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Kevin Milewski

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As we highlighted in our recent Practical Law Practice Note, Smart Contracts: Best Practices, various state lawmakers are paving the way for widespread use of blockchains and smart contracts in commerce. For example, on January 1, 2020, the Illinois Blockchain Technology Act (BTA) went into effect, resolving some legal uncertainties around the legal status of blockchains and smart contracts in Illinois.

“Smart Contracts,” as defined by the BTA, are contracts stored as electronic records which are verified by the use of a blockchain. Smart Contracts can be deployed in a variety of legal and non-legal contexts, ranging from car rentals to supply chain management. However, one question that has loomed over smart contracts is how courts will review their enforceability, given that smart contracts may not resemble typical, written agreements. Some legislatures, and now Illinois, have sought to address this issue head-on, rather than waiting for courts to decide.

The BTA provides four permitted uses for blockchain and smart contracts:

  1. A smart contract, record, or signature may not be denied legal effect or enforceability solely because a blockchain was used to create, store, or verify the smart contract, record, or signature.
  2. In a proceeding, evidence of a smart contract, record, or signature must not be excluded solely because a blockchain was used to create, store, or verify the smart contract, record, or signature.
  3. If a law requires a record to be in writing, submission of a blockchain which electronically contains the record satisfies the law.
  4. If a law requires a signature, submission of a blockchain which electronically contains the signature or verifies the intent of a person to provide the signature satisfies the law.

In effect, these permitted uses prevent a court from denying smart contracts contractual or evidentiary effect solely by virtue of their status as a smart contract or electronic record stored on a blockchain, though courts will still have to review on a case by case basis. Tennessee and Arizona, among other states, passed similar legislation regarding contractual enforceability of smart contracts. Vermont passed a similar law handling the evidentiary effect of digital records such as smart contracts. Wyoming has also been active in adopting regulations related to digital assets, smart contracts, and blockchains.

Proskauer authored an in-depth Practice Note published by Practical Law, which details best practices for the use of smart contracts on blockchains. It discusses functional and legal considerations for both standalone smart contracts and smart contracts used in conjunction with traditional written contracts (hybrid smart contracts) and explores the…

Based on a recent regulatory statement, entities involved with cryptocurrency or digital assets should revisit their anti-money laundering and countering the financing of terrorism obligations (AML/CFT) compliance under the Bank Secrecy Act (BSA).

On October 11, the leaders of the Commodity Futures Trading Commission (CFTC), the Financial Crimes Enforcement Network (FinCEN), and the Securities and Exchange Commission (SEC) issued a joint statement (the “Joint Statement”) regarding the application of the BSA to activities involving digital assets. The Joint Statement “reminds” those involved with such activities of their AML/CFT obligations and specifically calls out those entities that would be subject to such obligations: futures commission merchants and introducing brokers (regulated by the CFTC), money services businesses (regulated by FinCEN), and broker-dealers and mutual funds (regulated by the SEC).

Potentially indicating a key concern of the regulators going forward, the Joint Statement notes that the applicability of AML/CFT obligations is not dependent on the terminology surrounding the applicable assets, but rather the nature of the assets themselves: “Regardless of the label or terminology that market participants may use, or the level or type of technology employed, it is the facts and circumstances underlying an asset, activity or service, including its economic reality and use (whether intended or organically developed or repurposed), that determines the general categorization of an asset, the specific regulatory treatment of the activity involving the asset, and whether the persons involved are “financial institutions” for purposes of the BSA.” Thus, while market participants refer to digital assets in many different ways, how assets are referred to should not have a bearing on BSA compliance. By way of example, the Joint Statement offers that “something referred to as an ‘exchange’ in a market for digital assets may or may not also qualify as an ‘exchange’ as that term is used under the federal securities laws.”

Following the general statement, each leader provides additional comments, which should guide entities subject to each applicable regulator’s review. Heath Tarbert (Chairman, CFTC) notes that introducing brokers and futures commission merchants are required to report suspicious activity and implement reasonably-designed AML programs, regardless of whether the digital assets qualify as commodities or are used as derivatives. Kenneth A. Blanco (Director, FinCEN) advises those handling digital assets to review FinCEN’s May 2019 interpretive guidance, under which FinCEN makes clear that many digital asset activities would qualify a person as a money services business subject to AML/CFT obligations (unless the person is registered with and functionally regulated and examined by the SEC or CFTC, whereby they would be subject to the BSA obligations of those regulators).  Jay Clayton (Chairman, SEC) reminds persons engaged in activities involving digital assets as securities that they remain subject to federal securities laws, but certain rules also apply regardless of whether the assets are securities, such as broker-dealer financial responsibility rules.

The SEC recently announced its settlement of charges against boxer Floyd Mayweather and producer DJ Khaled for their failure to disclose payments they received for promoting Initial Coin Offerings (ICOs) on their social media accounts.

The federal securities laws contain an “anti-touting provision,” which regulates paid promotions of securities offerings. Specifically, Section 17(b) of the Securities Act of 1933 makes it unlawful for a person to “publish, give publicity to, or circulate any notice…or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received…without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof.” Importantly, the provision applies even to those not directly offering a security for sale. The SEC’s orders instituting cease-and-desist proceedings against Mayweather and Khaled both cited violations of Section 17(b).

According to the charges, Mayweather failed to disclose $300,000 he received from three ICO issuers. He received $100,000 from Centra Tech Inc. for posting on his social media accounts that “Centra’s…ICO starts in a few hours. Get yours before they sell out, I got mine and as usual I’m going to win big with this one!” Mayweather promoted ICOs on his social media accounts a number of other times and even dubbed himself “Floyd Crypto Mayweather” in one post (not to be confused with his usual moniker, Floyd “Money” Mayweather). Khaled also received $50,000 from Centra for posts calling Centra an “ultimate winner” and a “game changer.” Centra has been the subject of its own SEC scrutiny, with the SEC filing a civil action against Centra’s founders and the U.S. Attorney’s Office for the Southern District of New York filing corresponding criminal charges.