, these “exchanges” are regulated as payment processors or money transmitters under state law.

However, despite the Wyoming state law exemption, businesses which issue or exchange these tokens would still be subject to FinCEN’s regulations and the requirements to comply with the Bank Secrecy Act (BSA).  The BSA requires virtual currency exchangers and administrators, including those businesses that issue a virtual currency in exchange for other virtual currencies, fiat currency or types of value, to complete anti-money laundering (AML), know your customer (KYC) and other procedures to combat the financing of terrorism and prevent or detect the abuse of virtual currency to facilitate cyber-crime, money laundering, terrorist financing, black market sales of illegal or illicit products and services and other high-tech crimes. For more on FinCEN and the BSA, see HERE.

HB 70

Wyoming House Bill 70 removes utility tokens from specified securities and money transmission laws.  In particular, any person that develops, sells or facilitates the exchange of an open blockchain utility token would not be required to comply with specified securities and money transmission laws subject to providing specified verification authority.  The purpose of the statute is to make clear that utility tokens issued for non-investment purposes, are exempt from the Wyoming securities laws including registration and exemption provisions and broker-dealer registration requirements.

HB 70 defines an “open blockchain token” as a digital unit which is: (i) created (a) in response to the verification or collection of a specified number of transactions relating to a digital ledger or database, (b) by deploying computer code to a blockchain network that allows for the creation of digital tokens or other units, or (c) using any combination of (a) and (b); (ii) recorded in a digital ledger or database that is chronological, consensus-based, decentralized and mathematically verified, especially related to the supply of units and their distributions; and (iii) capable of being traded or transferred between persons without an intermediary or custodian of value.

HB 70 provides that the purpose of the token must be for “a consumptive purpose, which shall only be exchangeable for, or provided for the receipt of, goods, services or content, including rights of access to goods, services or content.”

Furthermore, HB 70 would not apply where the developer or seller of the token sold the token to the initial buyer as a financial investment.  The requirement that the token not be an investment can only be satisfied if: (i) the developer or seller does not market the token as a financial investment; and (ii) at least one of the following is true: (a) the developer or seller reasonably believed that it sold the token for a consumptive purpose; (b) the token has a consumptive purpose that is available at the time of sale and can be used at or near the time of sale; (c) if the token does not have a consumptive purpose at the time of sale, the token is prevented from being resold until the consumptive purpose is available; or (d) the developer or seller takes other reasonable precautions to prevent the buyers from purchasing the token as a financial investment.

The SEC has been clear in numerous statements that it believes that tokens that are issued for the purpose of capital raising and an increase in value, are securities offerings that must comply with the federal securities laws.  The SEC’s position relates to factors such as the method of issuance and sale of the tokens, use of proceeds, investment intent and expectation of profit, ability to increase value, whether the “utility” has been built out or established, and ability for secondary trading.  The SEC has specifically not taken into account the ultimate utility value of the token, nor directly answered the oft asked question of whether a token that is issued in a securities offering, can then morph into a commodity or other asset class, not subject to the securities laws.  It is my view, and the general view of the marketplace, that “utility tokens” can be sold in a “securities offering.”

Although the Wyoming statute attempts to address the investment intent, and even appears to attempt to address the SEC main criteria, I would suggest that issuers of any tokens should continue to comply with the federal securities laws until there is further guidance and certainty at the federal level.

SF 111

SF 111 provides that virtual currency is not subject to taxation as “property” in Wyoming.  That is, virtual currency would be treated as personal property, not subject to Wyoming property taxes.  SF 111 amends a prior statute that exempted money and cash on hand, currency, gold, silver and related items by adding virtual currencies.  Like HB 19, SF 111 defines a “virtual currency” as “any type of digital representation of value that: (i) is used as a medium of exchange, unit of account or store of value; and (ii) is not recognized as legal tender by the United States government.”

HB 101

HB 101 allows for the maintenance of corporate records of Wyoming entities via blockchain that utilizes electronic keys, network signatures and digital receipts.  In particular, the Act authorizes the use of electronic networks or databases for the creation or maintenance of corporate records, authorizes the use of a data address to identify shareholders, authorizes the acceptance of shareholder votes if signed by a network signature that corresponds to a data address and specifies the requirements for the use of electronic networks and databases.  In addition, the Act requires the secretary of state to review and update its rules for consistency.

HB 126

HB 126 allows the creation and use of “series LLC’s.”  Delaware is well known for its series LLC statute.  Series LLC have become popular in the blockchain space and accordingly it is thought that this will attract blockchain-based businesses.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC’s role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on platforms that trade cryptocurrencies and more on the continued regulatory confusion in the space, see HERE.

For information on FinCEN’s role and requirements related to the cryptocurrency marketplace, including requirements for issuers of ICOs, see HERE.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

© Legal & Compliance, LLC 2018

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FinCEN’S Role In Cryptocurrency Offerings

In the continuing dilemma over determining just what kind of asset a cryptocurrency is, multiple regulators have expressed opinions and differing views on regulations. Likewise, multiple regulators have conducted investigations and initiated enforcement proceedings against those in the cybersecurity space. The SEC has asserted the opinion that most, if not all, cryptocurrencies are securities; the CFTC has found them to be commodities; the IRS’s official definition is the same as the CFTC, and in particular a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, and now the Financial Crime Enforcement Network (FinCEN) has asserted that issuers of cryptocurrencies are money transmitters.

In particular, in a letter written to the US Senate Committee on Finance on February 13, 2018, FinCEN indicates that it expects issuers of initial coin offerings (ICOs) to comply with the Bank Secrecy Act (BSA), including its anti-money laundering (AML) and know your customer (KYC) requirements. FinCEN’s letter responded to a December 14, 2017 directed to it from the US Senate Committee on Finance requesting information on FinCEN’s oversight and enforcement capabilities over virtual currency financial activities. As with other agencies such as the SEC and CFTC, FinCEN desires to promote the financial innovation that can come with blockchain technology and cryptocurrencies, while preventing criminals, hackers, sanctions evaders and hostile foreign actors.

