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CryptocurrencyLegalRoundup–Securi5es,Deriva5ves,Enforcementand
Li5ga5onUpdates
June12,2019InvestmentNetwork’sDigitalAssetsWorkingGroupChicago,IllinoisThispresenta,onisforeduca,onalpurposesonly.Itshouldnotbeconstruedaslegaladviceoropinionorasasubs,tutefortheadviceofcounsel.
©2019StradleyRononStevens&Young,LLP
FirstofitsKindWhitePaperonDigitalAssetsandCrypto-Currencies
DigitalandDigiAzedAssets:
FederalandStateJurisdicAonalIssues
PreparedBy:
AmericanBarAssociaAonDerivaAvesandFuturesLawCommiKee
InnovaAveDigitalProductsandProcessesSubcommiKeeJurisdicAonWorkingGroup
“OurgoalwastoprovidearesourceandanalyAcalframeworkforconsideringthebroadrangeofissuesraisedbythesenewtechnologies.WehopethattheWhitePaperwillprovetobeavaluableresourceforlegalpracAAonersandotherswhoareacAveinthedigitalassetarena,aswellasforpolicymakers.”©2019StradleyRononStevens&Young,LLP 2
ComprehensiveSurveyoftheRegula5onofCrypto-CurrenciesandOtherDigitalAssetsatBoththeFederalandStateLevels 1. DigitalAssetsandBlockchainTechnology2. CommodityExchangeActandCFTCRegulaAon
3. FederalSecuriAesRegulaAon:SecuriAesActandExchangeAct
4. FederalSecuriAesRegulaAon:InvestmentCompanyActandInvestmentAdvisersAct
5. TheNeedforaBeKerCFTCandSECRegulatorySchemeforDigitalAssets
6. FinCENRegulaAon
7. InternaAonalRegulaAonofDigitalAssetsandBlockchainTechnology
8. StateLawConsideraAons
Appendix:50-StateVirtualCurrencyRegulaAonSurvey
©2019StradleyRononStevens&Young,LLP 3
TheHoweyTest-forInvestmentContractsAninvestmentcontractexistswhenthereis:
1. aninvestmentofmoney
2. inacommonenterprise
3. withareasonableexpectaAonofprofits
4. tobederivedfromtheeffortsofothers
©2019StradleyRononStevens&Young,LLP 4
HinmanSpeech(June2018)§ “Security”statusofadigitalassetcanchangeoverAme-adigitalassetmaystartoutasaninvestmentcontractandthentransformintoamediumofexchangetopurchasegoodsorservicesontheplacorm
§ KeytransformaAvedevelopment-decentralizaAon(awayfromcentralizaAon)
§ Etherisnotasecurity(evenifitoncewas)
©2019StradleyRononStevens&Young,LLP 7
November2018JointStatement
(CorpFin;IM;TradingandMarkets)Beyondfraudand1933ActregistraAon-pathtocompliance
withpanoplyofsecuriAeslaws§ AirfoxandParagon-1934ActregistraAon
§ CAM-thetwo1940Acts:
• InvestmentvehiclesthatholddigitalassetsecuriAesandthosewhoadviseothersaboutinvesAngindigitalassetsecuriAes,includingmanagersofinvestmentvehicles,mustbemindfulofregistraAon,regulatoryandfiduciaryobligaAonsundertheICAandIAA.
§ EtherDelta-1934ActregistraAonofexchanges
§ TokenLot-BrokerdealerregistraAon
©2019StradleyRononStevens&Young,LLP 8
FinHubFrameworkfor“InvestmentContract”AnalysisofDigitalAssets(April3,2019)
§ BasedonHoweyTest
• DeterminaAveelementisreasonableexpectaAonofprofitsderivedfromeffortsofothers
§ Collectspriorcases,speeches,andguidanceinoneplace
§ Introducesnewterm–AcAveParAcipants(APs)
• AP=promoter,sponsor,orotherthirdparty(oraffiliatedgroupofthirdparAes)
§ Addscolorand(extensive)detail,withexamples(the“characterisAcs”)
§ ConsideraAonsforre-evaluaAonofstatus
§ Accompaniedbyfirstdigitalassetsno-acAonleKer
©2019StradleyRononStevens&Young,LLP 9
ReasonableExpecta5onofProfits(orotherFinancialReturns)DerivedfromEffortsofOthers
Generalprinciples§ ExpectaAonoffinancialreturnscanbebasedon:• ParAcipaAngindistribuAonsor• Sellingatagaininthesecondmarketor• OthermethodsofrealizingappreciaAonontheasset
§ Thiscomponentismetwhen:• AnAcAveParAcipant(AP)providesessenAalmanagerialeffortsthataffectthesuccessof
theenterpriseand• Investorsreasonablyexpecttoderiveprofitfromthoseefforts
§ ObjecAveinquirythatlooksto:• ThetransacAonitselfandits"economicreality”• The“charactertheinstrumentisgivenincommercebythetermsoftheoffer,theplanof
distribuAon,andtheeconomicinducementsheldouttotheprospect"
• Themannerinwhichthedigitalassetisofferedandsold
©2019StradleyRononStevens&Young,LLP 10
RelianceontheEffortsofOthersTwokeyissues:§ DoesthepurchaserreasonablyexpecttorelyontheeffortsofanAP?
§ Arethoseefforts“theundeniablysignificantones,thoseessenAalmanagerialeffortswhichaffectthefailureorsuccessoftheenterprise,”asopposedtoeffortsthataremoreministerialinnature?
©2019StradleyRononStevens&Young,LLP 11
Characteris5cs-RelianceontheEffortsofOthersStrongpresenceofthefollowingcharacterisAcsindicatesapurchaser’srelianceonthe“effortsofothers:”§ AnAPisresponsibleforthe(ulAmate)funcAonalityofthenetwork:• InparAcularwhereanAPpromisesfurtherdevelopmentaleffortsinorderforthedigital
assettoaKainorgrowinvalue;• EssenAaltasksaretobeperformedbyAPvs.adecentralizednetwork(anunaffiliated,
dispersedcommunityofnetworkusers).
§ AnAPcreatesorsupportsamarketfor,orthepriceof,thedigitalasset,e.g.,anAP:• controlsthecreaAonandissuanceofthedigitalasset;or• takesotheracAonstosupportamarketpriceofthedigitalasset,suchasby
limiAngsupplyorensuringscarcity,through,forexample,buybacks,"burning,"orotheracAviAes.
§ AnAPhasaleadorcentralroleinthedirecAonoftheongoingdevelopmentofthenetworkorthedigitalasset,inparAcular,playsaleadorcentralroleindeciding:• governanceissues;• codeupdates;or
• methodofthirdpartytransacAonvalidaAon.©2019StradleyRononStevens&Young,LLP 12
Characteris5cs-RelianceontheEffortsofOthers§ AnAPhasaconAnuingmanagerialroleinmakingdecisionsaboutorexercisingjudgment
concerningthenetworkorthecharacterisAcsorrightsthedigitalassetrepresentsincluding,forexample:• CompensaAondecisions(forthird-partyserviceprovidersorpersonschargedwithoversightofthenetwork).
• Tradingdecisions(arrangingforasecondarymarketorplacormtoprovideliquidity).
• DeterminingwhowillreceiveaddiAonaldigitalassetsandunderwhatcondiAons.
• Manageriallevelbusinessdecisions,e.g.,useofproceedsfromsalesofthedigitalasset.
• ValidaAonorconfirmaAonmethodology(orotherresponsibilityfortheongoingnetworksecurity).
• Othermanagerialdecisionsthatwilldirectlyorindirectlyimpactthesuccessofthenetworkorthevalueofthedigitalassetgenerally.
§ APeffortstopromoteitsowninterestsandenhancethevalueofthenetworkordigitalassetarereasonablyexpected,forexample:• APhastheabilitytorealizecapitalappreciaAonfromthevalueofthedigitalasset(throughownership
interestinthedigitalasset).
• APdistributesthedigitalassetascompensaAontomanagementortheAP'scompensaAonisAedtothepriceofthedigitalassetinthesecondarymarket.
• TheAPownsorcontrolsownershipofintellectualpropertyrightsofthenetworkordigitalasset.
• APmoneAzesthevalueofthedigitalasset,especiallywherethedigitalassethaslimitedfuncAonality.
©2019StradleyRononStevens&Young,LLP 13
EffortsofOthers-Re-evalua5onFactorsForuseinevaluaAngwhetheradigitalassetpreviouslysoldasasecurityshouldbereevaluatedattheAmeoflateroffersorsales:§ WhetherornottheeffortsofanAP,includinganysuccessorAP,conAnuetobe
importanttothevalueofaninvestmentinthedigitalasset.
§ WhetherthenetworkonwhichthedigitalassetistofuncAonoperatesinsuchamannerthatpurchaserswouldnolongerreasonablyexpectanAPtocarryoutessenAalmanagerialorentrepreneurialefforts.
