Blockchain and the Law

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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U.S. House Continues to Explore Blockchain Regulation

Following up on their recent introduction of the Token Taxonomy Act, Representatives Darren Soto (D-FL) and Warren Davidson (R-OH) have teamed up again to introduce a new slate of bipartisan bills related to virtual currency. The two new bills, H.R. 922 and H.R. 923, were introduced on January 30, 2019 and are cosponsored by Representatives Ted Budd (R-NC) and Bonnie Watson Coleman (D-NJ).

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Two New Bitcoin ETF Proposals Pending as Cryptocurrency Markets Mature

Two recent proposals for bitcoin exchange-traded funds (“ETFs”) are vying to become the first to receive approval from the U.S. Securities and Exchange Commission (“SEC”) – one filed by CBOE BZX Exchange, Inc. (“CBOE”) and the other by NYSE Arca, Inc. (“NYSE Arca”). The SEC has yet to approve a cryptocurrency ETF, although several applications were filed throughout 2018.

A bitcoin ETF would allow investors to easily invest in bitcoin without needing to directly buy and manage the cryptocurrency themselves, potentially ushering in additional capital and enabling a wider range of institutional investors to tap into the market.

Once the proposals are published in the Federal Register, the SEC has an initial 45 days from the date of publication to issue a decision or request an extension, with total time not to exceed 240 days.

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Gladius Escapes Fines for Unregistered ICO after Self-Reporting to the SEC

On February 20, 2019, the SEC announced that it settled charges against Gladius Network LLC (“Gladius”) for failing to register non-exempt offers and sales of securities in violation of Sections 5(a) and 5(c) of the Securities Act. While the SEC has previously settled charges relating to unregistered ICOs, this is one of few occasions since its 2017 DAO Report that the SEC refrained from imposing civil monetary penalties for an ICO that it determined violated the registration requirements of the federal securities laws.

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Guidance on Cryptoassets: UK Financial Conduct Authority Issues Consultation Paper

On January 23, 2019, the UK Financial Conduct Authority (“FCA”) issued its widely anticipated “Guidance on Cryptoassets” consultation paper CP19/3 (the “Consultation”). The Consultation followed the UK Cryptoassets Task Force’s publication last October, which set out the UK’s policy and regulatory approach to cryptoassets and distributed ledger technology and called for the FCA to issue guidance on its regulatory perimeter. The purpose of the Consultation is to provide guidance on the proposed rules that the FCA intends to implement in relation to cryptoassets and to provide market participants with the opportunity to provide initial feedback.

Amongst other things, the Consultation provided some helpful clarification as to where cryptoassets would fall within the FCA’s regulatory perimeter.

Which cryptoassets are within the FCA’s regulatory perimeter?

The FCA’s guidance clarifies whether different types of cryptoassets would fall within the FCA’s regulatory scope and, in particular, outlines whether cryptoassets are likely to fall within one or more of the following categories:

This is relevant because if a cryptoasset falls within one of the above categories, it could mean that the relevant firm carrying out certain activities in relation to cryptoassets is engaging in a regulated activity. Firms that carry on regulated activities in the UK are required to obtain authorisation from the FCA in order to do so.

In addition, the FCA has highlighted that, while issuers of tokens may not need to be authorised themselves, other regulatory requirements may apply (e.g., under the UK financial promotion regime and/or the Prospectus Directive (2003/71/EC)).

In this respect, the FCA has stated the following in its Consultation:

  • “security tokens” (which the FCA defines to be a token which has the specific features of a typical security such as a share, debenture or unit in a collective investment scheme) are likely to fall within the definition of a “specified investment” and therefore fall within the FCA’s regulatory scope; and
  • on the other hand, “exchange tokens” (such as Bitcoin, Ether or Litecoin) and “utility tokens” (which grant holders access to a current or prospective product or service but do not grant holders rights to profit or ownership) would be unlikely to constitute a “specified investment”.

The FCA also stated in its Consultation that, while exchange tokens and utility tokens would probably not amount to a “specified investment”, they may still be brought into the FCA’s regulatory perimeter under the PSRs or EMRs depending on the specific features of the tokens.

The FCA ultimately reminded firms that due to the complexity of many tokens, firms should consider a number of factors to determine if the relevant token is a specified investment. Ultimately, this can only be assessed on a case by case basis and legal advice should be sought.

Impact on Firms

The Consultation provides some welcome clarity as to when cryptoassets may fall within or outside the FCA’s regulatory scope.

Firms that carry on cryptoasset business which is within the regulatory scope of the FCA will need to seek authorisation to carry on the relevant regulated activities. In addition, where a cryptoasset is a transferable security and will be either offered to the public in the UK or admitted to trading on a regulated market, the issuer would need to publish a prospectus approved by the FCA, unless an exemption applies.

Next Steps

The Consultation will remain open until April 5, 2019, with the FCA aiming to provide final guidance in summer 2019. HM Treasury is also expected to publish a consultation paper in early 2019 on exploring legislative change to potentially broaden the FCA’s regulatory remit to bring further types of cryptoassets within its regulatory scope.

A Taxonomy of the Proposed Token Taxonomy Act

On December 20, 2018, a bipartisan pair of Congressmen, Warren Davidson (R-OH) and Darren Soto (D-FL), introduced bill H.R. 7356 to enact the Token Taxonomy Act (the “Act”). The Act proposes several amendments to federal securities and tax laws that are intended to clarify how cryptoassets should be treated thereunder. Below, we discuss the key provisions of the Act and their potential implications for cryptoasset market participants. Emphasis is placed on “potential” because, as we will discuss, the Act will likely require certain revisions, as well as substantial political support, before becoming effective law. Continue Reading

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