SEC

Venture Capitalists Seek “Safe Harbor” for Virtual Currencies

By Jimena Rubio, LL.M. Candidate 2018 | Posted on

In the wake of further developments by the SEC, many key players in the industry are currently combining efforts to petition federal authorities to see certain virtual currencies in a “different light.” The Venture Capital Working Group is led by Andreessen Horowitz, which includes another significant VC firm, Union Square Ventures, and lawyers from Cooley LLP, McDermott Will & Emery LLP, and Perkins Coie LLP.

The primary purpose of the Group is to deter regulators from categorizing cryptocurrencies, such as Bitcoin and Ether, as securities. On March 28th, the Group met with the U.S. Securities Exchange and proposed a “safe harbor” for some cryptocurrencies.

The proposal suggests that digital tokens should generally be exempt from securities laws if they achieve “full decentralization” or “full functionality.” It adds that full decentralization could occur under several conditions, including when the token creator no longer has control of the network based on its ability to make unilateral changes to the functionality of the tokens. It can also be used, not just as a speculative investment, but for its intended purpose on a computer network.

The group notes that these definitions are only suggestions, but the “proposed safe harbor has been vetted by, and has the support of, many of the key players in the industry.” People briefed on the meeting said that regulators did not immediately embrace the safe harbor proposal.

Many entrepreneurs and law firms have been creating new ways for virtual currency projects to issue their tokens as securities and some exchanges have talked about getting registered as official securities exchanges. It is still unclear what will happen to tokens that did not register as securities but are later categorized as securities.

Furthermore, on April 26, a congressional hearing with testimony from the SECs Division of Corporation Finance took place to develop more reasonable approaches toward token sales and their classifications. The discussion marked a new attitude amongst SEC members and addressed how certain utility tokens could not be securities if purchased with no investment intention.

In the hearing, the SEC division head, William Hinman, stated:

“They can certainly imagine a token where the holder is buying a token for its utility, not as an investment; especially if it’s a decentralized network where it’s used, and not central actors where there would be information asymmetries where they would know more than token investors.”

Hinman — likely referring to the Venture Capital Working Group — replied that one of the steps that the SEC was taking was “meeting with participants that have these ideas of a token that shouldn’t be regulated as a security” and working with them on how they should be structured. Hinman pointed out that the SEC is heavily engaged with academics and other departments to better explore how everything might work, and that in the long run, the U.S. is “pragmatic” in its support of new technology.

Venture Capitalists Seek “Safe Harbor” for Virtual Currencies

What Do We Not Know about Bitcoin?

By Cremeithius Riggins, J.D. Candidate 2020 | Posted on

Have you ever gotten the feeling that everyone knows something you don’t know? Many people are starting to feel that way about Bitcoin.

 

Most recently, China has blocked everyone in its country from accessing websites that offer cryptocurrency trading services or initial coin offerings (“ICOs”). Yes, no more Bitcoin in China! The initial response is to ask why, but I think we have a better chance of figuring out who created Bitcoin than determining the ultimate motives of the Chinese government. The question that concerns me is: does the Chinese government know something about Bitcoin that other people or governments do not know?

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Celebrity Endorsements Leave ICOs Counting Much More than Coins

By Brianna Tsutsui, J.D. Candidate 2019 | Posted on

The Securities and Exchange Commission (SEC) recently issued a public statement cautioning celebrities like Paris Hilton, DJ Khaled, and Floyd Mayweather from endorsing “initial coin offerings,” commonly referred to as ICOs.

These celebrities were primarily using their various social media platforms to advertise for ICOs. A recent example is Mayweather’s attention-grabbing Instagram post from July, where he is photographed next to a briefcase filled with $100 bills. In the post, Mayweather indicated he would make an exuberant amount of money “on the Stox.com ICO.” Similarly, Hilton tweeted that she was “looking forward to participating in the new @LydianCoinLtdTowken.” However, the tweet has since been deleted.

But why has the SEC taken such an interest in celebrities advertising for ICOs when their social media accounts are often littered with other promotional messages for the latest detox tea or waist trainer? The answer is simple and yet complex. ICOs may technically be selling securities. If this is the case, according to the anti-touting rule, celebrities would then need to make it known if and when they are being paid to promote these ICOs. With nearly $3.3 billion invested in some 200 ICOs within the last year, it is clear why the SEC has taken such an interest in these Twitter and Instagram posts.

However, the SEC’s authority to regulate ICOs is certainly up for debate. Unlike an Initial Public Offering (IPO), ICOs allow companies to get money without obtaining debt or giving its investors equity. Instead, those who invest are given a digital currency called a “token.” It is still not entirely clear which of these tokens qualify as securities that would be subject to the SEC’s many regulations.