§ WhethertheeffortsofanAParenolongeraffecAngtheenterprise'ssuccess.
©2019StradleyRononStevens&Young,LLP 14
Characteris5cs-ReasonableExpecta5onofProfitsReasonableexpectaAonofprofitscanbeshownbythefollowing:§ Thedigitalassetgivestheholderrightstoshareintheenterprise'sincomeor
profitsortorealizegainfromcapitalappreciaAonofthedigitalasset;appreciaAoninvaluecancomefrom:• FuncAonality/successofthenetwork
• Secondarytradingmarketorplacormthatenablesdigitalassetholderstoreselltheirdigitalassetsandrealizegains
• DigitalassetholderrightstodividendsordistribuAons
§ ThedigitalassetisofferedbroadlytopotenAalpurchasersascomparedtobeingtargetedtoexpectedusersofthegoodsorservicesorthosewhohaveaneedforthefuncAonalityofthenetwork.• QuanAAesindicateinvestmentintentinsteadofdesiretousethenetwork(toomuchor
tooliKleforreasonablyexpecteduseofnetworkfuncAonality).
©2019StradleyRononStevens&Young,LLP 15
Characteris5cs-ReasonableExpecta5onofProfits§ LackofcorrelaAonbetween:
• Thepurchase/offeringpriceofthedigitalassetandthemarketpriceoftheparAculargoodsorservicesthatcanbeacquiredinexchangeforthedigitalasset;
• QuanAAesthedigitalassettypicallytradesin(ortheamountsthatpurchaserstypicallypurchase)andtheamountoftheunderlyinggoodsorservicesatypicalconsumerwouldpurchaseforuseorconsumpAon;
• Amountoffundsraisedandwhat’sneededtobuildnetworkfuncAonality(toomuchraised).
§ Thedigitalassetismarketed,directlyorindirectly,usinganyofthefollowing:• TheexperAseofanAPoritsabilitytobuildorgrowthevalueofthenetworkordigitalasset;
• IndicaAonsthatpurchasesareinvestments;
• IntenAontouseproceedsfromthesaleofthedigitalassetistodevelopthenetworkordigitalasset;
• Future(butnotpresent)funcAonalityofthenetworkordigitalasset(tobedeliveredbyAP);absenceofcurrentlyavailablegoodsandservicesonanexisAngnetwork;
• Thereadytransferabilityofthedigitalasset;tradingmarketofpromisethereofbyAP;
• ThepotenAalprofitabilityoftheoperaAonsofthenetwork,orthepotenAalappreciaAoninthevalueofthedigitalasset.
©2019StradleyRononStevens&Young,LLP 16
Re-Evalua5onConsidera5ons–Expecta5onofProfits§ PurchasersofthedigitalassetnolongerreasonablyexpectthatconAnueddevelopment
effortsofanAPwillbeakeyfactorfordeterminingthevalueofthedigitalasset.
§ ThevalueofthedigitalassethasshownadirectandstablecorrelaAontothevalueofthegoodorserviceforwhichitmaybeexchangedorredeemed.
§ Thetradingvolumeforthedigitalassetcorrespondstothelevelofdemandforthegoodorserviceforwhichitmaybeexchangedorredeemed.
§ WhetherholdersarethenabletousethedigitalassetforitsintendedfuncAonality,suchastoacquiregoodsandservicesonorthroughthenetworkorplacorm.
§ WhetheranyeconomicbenefitthatmaybederivedfromappreciaAoninthevalueofthedigitalassetisincidentaltoobtainingtherighttouseitforitsintendedfuncAonality.
§ NoAPhasaccesstomaterial,non-publicinformaAonorcouldotherwisebedeemedtoholdmaterialinsideinformaAonaboutthedigitalasset.
©2019StradleyRononStevens&Young,LLP 17
OtherRelevantConsidera5ons–ConsumerUseCharacteris5csDigitalassetswiththefollowingtypesofuseorconsumpAoncharacterisAcsarelesslikelytobeinvestmentcontracts.§ FullydevelopedandoperaAonaldistributedledgernetworkanddigitalasset.
§ ImmediateabilitytousethedigitalassetforitsintendedfuncAonalityonthenetwork(parAcularlywheretherearebuilt-inincenAvestoencouragesuchuse).
§ Digitalassetstructuredandimplementedtomeettheneedsofitsusers,ratherthantofeedspeculaAonastoitsvalueordevelopmentofitsnetwork:
• Forexample,thedigitalassetcanonlybeusedonthenetworkandgenerallycanbeheldortransferredonlyinamountsthatcorrespondtoapurchaser'sexpecteduse.
§ LimitedprospectsofappreciaAoninthevalueofthedigitalasset:
• Forexample,thedesignofthedigitalassetprovidesthatitsvaluewillremainconstantorevendegradeoverAme(noreasonableinvestmentexpectaAon).
§ Forvirtualcurrency,itcanimmediatelybeusedtomakepaymentsinawidevarietyofcontexts,oractsasasubsAtuteforreal(orfiat)currency:
• Canbeusedtopayforgoodsorserviceswithoutfirsthavingtoconvertittoanotherdigitalassetorrealcurrency.
• Operatesasastoreofvaluethatcanbesaved,retrieved,andexchangedforsomethingofvalueatalaterAme.
§ FordigitalassetrepresenAngrightstoagoodorservice,canberedeemedtoacquirethegoodorservicewithinadevelopednetworkorplacormonacurrentbasis.Relevantfactorsmayinclude:
• CorrelaAonbetweenthepurchasepriceofthedigitalassetandamarketpriceoftheparAculargoodorserviceforwhichitmayberedeemedorexchanged.
• AvailabilityinincrementsthatcorrelatewithaconsumpAveintentversusaninvestmentorspeculaAvepurpose.
• Exclusiveuseofdigitalassettoacquirethegoodorservice(showsintenttoconsume).
©2019StradleyRononStevens&Young,LLP 18
OtherRelevantConsidera5ons–ConsumerUseCharacteris5cs(cont.)§ PossibleeconomicbenefitfromappreciaAoninthevalueofthedigitalassetisincidentalto
obtainingtherighttouseitforitsintendedfuncAonality.
§ MarkeAngemphasizesthefuncAonalityofthedigitalasset,andnotthepotenAalfortheincreaseinmarketvalueofthedigitalasset.
§ PotenAalpurchaserscanuse(orhaveused)thedigitalassetforitsintendedfuncAonality.
§ RestricAonsonthetransferabilityofthedigitalassetareconsistentwiththeasset'suseandnotfacilitaAngaspeculaAvemarket.
§ IftheAPfacilitatesthecreaAonofasecondarymarket,transfersofthedigitalassetmayonlybemadebyandamongusersoftheplacorm.
§ Exampleofanonlineretailerwithafully-developedoperaAngbusiness:• Theretailercreatesadigitalassettobeusedbyconsumerstopurchaseproductsonlyontheretailer'snetwork,offers
thedigitalassetforsaleinexchangeforrealcurrency,andthedigitalassetisredeemableforproductscommensuratelypricedinthatrealcurrency.
• TheretailerconAnuestomarketitsproductstoitsexisAngcustomerbase,adverAsesitsdigitalassetpaymentmethodaspartofthoseefforts,andmay“reward”customerswithdigitalassetsbasedonproductpurchases.
• Uponreceiptofthedigitalasset,consumersimmediatelyareabletopurchaseproductsonthenetworkusingthedigitalasset.
• Thedigitalassetsarenottransferable;rather,consumerscanonlyusethemtopurchaseproductsfromtheretailerorsellthembacktotheretaileratadiscounttotheoriginalpurchaseprice.Underthesefacts,thedigitalassetwouldnotbeaninvestmentcontract.
©2019StradleyRononStevens&Young,LLP 19
OtherRelevantConsidera5ons–ConsumerUseCharacteris5cs(cont.)
FuncAonalitydoesnotguarantee“non-securitystatus,”wherefuncAonalityissAllbeingdevelopedorimproved.Relevantfactorsare:
§ Offeringthedigitalasset
• atadiscounttothevalueofthegoodsorservices;or
• inquanAAesthatexceedreasonableuse;and/or
§ LimitedornorestricAonsonresaleofdigitalassets,parAcularlywhereanAPisconAnuinginitseffortstoincreasethevalueofthedigitalassetsorhasfacilitatedasecondarymarket.
©2019StradleyRononStevens&Young,LLP 20
FrameworkConclusion§ Thesearesome(notall)ofthefactorsindicaAngthat:
• Thedigitalassetisasecurity
• Thedigitalassetisnotorisnolongerasecurity
§ NosinglefactorisdeterminaAve
§ WeencouragemarketparAcipantstoseektheadviceofsecuriAescounselandengagewiththestaffthroughwww.sec.gov/finhub.
©2019StradleyRononStevens&Young,LLP 21
TurnkeyNoAc5onLe`er§ Firstdigitalassetno-acAonleKer-relieffrom1933Actand1934ActregistraAon
forTokens§ BasedonthefactspresentedandopinionofcounselthattheTokensarenot
securiAes,TKJoffersandsellstheTokenswithoutregistraAonundertheSecuriAesActandtheExchangeAct.
