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SEC Cracking Down on The Crypto Wild West and Other Digital Asset Updates

After a few years of relative dormancy, the SEC is once again targeting the flourishing cryptocurrency market. On August 3, 2021, SEC Chair Gary Gensler gave a speech to the Aspen Security Forum in which he referred to the cryptocurrency marketplace as the Wild West. Days later, the SEC filed its first case involving securities using DeFi technology and then a few days after that, reached a $10 million settlement with Poloniex for operating an unregistered digital asset exchange. Shortly after that, the SEC took aim at Coinbase’s planned crypto lending program causing the crypto giant to shelf the business model for the time being. SEC Commissioners are joining in, giving speeches in various forums focused on crypto and the regulatory environment.

Background

In July 2017, the world of digital assets and cryptocurrency literally became an overnight business sector for corporate and securities lawyers, shifting from the pure technology sector, when the SEC issued its Section 21(a) Report on

November 2, 2021

SEC Chair Gary Gensler Testifies To Congress

On September 14, 2021, SEC Chairman Gary Gensler gave testimony to the U.S. Senate Committee on Banking, Housing and Urban Affairs highlighting the priorities of the SEC under his rule. After giving the obligatory opening statements on the size and impact of the U.S. capital markets, Gensler broke down the SEC agenda into four topics including market structure, predictive data analytics, issuers and issuer disclosure and funds and investment management.

Market Structure

Chair Gensler began his speech market structure by talking about the U.S. Treasury Market, which I found interesting mainly because I do not recall any speech or testimony by recent SEC chairpersons that focused on the topic (albeit I haven’t read them all, but I’ve read a lot!). During Covid, the Treasury Market suffered from liquidity issues prompting the SEC to consider rule and process changes, including those related to clearing, that could make the Treasury Markets more resilient and competitive. The SEC is also considering Treasury trading

September 28, 2021

Digital Asset Securities – Progress For Broker Dealers

In December 2020, the SEC issued a statement and request for comment regarding the custody of digital asset securities by broker-dealers. The Statement and request for comment sets forth suggestions for complying with the Customer Protection Rule and lists certain requirements that a broker-dealer could comply with to ensure that it would not be subject to an enforcement proceeding for violation of the Customer Protection Rule.

Two months later, in February 2021, the SEC Division of Examinations issued a risk alert focused on digital asset securities. These statements were the first hitting head on the topic of digital asset custody since an August 2019 joint statement by the SEC and FINRA on the custody of digital assets (see HERE) and October 2019 joint statement by the SEC, FinCEN and the CFTC (see HERE).

The SEC and FINRA have been discussing issues of custody related to tokens and digital assets for years. For example, issues surrounding the custody

August 3, 2021

SEC Chair Gary Gensler Testifies To Congress

On May 6, 2021, new SEC Chair Gary Gensler made his debut, giving testimony to the House Financial Services Committee. Although Mr. Gensler is not new to regulatory leadership – he was head of the Commodity Futures Trading Commission (CFTC) – and as such, his style is certainly not new to capital markets participants, the testimony was nonetheless very enlightening of the mindset of the new SEC regime. The purpose of the testimony was particularly related to the market volatility in January, including GameStop and AMC, and reactions to that trading frenzy including Robinhood’s temporary trading restrictions, but over four hours, touched on much more.

From thirty thousand feet, Gensler attributes the January volatility to an intersection of finance and technology. On a more granular level, he highlights: (i) gamification and user experience; (ii) payment for order flow; (iii) equity market structure; (iv) short selling and market transparency; (v) social media; (vi) market plumbing – i.e., clearance and settlement; and

May 25, 2021

Proposed 2021 U.S. Budget

In February, the Office of Management and Budget released the proposed fiscal 2021 United States government budget. The beginning of the Budget contains a message from President Trump delineating a list of key priorities of the administration including better trade deals, preserving peace through strength, overcoming the opioid crisis, regulation relief and American energy independence. The budget has some notable aspects that directly relate to the capital markets and its participants.

SEC

As the federal government has been doing for all agencies, the 2021 Budget seeks to eliminate agency reserve funds. Specifically regarding the SEC, the Budget cuts the SEC reserve by $50 million. The reduction in reserve fund is thought to increase overall accountability as the SEC would need to go to Congress to ask for additional funds if needed, with an explanation, instead of just accessing a reserve account. Reserve fund cuts are sent to the U.S. Treasury for deficit reduction.

However, the Budget also increases the

July 7, 2020

Hester Peirce Proposal For Treatment Of Cryptocurrency

SEC Commissioner Hester M. Peirce, nicknamed “Crypto Mom,” has made a proposal for the temporary deregulation of digital assets to advance innovation and allow for unimpeded decentralization of blockchain networks. Ms. Peirce made the proposal in a speech on February 6, 2020.

