Blockchain and the Law

Cover Article: Practical Law – The Journal, June/July Issue | “Supply Chain Management – Implementing Blockchain Technology”

We are happy to report that our recent in-depth Practice Note on Blockchain as applied to Supply Chain Management was selected to appear as the cover story for the June/July issue of Practical Law – The Journal. Read the full text here.

SEC Sues Kik for ICO

On June 4, 2019, the U.S. Securities and Exchange Commission (the “SEC”) filed a complaint in the Southern District of New York against Kik Interactive Inc. (“Kik”) alleging violations of Section 5 of the Securities Act of 1933 (the “Securities Act”).

The complaint arises from Kik’s offer and sale of $100 million worth of blockchain-based digital assets known as “Kin Tokens” from May to September 2017.

In that time period, Kik sold Kin Tokens both (1) to accredited investors pursuant to Simple Agreements for Future Tokens (or “SAFTs”) and (2) in a general public sale to purchasers in select jurisdictions, including the United States.

The SEC claims that Kik thereby offered and sold unregistered, non-exempt “investment contracts” – a form of securities – in violation of Sections 5(a) and 5(c) of the Securities Act.

(According to the SEC, although Kik attempted to sell discounted Kin Tokens under the SAFTs in satisfaction of the exemption from registration provided by Rule 506(c) under Regulation D, the subsequent delivery of Kin Tokens to SAFT purchasers in September 2017 constituted an offer and sale of securities that was either part of the same offering as the general public sale or alternatively, should be integrated with that offering. And, because Kik did not take reasonable (i.e., any) measures to verify that purchasers in the general public sale were accredited investors, the offering as a whole failed to satisfy the requirements of Rule 506(c) and thus was required to be registered with the SEC.)

Kik has been vocal in their opposition to the enforcement action and commitment to litigate.

In January 2019, Kik made its Wells Response publically available in a blog post entitled, “Four Commissioners at the SEC are About to Vote on the Future of Crypto in the U.S. You Need to Know Why We’re Fighting Back.”

More recently, Kik teamed up with other market participants to launch Defend Crypto, a donation platform that has raised over $4.4 million worth of digital assets to fund Kik’s litigation war chest.

Finally, in response to the SEC’s complaint, Kik’s General Counsel reportedly stated that:

For the reasons set forth in our Wells Submission, the SEC’s complaint against Kik is based on a flawed legal theory. Among other things, the complaint assumes, incorrectly, that any discussion of a potential increase in value of an asset is the same as offering or promising profits solely from the efforts of another; that having aligned incentives is the same as creating a “common enterprise”; and that any contributions by a seller or promoter are necessarily the “essential” managerial or entrepreneurial efforts required to create an investment contract. These legal assumptions stretch the Howey test [the four-pronged test for determining whether a transaction, contract or scheme constitutes an investment contract] well beyond its definition, and we do not believe they will withstand judicial scrutiny.

If Kik does indeed proceed to trial, its outcome will, one way or the other, reverberate throughout the industry. Stay tuned.

Dueling Bitcoin White Paper Copyright Registrations – What Does it Mean?

The plot has thickened in the longest-running “whodunit” in the blockchain space: Who is Satoshi Nakamoto, the pseudonymous creator of Bitcoin and author of the white paper that started it all, Bitcoin: A Peer-to-Peer Electronic Cash System? Published in 2008, Nakamoto’s paper proposed a form of electronic cash that would operate purely peer-to-peer, without the need for a trusted intermediary (such as a centralized financial institution) and in a verifiable manner that protects against the “double-spend” problem. That white paper served as the launch pad for the Bitcoin network and inspired blockchain’s proliferation. Over a decade later, the true identity of Nakamoto and whether Nakamoto is a single person or a collective remain a mystery, despite speculation and multiple claims to the digital throne.

Recently, claimants turned to intellectual property registrations in their campaigns for recognition. In April 2019, Australian entrepreneur Craig Wright (who has long claimed to be Nakamoto) sparked controversy in the blockchain community by filing two copyright registrations claiming authorship of Nakamoto’s white paper (Reg. No. TXu002136996) and the original Bitcoin source code (Reg. No. TX0008708058). In the wake of Wright’s claims, on May 24, 2019, Wei Liu, reportedly a cryptocurrency entrepreneur and a Chinese citizen with an address in California, upped the ante by also filing a copyright registration (Reg. No. TX0008726120) asserting that he had in fact authored the white paper.

The gauntlet, it seemed, had been thrown down. Continue Reading

Should Your Portfolio Companies Implement Blockchain?

Proskauer partners Daniel Ganitsky and Jeff Neuburger address five factors for private equity firms to consider when evaluating the critical business decision of implementing blockchain-based technology solutions for their portfolio companies:

Daniel Ganitsky: Technology is causing private equity firms to deal with a whole new set of questions for their portfolio companies. The use of blockchain technology is one of those questions. Given operational factors and the fact that private equity firms often provide additional access to capital, it may make sense for private equity firms to consider using blockchain technology in their portfolio companies.

Jeff Neuburger: There are a number of factors that a private equity firm should consider in evaluating blockchain for their portfolio companies.

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Blockstack Announces SEC Filing for $50 Million Regulation A Token Offering

On April 11, Blockstack Token LLC (“Blockstack”) filed a preliminary offering circular with the SEC for a $50 million token offering under Regulation A of the Securities Act. The offering circular is now under review with the SEC and must be qualified (i.e., cleared) by the SEC before sales of Blockstack’s tokens (“Stacks Tokens”) can be effectuated under the program.

Blockstack’s offering circular is notable because it treats the Stacks Tokens as securities today but discloses that the issuer expects the Stacks Tokens will, at some point in the future, no longer be required to be treated as securities under the federal securities laws. This approach is consistent with recent SEC staff guidance, which stated that the analysis of whether a digital asset represents an investment contract (and thus, a security) may change over time, depending on how the asset is used, offered and sold. Blockstack states that it will refer to the Framework for “Investment Contract” Analysis of Digital Assets, recently published by the SEC’s Strategic Hub for Innovation and Financial Technology, for regulatory guidance in connection with making this determination.

If the SEC qualifies Blockstack’s offering under Regulation A, it will be the first time the SEC has done so for the offer and sale of a blockchain-native digital asset. Continue Reading

SEC Gives Guidance on Securities Analysis for Digital Assets: TurnKey No-Action Letter and Framework Publication

The Securities and Exchange Commission (“SEC”) recently issued highly anticipated guidance to assist market participants in determining whether a digital asset is offered and sold as a security.

On April 3, 2019, the SEC’s Strategic Hub for Innovation and Financial Technology published an analytical framework for evaluating whether the offer and sale of a digital asset is an “investment contract” and therefore a security subject to regulation under the federal securities laws.  On the same day, the Division of Corporation Finance issued a no-action letter permitting TurnKey Jet, Inc. to offer and sell digital assets without registering or qualifying for an exemption under the Securities Act of 1933 or the Securities Exchange Act of 1934.

Our analysis of the no-action letter and the framework is available here.

Warning Shot: Charges Against OneCoin Include Securities Fraud

In early March, the Manhattan U.S. Attorney unsealed indictments against the leaders of the Bulgarian-based “purported” cryptocurrency “OneCoin” on wire fraud, money laundering and federal securities fraud charges relating to an alleged $3 billion pyramid scheme devised to market OneCoin. OneCoin’s lawyer has also been charged with conspiracy to commit money laundering for allegedly conducting financial transactions with some of the proceeds of the scheme to conceal the unlawful activities.

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