§ Factshighlightedinstaffresponse:• TKJwillnotuseanyfundsfromTokensalestodeveloptheTKJPlacorm,Network,orApp,andeachof
thesewillbefullydevelopedandoperaAonalattheAmeanyTokensaresold;
• TheTokenswillbeimmediatelyusablefortheirintendedfuncAonality(purchasingaircharterservices)attheAmetheyaresold;
• TKJwillrestricttransfersofTokenstoTKJWalletsonly,andnottowalletsexternaltothePlacorm;
• TKJwillsellTokensatapriceofoneUSDperTokenthroughoutthelifeoftheprogram,andeachTokenwillrepresentaTKJobligaAontosupplyaircharterservicesatavalueofoneUSDperToken;
• IfTKJofferstorepurchaseTokens,itwillonlydosoatadiscounttothefacevalueoftheTokens(oneUSDperToken)thattheholderseekstoreselltoTKJ,unlessacourtwithintheUnitedStatesordersTKJtoliquidatetheTokens;and
• TheTokenismarketedinamannerthatemphasizesthefuncAonalityoftheToken,andnotthepotenAalfortheincreaseinthemarketvalueoftheToken.
©2019StradleyRononStevens&Young,LLP 22
Overview
• RegistraAonrequirementsoftheInvestmentCompanyActof1940(“ICA”or“1940Act”)forfundsholdingdigitalassets
• 1940Actrequirementswhenregisteredfunds(“RICs”)investindigitalassets*
• RegistraAonrequirementsoftheInvestmentAdvisersActof1940(“IAA”or“AdvisersAct”)whenadvisingondigitalassets
• AdvisersActrequirementswhenregisteredadvisers(“RIAs”)adviseondigitalassets**Notdependentonthedigitalassetsbeing“securiAes.”
24©2019StradleyRononStevens&Young,LLP
TheInvestmentCompanyActof1940
§ ComprehensiveregulaAonofregisteredfunds• Mutualfunds,exchange-tradedfunds(“ETFs”),closed-endfunds(listedandunlisted)
§ RequirementsincludeSECregistraAonandreporAng,SECexamsandenforcement,investmentrestricAons,adviserrequirementsandshareholdersuits,governance,shareholderapprovals,affiliatedtransacAons,custody,capitalstructure,valuaAon,compliance
§ Canbeapplicableif:• AnissuerofdigitalassetsthataresecuriAesisaninvestmentcompany;or
• AfundinvestsindigitalassetsthataresecuriAes25©2019StradleyRononStevens&Young,LLP
OrthodoxInvestmentCompanies
§ Anissuerisaninvestmentcompanyif:• EngagedprimarilyinthebusinessofinvesAng,reinvesAng,ortradinginsecuriAes;
• Holdsitselfoutasbeingsoprimarilyengaged;or• Proposestoengageprimarilyinthatbusiness
§ “Engagedprimarily”test—TonopahMiningfactors- Company’shistoricaldevelopment- PublicrepresentaAonsofpolicy- AcAviAesofofficersanddirectors- Natureofpresentassets- Sourcesofpresentincome
26©2019StradleyRononStevens&Young,LLP
InadvertentInvestmentCompanies
§ Anissuerisalsoaninvestmentcompanyif:• EngagedorproposestoengageinthebusinessofinvesAng,reinvestment,owning,holding,ortradinginsecuriAes;and
• OwnsorproposestoacquireinvestmentsecuriAes*withavalueexceeding40%ofthevalueofitstotalassets(excludinggovernmentsecuriAesandcashitems)onanunconsolidatedbasis
*“InvestmentsecuriAes”excludegovernmentsecuriAesandsecuriAesofmajority-ownedsubsidiariesthatarenotfunds
27©2019StradleyRononStevens&Young,LLP
Excep5onstoInvestmentCompanyStatus§ PrimarilyengagedinabusinessorbusinessesotherthaninvesAng,reinvesAng,owning,holding,ortradinginsecuriAes(self-execuAng)
§ SECordertothateffectuponapplicaAon(goodfaithfilingprovidestemporaryexempAon)
§ Transientinvestmentcompanies(one-yearAmelimit)§ Rule3a-1:45%assetandincometestforinadvertentinvestmentcompaniesonly• 45%limitonassets(excludinggovernmentsecuriAesandcashitems)consisAngof,
and45%limitonnetincomeayertaxes(forlastfourfiscalquarters)derivedfrom,securiAesotherthan- GovernmentsecuriAes- SecuriAesofmajority-ownedsubsidiariesthatarenotfunds
- SecuriAesofprimarilycontrolledcompaniesthatarenotinvestmentcompanies
28©2019StradleyRononStevens&Young,LLP
Excep5onstoInvestmentCompanyStatus:PrivateFunds
§ §3(c)(1):AnissuerwhosesecuriAesarebeneficiallyownedbynotmorethan100persons• 250personsforqualifyingventurecapitalfund($10millionlimit)• Look-throughforfundsholding10%ofvoAngsecuriAes
§ §3(c)(7):AnissuerwhosesecuriAesareownedexclusivelybyqualifiedpurchasers*(atAmeofacquisiAon)
*Generally,anaturalpersonwithatleast$5millionininvestments,orotherpersonthatownsandinvestsatleast$25millionininvestments
§ Ineithercase,mustnotbemakingorproposingtomakeapublicoffering
29©2019StradleyRononStevens&Young,LLP
TheDAOReport(July2017)
§ SECdidnotanalyzewhetherTheDAOwasaninvestmentcompany,partlybecauseitnevercommencedbusiness• “ThosewhowouldusevirtualorganizaAonsshouldconsidertheirobligaAonsundertheInvestmentCompanyAct.”
§ WouldTheDAOhavebeenaninvestmentcompany?• IssuerofsecuriAes• EngagedprimarilyinthebusinessofinvesAng
• ?Notdeterminedwhetherinvestmentswouldhavebeenin“securiAes”
30©2019StradleyRononStevens&Young,LLP
CryptoAssetManagement§ OnlyenforcementacAonfinding1940ActviolaAonbyadigitalassetsfund.
ReleaseNos.33-10544,IA-5004,IC-33222(Sept.11,2018)§ FundstructuredasLPandformedforthepurposeofinvesAngindigitalassets;
representedthatitwasSEC-registered§ Orderfoundittobeaninadvertentinvestmentcompany–digitalassetsecuriAes
exceeding40%ofvalueofitsassets• Hadonly44investors,but3(c)(1)apparentlyunavailablebecauseitwasfoundtohavemade
publicoffering
§ FoundtohaveviolatedSecuriAesAct§5(a),(c)(failuretoregisterpublicoffering)and§17(a)(2)(materialmisstatementsinoffering),ICA§7(a)(failuretoregisterasRIC),andIAA§206(4)(failuretoregisterasRIA)andRule206(4)-8(materialmisstatementsw/r/tafund)• Sponsorfined$200,000
• Sponsorhaltedoffering,maderescissionoffering,disclosedmisstatements,andbeganRegulaAonDRule506(c)privateplacement
§ Offeringwasfor$3.6million;fund’svaluewas$37millionat12/31/201731©2019StradleyRononStevens&Young,LLP
SECStaffLe`eronCryptocurrency-relatedHoldings
§ LeKerfromDaliaBlass,DirectorofSECDivisionofInvestmentManagement(1/18/2018),seekingcommentonfundsholdingsubstanAalamountsofcryptocurrencyandrelatedproducts• IncludescryptocurrenciesthatarenotsecuriAesandthatareheldindirectly
• Responsesavailableonline,hKps://www.sec.gov/investment/fund-innovaAon-cryptocurrency-related-holdings
§ UnAlthesequesAonscanbeaddressedsaAsfactorily,staffwillviewunfavorablyregistraAonoffundsinvesAngsubstanAallyincryptocurrencyandrelatedproducts
32©2019StradleyRononStevens&Young,LLP
IssueswithCryptocurrencyHoldings§ ValuaAon• MutualfundsandETFsmustvaluetheirassetsoneachbusinessday
§ Liquidity• MutualfundsandETFsmustmaintainliquiditytosupportredeemabilityand(exceptforIn-KindETFs)mustclassifytheliquidityoftheirinvestments
§ Arbitragemechanism(forETFs)• HowcanETFsensuretheirmarketpricesdonotdeviatemateriallyfromtheirnetassetvalue?
§ PotenAalmanipulaAonandotherrisks• ConcernsthatcryptocurrencymarketshavelessinvestorprotecAon,greateropportuniAesforfraudandmanipulaAon
33©2019StradleyRononStevens&Young,LLP
MoreIssueswithCryptocurrencyHoldings§ Custody• HowwouldafundholdingcryptocurrencydirectlysaAsfytheICAcustody
requirements?- “SecuriAesandsimilarinvestments”generallymustbeincustodyofabankorbroker-dealer
• Howwoulditvalidateexistence,exclusiveownership,andsoywarefuncAonalityofprivatekeysandotherownershiprecords?