Virtual currency exchanges and administrators

FinCEN has been working with the Office of Terrorism and Financial Intelligence (FTI) to ensure that AML and procedures to combat the financing of terrorism apply to virtual currency exchanges and administrators that are in the US or do business in whole or part in the US, but do not have a physical presence here.  Virtual currency exchanges and administrators have been subject to the BSA’s money transmitter requirements since 2011. In 2013 FinCEN issued specific guidance that explicitly states that virtual currency exchanges and administrators are money transmitters that must comply with the BSA. An exchange that sells ICO coins or tokens, or exchanges them for other virtual currency, fiat currency or other value that substitutes for currency, is a money transmitter that is subject to the BSA.

To assist in identifying risks and the illicit use of virtual currency, including the abuse of virtual currency to facilitate cyber crime, money laundering, terrorist financing, black market sales of illegal or illicit products and services and other high-tech crimes, FinCEN examines BSA filings from virtual currency money services businesses (MSB) and other emerging payments providers, including filings pertaining to digital coins, tokens and ICOs. Trends, red flags and risks and reported to US law enforcement and other governmental agencies.

Entities that are subject to the BSA must: (i) register with FinCEN as a MSB; (ii) prepare a written AML compliance program that is designed to mitigate risks, including AML risks, and to ensure compliance with all BSA requirements including the filing of suspicious activity reports (SAR) and currency transaction reports; (iii) keep records for certain types of transactions at specific thresholds; and (iv) obtain customer identification information sufficient to comply with the AML program and recordkeeping requirements.

SAR reports that are filed with FinCEN have identifying information about the owner/customer. In cases where a bitcoin address is identified, FinCEN performs a blockchain analysis which can often enable investigators to tie it to a virtual currency exchanger, hosted wallet, or other source that may have the identity of the account owner. Blockchain network analytic tools can also tie a targeted bitcoin address to other persons that have transacted with a particular bitcoin address.  The investigative process may involve the issuance of subpoenas and FinCEN cooperates with law enforcement to help identify and trace bitcoin used in criminal activity.

FinCEN also conducts reviews and exams of registered MSBs. Of the approximate 100 registered entities, FinCEN has examined approximately one-third and has initiated several enforcement proceedings as a result of those exams. However, financial crimes and terrorism are international issues and not all countries regulate virtual currency businesses or require them to keep records. Accordingly, FinCEN has been working to encourage foreign countries to regulate these businesses and to cooperate in criminal investigations.

ICO issuers

FinCEN is working with the SEC and CFTC to clarify and enforce AML and counterterrorism obligations of businesses that engage in ICO activities. Although the FinCEN letter indicates that the obligation to comply with the BSA and its ensuing AML, registration, SAR and other requirements depends on the nature of the financial activity and a facts-and-circumstances analysis, ICO participants have unilaterally interpreted the FinCEN letter as requiring all ICO issuers to comply in one way or another.

FinCEN specifically states that an issuer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value, including fiat currency, is a money transmitter that must register as an MSB and comply with the BSA, including AML and KYC procedures. However, to the extent that an ICO involves the sale of securities or derivatives that would be under the jurisdiction of the SEC through its regulation of broker-dealers or CFTC through its regulation of merchants and brokers in commodities, those entities could comply with the SEC and CFTC’s AML and counterterrorism requirements.

The Securities Exchange Act of 1934 (“Exchange Act”) specifically requires brokerage firms to comply with the BSA and FinCEN rules. Brokerage firms are also required to comply with AML rules established by FINRA, including FINRA Rule 3310. The purpose of the AML rules is to help detect and report suspicious activity including the predicate offenses to money laundering and terrorist financing, such as securities fraud and market manipulation. FINRA also provides a template to assist small firms in establishing and complying with AML procedures.

In May 2016, FinCEN issued new final rules under the BSA requiring financing institutions, including brokerage firms, to adopt additional anti-money laundering (AML) procedures that include specific due diligence and ongoing monitoring requirements related to customer risk profiles and customer information. The rules also require financial institutions to collect and verify information about beneficial owners and control person of legal entity customers.  My blog on those rules can be read HERE.

FinCEN requires that financial institutions address the following four key elements in all of their AML programs: (i) customer identification and verification; (ii) beneficial ownership identification and verification; (iii) understanding the nature and purpose of customer relationships to develop risk profiles; and (iv) ongoing monitoring for reporting suspicious transactions and maintaining and updating customer information.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on platforms that trade cryptocurrencies and more on the continued regulatory confusion in the space, see HERE.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.

© Legal & Compliance, LLC 2018

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The SEC Has Provided Guidance On Ether and Bitcoin, Sort Of

On June 14, 2018, William Hinman, the Director of the SEC Division of Corporation Finance, gave a speech at Yahoo Finance’s All Markets Summit in which he made two huge revelations for the crypto marketplace. The first is that he believes a cryptocurrency issued in a securities offering could later be purchased and sold in transactions not subject to the securities laws. The second is that Ether and Bitcoin are not currently securities. Also, for the first time, Hinman gives the marketplace guidance on how to structure a token or coin such that it might not be a security.

While this gives the marketplace much-needed guidance on the topic, a speech by an executive with the SEC has no legal force. As a result, the blogs and press responding to Mr. Hinman’s speech have been mixed. Personally, I think it is a significant advancement in the regulatory uncertainty surrounding the crypto space and a signal that more constructive guidance will soon follow. I will summarize the entire speech later in this blog, but first right to the most salient point.

Although a speech by an SEC official does not have legal weight, it does give practitioners a firm foot on which to proceed. William Hinman is the Director of the Division of Corporation Finance (“CorpFin”), whose responsibility includes reviewing and commenting on SEC filings, a topic I’ve written about before. As described in my recent blog on the subject (see HERE), when responding to SEC comments, a company may also “go up the ladder,” so to speak, in its discussion with the CorpFin review staff. Such further discussions are not discouraged or seen as an adversarial attack in any way. For instance, if the company does not understand or agree with a comment, it may first talk to the reviewer. If that does not resolve the question, they may then ask to talk to the particular person who prepared the comment or directly with the legal branch chief or accounting branch chief identified in the letter. A company may even then proceed to speak directly with the assistant director, deputy director, and then even director.

