Blockchain and the Law

SEC Director William Hinman: “Current offers and sales of Ether are not securities transactions”

At last week’s Yahoo! All Markets Summit in Palo Alto, SEC Division of Corporation Finance Director William Hinman delivered a speech sure to send shockwaves through the crypto world. Applying the Howey test (which sets forth the elements necessary for determining whether a transaction involves the offer or sale of an “investment contract” and thus, a security, under the federal securities laws) to cryptoasset transactions, Director Hinman concluded that:

  1. To determine whether a token sale satisfies Howey, market participants should “primarily” consider whether the network on which the token operates is “sufficiently decentralized.”
  2. Alternatively it is possible, through technological or contractual means, to design cryptoassets so that they function more like a consumer item and less like a security; however, the economic realities of a given token transaction (specifically the manner in which the token is offered and sold and the reasonable expectations of purchasers) controls any such determination.
  3. Cryptoassets originally offered in a securities offering can later be sold in a manner that does not constitute an offering of a security.
  4. Current offers and sales of Ether are not securities transactions.

Although in no way officially binding as a matter of SEC policy or federal securities law, Director Hinman’s comments are tremendously important to the evolving cryptoasset marketplace in the United States. They provide guidance on a number of critical questions that exist at the margins of SEC Chairman Jay Clayton’s position that he has not seen a single token issued through an ICO that is not a security, and warrant deep and careful consideration.

Another SEC Enforcement Action against Allegedly Fraudulent ICO

On May 29, the SEC announced that it had secured injunctive relief halting an allegedly “ongoing fraud” involving an unregistered, non-exempt ICO that raised as much as $21 million in cryptoassets.

The SEC’s complaint charges Titanium Blockchain Infrastructure Services, Inc., EHI Internetwork and Systems Management, Inc. and Michael Stollery, (collectively, the “Titanium defendants”) with fraud in connection with the purchase, offer or sale of securities under Sections 10 and 17 of the Securities Exchange Act and the unregistered offer and sale of securities under Section 5 of the Securities Act.  Continue Reading

Ripple Faces Class Action Lawsuit Alleging Sale of Unregistered Securities

A class action lawsuit was filed on May 3rd against Ripple Labs Inc.—a fintech startup that controls the third-largest cryptocurrency in the world—and its CEO Brad Garlinghouse, alleging that Ripple sold unregistered, non-exempt securities in violation of federal and California state securities laws.

In their complaint, Plaintiffs characterized the sale of XRP (Ripple’s native token) as “a scheme by Defendants to raise hundreds of millions of dollars through the unregistered sale of XRP” and “what is essentially a never-ending initial coin offering (ICO).” In addition to attorney fees, costs of the suit, and punitive damages, the plaintiffs also request a declaration from the court that the sale of XRP is an unregistered securities sale and to enjoin defendants from further violating securities laws. Continue Reading

SEC Flexes Funny Bone in Fictional Token Offering

The Securities and Exchange Commission (the “SEC”) has taken to using humor and sarcasm to educate retail investors about the potential risks of purchasing tokens in initial coin offerings (“ICOs”).

This week, the SEC issued a press release presenting “a hot investment opportunity.”  The release pointed to a website touting the HoweyCoin—a fictional crypto token intending to disrupt the luxury travel industry—as “one of the largest cryptocurrency platforms ever built” and promising that it would provide potential investors with “excitement and guaranteed returns.” The website closely mimics common components of ICO issuer websites, including offers for tiered pre-sale purchaser discounts and an invitation to review a whitepaper, and contains egregious claims that the tokens are SEC-compliant, images of opulence, and fake celebrity endorsements for good measure.

For those of you who are not securities lawyers, the name “Howeycoin” is a reference to the seminal Supreme Court decision in SEC v. W.J. Howey Co., which first set forth the test for what constitutes an “investment contract” (and thus, a security) under the U.S. federal securities laws.