• TowhatextentwouldcybersecuritythreatsorpotenAalforhacksimpactsafekeeping?
• Staffnotawareoffundcustodialservicesforcryptocurrencies- SincetheBlassleKer,severalcryptocurrencycustodiansarereported(e.g.,Gemini,Bitgo,
Coinbase,Fidelity)
• Ifafundinvestsincryptocurrency-relatedderivaAvesthatarenotcash-seKled,couldithandlephysicalseKlement?
• SEChasindicateditplansacustodyrulemaking,withproposallikelyinearly2020
34©2019StradleyRononStevens&Young,LLP
StructuralApproaches§ Registeredfunds(mostlyETFs)• AllregistraAonstatementswithdrawninresponsetoBlassleKer
§ Privatefunds• Compliantapproach,subjectto3(c)(1)/3(c)(7)limitsandIAAcompliance
§ Non-1940Actcryptocurrencyfunds• AccesscryptocurrenciesbyinvesAnginbitcoinorbitcoinfutures• Forexchange-tradedproducts(“ETPs),SECsofarhasrefusedtoapprovesecuriAesexchangelisAngs–concernsthatbitcoinmarketsareunregulated.WinklevossBitcoinTrust,ReleaseNo.34-83723(July26,2018)
• Thereisatleastoneover-the-countercryptocurrencyfundthatisregisteredonlyundertheSecuriAesActof1933,BTCSInc.- InvestsindigitalassetsthatarenotsecuriAes(bitcoin,ether)
35©2019StradleyRononStevens&Young,LLP
InvestmentAdvisersActof1940
§ PrimaryfederalstatuteregulaAngpersonswhoprovideinvestmentadvicewithrespecttosecuriAes
§ RequirementsincludeSECregistraAon,SECexamandenforcementauthority,supervision,clientdisclosures,advisoryagreementprovisions,adverAsingregulaAon,complianceprogram
§ TheDAOReport:BecauseTheDAOnevercommencedoperaAon,didnotanalyzeadviserstatus• “ThosewhowouldusevirtualorganizaAonsshouldconsidertheirobligaAonsundertheAdvisersAct.”
§ CryptoAssetManagementorderincludedIAAviolaAons
36©2019StradleyRononStevens&Young,LLP
InvestmentAdviserDefini5on
§ Ingeneral,aninvestmentadviserisapersonwho:• Providesadvice,orissuesreportsoranalyses,regardingsecuriAes;
• Isinthebusinessofprovidingsuchservices;and• ProvidessuchservicesforcompensaAon
§ “Security”hasthesamemeaningundertheAdvisersActasunderthe1940Act
§ AdviceaboutinterestsinenAAesthatownnon-securiAeswouldgenerallybeadviceaboutsecuriAes
37©2019StradleyRononStevens&Young,LLP
FederalorStateRegistra5on
§ FederalregistraAongenerallyrequiredif:• AdvisertoaRIC;or• Atleast$100millioninassetsundermanagement(opAonalfor$100-$110millionlevel)- AnaccountisasecuriAesporcolio(andcountsasassetsundermanagement)ifatleast50%oftotalvalueconsistsofsecuriAes(includingcashandcashequivalents)
§ StateregistraAonrequirementsvarybystate• NoregistraAonatstatelevelifSEC-registered• RegistraAonmayberequiredinmulAplestates
38©2019StradleyRononStevens&Young,LLP
InvestmentAdviserRepresenta5ves
§ MoststatesimposearegistraAonandtesAngrequirementoninvestmentadviserrepresentaAves(“IARs”),if:• TheIARprovidesinvestmentadviceonbehalfoftheadviser;• TheIARhasmorethanfiveclientswhoarenaturalpersons,whoaremorethan10%oftheIAR’sclients(exceptforqualifiedclients*);and
• TheIARhasaplaceofbusinesswithinthestate*Aqualifiedclientgenerallyhasatleast$1millionundertheadviser’smanagementoranetworthofmorethan$2.1million(includingprimaryresidence)
39©2019StradleyRononStevens&Young,LLP
SelectedAdvisersActRequirements
§ FiduciaryobligaAonsandconflictsofinterestdisclosures–notlimitedtosecuriAes
§ Codeofethics:AccesspersonsmustreportpersonalsecuriAestransacAonsandholdingstotheRIA• CompliancechallengesfordigitalassetsecuriAes–currentlyanissueforallRIAs
40©2019StradleyRononStevens&Young,LLP
IAACustodyRule§ Rule206(4)-2requires“funds”and“securiAes”tobemaintainedbyaqualifiedcustodian*
*Generally,abank,broker-dealer,orfuturescommissionmerchant• ThisincludesaprivatefundthattheRIAcontrols(butnotaRIC)• FundsandsecuriAesmustbeverifiedbyactualexaminaAonbyanindependentpublicaccountant
§ StaffleKer(3/12/2019)raisesquesAonsondigitalassetsandcustodyrule• WhensecuriAesdonottradeonadelivery-versus-paymentbasis,doesabilitytotradegiverisetocustody?UnderconsideraAon
• InvitaAonforcommentsoncustodyofdigitalassets;nocommentsyetposted
41©2019StradleyRononStevens&Young,LLP
AreDigitalAssetsCommodi5es?
§ Yes,CFTCini5allyassertedthisposiAoninadministra5veproceedings
• DidnotprovideitsraAonale
§ Incivilac5ons,defendantschallengedthisasserAon• CFTCrequiredtosupplysomera5onale
§ CourtssidedwithCFTC,butsplitonra5onale
43©2019StradleyRononStevens&Young,LLP
WhatisaCommodity?
§ Twocategoriesofcommodi5es• Anenumeratedlistofagriculturalcommodi5es;and
• Allothergoodsandar5cles,…andallservices,rights,interestsinwhichcontractsforfuturedeliveryarepresentlyorinthefuturedealtin
44©2019StradleyRononStevens&Young,LLP
Legisla5veHistoryBehindDefini5on
§ SecondcategoryofdefiniAonaddedin1974§ IntendedtograntnewlycreatedCFTCauthorityovertransac5onsrela5ngtofuturesmarkets
§ ExpandedCFTC’sjurisdic5onwithoutcongressionalac5on(notaddingcommodiAesinpiecemeal)
• ExpandeddefiniAoninvitesques5onsastoCFTC’sjurisdic5on• Especiallyfornovelproducts
45©2019StradleyRononStevens&Young,LLP
AreDigitalAssetsaCommodity?§ Listofitems,“andallothergoodsandar5cles,…andallservices,rights,andinterests…inwhichcontractsforfuturedeliveryarepresentlyorinthefuturedealtin.”
• Aretheygoodsandar5cles?• Aretheyservices,rightsandinterests?• Dotheyalsoneedafuturescontract?• Isitenoughtohaveafuturescontractonanotheritemthatbelongstothesamecategoryofcommodity?
- MyBigCoin–similartoValencia–naturalgasissimilartowestcoastnaturalgas
46©2019StradleyRononStevens&Young,LLP
WhatisaDeriva5ve?
§ Deriva5veiscontractwherevaluederivesfromvalueofunderlyinginterest
• E.g.commodity,interestrate,occurrenceofanevent,orsecurity
48©2019StradleyRononStevens&Young,LLP
PiecemealRegula5onofDeriva5ves
§ CEAregulatesmanytypesofderiva5ves§ CEAalsoregulatescertainretailtransac5onsthatarenotnecessarilyderiva5ves
§ CEAimposesrequirementstodifferentclassifica5onsoftransac5ons
§ CEAfurtherdis5nguishesbasedonunderlyinginterest
49©2019StradleyRononStevens&Young,LLP
WhataretheDifferentClassifica5onsofDeriva5ves?
1) FuturesContracts— Contractsforsaleofcommodi5esforfuturedelivery
— Excludes:Commercialmerchandisingcontractsfordeferreddeliveryofacommodity
2) Op5onsonFutures• Exercisablerighttobuyorsellafuturescontract
3) Op5ononCommodi5es—Exercisablerighttobuyorsellacommodity
50©2019StradleyRononStevens&Young,LLP
Classifica5onsofDeriva5ves(cont.)
