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Hester Peirce Proposal For Treatment Of Cryptocurrency

Posted by Securities Attorney Laura Anthony | March 6, 2020 Tags: 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. W. J. Howey Co.

However, although capital raising seems clear, the breadth of the SEC’s jurisdiction and involvement are much less so. Not all token issuances and digital assets are used for capital raising, but rather these digital assets are fundamental to the operations of decentralized applications. Amazing new networks are being built and traditional applications are being disrupted at every turn. However, the ability to publicly issue the digital tokens that drive these networks continues to challenge the best practitioners, with all avenues leading back to some form of registration. The SEC’s temporary injunction against Telegram and its Grams digital token, the one token everyone firmly believed was a pure utility, together with the successful Regulation A offering of Blockstack’s token, has made Regulation A the clear choice for a public token issuance.

In theory, an S-1 would work as well, though to date no one has tried and likely will not do so in the short term. The issue with an S-1 is testing the waters and gun jumping (see HERE). Public communication in advance of an S-1 is strictly limited whereas most token offerings rely heavily on pre-marketing. Regulation A broadly allows pre-offering marketing, offers and communications (see HERE).

Currently, those who operate in the digital asset space must carefully navigate rough, uncharted waters while doing everything possible to comply with federal regulations. Although Regulation A+ works for the public issuance of a token, the issue of transitioning from a security to a utility a Hester Peirce Proposal For Treatment Oft this point requires a leap of faith. The SEC has been clear that when a network becomes decentralized enough, a token can cease to be a security. The question remains: how can a token that begins as a security, be utilized and traded freely in a network, in its utilitarian purpose, such to allow the network to grow in decentralization?

The SEC has also been clear that the secondary trading of securities, including digital assets, requires a broker-dealer license (see, for example, HERE). Currently there is no active secondary trading market for digital asset securities in the U.S., though we are getting closer. However, secondary trading is different than use in a network for a token’s intended purpose.

Although there is no written guidance or pronouncement from the SEC Division of Trading and Markets, it appears that the SEC will allow a token that is a security to be used in a network without compliance with the registration or exemption provisions of the federal securities laws. The basis for this conclusion is the clearance of Blockstack’s Regulation A offering, which announces that the token can be used on the network and informal calls with FinHUB (see HERE) and digital asset legal practitioners. This does not provide the sort of comfort that a business investing millions of dollars into technology wants to rely upon.

That is one huge gap in the digital asset regulatory framework, but many more exist, leading Commissioner Peirce to throw out the first of what will probably be several proposals that hopefully bring us to a working structure.

Commissioner Peirce’s Proposal

Ms. Peirce begins by pointing out what I and every other practitioner have pointed out while trying to traverse the law’s application to digital assets, and that is that compliance with the law while furthering the meritorious digital asset technology is an unwinnable struggle. Ms. Peirce states, “[W]hether it is issuing tokens to be used in a network, launching an exchange-traded product based on bitcoin, providing custody for crypto assets, operating a broker-dealer that handles crypto transactions, or setting up an alternative trading system where people can trade crypto assets, our securities laws stand in the way of innovation.”

Although the issues are widespread, Ms. Peirce focuses on the issue of getting tokens into the hands of potential network users without violating securities laws. Where a token is a security, the ability to grow a network and utilize a token within the network is unreasonably hampered.

Furthermore, although many tokens may be bundled in such a way as to create an investment contract under Howey, she thinks the SEC has gone too far in its analysis. The mere fact that a token is marketed as potentially increasing in value should not make it a security. If that were the case, quality handbags, designer sneakers, fine art and good wines would all be securities under the purview of the SEC.

The options available for digital asset technology innovators are limited. A network could simply open source the code and allow mining to create the initial tokens. A network could also take its chances and conclude that a token is not a security and proceed with the issuance, although that did not work out well for Telegram. The option most networks have chosen is to either avoid the U.S. altogether or rely on Regulation D and/or Regulation S for token issuances, and recently Regulation A for a more public issuance.

The safe harbor proposed by Commissioner Peirce is designed for projects looking to build a decentralized network. The safe harbor is admittedly in a draft form. Commissioner Peirce hopes for active public input as well as involvement within the SEC to help take her draft and formulate a workable plan that is either a rule or a no-action position, but that the market can rely on in moving forward.