HoweyCoin is marketed as a token directly redeemable for travel services or merchandise, in addition to being an investment vehicle. Presenting HoweyCoin as a token with purported functionality highlights the SEC’s position that even tokens with “utility”(e.g., eligibility to be exchanged for goods or services) remain subject to SEC scrutiny.

Clicking on “Buy Coins Now!” takes the visitor to a SEC information page that warns retail investors as to the risks of ICOs.

This education effort comes as the SEC, along with various state securities commissions, remain vigilant in shutting down fraudulent, unregistered and non-exempt ICOs.

Blockchain as a Content Distribution Technology: Copyright Issues Abound

Content owners and their attorneys have been enthusiastically anticipating the use of blockchain as a mechanism for royalty accounting, recording the chain of title of intellectual property interests, and protecting, tracking and administering IP.

The enthusiasm is a little less vigorous, however, when the topic turns to the use of blockchain as a vehicle for content distribution.  Some of those discussions are still appealing to content owners and their counsel as they focus on the use of blockchain as a means of effectuating a decentralized digital rights management-type system to allow distribution of content to authorized users in a secure way. Copyright anxiety arises, however, with the recognition that the technology can also be used to facilitate the distribution of infringing content, notably in the form of anonymous transactions that are embodied in a block in a permanent and immutable manner. Continue Reading

Cryptoasset Exchanges Respond to New York Attorney General’s Virtual Markets Integrity Initiative

On April 17, 2018, the New York Attorney General’s Office (“OAG”) launched a Virtual Markets Integrity Initiative and sent letters to thirteen cryptoasset trading platforms requesting, through a questionnaire, disclosures on their operations, internal controls, and safeguards to protect customer assets.  The questionnaire focused on six major topic areas, including: 1) Ownership and Control, 2) Basic Operation and Fees, 3) Trading Policies and Procedures, 4) Outages and Other Suspensions of Trading, 5) Internal Controls, and 6) Privacy and Money Laundering.  The OAG characterized the initiative as a mechanism to “increase transparency and accountability” on “platforms used by consumers to trade virtual or ‘crypto’ currencies like bitcoin and ether.”  Notably, the thirteen trading platforms were only given two weeks to respond to the questionnaire.

While cryptoasset exchanges already face regulatory scrutiny from the SEC, the CFTC, and certain state regulators (including other agencies within New York), among others, the OAG determined  that their mandate to protect customers/ investors and ensure the fairness of New York’s financial markets necessitated further action.  Two of the targeted trading platforms –  Coinbase and Kraken – publicized markedly different responses to the OAG’s inquiries, the content of which sheds light on how some of the industry’s key players are approaching regulation; and perhaps, how regulators should be approaching some of the industry’s key players. Continue Reading

Regulatory Scrutiny of the ICO Market – What Fund Managers Should Know

Last week, former CFTC Chairman Gary Gensler explained in remarks at M.I.T. that he believes the second and third most widely used virtual currencies—Ether and Ripple—may have been issued and traded in violation of securities regulations.  This comes on the heels of a crackdown on cryptocurrency-related securities by the SEC, which is particularly focused on initial coin offerings (ICOs).  For fund managers, we believe the increased regulatory pressure will be felt in some expected, and some not-so-expected, ways.

ICO enforcement is trending: The SEC’s Cyber Unit has ramped up enforcement pressure, issuing dozens of subpoenas and information requests to technology companies and advisers involved in the ICO market.  The requests have sought information about the structure for sales and pre-sales of ICOs.  This uptick in enforcement pressure isn’t surprising, especially given Chairman Clayton’s repeated warnings that participants in the ICO space are not complying with the required securities laws (for example, notably stating that he has yet to see an ICO that “doesn’t have a sufficient number of hallmarks of a security.”)  There are no signs the SEC will slow down its scrutiny of crypto-related assets.  The SEC has already indicated that it will devote significant resources to policing the ICO market.  Continue Reading

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