Related to Bitcoin, Director Hinman stated, “…when I look at Bitcoin today, I do not see a central third party whose efforts are a key determining factor in the enterprise. The network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception. Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value.” Similarly, related to Ether, Mr. Hinman stated, “…putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.”

As a direct result of these statements, at least 2 of our clients, with our support, have shifted how they will proceed with Regulation A offerings in which tokens are being offered, and Bitcoin and Ether expected to be accepted as a form of payment. Prior to Mr. Hinman’s comments, CorpFin issued comments to our clients, which comment letters gave an indication of the progression of the SEC’s thinking. In particular, in an earlier letter the SEC comment was in relevant part as follows:

We note that you will accept Bitcoin, Ether, Litecoin or Bitcoin Cash as payment for your common stock. Please disclose the mechanics of the transaction. For example, explain the following:

  • whether the digital assets are securities and, where you have determined they are, how you will structure each individual transaction so that you are in compliance with the federal securities laws;
  • disclose how long the company would typically hold these digital assets, some of which may be securities, before converting to U.S. dollars;
  • include risk factor disclosure discussing the impact of holding such assets and/or accepting this form of payment, including price volatility and liquidity risks as well as risks related to the fragmentation, potential for manipulation, and general lack of regulation underlying these digital asset markets; and
  • disclose how you will hold the digital assets that you may receive in this offering as payment in exchange for shares of your common stock. If you intend to act as custodian of these digital assets, some of which may be securities, please tell us whether you intend to register as a custodian with state or federal regulators and the nature of the registration.

The comment letter included many other points on cybersecurity, price volatility, risk factors and other issues not related to whether the Bitcoin or Ether were a security. In a recent comment letter for a different client, also offering tokens in a Regulation A offering and accepting Bitcoin and Ether as payment, the SEC did not issue any questions as to whether Bitcoin or Ether were a security, but did include substantially the same questions related to cybersecurity, price volatility, risk factors and other business points.

The SEC CorpFin is pragmatic in its approach and despite frustrations at times, would not allow its Division Director to make public statements and then allow its staff to issue comments or take positions that were in direct contravention to those statements. Keep in mind that SEC no-action letters technically do not set precedence or have any legal bearing outside of the parties to the letter, but are regularly relied upon by the SEC and practitioners for guidance.

Although Mr. Hinman’s speech does not have legal authority, I am confident that the SEC will not raise the issue or question whether Bitcoin or Ether are a security in current and future registration statements or Regulation A offerings, at least until there is different legal authority than exists today.… And, there could be different legal authority in the future. I attended a Regulation A conference in New York in the beginning of June, and one of the panels was related to cyrptocurrencies. In addition to attorneys in the space, the panel included Anita Bandy, Assistant Director of the SEC Division of Enforcement.  Referring to token or coin offerings, one of the panel members specifically stated that Ether is a security and Ms. Bandy did not correct him. Furthermore, at the end of the panel, I privately asked Ms. Bandy if it is her opinion that Ether is a security today. She politely refused to answer the question, letting me know that she couldn’t express an opinion on that without conferring with other SEC management.  Two days later, Mr. Hinman gave his speech.

…. But, Mr. Hinman is Director of CorpFin and Ms. Bandy is part of the Division of Enforcement.  Although I believe that the SEC divisions are communicating with each other on the very relevant and important subject of cryptocurrency, and have even issued joint statements on the subject, they are separate. Moreover, decoding Mr. Hinman’s statements further, he said, “… putting aside the fundraising that accompanied the creation of Ether…” This begs the question: What would happen if the SEC Division of Enforcement took action related to the initial fundraising and creation of Ether, and how would that impact the current status of Ether? My thought is that they are mutually exclusive.  Ether is decentralized today and will continue its own course.

The SEC Division of Enforcement could take action similar to the Munchee, Inc. case where it settled the proceeding with no civil penalty. The SEC could also issue another report on Ether similar to the Section 21(a) Report on the DAO issued a year ago in July 2017, though I don’t know what new or different information it could add to that analysis. If Ether violated the federal securities laws at its issuance, it did so in the same way as the DAO, using the SEC v. W. J. Howey Co. test. Perhaps a new report could provide more guidance as to the analysis of when a crypto reaches a point where it is decentralized enough such that it no longer meets the parameters laid out in Howey, or that might be wishful thinking on my part.

Director Hinman’s Speech “Digital Asset Transactions: When Howey Met Gary (Plastic)”

Director Hinman opens his speech with the gating question of whether a digital asset that is offered and sold as a security can, over time, become something other than a security. He then continues that in cases where the digital asset gives the holder a financial interest in an enterprise, it would remain a security.  However, in cases where the enterprise becomes decentralized or the digital asset can only be used to purchase goods or services available through a network, the purchase and sale of the digital asset would no longer have to comply with the securities laws.

Reiterating the oft-repeated view of the SEC, Hinman notes that most initial coin or token offerings are substantially similar to debt or equity offerings in that they are just another way to raise money for a business or enterprise. In particular, funds are raised with the expectation that the network or system will be built and investors will get a return on their investment. The investment is often made for the purpose of the return and not by individuals that would ever use the eventual utility of the token. The return is often through the resale of the tokens or coins in a secondary market on cryptocurrency trading platforms.

In this case, the Howey Test is easy to apply to the initial investment. The Howey Test requires an investment of money in a common enterprise with an expectation of profit derived from the efforts of others. The emphasis is not on the thing being sold but the manner in which it is sold and the expectation of a return.  Certainly, the thing being sold is not a security on its face; it is simply computer code.  But the way it is sold – as part of an investment, to non-users, by promoters to develop the enterprise – can be, and in that context most often is, a security. Furthermore, in the case of ICOs, which are high-risk by nature, the disclosure requirements of the federal securities laws are fulfilling their purpose.

The securities laws apply to both the issuance or initial sale, and the resale of securities. In the case of coins or tokens, a careful analysis must be completed to determine if the resale of the coin or token also involves the sale of a security and compliance with the securities laws. If the network on which the token or coin is to function is sufficiently decentralized such that purchasers would not reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts, the assets may no longer represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful, such as with Ether and Bitcoin as discussed above.