The safe harbor would provide network developers with a three-year grace period within which they could facilitate participation in and the development of a functional or decentralized network, exempt from the federal securities laws as long as certain conditions are satisfied. In particular, (i) the offer and sale of tokens would be exempted from the provisions of the Securities Act of 1933 (“Securities Act”) other than the anti-fraud provisions; (ii) tokens would be exempt from registration under the Securities Exchange Act of 1934 (“Exchange Act”); and (iii) persons engaged in certain token transactions would be exempt from the definitions of “exchange,” “broker,” and “dealer” under the Exchange Act.

In order to qualify for the safe harbor, several conditions must be met including: (i) the development team must intend the network to reach maturity, either through full decentralization or token functionality, within three years of the date of the first token sale, and act in good faith to meet that goal. I note that good faith is a hard standard to prove; (ii) the team must disclose key information on a freely accessible public website; (iii) the token must be offered and sold for the purpose of facilitating access to, participation on, or the development of the network; (iv) the team must take reasonable efforts to create liquidity for users; and (v) the team would have to file a notice of reliance on the safe harbor on EDGAR within 15 days of the first token sale.

Determining decentralization requires an analysis of whether the network is not controlled and is not reasonably likely to be controlled, or unilaterally changed, by any single person, group of persons, or entities under common control. Functionality would be when holders can use the tokens for the transmission and storage of value or to participate in an application running on the network.

The key information that would need to be disclosed on a public website includes (i) the source code; (ii) transaction history; (iii) purpose and mechanics of the network (including the launch and supply process, number of tokens in initial allocation, total number of tokens to be created, release schedule for the tokens and total number of tokens outstanding); (iv) information about how tokens are generated or minted, the process for burning tokens, the process for validating transactions and the consensus mechanism; (v) the governance mechanisms for implementing changes to the protocol; (vi) the plan of development, including the current state and timeline for achieving maturity; (vii) financing plans, including prior token sales; (viii) the names and relevant experience, qualifications, attributes, or skills of each person that is a member of the team; (ix) the number of tokens owned by each member of the team, a description of any limitations or restrictions on the transferability of tokens held by such persons, and a description of the team members’ rights to receive tokens in the future; (x) the sale by any member of 5% or more of his or her originally held tokens; and (xi) any secondary markets on which the tokens trade. Disclosures would need to be updated to reflect any material changes.

The requirement to make good-faith efforts to create liquidity for users could include a secondary trading market. In that case, the team would be required to utilize a trading platform that can demonstrate compliance with all applicable federal and state law, as well as regulations relating to money transmission, anti-money laundering, and consumer protection. Although I find this requirement perplexing, Commissioner Peirce believes it will help facilitate the distribution of the tokens such that they can flow back to a utility use on the network.

As mentioned, the safe harbor would not include the anti-fraud provisions of the securities laws. In addition, the safe harbor would be subject to the bad actor rules, such that it could not be used if any member of a team fell within the bad actor provisions (see HERE). The safe harbor would pre-empt state securities laws, but as with other pre-emptions, it would not include the state anti-fraud provisions.

The safe-harbor would be retroactive in that it would apply to tokens previously issued in registered or exempt offerings to allow for the free use of the token to build the network, and secondary sales.

Conclusion

Although as Commissioner Peirce notes, it has to start somewhere, it is a given in the industry that the proposal as written will not likely gain traction. It is simply too anti-regulation for any regulator’s and perhaps even industry participant’s liking. However, it does lay the framework to open the conversation and start towards a workable solution. Certainly, the current plan to let tokens registered as securities, be used as utilities, until we say otherwise, is not any better. The industry needs a workable solution, and I am glad an SEC Commissioner is taking a step forward.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal’s op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC’s role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and the need for even further guidance in this space, see HERE.

For a discussion of William Hinman’s speech related to ether and bitcoin and guidance in cryptocurrencies in general, see HERE.

For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.

For a review of Wyoming’s blockchain legislation, see HERE.

For a review of FINRA’s request for public comment on FinTech in general and blockchain, see HERE.

For my three-part case study on securities tokens, including a discussion of bounty programs and dividend or airdrop offerings, see HERE; HERE and HERE.

For a summary of three recent speeches by SEC Commissioner Hester Peirce, including her views on crypto and blockchain, and the SEC’s denial of a crypto-related fund or ETF, see HERE.

For a review of SEC enforcement-driven guidance on digital asset issuances and trading, see HERE.