4) Swap—Contractsdependonvalueofsomethingelse—Certainexclusions
5) RetailOTCforeigncurrencyin“Financed”6) RetailCommodityTransac5ons- transacAonsincommodi5es- thatarenotforeigncurrenciesorsecuri5es- withretailcustomers- enteredintoorofferedonamargined,leveragedor
financed(hereinayer“Financed”)basis
51©2019StradleyRononStevens&Young,LLP
FuturesandOp5onsRegula5on
§ Mustbetradedonorsubjecttorulesoffuturesexchange(i.e.,aDCM)
§ Mustbecentrallyclearedbyaderiva5vesclearinghouse(i.e.,aDCO)
§ FCM,IB,CTAorCPOregistra5on
52©2019StradleyRononStevens&Young,LLP
CommodityOp5onsRegula5on
§ CFTChasbroadauthoritytoadoptrulesoncommodityop5ons
§ Noauthorityoverop5onsonsecurity(orgroupofindexsecuri5es)
§ Generallyregulatedasswaps§ Excep5on:Op5onsonexemptcommodi5es• TradeOp5onExemp5on
53©2019StradleyRononStevens&Young,LLP
SwapsRegula5on
§ Noexchange-tradingrequirement
§ Onlysomeswapsrequiremandatoryclearing§ Alltradeinforeportedtoswapdatarepository(SDR)§ FCM,IB,CTA,CPO,SDorMSPregistra5on
54©2019StradleyRononStevens&Young,LLP
WhatareRetailCommodityTransac5ons?
§ Transac5onsincommodi5es• Otherthan:foreigncurrenciesorsecuri5es
§ Enteredbyretailcustomers
§ OnFinancedbasis§ CFTChasimplieddigitalassetslikelyfallunderthiscategory
55©2019StradleyRononStevens&Young,LLP
RetailCommodityTransac5onsRegula5on
§ Regulatedasor“asif”theyarefutures§ Mustbeexchangetradedandcleared§ FCM,IB,CTAorCPOregistra5onrequired§ Bilinex–Operatedunregisteredonlineplalormindigitalassets–failedtoregisterasFCM
56©2019StradleyRononStevens&Young,LLP
2Exemp5onstoRetailCommodityTransac5ons
§ ActualDeliveryExempAon§ EnforceableDeliveryObligaAonExempAon- Importanceofeitherexemp5on:- AllowsOTCtradingand- Noregistra5on
57©2019StradleyRononStevens&Young,LLP
ActualDeliveryExemp5on
§ Contractforsaleofcommodity§ Thatresultsin“actualdelivery”within28days§ Requirements:• Buyermusthaveabilitytotakepossessionandcontrolofen5reamountanduseitfreelywith28days;AND
• Sellercannotretainanyinterestorcontrolayer28days
58©2019StradleyRononStevens&Young,LLP
Whyis“ActualDelivery”DebatedinDigitalAssets?
§ Bi>inexCase• Bitcoinpurchasedwithborrowedfundsbyretailinvestors• Deliveredtoaprivatewallet• Coinswereheldforbenefitofbuyer• Coinsalsoheldascollateralforloan• Buyerdidnothaverighttoaccessorusebitcoinun5lsa5sfac5onofloan
§ Courtheldnoactualdelivery
59©2019StradleyRononStevens&Young,LLP
HowMightMonexShakeThingsUp?§ Insimilarcaseinvolvingpreciousmetals(whichCFTCrelatestodigitalassets)
§ CFTCargued:ActualdeliveryrequiresafulltransferofpossessionandcontrolovercommodiAes
§ Monexcourtdisagreed;foundthat:• Thisisacommonprac5ce• CFTC’sviewwouldeliminatetheActualDeliveryExemp5on• Customerscouldgetphysicalpossessionifmadefullpayment• CFTCappealedto9thCircuit
60©2019StradleyRononStevens&Young,LLP
WhatDidMonexSayAboutFraud?
§ CFTCcanonlyassertjurisdic5onwhenitshowsbothfraudANDmanipula5on
§ ConflictswithMcDonnell,andothercourts,whereeitherissufficient
§ Monexcurrentlyonappeal
61©2019StradleyRononStevens&Young,LLP
ExclusionsfromCFTCRegula5on
1. SpotContracts
2. CommercialForwardContracts
63©2019StradleyRononStevens&Young,LLP
SpotTransac5ons
§ CFTCnotauthorizedtoadoptrulesregulaAngtradinginspotmarkets
§ Authoritytomonitorandrequirecertainrepor5ng§ Authorityoverfraudandmanipula5onofanycommodity
64©2019StradleyRononStevens&Young,LLP
WhatisaSpotContract?
§ Spotcontract:• commercialcontract• forsaleofcommodity• fordeliverywithin2days(orothershortindustryAmeframe)
• commodityistypicallydelivered
65©2019StradleyRononStevens&Young,LLP
SpotContractRegula5on
§ Generallyoutsideregula5onofCEA
§ Mostcryptofirms§ CFTCsAllhasjurisdic5onover:• Exceptforfraudandmanipula5on• ExceptforpotenAalapplicaAonofretailcommodityprovisions(i.e.,iffinanced)
66©2019StradleyRononStevens&Young,LLP
WhatClassifica5onsofCommodi5esareThere?
§ ForeignCurrency• CFTChasexplicitlyclaimedthatdigitalassetsarenotforex
§ Agriculturalv.Excludedv.Exempt• CFTChasimplicitlyclaimedthatdigitalassetsareexemptcommodi5es
§ Securi5esCommodityv.Non-Securi5esCommodity• CFTCseemstoassumedigitalassetsarenon-securi5es
68©2019StradleyRononStevens&Young,LLP
WhatisanExcludedCommodity?
§ “Financial”commodiAes
§ Relatetoratesorconsequencesoffinancialnature
§ Examples:interestrates,exchangerates,securityindexes,etc.
§ Usuallythoughttobeoutsidecontrolofpar5es
69©2019StradleyRononStevens&Young,LLP
WhatisanExemptCommodity?
§ Catch-allcategory
§ Notagriculturalorexcludedcommodity
§ Examples:metals,energycontracts
§ DigitalassetsgenerallythoughtbyCFTCtobeexemptcommodi5es
70©2019StradleyRononStevens&Young,LLP
BenefitsifExemptCommodity
§ Forwardcontractexclusionfrom“swap”definiAonislimitedtoexemptcommodiAes
§ Tradeop5onexemp5onfrom“swap”definiAonislimitedtoexemptandagriculturalcommodiAes
§ Exclusionfrom“futures”definiAongenerallynotavailableforexcludedcommodi5es
71©2019StradleyRononStevens&Young,LLP
Securityv.Non-SecurityCommodi5es
§ SecurityCommodity• commoditybasedonasecurity
§ Non-SecurityCommodity• commoditynotbasedonsecurity
§ CFTCseemstoassumethatdigitalassetsarenon-securitycommodi5es
§ SEClikelytodisagree
73©2019StradleyRononStevens&Young,LLP
ImportanceofDis5nc5on§ CFTCjurisdic5onoverfraudandmanipula5oncommodi5es§ CFTConlyhasfullregulatoryauthorityoverderiva5vesonnon-securitycommodi5es
§ Alloca5onofSECandCFTCjurisdic5onwhen:• Securitycommodity• Non-securitycommodityembeddedinasecurity
• Deriva5vehasbothsecuri5esandnon-securitycommodi5esasunderlyingreferencecomponents
74©2019StradleyRononStevens&Young,LLP
Jurisdic5onalChallenges&Gaps
§ Novelcharacteris5cscreateunprecedentedchallenges
§ Temporaltransforma5ons
§ GapsinregulaAonofspotmarkets§ RepeatedBitcoinETFrejec5onsduetoconcernsofunregulatedspotmarket
75©2019StradleyRononStevens&Young,LLP
UnansweredQues5ons§ Whatkindofcommodityisit?• Security• Foreigncurrency• Agricultural• Exempt(physical/non-financialbutnotagricultural)• Excluded(financial)
§ AddressingpotenAalforregulatoryoverlap• DualregulaAon• InconsistentregulaAon• FricAonbetweenregulators• Marketuncertainty• AllocaAonofjurisdicAon(CongressionalacAon)
©2019StradleyRononStevens&Young,LLP 76
NFA–CryptoDisclosures
§ EffecAveOctober31,2018:• AllNFAmembersthatengageindigitalassetsrequiredtoprovidecertaincrypto-relateddisclosures
• TailoredandprescribeddisclosuresdependingonnatureofcryptotransacAons
©2019StradleyRononStevens&Young,LLP 7777
June2018
§ TheDAOReportofInvesAgaAon• HoweytestappliestodeterminewhethertokensaresecuriAes
• SecuriAesmustberegisteredabsentavalidexempAonfromregistraAon
§ TheCyberUnit§ CriminalandCivilFraudSchemes§ UnregisteredSecuriAesOfferings
79©2019StradleyRononStevens&Young,LLP
HowweHowey
§ May9,2019speechbyCommissionerHesterM.Peirce• “IalsoexpressedmyconcernthattheSECwouldleadwithitsenforcementpowers,thusallowinganxietyabouttherisksofnewtechnologytoovershadowtheopportuniAesitpresents.IworriedthathastyregulaAonwouldsmothertheindustryinitsinfancy.Myconcernsdidnotbecomereality.TheenforcementacAonswehavetakentodateinthecryptospacehave-forthemostpart-exhibitedappropriaterestraint.”
§ Appropriaterestraint?