Whether or not a token qualifies as a security turns on what it actually represents. We now enter the world of cryptocurrencies. Most tokens are recorded into a “blockchain” known as Ethereum. Ethereum is similar to a ledger, and it also accounts for a type of currency known as “ether.”  Ethereum also maintains “smart contract” programs. Individuals can invest ether into an ICO’s smart contract. As a result, tokens that may be traded are produced, and the ICO issuer of the tokens can choose to keep the ether or use it to finance its company.

The SEC holds that irrespective of the technology behind tokens, they are considered securities when companies use them to raise money. Alternatively, ICO advocates argue that tokens have a utility function beyond financing and should not be subject to SEC regulations.

Although the SEC has not enforced any violations against specific individuals, the Hiltons and Mayweathers of the world should probably add in a protective #ad hashtag when they get paid, to avoid liability for securities regulations that are often harsh.

Celebrity Endorsements Leave ICOs Counting Much More than Coins (PDF)

SEC fines Zenefits and former CEO Parker Conrad

By Rujie Zhou, LL.M. Candidate 2018 | Posted on

On October 26, 2017, the Securities and Exchange Commission (the “SEC”) fined a Silicon Valley unicorn startup, Zenefits, and its former CEO Parker Conrad for “materially false and misleading statements and omissions” to the company’s investors regarding non-compliance with state insurance laws. This is a first for a Silicon Valley startup.

Zenefits and Conrad agreed to pay a combined nearly $1 million in fines to settle accusations. The company agreed to pay $450,000 and Conrad agreed to pay nearly $534,000, of which $350,000 represents disgorgement of ill-gotten gains and a penalty of $160,000. But Zenefits did not confirm or deny the SEC’s findings that they violated federal securities laws.

San Francisco-based Zenefits makes software for business to automate their human resources activities, but also acts as a health insurance broker. 90 percent of the company’s revenue comes from brokerage fees from their health insurance business.

The SEC claimed that Zenefits used inadequate compliance procedures under Conrad’s control, allowing employees to sell health insurance without the necessary state licenses. Conrad created and shared a program allowing employees to complete California licensing education requirements in fewer hours than the law required. Separately, in 2016, in a concession to investors, Zenefits slashed its valuation by more than half to $2 billion from $4.5 billion and investors agreed not to sue Zenefits. The SEC asserted that when Zenefits and Conrad raised funds in 2014 and 2015, they failed to adequately disclose their knowledge of these compliance lapses.

In contrast to the SEC’s broad authority to police behavior in public traded companies, it has relatively limited authority in the world of private companies; by law, it can only police misrepresentations and fraud in the sale of private company stock. Zenefits is the first case in which the SEC took action against a privately held Silicon Valley startup for misleading its investors. In the future, the SEC will keep a watchful eye on Zenefits.

SEC fines Zenefits and former CEO Parker Conrad

A New Approach to Financial Regulatory Enforcement

By Nicole Danesh, J.D. Candidate 2019 | Posted on

The regulatory enforcement of the financial industry may soon change. As the new administration settles into Washington; reports have suggested the rise of dedicated efforts to change, and potentially reduce, financial regulation by the Securities and Exchange Commission (“SEC”) and the Consumer Financial Protection Bureau. While these efforts have not yet fully materialized, there are some indications that they will soon impact the financial services industry.

The pressures to alter the regulatory framework are two-fold. First, major banks want to change the way regulatory agencies collect data related to possible crimes. If the banks can modify the framework in a way that would shift more responsibility to the government, then this may lower the banks’ costs of compliance. Second, government officials and regulatory agencies have taken steps to change the enforcement landscape from the top-down. For example, last month, the acting chairman of the SEC, Michael Piwowar, took steps to limit the agency’s powers. Piwowar’s directive gave exclusive power to the director of the enforcement division to authorize formal investigations. This will both limit inquiries and slow down the process of starting investigations. Consequently, the new structure will weaken financial regulatory enforcement.

Scaling back regulation may create undesirable consequences. Particularly concerning is the idea that violations can go undetected for quite some time until they grow into large and harmful issues. Additionally, a lack of sufficient regulation will increase the risk of another financial crisis.

On the other hand, excess regulations are not always desirable either. Too many regulations can create extremely high costs which may not be proportional to the consequential benefits of detecting minor violations. In order to prevent this, a current administration official and financial regulator has recently called for easing the strict requirements that arose after the 2008 crisis.

Ultimately, these new approaches might simply be an attempt to curb over-regulation. However, it may also offer a way for companies to tip-toe around the law in the name of generating profits. Regardless, regulatory agencies must strike a balance in structuring the new enforcement frameworks and make sure that the new regulatory regime is neither too stringent nor too lenient. This balance is key in preventing arbitrary targeting—wasting taxpayer resources in the process and burdening private businesses—and in incentivizing lawful behavior in the financial industry.