The world of digital assets and cryptocurrency literally became an overnight business sector for corporate and securities lawyers, shifting from the pure technology sector with the SEC’s announcement that a cryptocurrency is a security in its Section 21(a) Report on the DAO investigation. Since then, there has been a multitude of enforcement proceedings, repeated disseminations of new guidance and many speeches by some of the top brass at the SEC, each evolving the regulatory landscape. Although I wasn’t focused on digital assets before that, upon reading the DAO report, I wasn’t surprised. It seemed clear to me that the capital raising efforts through cryptocurrencies were investment contracts within the meaning of SEC v.

March 3, 2020

OTCQB And OTC Pink Rule Changes

In December 2019 the OTC Markets updated its Pink Disclosure Guidelines and Attorney Letter Agreement and Guidelines. The Pink disclosure guidelines and attorney letter apply to companies that elect to report directly to OTC Markets pursuant to its Alternative Reporting Standard. Furthermore, in January 2020 OTC Markets amended the OTCQB standards related to the disclosure of convertible debt and notification procedures for companies undergoing a change in control. The OTCQB also updated its criteria for determining independence of directors, and added additional transfer agent requirements for Canadian Companies.

The OTC Markets divide issuers into three (3) levels of quotation marketplaces: OTCQX, OTCQB and OTC Pink Open Market. The OTC Pink Open Market, which involves the highest-risk, highly speculative securities, is further divided into three tiers: Current Information, Limited Information and No Information. Companies trading on the OTCQX, OTCQB and OTC Pink Current Information tiers of OTC Markets have the option of reporting directly to OTC Markets under its Alternative

February 18, 2020

The SEC, FinCEN And CFTC Issue A Joint Statement On Digital Assets

On October 11, 2019 the SEC, FinCEN and CFTC issued a joint statement on activities involving digital assets. Various agencies have been consistently working together, with overlapping jurisdiction, on matters involving digital assets and distributed ledger technology. Earlier, in August, the SEC and FINRA issued a joint statement on the custody of digital assets, including as it relates to broker-dealers and investment advisors (see HERE).

The purpose of the joint statement is to remind persons engaged in activities involving digital assets of their anti-money laundering and countering the financing of terrorism (AML/CFT) obligations under the Bank Secrecy Act (BSA). AML/CFT obligations apply to entities that the BSA defines as “financial institutions,” such as futures commission merchants and introducing brokers obligated to register with the CFTC, money services businesses (MSBs) as defined by FinCEN (for more information on MSBs see HERE), and broker-dealers and mutual funds obligated to register

November 5, 2019

A Drill Down On Rule 506 Of Regulation D

On June 18, 2019, the SEC issued a 211-page concept release and request for public comment on ways to simplify, harmonize, and improve the exempt (private) offering framework. The concept release seeks input on whether changes should be made to improve the consistency, accessibility, and effectiveness of the SEC’s exemptions for both companies and investors, including identifying potential overlap or gaps within the framework. See HERE for my blog on the release. As the topic of private exemptions becomes front and center, it is a good time to blog about the most commonly used of those exemptions, Rule 506.

Ever since the National Securities Markets Improvement Act of 1996 (“NSMIA”) amended Section 18 of the Securities Act to pre-empt state blue sky review of specified securities and offerings including offerings made in reliance on Rule 506 of Regulation D under the Securities Act of 1933 (“Securities Act), the vast majority of private capital raises are completed relying on Rule

October 1, 2019

SEC And FINRA Joint Statement On Custody Of Digital Assets

On July 8, 2019, the SEC’s Division of Trading and Markets and FINRA’s Office of General Counsel issued a joint statement on broker-dealer custody of digital asset securities (“Joint Statement”). The SEC and FINRA have been discussing issues of custody related to tokens and digital assets for years. For example, issues surrounding the custody of digital assets have been continuously cited by the SEC as one of the reasons for the failure to approve a cryptocurrency ETF.

The Joint Statement begins with the admission that historical rules do not adequately cover the complex issues related to digital assets, including rules related to the loss or theft of a security. In recent months the SEC and FINRA staff have been engaging in conversations with industry participants regarding how the rules could be applied or modified to suit the needs of the emerging technology of digital assets.