An analysis as to whether an investment contract and therefore a security is being sold must be made based on facts and circumstances at any given time.  Investment contracts can be made out of virtually any asset if it is packaged and promoted as such. Accordingly, although Bitcoin or Ether may not be a security on their own, if they were packaged as part of a fund or trust, they could be part of an investment contract that would need to comply with the federal securities laws.

Hinman provides some guidance in determining whether a particular sale involves the sale of an investment contract. The primary consideration is whether a third party, such as a person, entity, or coordinated group, drives the expectation of a return on investment. Questions to consider include:

  1. Is there a person or group that has sponsored or promoted the creation and sale of the digital asset, the efforts of whom play a significant role in the development and maintenance of the asset and its potential increase in value?
  2. Has this person or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in value in the digital asset? Would purchasers reasonably believe such efforts will be undertaken and may result in a return on their investment in the digital asset?
  3. Has the promoter raised an amount of funds in excess of what may be needed to establish a functional network, and, if so, has it indicated how those funds may be used to support the value of the tokens or to increase the value of the enterprise? Does the promoter continue to expend funds from proceeds or operations to enhance the functionality and/or value of the system within which the tokens operate?
  4. Are purchasers “investing,” i.e., seeking a return? In that regard, is the instrument marketed and sold to the general public instead of to potential users of the network for a price that reasonably correlates with the market value of the good or service in the network?
  5. Does application of the Securities Act protections make sense? Is there a person or entity others are relying on that plays a key role in the profit-making of the enterprise such that disclosure of their activities and plans would be important to investors? Do informational asymmetries exist between the promoters and potential purchasers/investors in the digital asset?
  6. Do persons or entities other than the promoter exercise governance rights or meaningful influence?

Hinman then, for the first time, gives some guidance to issuers and their counsel in determining whether a particular token or coin is being structured as a security. Hinman is clear that this list of factors is not comprehensive but rather lays the groundwork for a thoughtful analysis.  Items to consider include:

  1. Is token creation commensurate with meeting the needs of users or, rather, with feeding speculation?
  2. Are independent actors setting the price or is the promoter supporting the secondary market for the asset or otherwise influencing trading?
  3. Is it clear that the primary motivation for purchasing the digital asset is for personal use or consumption, as compared to investment? Have purchasers made representations as to their consumptive, as opposed to their investment, intent? Are the tokens available in increments that correlate with a consumptive versus investment intent?
  4. Are the tokens distributed in ways to meet users’ needs? For example, can the tokens be held or transferred only in amounts that correspond to a purchaser’s expected use? Are there built-in incentives that compel using the tokens promptly on the network, such as having the tokens degrade in value over time, or can the tokens be held for extended periods for investment?
  5. Is the asset marketed and distributed to potential users or the general public?
  6. Are the assets dispersed across a diverse user base or concentrated in the hands of a few that can exert influence over the application?
  7. Is the application fully functioning or in early stages of development?

In another step towards regulatory guidance, Hinman said the SEC is prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use. As recently as 3 months ago, the SEC had indicated it was not processing no-action letters on the subject at that time. In his speech, Hinman recognizes the implication of determining something is a security, including related to broker-dealer licensing, exchange registration, fund registration, investment advisor registration requirements, custody and valuation issues.

Hinman also expressed excitement about the potential surrounding digital ledger technology, including advancements in supply chain management, intellectual property rights licensing, and stock ownership transfers. He thinks the craze behind ICOs has passed, and I agree. In particular, as he states, realizing that securities laws apply to an ICO that funds development, industry participants have started to revert back to traditional debt or equity offerings and only selling a token once the network has been established, and then only to those that need the functionality of the network and not as an investment.

There have been earlier signs that the SEC is softening and rethinking its approach to cryptocurrencies as well.   In a speech to the Medici Conference in Los Angeles on May 2, 2018, SEC Commissioner Hester M. Peirce warned against regulators stifling the innovation of blockchain by trying to label token and coins as securities and even when they are securities, being myopic on the need to fit within existing securities laws and regulations.  Like Director Hinman, Commissioner Peirce encourages communication between market participants and the SEC as everyone tries to navigate the marketplace and technology.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty, and need for even further guidance in this space, see HERE.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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Online Platforms Trading Cryptocurrencies; Continued Uncertainty In Crypto Space

I have been writing often about the cryptocurrency marketplace and the SEC and other regulators’ statements and concerns about compliance with the federal securities laws. On July 25, 2017, the SEC issued a Section 21(a) Report on an investigation related to an initial coin offering (ICO) by the DAO, concluding that the ICO was a securities offering.  In that Report the SEC stated that securities exchanges providing for trading must register unless an exemption applies.  In its numerous statements on cryptocurrencies since then, the SEC has consistently reminded the public that exchanges that trade securities, including cryptocurrencies that are securities, must be licensed by the SEC.

The SEC has also stated that as of today, no such licensed securities cryptocurrency exchange exists.  However, a few CFTC regulated exchanges have now listed bitcoin futures products and, in doing so, engaged in lengthy conversations with the CFTC, ultimately agreeing to implement risk mitigation and oversight measures, heightened margin requirements, and added information sharing agreements with the underlying bitcoin trading platforms.

The topic of the registration of exchanges for trading cryptocurrencies is not new to regulators.  Years before the Section 21(a) DAO Report and crypto craze, on December 8, 2014, the SEC settled charges against BTC Virtual Stock Exchange and LTC-Global Virtual Stock Exchange, which traded securities using virtual currencies, bitcoin or litecoin.  According to the SEC release on the matter, “the exchanges provided account holders the ability to use bitcoin or litecoin to buy, sell, and trade securities of businesses (primarily virtual currency-related entities) listed on the exchanges’ websites.  The venues weren’t registered as broker-dealers despite soliciting the public to open accounts and trade securities.  The venues weren’t registered as stock exchanges despite enlisting issuers to offer securities for the public to buy and sell.” The exchanges charged and collected transaction-based compensation for each executed trade on the platforms.

