Blockchain and the Law

Major Italian News Agency Uses Blockchain-Based Label to Verify the Origin of Its Articles

The leading Italian news agency, Agenzia Nazionale Stampa Associata (ANSA), which represents 24 major Italian newspapers and distributes over 3,000 news articles daily, announced in early April that it has begun using a blockchain-based solution run on the Ethereum public blockchain to verify the origin of news stories that appear on ANSA platforms or are distributed to other sites, such as social media pages. Stories actually originating from the ANSA platform (without modification) now bear a green digital “ANSAcheck” certificate that informs readers that the preceding story is a verified ANSA news article and is not manipulated or spoofed content or a story that has been altered to spread disinformation. (An image of the ANSAcheck stamp is below; for an example of the certificate on the Internet, look for the digital stamp at the end of this ANSA story).

ANSA Check Stamp

Under the ANSAcheck program, each news item from ANSA is reduced to a cryptographic hash using EY OpsChain Traceability technology and stored as a digital token on the public Ethereum blockchain. When a reader opens an ANSA story on a web browser, the browser compares the text of the article with the parameters recorded on the blockchain and displays the ANSAcheck digital seal if there is a match. If clicked on, the digital seal displays certain data, such as the date the story was published and other block information, as well as an ANSA Certificate, an example of which is shown below. Continue Reading

Hawaii is Latest State to Implement a Regulatory Sandbox to Attract Cryptocurrency Business

On March 17, 2020, the governor of Hawaii announced the Digital Currency Innovation Lab, a collaborative effort between Hawaii’s Department of Commerce and Consumer Affairs, the Division of Financial Institutions (DFI) and Hawaii Technology Development Corporation, to regulate business transactions utilizing cryptocurrencies. The two-year pilot program allows selected companies to conduct business transactions using digital currency that otherwise would require a Hawaii Money Transmitter License under the state’s Money Transmission Act. The announcement of this program came just weeks after SB2594 was proposed in the Hawaiian Senate to allow banks to hold digital assets for their customers.

The Application Process

Applicants must provide financial disclosures based on their legal entity structure. For example, firms organized as corporations would be required to submit their most recent audited financial statements and financial statements for the preceding two years. Applicants must also provide entity structure charts and anti-money laundering disclosures regarding beneficial owners.

Beyond the initial and yearly fees, the application process requires an extensive list of disclosures. If an applicant is accepted, they must provide annual reports to DFI by December 31 of each year during which the accepted applicant participates in the Virtual Currency Pilot Program, including (1) the number of transactions for the year ending October 31, (2) the value of those transactions, (3) the number of complaints received, and (4) any pending or current regulatory enforcement orders against the applicant.

Hawaii’s Changing Policy

Hawaii’s pilot program represents a shift in policy in favor of digital currency innovation. Previously, in 2017, Hawaii had imposed cash reserve requirements on companies using digital currencies to hold an equal amount of government-backed currency. This prompted some cryptocurrency firms to re-evaluate their strategy in Hawaii. Before this program was launched, the DFI could pursue enforcement actions against actors conducting unlicensed money transmission activity. Under this program, companies will have the benefit of a “no action” directive issued by DFI in favor of the Digital Currency Innovation Lab’s participants.

Other State Programs

Notably, unlike other states’ cryptocurrency initiatives such as Utah and Wyoming, Hawaii is creating this “sandbox” initiative not through the state’s legislature, but rather through DFI’s broad regulatory authority. While this does potentially allow for more administrative flexibility, DFI is vested with unchecked discretion, as evidenced by the lack of appeal if an applicant is rejected and the fact that DFI can terminate any company’s participation in the sandbox on any, or no, basis without explanation.

Other states are following the trend and are flirting with the idea of a similar digital sandbox initiative. Rhode Island legislators introduced the Rhode Island Economic Growth Blockchain Act in March, which calls for “a comprehensive regulatory sandbox”. RI H7989 provides for a blockchain technology advisory council to conduct research and promote entrepreneurial development. Rhode Island’s sandbox would allow for a waiver of statutes and rules that otherwise would not permit for a specific financial technology. In comparison with Hawaii and other states, companies seeking a waiver in Rhode Island would need to provide certain disclosures regarding capital requirements and risks to consumers, as well as a detailed proposal about the financial service or product.

While the Digital Currency Innovation Lab offers a sign that Hawaii will allow innovative business solutions with respect to digital currency, the current proposal is fraught with uncertainty. DFI may grant or deny applications in its sole discretion and there is no right of appeal. Similar to other sandboxes, no plan exists for what happens after the two-year incubator period concludes in 2022. In light of these and other concerns, digital currency companies may not participate until a more certain regulatory and legal framework is proposed over a longer time horizon. Applicants must apply for this program by May 1, 2020; however, due to uncertainty surrounding COVID-19, the commencement date for accepted applicants is still undetermined.