Any entity that transacts business in digital asset securities must comply with the federal securities

August 6, 2019

FinCEN Guidance On Cryptocurrency

In May 2019, the Financial Crime Enforcement Network (FinCEN) issued a thirty-page comprehensive review of its regulations as pertains to convertible virtual currencies. Previously, in February 2018, FinCEN stated that it expects issuers of initial coin offerings (ICOs) to comply with the Bank Secrecy Act (BSA), including its anti-money laundering (AML) and know your customer (KYC) requirements (see HERE).

In general, entities that are subject to the BSA must: (i) register with FinCEN as a money services business (MSB); (ii) prepare a written AML compliance program that is designed to mitigate risks, including AML risks, and to ensure compliance with all BSA requirements including the filing of suspicious activity reports (SAR) and currency transaction reports; (iii) keep records for certain types of transactions at specific thresholds; and (iv) obtain customer identification information sufficient to comply with the AML program and recordkeeping requirements.

Although the new guidance does not establish any new regulatory requirements, it is the first time

July 16, 2019

Securities Token Or Not? A Case Study – Part III

This is the third part in my three-part series laying out fact patterns and discussing whether a specific digital asset is a security, a utility, currency, commodity or some other digital asset. In Part 1 of the series, I examined a decentralized token that had been issued without any concurrent capital raise and was able to conclude such token was not a security. Part 1 can be read HERE. In Part 2 I examined a token that was issued with the intent of being a utility token, but as a result of the clear speculative motivation for purchasers, and the lack of decentralization, concluded it was a security. Part 2 can be read HERE.

In this Part 3 of the series, I examine the issuance of the Free Token as a dividend and its cousin the Bounty Token. Unlike the prior blogs in this series, which examined the question of whether a particular token is a security, this blog

October 9, 2018

Securities Token Or Not? A Case Study – Part II

This is the second part in my three-part series laying out fact patterns and discussing whether a specific digital asset is a security, a utility, currency, commodity or some other digital asset. Although the first and easy answer is that if a digital asset is being issued today, it is most assuredly a security upon issuance that needs to comply with the federal securities laws, the answer is not always that straightforward for digital assets that have been in the marketplace for a period of time, such as Bitcoin and Ether, or for new digital assets that are carefully being constructed to fall outside the purview of a securitized token.

In the first part of this series, we examined the Oldie Token and, under the fact pattern presented, was able to determine that the Oldie Token was not a security. Part 1 can be read HERE. In this part we will examine the Functional Token, which has not

October 2, 2018

Security or Utility Token? A Case Study – Part I

Is it a security or is it a utility, currency, commodity or some other digital asset? That question has been continuously raised by those working with digital assets such as cryptocurrencies, virtual coins and tokens, including by digital asset issuers and companies that run platforms for the issuance or trading of such digital assets. Although the first and easy answer is that if a digital asset is being issued today, it is most assuredly a security upon issuance that needs to comply with the federal securities laws, the answer is not always that straightforward for digital assets that have been in the marketplace for a period of time, such as bitcoin and ether, or for new digital assets that are carefully being constructed to fall outside the purview of a securitized token.

The “STO” standing for security token offering has quickly gained favor alongside “ICO” with an industry-understood distinction. An STO is designed to

September 25, 2018

Wyoming’s Blockchain Legislation

Wyoming continues to position itself as a business-friendly state most recently by passing groundbreaking blockchain legislation defining cryptocurrency coins or tokens as a whole new asset class separate from securities and commodities. While it is unlikely that Wyoming’s new statutes will impact the SEC’s view that most, if not all, cryptocurrencies, or at least those issued to investors or used for capital raising, are securities, or the CFTC’s view that cryptocurrencies that are used as a medium of exchange, are a commodity, Wyoming has done what federal lawmakers have not yet endeavored – created comprehensive blockchain legislation.

In March 2018, Wyoming passed five separate bills addressing securities, corporate, banking and tax matters which could entice cryptocurrency and blockchain businesses to locate within the state. The statutes are part of an initiative in Wyoming called ENDOW – Economically Needed Diversity Options for Wyoming.

HB 19

Wyoming House Bill 19 provides an exemption for virtual currency, including bitcoin and

July 31, 2018

FinCEN’S Role In Cryptocurrency Offerings

In the continuing dilemma over determining just what kind of asset a cryptocurrency is, multiple regulators have expressed opinions and differing views on regulations. Likewise, multiple regulators have conducted investigations and initiated enforcement proceedings against those in the cybersecurity space. The SEC has asserted the opinion that most, if not all, cryptocurrencies are securities; the CFTC has found them to be commodities; the IRS’s official definition is the same as the CFTC, and in particular a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, and now the Financial Crime Enforcement Network (FinCEN) has asserted that issuers of cryptocurrencies are money transmitters.