Since the Section 21(a) DAO Report, most of the statements from the SEC and other regulators have focused on ICOs and the issuance of cryptocurrencies as opposed to focusing on the exchanges that trade cryptos.  On March 7, 2018, the SEC finally issued a public statement directed specifically to online platforms for the trading of digital assets – i.e., cryptocurrencies.  This blog will summarize that statement.  Also, at the end of this blog is a list with links to my numerous other blogs on the topic of distributed ledger technology (blockchain), cryptocurrencies and ICOs.

SEC Statement on Potentially Unlawful Online Platforms for Trading Digital Assets

Online trading platforms have become prevalent for the buying and selling of coins and tokens, including new cryptocurrencies offered in initial coin offerings (ICOs).  Many platforms bring buyers and sellers together in one place and offer investors access to automated systems that display priced orders, execute trades, and provide transaction data.  If a platform offers trading of digital assets that are securities and operates as an “exchange,” as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.  As mentioned above, no such SEC-registered platform exists as of today.

In its statement, the SEC cautions investors that “[T]o get the protections offered by the federal securities laws and SEC oversight when trading digital assets that are securities, investors should use a platform or entity registered with the SEC, such as a national securities exchange, alternative trading system (‘ATS’), or broker-dealer.”

The SEC is concerned that online platforms have the appearance of regular licensed securities exchanges, including using the word “exchange” when they are not.  The SEC does not review the standards these “exchanges” use to pick or vet digital assets and cryptocurrencies, the trading protocols used to determine how orders interact and are executed, nor any internal controls or procedures of these platforms.  Furthermore, the SEC warns that data provided by these trading platforms, such as bid and ask prices and execution information, may lack integrity.

The SEC provides a list of questions for investors to ask when considering trading on an online platform, including:

  • Do you trade securities on this platform? If so, is the platform registered as a national securities exchange (see our link to the list below)?
  • Does the platform operate as an ATS? If so, is the ATS registered as a broker-dealer and has it filed a Form ATS with the SEC (see our link to the list below)?
  • Is there information in FINRA’s BrokerCheck ® about any individuals or firms operating the platform?
  • How does the platform select digital assets for trading?
  • Who can trade on the platform?
  • What are the trading protocols?
  • How are prices set on the platform?
  • Are platform users treated equally?
  • What are the platform’s fees?
  • How does the platform safeguard users’ trading and personally identifying information?
  • What are the platform’s protections against cybersecurity threats, such as hacking or intrusions?
  • What other services does the platform provide? Is the platform registered with the SEC for these services?
  • Does the platform hold users’ assets? If so, how are these assets safeguarded?

Registration or Exemption of an Exchange

Section 5 of the Exchange Act of 1934, as amended (“Exchange Act”) makes it unlawful for any broker, dealer, or exchange, directly or indirectly, to effect any transaction in a security, or to report any such transaction, in interstate commerce, unless the exchange is registered as a national securities exchange or is exempted from such registration.  A national securities exchange registers with the SEC under Section 6 of the Exchange Act.

Section 3(a)(1) of the Exchange Act defines an “exchange” as “any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood….”  Exchange Act Rule 3b-16 further defines an exchange to mean “an organization, association, or group of persons that: (1) brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of the trade.” The SEC has also stated that “an exchange or contract market would be required to register under Section 5 of the Exchange Act if it provides direct electronic access to persons located in the U.S.”

According to the SEC website, as of today there are 21 licensed exchanges registered with the SEC.  Exchanges that trade securities futures are registered with the SEC through a notice filing under Section 6(g) of the Exchange Act.  There are 5 such registered exchanges.  There are two exchanges that the SEC has exempted from registration on the basis of limited volume transactions.

Continued Uncertainty

Although the SEC is certainly correct that an online trading platform that trades securities must be licensed by the SEC, that would not be the case if the asset being traded is not a security.  In fact, if the asset is a currency (and not a security) or a “thing” such as loyalty points, no US federal agency would regulate its trading.  The SEC only regulates the trading of securities and security-related products.  The CFTC has regulatory oversight over futures, options, and derivatives contracts on virtual currencies and has oversight to pursue claims of fraud or manipulation involving a virtual currency traded in interstate commerce.  Beyond instances of fraud or manipulation, the CFTC generally does not oversee “spot” or cash market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing.  Rather, these “exchanges” are regulated as payment processors or money transmitters under state law.

Likewise, no federal regulator has direct jurisdiction over “exchanges” that trade loyalty points such as converting airline points to use for hotels, cars, consumer goods and services, or cash.  Online platforms such as www.points.com and www.webflyer.com operate using contractual partnerships with entities that issue loyalty points.  In fact, points.com is owned by Points International Ltd., which trades on the TSX and Nasdaq and refers to itself as “the global leader in loyalty currency management.”  Certainly, today there is a vast difference in the trading of loyalty points versus those looking to make profits in cryptocurrency trading, but there are also analogies, especially with the “currency” side.  In a recent 6-K, Points has this to say about the loyalty industry:

Year-over-year, loyalty programs continue to generate a significant source of ancillary revenue and cash flows for companies that have developed and maintain these loyalty programs. According to the Colloquy group, a leading consulting and research firm focused on the loyalty industry, the number of loyalty program memberships in the US increased from 3.3 billion in 2014 to 3.8 billion in 2016, representing an increase of 15% (source: 2017 Colloquy Loyalty Census Report, June 2017). As the number of loyalty memberships continues to increase, the level of diversification in the loyalty landscape is evolving. While the airline, hotel, specialty retail, and financial services industries continue to be dominant in loyalty programs in the US, smaller verticals, including the restaurant and drug store industries are beginning to see larger growth in their membership base. Further, newer loyalty concepts, such as large e-commerce programs, daily deals, and online travel agencies, are becoming more prevalent. As a result of this changing landscape, loyalty programs must continue to provide innovative value propositions in order to drive activity in their programs.

Companies that believe that their crypto is truly a utility with currency value may feel they have more in common with a loyalty point than a security, and regulators have yet to be able to give any level of firm ground on which to stand.