80©2019StradleyRononStevens&Young,LLP
TokenLot(Sept.2018)§ CyberUnitobtainedaseKlementwithaself-described“ICOSuperstore”andits
ownersforacAngasanunregisteredbroker-dealer§ Firstcasecharginganunregisteredbroker-dealerforsellingdigitaltokens§ TokenLotpromoteditswebsiteasawaytopurchasedigitaltokensduringICOs
andtoengageinsecondarytrading§ TokenLotprofitedfromfacilitaAngtradesandreceivedapercentageoffunds
raisedduringtheofferings§ ConductviolatedSecAon15(a)oftheExchangeActandSecAons5(a)and(c)ofthe
SecuriAesAct§ Agreedtoretainaqualifiedindependentintermediarytotakepossessionofthe
digitaltokensanddestroythem§ Jointdisgorgementandprejudgmentinterestof$478,929anda$45,000civil
penaltyandthree-yearindustrybarforeachofthetwoowners
©2019StradleyRononStevens&Young,LLP 8181
TokenLot(Sept.2018)(cont.)§ EnforcementDivisionCo-DirectorAvakian:“U.S.securiAeslawsprotectinvestors
bysubjecAngbroker-dealersandothergatekeeperstoSECoversight,includingthoseofferingICOsandsecondarytradingindigitaltokens[.]WeconAnuetoencouragethosedevelopingdigitalassettradingbusinessestocontacttheSECstaffatFinTech@sec.govforassistanceinanalyzingregistraAonandothersecuriAeslawrequirements.”
§ EnforcementDivisionCo-DirectorPeikin:“ThepenalAesinthiscasereflectthepromptcooperaAonandremedialacAonsbyTokenLot,Kugel,andLewiK[.]TokenLot,Kugel,andLewiKprovidedvaluableinformaAontoCommissionstaff,stoppedtheconduct,andrefundedmoneytoinvestors.”
©2019StradleyRononStevens&Young,LLP 8282
CryptoAssetManagement(Sept.2018)§ AssetManagementUnitseKledfirstenforcementacAonforaninvestmentcompany
violaAonbyahedgefundanditsfounderbasedonitsinvestmentsindigitalassets§ CAMofferedafundthatoperatedasanunregisteredinvestmentcompanywhilefalsely
markeAngitasbeingregulatedbytheSECandthatithadfiledaregistraAonstatement§ Fundinvestedmorethan40percentofthefund’sassetsinthebusinessofinvesAng,
holdingandtradingcertaindigitalassetsthatwereinvestmentsecuriAesandsometthedefiniAonofaninvestmentcompany
§ CAMviolatedSecAons5(a)and5(c)oftheSecuriAesActandcausedtheFund’sviolaAonofSecAon7(a)oftheInvestmentCompanyAct
§ BothCAManditsfounderviolatedSecAon17(a)(2)oftheSecuriAesActandSecAon206(4)(andRule206(4)-8thereunder)oftheAdvisersAct
§ Ayerbeingcontacted,CAMceaseditspublicofferingandofferedbuybackstoinvestors–beganofferingsecuriAesinJanuary2018pursuanttoRegDRule506(c)exempAon
§ $200,000jointcivilpenalty
©2019StradleyRononStevens&Young,LLP 8383
EtherDelta(Nov.2018)§ AcAonbyCyberUnitandNewYorkRegionalOfficeagainstthefounderofanonlineplacormforsecondarymarkettradingofERC20tokens,atypeofblockchain-basedtokencommonlyissuedinICOs
§ PlacormoperatedasanunregisterednaAonalsecuriAesexchangebyprovidingforthetradingoftokensthataresecuriAesunderthefederalsecuriAeslaws
§ PlacormusedasmartcontractrunontheEthereumblockchaintofacilitatethetrades
§ AlmostallofthetradingacAvityontheplacormoccurredayertheissuanceoftheDAOreport
§ ViolatedSecAon5oftheExchangeAct§ Founderagreedtopay$313,000indisgorgementandprejudgmentinterestanda$75,000civilpenalty(duetohiscooperaAonwiththeinvesAgaAonandagreementtotesAfyinanyrelatedenforcementacAon)
©2019StradleyRononStevens&Young,LLP 8484
EtherDelta(Nov.2018)(cont.)§ EnforcementDivisionCo-DirectorAvakian:“EtherDeltahadboththeuserinterfaceandunderlyingfuncAonalityofanonlinenaAonalsecuriAesexchangeandwasrequiredtoregisterwiththeSECorqualifyforanexempAon.”
§ EnforcementDivisionCo-DirectorPeikin:“WearewitnessingaAmeofsignificantinnovaAoninthesecuriAesmarketswiththeuseandapplicaAonofdistributedledgertechnology[.]Buttoprotectinvestors,thisinnovaAonnecessitatestheSEC’sthoughculoversightofdigitalmarketsandenforcementofexisAnglaws.”
©2019StradleyRononStevens&Young,LLP 8585
Blockvest(Nov.2018)§ AcAonbyMarketAbuseandCyberUnittoaKempttohaltaplannedICOthatsold
tokensthroughawebsiteandrepresentedthattheofferinghadbeenapprovedbytheSEC
§ SECiniAallysoughtandreceivedatemporaryrestrainingorderfreezingdefendants’assetsandgranAngotheremergencyrelief
§ Ayerreceivingthetemporaryrestrainingorder,theSECsoughtapreliminaryinjuncAon
§ DefendantresistedthepreliminaryinjuncAononthegroundsthatthetokenswereonlyusedtotestanonlineplacorm
§ InNovember2018,thedistrictcourtdeniedtheSEC’smoAonforapreliminaryinjuncAon,noAngthatissuesoffactexistedastowhetherthetokensweresecuriAesunderHoweyandwhetherthetestinvestorshadanexpectaAonofprofitsorweresimplyassisAngwithtesAngtheplacorm
§ SECwonitsmoAonrequesAngreconsideraAoninFebruary2019andthedistrictcourtgrantedtherequestedpreliminaryinjuncAon
©2019StradleyRononStevens&Young,LLP 8686
MayweatherandKhaled(Nov.2018)§ NewYorkRegionalOfficeandtheCyberUnitseKledchargeswithprofessionalboxerandmusicproducerforfailingtodisclosepaymentstheyreceivedforpromoAnginvestmentsinICOs
§ FirstcasestochargetouAngviolaAonsinvolvingICOs§ ViolatedSecAon17(b)oftheSecuriAesAct§ $314,775indisgorgementandprejudgmentinterestanda$300,000civilpenaltyfortheboxerand$52,725indisgorgementandprejudgmentinterestanda$100,000civilpenaltyforthemusicproducer
§ BothcelebriAesalsoagreedtonotpromoteanysecuriAes,digitalorotherwise,fortwo(producer)tothree(boxer)years
©2019StradleyRononStevens&Young,LLP 8787
MayweatherandKhaled(Nov.2018)(cont.)§ EnforcementDivisionCo-DirectorAvakian:“Thesecaseshighlighttheimportanceoffulldisclosuretoinvestors[.]Withnodisclosureaboutthepayments,MayweatherandKhaled'sICOpromoAonsmayhaveappearedtobeunbiased,ratherthanpaidendorsements.”
§ EnforcementDivisionCo-DirectorPeikin:“InvestorsshouldbeskepAcalofinvestmentadvicepostedtosocialmediaplacorms,andshouldnotmakedecisionsbasedoncelebrityendorsements[.]Socialmediainfluencersareoyenpaidpromoters,notinvestmentprofessionals,andthesecuriAesthey’retouAng,regardlessofwhethertheyareissuedusingtradiAonalcerAficatesorontheblockchain,couldbefrauds.”
©2019StradleyRononStevens&Young,LLP 8888
Kik(Dec.2018)§ SECissuedaWellsNoAcetoKikinNovember2018indicaAngthatitwouldrecommendtheCommissionfileanacAonforviolaAonsofSecAons5(a)and5(c)oftheSecuriAesAct
§ KiksubmiKedapubliclyavailableresponseinDecemberandmadethefollowingarguments:• Asacurrency(resemblingBitcoinandEther),KikisexemptfromthedefiniAonofa
“security”underthefederalsecuriAeslaws• ThetokenssoldbyKikdonotconsAtuteinvestmentcontracts- ThereisnocommonenterprisebetweenKikand/ortheKinFoundaAonand
purchasersoftheKintokens- Kinpurchaserswerenotledtoexpectprofitsfromtheeffortsofothers
§ OnJune4,2019,theSECsuedKikforconducAnganillegal$100millionsecuriAesofferingofdigitaltokensinviolaAonofSecAons5(a)and5(c)oftheSecuriAesActof1933
©2019StradleyRononStevens&Young,LLP 8989
GladiusNetworkLLC(Feb.2019)§ CyberUnitseKledchargeswithacompanyforconducAnganunregisteredICO
§ Tokensintendedtoserveasadecentralized,peer-to-peernetworkthatwouldusedistributedledgertechnologytofightagainstcyberaKacksbyallowingownerstoaccesssparebandwidthandstorage
§ Companyself-reporteditsconducttotheSEC,undertooktoreturnfundstoinvestorswhopurchasedtokensintheICOandtoregisteritstokensassecuriAespursuanttotheSecuriAesExchangeActof1934
§ CommissionmadethedeterminaAonnottoimposeacivilpenaltyduetotheseremedialactsandtheextensivecooperaAonwithitsinvesAgaAon
§ ChiefCohen:“Today’scaseshowsthebenefitofself-reporAngandtakingproacAvestepstoremediateunregisteredofferings.”