A New Approach to Financial Regulatory Enforcement (PDF)

SEC finds U.S. Crowd-Funding Offers New Capital Source

By Roslyn Akel, J.D. Candidate 2019 | Posted on

Crowdfunding has become an increasingly popular form of raising capital for small businesses and entrepreneurs.

Social Media platforms have come to play a large role in facilitating crowd funding. They also, as a platform for crowd funding, have enabled regulators to foster fair valuations in determining the value of enterprises whose shares are offered for sale.

In May 2016, the U.S. Securities and Exchange Commission (“SEC”) issued a new rule, Reg CF, to regulate crowd funding. The Jumpstart Our Business Startups (JOBS) Act, passed into law in 2012, empowered the SEC to write new rules to create a regulatory regime for crowdfunding.

These new regulations allow crowdfunding, up to $1 million, from accredited and non-accredited investors alike. Reg CF is essentially the first step in the capital ladder for early-stage companies. The intent was to create a low barrier to capital formation in order to enable businesses at their earliest stages to attain sufficient capital to get off the ground.

However, the new regulations, despite their intent to lower the barriers of capital formation, have been criticized by some as overly strict, costly, and ultimately creating barriers to capital formation. Many critics believe that the new regulations may actually be a deterrent to crowdfunding.

Mike Piwowar, acting SEC Chairman, echoed concerns that the rules were too restrictive. Piwowar stated, “[t]he commission should consider whether any further steps should be taken to improve our crowdfunding regulations, including the use of exemptive authority.”

Likewise, the Division of Economic and Risk Analysis (“DERA”), published a report that provided updates on the current state of issuers utilizing these new regulations as well as some critiques for changes to be made in the future. The DERA report affirmed the sentiment that the industry is quickly evolving and that today’s activity is probably not wholly indicative of future outcomes.

Looking forward, this is just the start for regulating crowdfunding. Changes are undoubtedly on the horizon. Congress is in the process of updating Reg CF to reflect some of the issues within the industry. Specifically, there are hopes that this update will allow special purpose vehicles which, in turn, would more easily align the interests of issuers and borrowers as well as more easily manage shareholder interests.

Despite the plethora of critiques, these new regulations are still a step in the right direction. They regulate crowd funding in a manner that will strike a balance to meet the needs of issuers, borrowers, and business in ultimately driving the success of newly formed businesses.

SEC finds U.S. Crowd-Funding Offers New Capital Source (PDF)

President Trump to Repeal Dodd-Frank

By Laura Tobon, LL.M. Candidate 2017 | Posted on

President Trump Scales Back Dodd-Frank

The Dodd-Frank Wall Street Reform and Consumer Protection Act, better known as the Dodd-Frank Act (the “Act”), is a financial reform package passed during the Obama administration as a response to the financial crisis of 2008. The Act, signed into law in 2010, re-designed Wall Street and the American financial industry. Banks and other financial institutions were forced to undergo a series of new regulatory exams and cut back on their lucrative, but illiquid, private equity and hedge fund investments. The Act created new governmental agencies and strategies to oversee mid-sized banks all the way up to multi-billion-dollar firms. Now, seven years after its enactment, President Donald Trump has pledged to significantly reduce and repeal the Act.

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Snap’s IPO and Lack of Shareholders’ Rights

By Frederic Peeters, LL.M. Candidate 2017 | Posted on

Snap Inc. (“Snap”) recently filed its IPO with the SEC. The intended IPO of the parent company of the messaging app Snapchat has already been heavily debated and various commentators have criticized Snap’s intended governance structure.

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Supreme Court Appointment Threatens Long-Standing Chevron Doctrine

By Alisha Mahalingam, J.D. Candidate 2018 | Posted on

Agency law is having a moment in the spotlight. With the nomination of Judge Neil M. Gorsuch to the Supreme Court, attention is being drawn to issues where his vote stands to make an impact. One such issue is Chevron deference, a long-standing agency law doctrine followed by the Supreme Court for over thirty years. Chevron deference has been cited in decisions affecting numerous agencies ranging from the EPA to the SEC.

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The Future of the Securities and Exchange Commission

By Nicole Saweres, J.D. Candidate 2019 | Posted on

Last week, U.S Securities and Exchange Commission Chairwoman, Mary Jo White, announced that she will resign at the end of President Barack Obama’s second term. While this comes as no surprise, there is collective worry as to who will be appointed next. If Hilary Clinton had won the presidency, the new SEC chair would likely have followed Mary Jo White’s footsteps and stayed firm on tough regulations and Wall Street enforcement.

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