In a hearing before the House Financial Services Committee on May 16, 2018, Stephanie Avakian, co-director of the SEC Division of Enforcement, told lawmakers that the SEC will continue to look at each case involving a cryptocurrency on a facts-and-circumstances basis.  Ms. Avakian and co-director Steven Peiken both gave testimony and sat in the hot seat.  The Financial Services Committee members were pushing for more definitive input on how ICOs should be defined and regulated, without result.  The hearing became contentious, with Committee members becoming frustrated with the lack of direction and lack of certainty from the SEC as to how they define and view cryptocurrencies, other than “on a case-by-case basis” and using the same federal securities principles that already exist – a mantra that has been repeated.

However, the SEC enforcement division could rightfully feel they are being put in an unfair position with this line of questioning.  Commissioner Hester M. Peirce warned against rulemaking by enforcement in a recent speech.  Ms. Peirce has strong opinions on the subject.  She states, “[D]ue process starts with telling individuals in advance what actions constitute violations of the law.”  She continues with “[A] related issue to which I am paying attention is the degree to which our enforcement process is being used to push the bounds of our authority. Congress sets the parameters within which we may operate, and we ought not to stray outside those boundaries through, for example, overly broad interpretations of  ‘security’ or extraterritorial impositions of the law. Our canons of ethics specifically caution us against exceeding ‘the proper limits of the law’ and argue for us remaining ‘consistent with the statutory purposes expressed by the Congress.’”

In fairness, Ms. Peirce was talking in the context of enforcement as a whole.  Not once did she mention cryptocurrencies, ICOs or blockchain in that speech.  However, in light of the prevalence of the topic and many industry leaders, politicians and market participants looking to the SEC for guidance on the question of “what is a cryptocurrency” and “how should it be regulated,” I can’t help but think the SEC is looking back at Congress with the same question.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

SEC Continues to Review, And Delay, Crypto Funds

On January 18, 2018, the SEC issued a letter to the Investment Company Institute and the Securities Industry and Financial Markets Association (SIFMA) explaining why the SEC could not approve a cryptocurrency-related exchange traded fund (ETF) or mutual fund. The letter, authored by SEC Division of Investment Management director Dalia Blass, explains the SEC’s reservations and concerns about approving a crypto-related mutual fund or ETF. The letter advised against seeking registration of funds that invest heavily in cryptocurrency-related products until the raised questions and concerns can be properly addressed.

The SEC letter comes a year after the SEC rejected a proposal by Cameron and Tyler Winklevoss, famously linked to the founding of Facebook, to create a bitcoin-tracking ETF. Since that time the SEC has privately rejected several similar requests. Many in the industry appreciate the SEC letter as it offers specific guidance and concrete issues to be addressed as the march towards the eventual approval of a crypto-related fund continues.

Since the January 18 letter, the SEC has been reviewing and conducting proceedings on a New York Stock Exchange (NYSE) proposal to list and trade five bitcoin-related ETFs. The proceedings are expected to go on for a few months. This blog will begin with an explanation of what exactly is an ETF and then address the SEC’s concerns related to the clearance of crypto-related ETFs.

What is an ETF?

Exchange traded funds or ETFs are funds that track indexes. Historically, exchange traded funds have tracked big-board indexes such as the Nasdaq 100, S&P 500 or Dow Jones; however, as ETFs have risen in popularity, there are now funds that track lesser-known indexes or specially created indexes to feed the ETF market. There are indexes based on market sectors, such as tech, healthcare, financial; foreign markets; market cap (micro-, small-, mid-, large-, and mega-cap); asset type (small-growth, large-growth, etc.); and commodities. The primary difference between an ETF and other index funds is that an ETF does not try to outperform the corresponding index, but rather tries to track and replicate the performance.

An ETF allows an investor the advantage of copying an index with a single stock trade, without the risk associated with a fund manager trying to outperform the market.  Since the fund manager is simply copying and mirroring the particular index, the management style is referred to as “passive management.”

Passive management reduces the administrative costs from an actively managed portfolio, and that savings can be passed down to the investors. A typical private hedge fund charges 2% per annum for administrative fees. That fee is reduced to 1% for mutual or registered funds. The typical fee for an ETF is less than .20% per year. Moreover, since an ETF does not trade as actively as typical funds, it has fewer capital gain events and therefore lower taxes.

An ETF trades just like a stock, with continuous trading throughout a day. ETFs are generally margin-eligible and accordingly can be sold short. Conversely, mutual funds are generally only priced once a day after market closings and are not margin-eligible.

ETFs have become increasingly popular over the years, especially with investors that are interested in market sectors, regions or asset types. It is not surprising that investors are interested in crypto-related ETFs and that fund creators are likewise trying to meet this investor demand.

SEC Position on Crypto-related Mutual Funds and ETFs

As mentioned, On January 18, 2018, the SEC Division of Investment Management issued a letter to the Investment Company Institute and the Securities Industry and Financial Markets Association (SIFMA) explaining why the SEC could not approve a cryptocurrency-related exchange traded fund (ETF) or similar investment product such as a mutual fund.

The SEC begins with its commitment to fostering innovation and the development of new types of investment products, ETFs being a primary example, but quickly continues with the assertion that multiple investor protection issues need to be resolved before a crypto-related fund could be offered.  The primary issues are valuation, liquidity, custody, arbitrage, potential manipulation and other risks.

The concerns and questions raised by the SEC will also impact future changes to exchange listing standards by the Division of Corporation Finance, the Division of Trading and Markets and the Office of the Chief Accountant. The SEC foresees needed changes to accounting, auditing and reporting requirements for crypto-related funds and ETFs.

Valuation

Mutual funds and ETFs must value their assets on each business day in order to reach a net asset value (“NAV”). NAV is used to determine fund performance, what investors pay for mutual funds and what authorized participants pay for ETFs as well as what they receive when they redeem or sell. The SEC is concerned that a fund or ETF would not have the necessary information to value a cryptocurrency as a result of their volatility, fragmentation, lack of regulation, nascent state and current trading volume (or lack thereof) in the cryptocurrency futures markets.

The SEC has requested that the industry evaluate and provide information as to how valuations would be conducted. Furthermore, the SEC has asked how funds would develop and implement policies and procedures related to crypto-related valuations to ensure that the requirements as to fair value are met. Likewise, the SEC would need satisfaction that a fund or ETF could adequately address the accounting and valuation impacts of “forks” such as when a cryptocurrency diverges into two separate currencies with different prices.