©2019StradleyRononStevens&Young,LLP 9090
NextBlockGlobalLtd.(May2019)§ AssetManagementUnitandOntarioSecuriAesCommission(OSC)seKledchargeswithacompanyanditsco-founderandformerCEOformakingmisrepresentaAonsinconnecAonwithasecuriAesofferingin2017
§ NextBlockandco-founderfalselyrepresentedtoinvestorsthatasmanyasfourprominentindividualsintheblockchainindustrywereservingasadvisorstoNextBlock
§ FollowingdisclosureofthemisrepresentaAon,NextBlockiniAatedcourtproceedingsinOntariotowindupthecompanyandreturntheofferingproceedstoinvestors
§ $25,000civilpenaltyforco-founderandacease-and-desistorderforNextBlockandco-founder
§ NextBlockagreedtopaytheOSCaCAD$700,000administraAvepenaltyandCAD$100,000toreimbursethecostoftheinvesAgaAonwhileco-founderagreedtopayaCAD$300,000administraAvepenalty
©2019StradleyRononStevens&Young,LLP 9191
ArgyleCoinLLC(May2019)§ AcAonbyMiamiRegionalOfficeagainstacompanyanditsprincipalforrunningaPonzischeme
§ Investorsluredtoinvestincryptocurrencythroughfalseclaimthatinvestmentrisk-freebecauseitwasbackedbydiamonds
§ Instead,investorfundsmisappropriatedtopayotherinvestorsandforpersonalexpenses
§ ChargedviolaAonsofSecAons5(a),5(c),17(a)(1),and17(a)(3)oftheSecuriAesActof1933andSecAon10(b)oftheSecuriAesExchangeActof1934andRules10b-5(a)and(c)thereunder
©2019StradleyRononStevens&Young,LLP 9292
DanielPacheco(May2019)§ AcAonbyLosAngelesRegionalOfficeagainstindividualandtwocompanieshe
controlledforconducAngafraudulent,unregisteredofferingofsecuriAes§ InvestorsreceivedinstrucAonalpackagesand“points”thatcouldbeconvertedintoa
cryptocurrencyandcouldreceivecashcommissionsandaddiAonalpointsbyrecruiAngnewinvestors
§ Cryptocurrency,infact,afraudulentpyramidscheme§ PachecoalsoconvertedinvestorfundstopurchaseahomeandaRollsRoyce§ MicheleWeinLayne,DirectoroftheSEC’sLosAngelesRegionalOffice:“Weallegethat
Pachecohidanoldfraudundertheguiseofcu�ng-edgetechnology.HeenAcedinvestorsbyofferingthemtheopportunitytospeculateincryptocurrency,wheninfacthewassimplyoperaAngapyramidscheme.”
§ ChargedviolaAonsofSecAons5(a),5(c),17(a)(1),17(a)(2)and17(a)(3)oftheSecuriAesActof1933andSecAon10(b)oftheSecuriAesExchangeActof1934andRules10b-5(a),(b),and(c)thereunder
©2019StradleyRononStevens&Young,LLP 9393
FINRAAlerts
§ FINRA–InvestorAlertsoncryptoandblockchain• CryptocurrencyTradingPlacorms:DoYourHomework• Don’tFallforCryptocurrency-RelatedStockScams• Bitcoin:MoreThanaBitRisky• Ge�ngaHandleonVirtualCurrencies• Here’sHowtoAvoidCryptoStockScams• BitcoinBasics–9ThingsYouShouldKnowAbouttheVirtualCurrency
• Podcast:DemysAfyingCryptocurrency
95©2019StradleyRononStevens&Young,LLP
TimAyre–HempCoins–FINRA§ FirstFINRAdisciplinaryac5onrelaAngto
cryptobusiness§ TimAyre–RegisteredRepresentaAve–B/DAyreInvestments–Rocky
MountainAyre
§ CreatedaSecuritywhen:• PurchasedrightstoHempCoinfromTHCFarmaceu5cals;and• BackedcryptowithsharesofRMTN- ataraAoof1RMTNto10HempCoins
§ Outcome:• Engagedinofferandsaleofunregisteredsecuri5esinviola5onof1933Act,Sec5on5• VariousfraudulentstatementsviolatedSEA1934,Rule10b-5andFINRARules2020and2010• EngagedinPrivateSecuriAesTransacAonsWithoutNoAcetoFirm–FINRARules3280and2010• BarredfromIndustry
©2019StradleyRononStevens&Young,LLP 9696
NASAA:Opera5onCryptosweep § TheNASAAlaunchedataskforcein2018toinvesAgateICOsandcryptocurrency-
relatedinvestmentproducts.OperaAonCryptosweephasresultedinnearly50enforcementacAonsincluding:• AdosiaLLC–engagedinanunregisteredsecuriAesofferinginviolaAonoftheNorthCarolina
SecuriAesAct.ThetechnologycompanyundertookanICOtopromoteitsblockchain-enabledplacormwithoutregisteringwiththestate.AdosiaanditsexecuAveagreedtoaconsentorderwhichpermanentlybarsbothfromfurtherviolaAngtheAct.
• BCHoldingsandInvestmentsLLC–madefalseandmisleadingstatementsinconnecAonwiththeofferandsaleofinvestmentsincryptocurrencymining.TheinvestmentprogramwasasecurityandunregisteredinviolaAonoftheTexasSecuriAesAct.TheSecretaryofStateissuedaceaseanddesistorderwhichresultsinacriminaloffenseifviolated.
• ForexEA&BitcoinInvestmentLLCetal.–madefraudulentrepresentaAonsguaranteeinginvestorreturnsinconnecAonwithacryptocurrencytradingprogram.TheinvestmentcontractswereunregisteredsecuriAesandnorespondentwasabroker/dealer.InvestorfundswereusedforpersonaluseTheGeorgiaSecuriAesCommissionerissuedanemergencyceaseanddesistorderbarringthecompanyfromviolaAngthestate’sUniformSecuriAesAct.
98©2019StradleyRononStevens&Young,LLP
Takatav.RiotBlockchainInc.,f/k/aBiop5x,et.al
§ ClassacAonsuitallegesRiotBlockchainInc.,formerlyknownasBiopAx,Inc.,engagedinapumpanddumpschemetoinflatethecompany’sstockayeritswitchedfocusfrombiopharmaceuAcaltocryptocurrencytechnology• CompanyexecuAvesallegedlymadefalseandmisleadingstatementsaboutthe
company’sbusiness,operaAonsandprospectsinordertoincreasethestockpriceandlureinvestors.
§ TheclassacAonissAllpending.RiotBlockchainInc.filedamoAontodismissinMarch2019arguingthatcorporatemismanagementdoesnotconsAtutefederalsecuriAesfraud.Todate,thecourthasnotruledonthismoAon.
§ TheSECalsofiledacivilacAonagainstthecompany’sCEO,alongwithitslargestinvestorandotherexecuAves,allegingfraudulentmanipulaAonofstockpricesofcompaniesotherthanRiotBlockchain.
100©2019StradleyRononStevens&Young,LLP
Symphonyv.Thompson§ SymphonyFSLimited,acompanythattradesindigitalassetsandcryptocurrenciesfiledanacAonagainstescrowagentJ.BarryThompsonforbreachofcontractayeranescrowdealfellthrough.ThompsonoperatedVolanAsEscrowPlacormLLC,anescrowbusinessrelatedtocryptocurrencytransacAons.• SymphonynegoAatedwithVolanAsforthepurchaseofbitcoin.Ayerwiring
morethan$4milliontotheVolanAsescrowaccount,Symphonyneverreceivedthebitcoinsorarefund.Thompsonallegedlypurchased500bitcoinsforSymphonybutnevertransferredthemtothecompany.Thompsonclaimedthefundswerestolenbyathird-partyintermediaryheusedforthetransacAon.
§ SymphonybroughtanarbitraAonclaimagainstVolanAsandfiledinfederalcourtagainstThompson.
101©2019StradleyRononStevens&Young,LLP
UnitedAmericanInc.v.BitmainInc.etal.
§ PlainAfffiledanacAonagainstBitmain,abitcoinminer,alleginganAtrustviolaAonsandnegligentmisrepresentaAoninaddiAontootherclaims.• BitmainInc.alongwithotherdefendantsallegedlyengagedinaschemeto
manipulatethecryptocurrencymarketforBitcoinCashtothedetrimentofinvestors.UnitedAmericanInc.alsoallegedthatthedefendantsconspiredtohijackacryptocurrencysoywareupgraderesulAnginaglobalcapitalizaAonmeltdownofmorethan$4billion.