Digital Dollars: Amid the COVID-19 Crisis, Support for a U.S. Digital Currency Emerges

During congressional debates over the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), a relatively novel idea was the focus of proposals from the Senate and House of Representatives: “digital dollars.” Several legislative proposals introduced the idea to address the delay between passage of the CARES Act and distribution of direct stimulus payments to taxpayers, one of the pillars of the act. While the concept did not find its way into the final bill, its inclusion in proposals from both the Senate and House indicate that the viability – and specific application – of a central bank digital currency may be emerging.

In the Senate, Ranking Senator Sherrod Brown (D-OH) introduced the Banking for All Act (BAA) on March 24, 2020. Senator Brown touted the BAA as an avenue for rapid payment of stimulus checks to individuals. Specifically, the BAA would allow all residents and citizens of the United States, and businesses domiciled in the United States, to set up a free digital dollar wallet, called a “FedAccount”, which would be maintained by member national, state and local banks, as well as U.S. Post Offices. A FedAccount would allow a holder “receive payments from the United States pursuant to a Federal law relating to the coronavirus disease 2019 (COVID-19),” as well perform more general tasks such as withdrawing and receiving money, and making payments.

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Smart Contracts: Benefits, Legal Enforceability and Best Practices

The combination of smart contracts with blockchain technology has created new opportunities to conduct business, realize efficiencies and establish legally enforceable digital contracts. In this two-part video series, Proskauer’s Jeffrey Neuburger and Wai Choy share:

  • Part 1 (Smart Contracts: Benefits & Legal Enforceability): An overview of smart contracts and their use cases, and the law regarding enforceability of computer code as legal contracts; and
  • Part 2 (Smart Contracts: Best Practices): Best practices they have developed for successfully and efficiently implementing smart contracts and coordinating any associated traditional contract.

For a more in-depth discussion of smart contracts, associated issues and best practices, please read Proskauer’s Practice Note titled Smart Contracts: Best Practices.

Court Sides with SEC in Ruling to Prevent Telegram from Distributing Grams

In the latest development in the ongoing dispute between the SEC and Telegram Group Inc. (Telegram), Judge P. Kevin Castel of the U.S. District Court for the Southern District of New York in a March 24, 2020 opinion granted the SEC’s motion for preliminary injunction to prevent Telegram from distributing Grams purchased in its initial coin offering (ICO).

The case between the SEC and Telegram began last October, when the SEC filed an emergency action to stop Telegram (and its wholly owned subsidiary TON Issuer Inc.) from continuing its offering of Grams. In 2018, Telegram had raised approximately $1.7 billion through the sale of its ICO to finance the creation of the Telegram Open Network (also known as the TON Blockchain). The SEC alleged that Grams were securities, which Telegram failed to register in accordance with Sections 5(a) and 5(c) of the U.S. Securities Act (Securities Act).

Earlier this month, Telegram submitted a letter to Judge Castel arguing that a recent decision of the California Court of Appeal, Second Division, in Siry Investment, L.P. v. Farkhondehpour supported its case against the SEC. In its letter, Telegram argued the Siry court’s opinion supported its central argument that Grams are not securities, but rather a commodity. Telegram suggested that the “economic reality” of Gram purchasers’ intent, reflected in language in the Gram Purchase Agreements that the purchasers would only sell Grams “in accordance with applicable securities laws,” undercuts the claim that the Grams are securities, since they did not intend for them to be securities.

The SEC adamantly disagreed in its response on March 9, asserting that the totality of the circumstances must be considered. Specifically, such “boilerplate” language did not reflect, one way or another, Telegram’s or the purchasers’ intent or actual economic reality, because the economic reality of the Purchase Agreements is a result of the total economic inducements and commercial realities of the transaction. In other words, the SEC continued to point to, among other things, Telegram’s statements during the ICO that the SEC believes led Gram purchasers to expect they could make a profit by buying Grams and selling them on the secondary public market.

In his opinion, Judge Castel agreed with the SEC and held that the Gram Purchase Agreements, Telegram’s implied promises to develop the TON Blockchain and the planned distribution of Grams, taken as a whole, required registration under the Securities Act (see our post here for more information on how the SEC analyzes whether digital assets are securities). He emphasized that the purchasers intended to invest in and then sell Grams for a profit on the secondary market, citing one investor who declared in an email that they “hoped for an increase in the value of Grams and an opportunity to eventually sell Grams if the value increased” and that they did “not believe that [they] intended to use Grams as currency or for consumptive purposes.” The purchasers wanted to maximize value through resale in the public markets, not simply to store or transfer value from Dollars or Euros to Grams.  As such, the court granted the SEC’s motion to enjoin Telegram from distributing Grams and held that Telegram’s ICO violated the Securities Act and required registration. Interestingly, the court also found that the purchasers were “statutory underwriters” (thus also limiting a potential exemption from registration).

Telegram filed a notice following the ruling indicating that it would appeal the court’s decision. Continued litigation might provide further guidance and will determine whether Telegram will ultimately prevail. Nonetheless, the court’s opinion here is important because it develops the regulatory landscape for ICOs by highlighting regulators’ focus on the totality of an issuer’s ICO, and not merely on the “labels” that issuer’s might use to distinguish and qualify certain portions of their offerings for an exemption from registration, as Telegram attempted to do here. Issuers considering future ICOs should keep this in mind.