The SEC questions the policies a fund would implement to identify and determine eligibility and acceptability for newly created cryptocurrencies. The SEC has concern as to how a fund would consider the impact of market information and manipulation in the underlying cryptocurrency markets as related to the determination of the settlement price of cryptocurrency futures.

Liquidity

Investments in open-ended funds such as mutual funds and ETFs are redeemable on a daily basis and as such, the funds must maintain sufficient liquid assets to satisfy redemptions.  Rule 22e-4 promulgated under the Investment Company Act of 1940 (the “1940 Act”) requires funds to implement liquidity risk management programs. Under the rule, funds must classify their investments into one of four liquidity categories and limit their investments in illiquid securities to 15% of the fund’s assets.

The SEC is concerned with the steps a fund or ETF that invests in cryptocurrencies or crypto-related products would take to ensure that it would have sufficient liquidity to meet daily redemptions. Moreover, the SEC raises questions as to how such funds would satisfy Rule 22e-4 and in particular, how could any crypto-related investment be classified as anything other than illiquid under the rule.

The SEC specifically asks how such funds would take into account the trading history, price volatility and trading volume of cryptocurrency futures contracts, and would funds be able to conduct a meaningful market-depth analysis in light of these factors.  Similarly, given the fragmentation and volatility in the cryptocurrency markets, would these funds need to assume an unusually sizable potential daily redemption amount in light of the potential for steep market declines in the value of underlying assets.

Custody

The 1940 Act provides for certain requirements related to the custody of securities held by funds, including who may act as a custodian and when funds must verify holdings. The SEC questions how a fund or ETF could satisfy the custody requirements for cryptocurrency-related products. The SEC notes that there are currently no custodians providing fund custodial services for cryptocurrencies. Likewise, although currently all bitcoin future contracts are cash-settled, if physical settlement contracts develop, the SEC questions how a fund will custody the bitcoin to make delivery.

The SEC further questions how a fund will validate existence, exclusive ownership and software functionality of private cryptocurrency keys and other ownership records.  Another issue for cryptocurrencies is cybersecurity and the threat of hacking.  The SEC has concerns about how custodians can satisfy their requirements for the safekeeping of crypto assets.

Arbitrage for ETFs

ETFs obtain SEC orders that enable them to operate in a specialized structure that provides for both exchange trading of their shares throughout the day at market-based prices, and “creation unit” purchases and redemptions transacted at NAV by authorized participants. In order to promote fair treatment of investors, an ETF is required to have a market price that would not deviate materially from the ETF’s NAV. The SEC questions how an ETF could comply with the terms of an order considering the fragmentation, volatility and trading volume in the cryptocurrency marketplace.

The SEC would like funds to engage with market makers and authorized participants to understand the feasibility of the arbitrage for ETFs investing substantially in cryptocurrency and cryptocurrency-related products. The SEC also questions how trading halts or the shutdown of a cryptocurrency exchange would affect the market price or arbitrage.

Potential Manipulation and Other Risks

The SEC believes that the current cryptocurrency markets have substantially fewer investor protections than traditional securities markets. Moreover, the SEC, other federal regulators, and state regulators have found considerable fraud in the cryptocurrency marketplace. The SEC is concerned about how a fund would address fraud concerns in the underlying markets when offering investments in the fund to retail investors. Similarly, the SEC is concerned about the disclosure of, and ability for a retail investor to understand, the risks of an investment in a crypto-related fund.

Likewise, the SEC would like funds to engage in discussions with broker-dealers who may distribute the funds, as to how the broker-dealer will satisfy their suitability requirements. The SEC is also concerned with how an investment advisor will satisfy their fiduciary obligations when recommending a crypto-related fund.

Further Reading on DLT/Blockchain and ICOs

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

What is a SAFT?

A Simple Agreement for Future Tokens (“SAFT”) is an investment contract originally designed to provide a compliant alternative to an initial coin offering (ICO).  A SAFT as used today was intended to satisfy the U.S. federal securities laws, money services and tax laws and act as an alternative to an ICO when the platform and other utilization for the cryptocurrency or token was not yet completed. The form of the SAFT is the result of a joint effort between the Cooley law firm and Protocol Lab as detailed in the white paper released on October 2, 2017 entitled “The SAFT Project: Toward a Compliant Token Sale Framework.” As discussed in this blog, the SAFT’s compliance with federal securities laws has now come into question by both the SEC and practitioners.

SAFT’s are offered and sold to accredited investors as an investment to fund the development of a business or project in a way not dissimilar to the way equity changes hands in traditional venture capital. A SAFT was developed from the oft-used simple agreement for future equity (SAFE) contract in the venture capital setting. In a SAFT sale, no coins are ever offered, sold or exchanged. Rather, money is exchanged for traditional paper documents that promise access to future product. Fundamentally, a SAFT has been relying on the premise that the future product is not in and of itself a security.

Although the SEC had been looking at ICO’s for a while, on July 25, 2017 it issued a Section 21(a) Report on an investigation related to an initial coin offering (ICO) by the DAO concluding that the ICO was a securities offering. The Section 21(a) Report established that the Howey Test is the appropriate standard for determining whether a particular token involves an investment contract and the application of the federal securities laws. SEC Chair Jay Clayton has confirmed this standard in several public statements and in testimony before the United States Senate Committee on Banking Housing and Urban Affairs (“Banking Committee”). For a review of the Howey Test, see HERE.

Following the Section 21(a) Report, in a slew of enforcement proceedings by both the SEC and state securities regulators, and in numerous public statements, it is clear that regulators have viewed most, if not all, ICO’s as involving the sale of securities. At the same time, the SAFT grew in popularity as an attempt to comply with the securities laws. The SEC’s position is based on an analysis of the current market for ICO’s and the issuance of “coins” or “tokens” for capital raising transactions and as speculative investment contracts.