§ PlainAffisseekingresAtuAon,disgorgementandtrebledamages.
§ InFebruary2019,threedefendantsfiledamoAontodismissdenyingtheallegedconspiracyandarguingthattheallegedmeltdownwassimplyamarketcorrecAon.ThecaseissAllpending
102©2019StradleyRononStevens&Young,LLP
LongfinCorp.etal§ ShareholdersfiledaclassacAonagainstLongfin,atechnologytradingcompany,
forallegedlymakingfalseandmisleadingstatementsinviolaAonoffederalsecuriAeslaws.• LongfinanditsexecuAvesallegedlymadefalsestatementsaboutthebusiness,
operaAonsandprospects.ThecompanyalsoallegedlyfailedtodisclosethatitwasineligibletobelistedontheRussell2000and3000indices.InvestorslostmillionsayerthecompanywasbootedfromtheRussellindex.
• ThecaseissAllpending§ TheSECalsofiledanacAonagainstLongfinanditsexecuAvesforallegedlyselling
unregisteredsecuriAes• Thecompany’sstockpricesskyrocketedayeritacquiredacryptocurrency
business.ItallegedlysoldrestrictedsharesofitsstocktocompanyaffiliatesinviolaAonoffederalsecuriAeslaws.
• ApreliminaryinjuncAonwasgrantedtofreezethecompany’sassetsunAltrial.OnJune10,2019,threeexecuAvesreachedaseKlementarrangementwiththeSECagreeingtopayroughly$26million.
103©2019StradleyRononStevens&Young,LLP
InReTezosSecuri5esLi5ga5on
§ ClassacAonsuitallegingTezossolditscryptocurrency,“Tezotokens,”asunregisteredsecuriAes.PlainAffsalsoallegethattheycontributedmorethan$109milliontotheSwisscompany’sICObutthetokensneverappreciatedinvalue.• TezosarguedthatthetokenswereneverguaranteedandtheICOwassimplyafundraisingevent.
• Thedefendants’moAontodismisswasdenied.EventhoughthecompanyisaSwissenAty,federalsecuriAeslawsAllappliedbecausethecompanymarketedmainlytoU.S.ciAzens.
104©2019StradleyRononStevens&Young,LLP
RuthS.EpsteinRuthEpsteinhasmorethan30yearsofcorporate,securiAesandfinancialservicesexperience,includingfiveyearswiththeSecuriAesandExchangeCommissionintheDivisionofEnforcementandtheOfficeofGeneralCounsel.RuthconcentratesoncomplexissuesfacedbyparAcipantsintheinvestmentmanagementandvariableinsuranceproductsindustriesandcounselsfinancialservicesclientsonabroadrangeofregulatory,governance,productdevelopmentandenforcementissues.SheassistsclientsinrespondingandadapAngtoexpandedregulaAonoftheirindustrybytheCommodityFuturesTradingCommission(CFTC)andtheNaAonalFuturesAssociaAon(NFA).RuthisafrequentauthorandlecturerontopicsaffecAngherclients.Inrecentyears,shehasco-authoredfour“friendoftheCourtbriefs”inmaKersofcriAcalimportancetotheindustry,includingtwointheU.S.SupremeCourt–Jonesv.HarrisAssociatesLP(standardforreviewofadvisoryfees)andJanusCapitalGroup,Inc.,etal.v.FirstDeriva,veTraders(responsibilityforstatementsinmutualfundprospectuses).Asco-chairoftheAmericanBarAssociaAon’sSub-CommiKeeonSecuriAesAcAviAesofInsuranceCompanies,RuthtookanacAveroleinthedebatesurroundinganumberofimportantregulatoryiniAaAvesaffecAngfundsandvariableproducts,includingtheSEC’ssummaryprospectusandXBRLproposals.SheisacAvelyinvolvedwithclientsandindustrygroupsindialoguewiththeCFTCregardingtheCFTC’sregulaAonoffundsandadvisers,inconnecAonwithrelatedrulemakingproposalsandissuanceofinterpretaAveguidance.
106©2019StradleyRononStevens&Young,LLP
JohnM.BakerJohnBakerfocuseshispracAceoncomplexsecuriAeslawandbankingissuesformutualfundsandtheirboardsofdirectors/trustees,investmentadvisers,broker-dealers,banks,hedgefundsandotherparAcipantsinthefinancialmarkets.JohnisknownthroughoutthemutualfundindustryasthecreatorandmoderatorofFundLaw,aleadingonlinediscussiongroupthatreportsdevelopmentsandchangesinsecuriAeslaw,withanemphasisonlegalissuesimpacAngtheinvestmentmanagementindustry.PriortojoiningStradleyRonon,JohnwasseniorcounselforaleadingBostonfinancialinsAtuAon,whereheservedastheprimarylegaladvisortothebankinitsroleasinvestmentadvisertomutualfundswithmorethan$9billioninassets.FollowingaclerkshipwiththeHon.BoyceF.MarAnJr.oftheU.S.CourtofAppealsfortheSixthCircuit,JohnwasanassociateandofcounselwithaMassachuseKslawfirm.HealsoservedastheformervicepresidentandgeneralcounselofChildWorldInc.,a151-storetoyretailer.
107©2019StradleyRononStevens&Young,LLP
NicoleM.KalajianNicolerepresentssecuriAes,commodiAesandcryptocurrencyprofessionalsinavarietyofregulatory,complianceandcorporatemaKers.Shehasextensiveexperiencewithrespecttohedgefunds,commoditypools,privateequityfunds,cryptocurrencyfunds,venturecapitalfunds,realestatefunds,fundoffundsandsociallyresponsibleinvestmentvehicles.Nicoleprovideslegalandcomplianceguidancetoregisteredandexemptinvestmentadvisers,commoditypooloperators(CPOs),commoditytradingadvisors(CTAs),introducingbrokers(IBs),forex(FX)firms,proprietarytradingfirms,futurescommissionmerchants(FCMs)andbroker-dealers(BDs).NicoleprovideslegalandcomplianceguidanceconcerningthelaunchofsecuriAestokenofferings(STOs),i.e.,compliantiniAalcoinofferings(ICOs).Shealsoservesascounseltoboards,mutualfundsandexchange-tradedfunds(ETFs).
Nicoledraysanddevelopsofferingdocuments,compliancemanuals,policiesandprocedures,corporatematerials,businesscontracts,investmentagreementsandadverAsingmaterials.Shealsoprovideslegalandstructuringguidanceconcerningmaster-feederstructures,domesAcandforeignfunds,internaAonalofferings,separatelymanagedaccountsandrobo-adviserplacorms.
NicoleisaFounderoftheInvestmentNetworkandtheDigitalAssetsWorkingGroup,andistheDirectoroftheWashingtonD.C.ComplianceRoundtableoftheChicagoRegion.NicolewasselectedasaSuperLawyersRisingStarin2016,2017,2018and2019.
108©2019StradleyRononStevens&Young,LLP
GregoryD.DiMeglioGregDiMegliorepresentsinvestmentcompanies,investmentadvisers,broker-dealers,publiccompanies,boardsofdirectors,boardcommiKees,auditors,otherenAAesandindividualsinconnecAonwithexaminaAons,invesAgaAonsandenforcementacAonsbytheU.S.SecuriAesandExchangeCommission(SEC),DepartmentofJusAce,otherfederalandstateregulators,andindustryself-regulatoryorganizaAons.HealsoconductsinternalinvesAgaAonsdesignedtoassistclientsinprevenAngorlimiAngthescopeofpotenAalenforcementacAon.PriortojoiningStradleyRonon,GregwasaseniorcounselintheSEC’sDivisionofEnforcementinWashington,D.C.DuringnearlyeightyearswiththeSEC,GregwasresponsibleforanumberofsignificantenforcementinvesAgaAonsandacAonsandreceivedaDivisionofEnforcementDirector’sAward.WhileatStradleyRonon,hehasbeennamedmulApleAmestotheBestLawyersinAmerica
109©2019StradleyRononStevens&Young,LLP
PaulaD.ShaffnerPaulaShaffneriswidelyrecognizedasafierceadvocateforclientsinthefinancialservicesindustry.Foralmost30years,PaulahasrepresentedindividualsandcompaniesinsecuriAesliAgaAon,anddefendedclientsinregulatorymaKersbeforetheU.S.SecuriAesandExchangeCommission(SEC),theFinancialIndustryRegulatoryAgency(FINRA)andvariousexchangesandstateregulators.ShealsorepresentsclientsinliAgaAonfiledincourtorarbitraAon.PaulaconductsinternalinvesAgaAonsandprovidescompliancecounseling.Herclientsincludepubliccompanies,mutualfunds,hedgefunds,investmentcompaniesandadvisers,brokerdealersandindividualsassociatedwiththoseenAAes.
110©2019StradleyRononStevens&Young,LLP