In particular, in a letter written to the US Senate Committee on Finance on February 13, 2018, FinCEN indicates that it expects issuers of initial coin offerings (ICOs) to comply with the Bank Secrecy Act (BSA), including its anti-money laundering (AML) and know your customer (KYC)

July 10, 2018

The SEC Has Provided Guidance On Ether and Bitcoin, Sort Of

On June 14, 2018, William Hinman, the Director of the SEC Division of Corporation Finance, gave a speech at Yahoo Finance’s All Markets Summit in which he made two huge revelations for the crypto marketplace. The first is that he believes a cryptocurrency issued in a securities offering could later be purchased and sold in transactions not subject to the securities laws. The second is that Ether and Bitcoin are not currently securities. Also, for the first time, Hinman gives the marketplace guidance on how to structure a token or coin such that it might not be a security.

While this gives the marketplace much-needed guidance on the topic, a speech by an executive with the SEC has no legal force. As a result, the blogs and press responding to Mr. Hinman’s speech have been mixed. Personally, I think it is a significant advancement in the regulatory uncertainty surrounding the crypto space and a signal that more constructive guidance

June 19, 2018

Online Platforms Trading Cryptocurrencies; Continued Uncertainty In Crypto Space

I have been writing often about the cryptocurrency marketplace and the SEC and other regulators’ statements and concerns about compliance with the federal securities laws. On July 25, 2017, the SEC issued a Section 21(a) Report on an investigation related to an initial coin offering (ICO) by the DAO, concluding that the ICO was a securities offering. In that Report the SEC stated that securities exchanges providing for trading must register unless an exemption applies. In its numerous statements on cryptocurrencies since then, the SEC has consistently reminded the public that exchanges that trade securities, including cryptocurrencies that are securities, must be licensed by the SEC.

The SEC has also stated that as of today, no such licensed securities cryptocurrency exchange exists. However, a few CFTC regulated exchanges have now listed bitcoin futures products and, in doing so, engaged in lengthy conversations with the CFTC, ultimately agreeing to implement risk mitigation and oversight measures, heightened margin requirements, and added

June 5, 2018

SEC Continues to Review, And Delay, Crypto Funds

On January 18, 2018, the SEC issued a letter to the Investment Company Institute and the Securities Industry and Financial Markets Association (SIFMA) explaining why the SEC could not approve a cryptocurrency-related exchange traded fund (ETF) or mutual fund. The letter, authored by SEC Division of Investment Management director Dalia Blass, explains the SEC’s reservations and concerns about approving a crypto-related mutual fund or ETF. The letter advised against seeking registration of funds that invest heavily in cryptocurrency-related products until the raised questions and concerns can be properly addressed.

The SEC letter comes a year after the SEC rejected a proposal by Cameron and Tyler Winklevoss, famously linked to the founding of Facebook, to create a bitcoin-tracking ETF. Since that time the SEC has privately rejected several similar requests. Many in the industry appreciate the SEC letter as it offers specific guidance and concrete issues to be addressed as the march towards the eventual approval of a crypto-related fund

May 22, 2018

What is a SAFT?

A Simple Agreement for Future Tokens (“SAFT”) is an investment contract originally designed to provide a compliant alternative to an initial coin offering (ICO). A SAFT as used today was intended to satisfy the U.S. federal securities laws, money services and tax laws and act as an alternative to an ICO when the platform and other utilization for the cryptocurrency or token was not yet completed. The form of the SAFT is the result of a joint effort between the Cooley law firm and Protocol Lab as detailed in the white paper released on October 2, 2017 entitled “The SAFT Project: Toward a Compliant Token Sale Framework.” As discussed in this blog, the SAFT’s compliance with federal securities laws has now come into question by both the SEC and practitioners.

SAFT’s are offered and sold to accredited investors as an investment to fund the development of a business or project in a way not dissimilar to the way equity changes

April 24, 2018

The Senate Banking Committee’s Hearing On Cryptocurrencies

On February 6, 2018, the United States Senate Committee on Banking Housing and Urban Affairs (“Banking Committee”) held a hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission.” Both SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancarlo testified and provided written testimony. The marketplace as a whole had a positive reaction to the testimony, with Bitcoin prices immediately jumping up by over $1600. This blog reviews the testimony and provides my usual commentary.