SAFT users rely on the premise that a cryptocurrency which today may be an investment contract (security) can morph into a commodity (currency) or other type of digital asset. The SAFT would delay the issuance of the cryptocurrency until it has reached its future utility. Investors in a SAFT automatically receive the cryptocurrency when it is publicly distributed in an ICO. The SAFT investors generally receive the crypto at a discount to the public offering price. However, this premise is taking a direct hit lately. Although I’ll lay out more on the SAFT history and why it was thought of as a solution further in this blog, I’ll jump right to the current analysis, and why a SAFT might not provide the intended protections.

The SAFT Problem

Although everyone, including regulators, agree that the state of the law in the area of cryptocurrencies and tokens is unsettled, regulators, including both the CFTC and SEC, have increasingly taken positions that would bring cryptocurrencies within their jurisdiction. I believe regulators are reacting to overarching fraud and therefore a necessity to take action to protect investors. Without congressional rule making and definitive guidance, regulators have no choice but to make the current law fit the circumstances. In some cases that works fine, but in others it does not and I suspect continuing changes in interpretations, enforcement premises and ultimately rule making will occur.

As I’ve previously discussed, the CFTC first found that Bitcoin and other virtual currencies were properly defined as commodities in 2015. Accordingly, the CFTC has regulatory oversight over futures, options, and derivatives contracts on virtual currencies and has oversight to pursue claims of fraud or manipulation involving a virtual currency traded in interstate commerce. Beyond instances of fraud or manipulation, the CFTC generally does not oversee “spot” or cash market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing. Rather, these “exchanges” are regulated as payment processors or money transmitters under state law. See HERE.

The SEC has also taken the stance that ICO’s involve the sale of securities, and that exchanges providing for the after-market trading of cryptocurrencies must register unless an exemption applies. The SEC is now taking it one step further, postulating that the tokens or cryptocurrencies underlying the SAFT could also be a security (and when I say “could” I mean “are”), in which case the SAFT structure is nothing more than a convertible security and fails to comply with the federal securities laws and makes it even more likely that it would result in an enforcement proceeding, or private litigation.

A SAFT is a type of pre-ICO investment with the investors automatically receiving the crypto when the company completes its public ICO. If the underlying token is a security, then the future ICO fails to comply with the federal securities laws and the original SAFT also fails to comply.

Getting ahead of this issue, many companies have structured a SAFT such that the future ICO is also labeled a security, and the SAFT investor will receive the crypto when the future ICO is registered with the SEC. However, this results in a private pre-public security sale, which in and of itself is prohibited by the securities laws.

In particular, Securities Act CD&I 139.01 provides:

Question: Where the offer and sale of convertible securities or warrants are being registered under the Securities Act, and such securities are convertible or exercisable within one year, must the underlying securities be registered at that time?

Answer: Yes. Because the securities are convertible or exercisable within one year, an offering of both the overlying security and underlying security is deemed to be taking place. If such securities are not convertible or exercisable within one year, the issuer may choose not to register the underlying securities at the time of registering the convertible securities or warrants. However, the underlying securities must be registered no later than the date such securities become convertible or exercisable by their terms, if no exemption for such conversion or exercise is available. Where securities are convertible only at the option of the issuer, the underlying securities must be registered at the time the offer and sale of the convertible securities are registered since the entire investment decision that investors will be making is at the time of purchasing the convertible securities. The security holder, by purchasing a convertible security that is convertible only at the option of the issuer, is in effect also deciding to accept the underlying security. [Aug. 14, 2009] (emphasis added)

In a Crowdfund Insider article published March 26, 2018, one practitioner (Anthony Zeoli) has had discussions with the SEC on the subject. As reported in the article, the SEC has stated that if the SAFT investor will automatically receive tokens in the future when and if the tokens are registered, without any further action on the part of the investor, then the tokens must be registered as of the date of the SAFT investment.

Of course, the future ICO or token offering could be completed in a private offering in compliance with the federal securities laws, such as using Rule 506(c) and limiting all sales to accredited investors (see HERE on Rule 506(c)). However, assuming the token or coin really is designed to create a decentralized community or to have utility value that can be widely used by the public, limiting sales to accredited investors does not meet the needs of the issuers. Moreover, even if the future offering is structured as a private securities offering, the SAFT sale disclosure documents would need to include full disclosure on the future coin or token such that the investor could make an informed investment decision at the time of the SAFT investment.

In the same article, Zeoli delves into a more nuanced issue, which is the rising difference in the meaning of a “coin” vs a “token.” A SAFT is a simple agreement for future “tokens” but is being used to pre-sell initial “coin” offerings. If a coin and a token are two very different things (as Zeoli suggests—think stock vs. LLC interest), then the underlying contract has systemic problems beyond the registration and exemption provisions of the federal securities laws and may be a misrepresentation resulting in fraud claims.

More On SAFT; Background

As mentioned, the current form of a SAFT was created by a joint effort between the Cooley law firm and Protocol Lab as detailed in the white paper released on October 2, 2017 entitled “The SAFT Project: Toward a Compliant Token Sale Framework.” The SAFT was intended to comply with the federal securities, money transmittal and tax laws. Also, as discussed, the SAFT relies on the premise that a cryptocurrency which today may be an investment contract (security) will tomorrow be a non-security digital asset satisfying the Howey Test.  The SAFT would delay the issuance of the cryptocurrency until it has reached its future utility.

The original SAFT white paper states:

The SAFT is an investment contract. A SAFT transaction contemplates an initial sale of a SAFT by developers to accredited investors. The SAFT obligates investors to immediately fund the developers. In exchange, the developers use the funds to develop genuinely functional network, with genuinely functional utility tokens, and then deliver those tokens to the investors once functional. The investors may then resell the tokens to the public, presumably for a profit, and so may the developers.

The SAFT is a security. It demands compliance with the securities laws. The resulting tokens, however, are already functional, and need not be securities under the Howey test. They are consumptive products and, as such, demand compliance with state and federal consumer protection laws.

Despite its good intentions, as of today, the model SAFT no longer works.

Further Reading on DLT/Blockchain and ICO’s

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICO’s, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICO’s and accounting implications, see HERE.

For an update on state distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICO’s and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICO’s, see HERE.

For a review of the CFTC role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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