Department of Homeland Security Lists Blockchain Managers Among “Critical Services Workers” During COVID-19 Response

On March 19, 2020, the U.S. Department of Homeland Security, Cybersecurity and Infrastructure Security Agency (CISA), issued Guidance on the essential critical infrastructure workforce needed to ensure national resilience during the COVID-19 response. CISA developed its initial list of critical infrastructure workers to help state and local officials determine which operations are essential to critical infrastructure as they attempt to balance public health with the need for continued operations in essential areas.

Along with more obvious critical infrastructure workers in sectors such as energy, transportation, public works, communications and healthcare, CISA’s advisory list expressly included blockchain workers involved in the agricultural and food distribution supply chain, namely: “Employees and firms supporting food, feed, and beverage distribution, including warehouse workers, vendor-managed inventory controllers and blockchain managers.”

As we noted in our Practice Note on Blockchain and Supply Chain Management, blockchain offers substantial benefits in the supply chain context. Several major blockchain-based supply chain implementations are currently in use across the country. These initiatives are designed to achieve higher levels of traceability and efficiency as compared to traditional supply chain processes and systems.

The inclusion of blockchain managers in CISA’s Guidance as critical infrastructure workers highlights blockchain’s already significant role in our supply chain ecosystem, and its importance in making this nation’s supply chains safer and more efficient.

We expect that the adoption of blockchain-based supply chain systems will increase dramatically, and that working through the current global health crisis will provide additional insight into how blockchain solutions can be used to mitigate the impact of unforeseen events. Blockchain technology is particularly useful, for example, in almost immediately identifying bottlenecks or supply chain participants that are impeded from performing their defined functions. Such a feature can significantly reduce delays and enable downstream consumers to identify alternative suppliers on a real-time basis to minimize disruption of their business. Clearly, the ability to respond in that way is extremely valuable, especially in times of global economic stress.

SEC Settles Charges Against Enigma MPC for its Unregistered ICO

On February 19, 2020, the U.S. Securities and Exchange Commission (SEC) settled charges against Enigma MPC (Enigma) related to Enigma’s 2017 issuance of “ENG Tokens”. The SEC found Enigma engaged in an unregistered initial coin offering (ICO), in which it offered and sold securities in violation of Sections 5(a) and 5(c) of the Securities Act of 1933 (Securities Act).

Under the settlement, Enigma is required to pay a $500,000 civil penalty. Additionally, Enigma agreed to return funds to investors who purchased ENG Tokens in the ICO and who timely assert a claim via the specified claims process, to register ENG Tokens as a class of securities, and to file periodic reports with the SEC. While Enigma agreed to the terms of the settlement, it did not admit nor deny the SEC’s findings. In a blog post, Enigma stated the “settlement clears the way for our development team to focus fully on our original and continued vision: building groundbreaking privacy solutions that improve the adoption and usability of decentralized technologies, for the benefit of all.”

According to the SEC’s order, Enigma conducted its ICO to raise funds to develop a platform for digital asset traders to test trading strategies, and to build a data marketplace for cryptocurrency-related, and other, data. From June to September 2017, Enigma issued 75 million ENG Tokens and raised digital assets (i.e., Bitcoin and Ether) valued at approximately $45 million.

The SEC determined the ENG Tokens were offered and sold as securities, applying its framework for evaluating whether the offer and sale of a digital asset is an “investment contract” (and therefore a security subject to regulation and whose offer and sale must be registered or qualify for an exemption). As might be expected, the SEC focused on the purchasers’ reasonable expectation of profit. Specifically, the SEC cited various representations Enigma made to investors in connection with the ICO, about the use of the raised capital to develop its products, and the potential success of such products and its business.

Further, the SEC’s order detailed that Enigma, as part of the offering, sold ENG Tokens both (1) in a “Pre-Sale,” at around a 10% discount, pursuant to purchase agreements (specifically, Simple Agreements for Future Tokens (SAFTs)), which were supposed to only be sold to accredited investors and (2) in a one-day “Crowd Sale” to general public investors. Though Enigma filed a Form D claiming an offering exemption under Rule 506(c) (the “general solicitation” exemption), the SEC did not agree that the offering satisfied this exemption.

Ultimately, the SEC determined Enigma was required, and failed, to register its ICO in accordance with the Securities Act. “All investors are entitled to receive certain information from issuers in connection with a securities offering, whether it involves more traditional assets or novel ones,” stated John T. Dugan, Associate Director for Enforcement in the SEC’s Boston Regional Office. “The remedies in [the SEC’s] order provide ICO investors with an opportunity to obtain compensation and provide investors with the information to which they are entitled as they make investment decisions.”

This is one of the SEC’s latest actions against the once popular ICO, which was used by entities to raise significant amounts of money without complying with U.S. securities laws. As the SEC continues to bring actions against ICOs, we expect to see more fundraising in the distributed ledger world conducted in compliance with the Securities Act, including, for example, through security token offerings (often referred to as STOs).