The SEC and CFTC Share Joint Regulatory Oversight

The Banking Committee hearing follows SEC and CFTC joint statements on January 19, 2018 and a joint op-ed piece in the Wall Street Journal published on January 25, 2018 (see HERE). As with other areas in capital markets, such as swaps, the SEC and CFTC have joint regulatory oversight over cryptocurrencies. Where the SEC regulates securities and securities markets, the CFTC

March 6, 2018

The Treasury Department Report To The President On Capital Markets

In October 2017, the U.S. Department of the Treasury issued a report to President Trump entitled “A Financial System That Creates Economic Opportunities; Capital Markets” (the “Treasury Report”). The Treasury Report was issued in response to an executive order dated February 3, 2017. The executive order identified Core Principles and requested the Treasury Department to identify laws, treaties, regulations, guidance, reporting and record-keeping requirements, and other government policies that promote or inhibit federal regulation of the U.S. financial system in a manner consistent with the Core Principles. In response to its directive, the Treasury Department is issuing four reports; this one on capital markets discusses and makes specific recommendations related to the federal securities laws.

The Core Principles are:

Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
Prevent taxpayer-funded bailouts;
Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk

February 27, 2018

The CFTC And Cryptocurrencies

The SEC and U.S. Commodity Futures Trading Commission (CFTC) have been actively policing the crypto or virtual currency space. Both regulators have filed multiple enforcement actions against companies and individuals for improper activities including fraud. On January 25, 2018, SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancarlo published a joint op-ed piece in the Wall Street Journal on the topic.

Backing up a little, on October 17, 2017, the LabCFTC office of the CFTC published “A CFTC Primer on Virtual Currencies” in which it defines virtual currencies and outlines the uses and risks of virtual currencies and the role of the CFTC. The CFTC first found that Bitcoin and other virtual currencies are properly defined as commodities in 2015. Accordingly, the CFTC has regulatory oversight over futures, options, and derivatives contracts on virtual currencies and has oversight to pursue claims of fraud or manipulation involving a virtual currency traded in interstate commerce. Beyond instances of fraud

February 20, 2018

The SEC And CFTC Joint Statements On Cryptocurrencies; Global Regulators Join In

On January 19, 2018 and again on January 25, 2018, the SEC and CFTC divisions of enforcement issued joint statements regarding cryptocurrencies. The January 19 statement was short and to the point, reading in total:

“When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws. The Divisions of Enforcement for the SEC and CFTC will continue to address violations and bring actions to stop and prevent fraud in the offer and sale of digital instruments.”

The January 25, 2018 statement was issued by SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancarlo and was published as an op-ed piece in the Wall Street Journal. In summarizing the statements, I add my usual commentary and facts and information

February 6, 2018

SEC Chief Accountant Speaks On Initial Coin Offerings (ICO’s)

On September 11, 2017, the SEC Chief Accountant, Wesley R. Bricker, gave a speech before the AICPA National Conference on Banks & Savings Institutions. The bulk of the speech was similar to Mr. Bricker’s June 2017 speech before the 36th Annual SEC and Financial Reporting Institute Conference, summarized HERE. However, one topic that was new, and interesting enough to spark this blog, was related to initial coin offerings (ICO’s). Note that offers and sales of digital coins, cryptocurrencies or tokens using distributed ledger technology (DLT) or blockchain have become widely known as ICO’s.

As the capital markets become more and more focused on all things blockchain, including ICO’s, secondary token trading, and disruptive changes made possible by distributed ledger technology (DLT), which is inevitably transforming capital market processes, the SEC is fronting a wave of questions and concerns on the subject. On July 25, 2017, the SEC issued a report on an investigation related to an

October 17, 2017

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CFTC

SEC Cracking Down on The Crypto Wild West and Other Digital Asset Updates

SEC Chair Gary Gensler Testifies To Congress

Digital Asset Securities – Progress For Broker Dealers

Proposed 2021 U.S. Budget

Hester Peirce Proposal For Treatment Of Cryptocurrency

OTCQB And OTC Pink Rule Changes

The SEC, FinCEN And CFTC Issue A Joint Statement On Digital Assets

A Drill Down On Rule 506 Of Regulation D

SEC And FINRA Joint Statement On Custody Of Digital Assets

FinCEN Guidance On Cryptocurrency

Securities Token Or Not? A Case Study – Part III

Securities Token Or Not? A Case Study – Part II

Security or Utility Token? A Case Study – Part I

Wyoming’s Blockchain Legislation

FinCEN’S Role In Cryptocurrency Offerings

The SEC Has Provided Guidance On Ether and Bitcoin, Sort Of

Online Platforms Trading Cryptocurrencies; Continued Uncertainty In Crypto Space

What is a SAFT?

The Senate Banking Committee’s Hearing On Cryptocurrencies

The Treasury Department Report To The President On Capital Markets

The CFTC And Cryptocurrencies

SEC Chief Accountant Speaks On Initial Coin Offerings (ICO’s)

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