For information on the SEC’s FinTech hub, see HERE.

For the SEC’s most recent analysis matrix for digital assets and application of the Howey Test, see HERE.

For FinCEN’s most recent guidance related to cryptocurrency, see HERE.

For a discussion on the enforceability of smart contracts, see HERE.

For a summary of the SEC and FINRA’s joint statement related to the custody of digital assets, see HERE.

For a review of the SEC, FinCEN and CFTC joint statement on digital assets, see HERE.

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The SEC’s Strategic Hub For Innovation And Financial Technology

Posted by Securities Attorney Laura Anthony | December 11, 2018

Responding to the growing necessity, in mid-October the SEC launched a Strategic Hub for Innovation and Financial Technology (FinHub). The FinHub will serve as a resource for public engagement on the SEC’s FinTech-related issues and initiatives, such as distributed ledger technology (including digital assets), automated investment advice, digital marketplace financing, and artificial intelligence/machine learning. The FinHub also replaces and consolidates several SEC internal working groups that have been working on these matters.

According to the SEC press release on the matter, the FinHub will:

Provide a portal for the industry and the public to engage directly with SEC staff on innovative ideas and technological developments;
Publicize information regarding the SEC’s activities and initiatives involving FinTech on the FinHub web page;
Engage with the public through publications and events, including a FinTech Forum focusing on distributed ledger technology and digital assets planned for 2019;
Act as a platform and clearinghouse for SEC staff to acquire and disseminate information and FinTech-related knowledge within the agency; and
Serve as a liaison to other domestic and international regulators regarding emerging technologies in financial, regulatory, and supervisory systems.

Although I’m sure FinHub supports engagement in all FinTech areas, the website itself is broken into four categories: (i) blockchain/distributed ledger; (ii) digital marketplace financing; (iii) automated investment advice; and (iv) artificial intelligence/machine learning. Under each category the SEC has tabs with information such as regulations, speeches and presentations, opportunities for public input and empirical information.

Blockchain/Distributed Ledger

Blockchain and distributed ledger generally refer to databases that maintain information across a network of computers in a decentralized or distributed manner. Blockchains are often used to issue and transfer ownership of digital assets that may be securities, depending on the facts and circumstances.

Clearly illustrating the need for regulatory initiatives, the “regulation, registration and related matters” tab under blockchain/distributed ledger is limited to public speeches, testimony and pronouncements, and enforcement actions, and not regulation (as none exists). Although certainly we in the community give public statements weight, they actually have no binding legal authority. The speeches, testimony and pronouncements that the SEC lists in this tab, and as such the ones that the SEC gives the most weight to, include (i) Chair Clayton’s testimony on virtual currencies to the Senate banking committee (see HERE); (ii) William Hinman’s speech on digital asset transactions (see HERE); (iii) statement on potentially unlawful online platforms for trading digital assets (see HERE); and (iv) remarks before the AICPA National Conference of Banks & Savings institutions (see HERE and HERE).

Providing more legal guidance are the enforcement proceedings. The SEC has provided a running list of all cyber enforcement actions broken down by category including digital asset/initial coin offerings; account intrusions; hacking/insider trading; market manipulation; safeguarding customer information; public company disclosure and controls; and trading suspensions.

Digital Marketplace Financing

Digital marketplace financing refers to fundraising using mass-marketed digital media – i.e., crowdfunding. In this category, the SEC includes traditional Title III Crowdfunding under Regulation CF and platforms for the marketing of Regulation D, Rule 506(c) offerings for the offering of debt or equity financing. Under the Regulation tab the SEC includes Regulation CF and the SEC’s Regulation CF homepage, including investor bulletins.

The SEC does not include a link to Rule 506(c) or Section 4(c) of the Securities Act, which provide an exemption for advertised offerings where all purchasers are accredited investors, and the platforms or web intermediaries that host such offerings, respectively. However, many securities token offerings are being completed relying on these exemptions from the registration provisions – in fact, more so than Regulation CF which is limited to $1,070,000 in any twelve-month period. In my opinion, this is a miss on the site layout.

This area of the FinHub website also provides a link to one of the first published SEC investor bulletins on initial coin offerings, including some high-level considerations to avoid a scam. Finally, this area provides a link to a Regulation CF empirical information page published by the SEC. Unfortunately I do not find the data to be user-friendly and could not determine how many, if any, Regulation CF offerings have included digitized assets or FinTech-related issuers.

Automated Investment Advice

Automated investment advisers or robo-advisers are investment advisers that typically provide asset management services through online algorithmic-based programs. Since their introduction, the SEC has been involved with regulating these market participants. Under this section, the SEC provides links to guidance related to robo-advisors.

Robo-advisers, like all registered investment advisers, are subject to the substantive and fiduciary obligations of the Advisers Act. However, since robo-advisers rely on algorithms, provide advisory services over the internet, and may offer limited, if any, direct human interaction to their clients, their unique business models may raise certain considerations when seeking to comply with the Advisers Act. In particular, the Advisors Act requires that a client receive information that is critical to his or her ability to make informed decisions about engaging, and then managing the relationship with, the investment adviser. As a fiduciary, an investment adviser has a duty to make full and fair disclosure of all material facts to, and to employ reasonable care to avoid misleading, clients. The information provided must be sufficiently specific so that a client is able to understand the investment adviser’s business practices and conflicts of interests. Such information must be presented in a manner that clients are likely to read (if in writing) and understand.

Since robo-advisors provide information and disclosure over the internet without human interaction and the benefit of back-and-forth discussions, the disclosures must be extra robust and provide thorough material on the use of an algorithm. The SEC’s guidance on the subject contains a fairly thorough list of matters that should be included in the client information.

Artificial Intelligence/Machine Learning

Machine learning and artificial intelligence refer to methods of using computers to mine and analyze large data sets. The SEC includes links to a few speeches and presentations under this tab. The SEC uses machine learning and AI in numerous ways, including market risk assessment and helping identify risks that could result in enforcement proceedings such as the detection of potential investment adviser misconduct.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and the need for even further guidance in this space, see HERE.

For a discussion of William Hinman’s speech related to ether and bitcoin and guidance in cryptocurrencies in general, see HERE.

For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.

For a review of Wyoming’s blockchain legislation, see HERE.

For a review of FINRA’s request for public comment on FinTech in general and blockchain, see HERE.

For my three-part case study on securities tokens, including a discussion of bounty programs and dividend or airdrop offerings, see HERE; HERE; and HERE.

For a summary of three recent speeches by SEC Commissioner Hester Peirce, including her views on crypto and blockchain, and the SEC’s denial of a crypto-related fund or ETF, see HERE.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

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Security or Utility Token? A Case Study – Part I

Posted by Securities Attorney Laura Anthony | September 25, 2018 Tags: 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 be a security or financial instrument offering usually backed by stock, assets, revenues or profits in a company. An ICO may or may not be designed to be a security or financial instrument upon issuance, has utility or commodity attributes, and often involves a token offering entirely outside of the United States precluding US investors (some doing so more successfully than others, but that is another topic).

In this three-part blog, I will lay out fact patterns and analyze whether a digital asset is a security including (i) the issued- and trading-for-years Oldie Token; (ii) the about-to-be-issued Functional Token; and (iii) the newly-issued-as-a-dividend Free Token including a discussion of the definition of a “sale” under the Securities Act and its cousin, the Bounty Token.

Sources Applicable to an Analysis of all Digital Assets

In determining whether a digital asset is a security and/or needs to comply with the U.S. federal securities laws in its issuance and distribution, at least the following sources should be reviewed and considered by securities counsel. This is not a comprehensive list of facts and circumstances, and the evolving state of the U.S. and international laws must also be considered, but it covers the basics.

The Securities Act;
The Exchange Act;
SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (“Howey”);
Reves v. Ernst & Young, 494 U.S. 56 (1990) (“Reves”);
Report of Investigation Pursuant to Section 21(a) of the Exchange Act: The DAO (July 25, 2017)(the “DAO Report”);
In the Matter of Munchee Inc. (“Munchee Order”);
Statement on Cryptocurrencies and Initial Coin Offerings (SEC Chairman Jay Clayton) (December 11, 2017) (“SEC Cryptocurrency Statement”);
Speech by William Hinman, the Director of the SEC Division of Corporation Finance at Yahoo Finance’s All Markets Summit on June 14, 2018;
SEC v. PlexCorps et al., Civil Action No. 17-cv-07007 (E.D. N.Y., filed December 1, 2017) (“PlexCorp Litigation”);
In the Matter of Tomahawk Exploration LLC et al (“Tomahawk Matter”);
The Bitcoin White Paper;
The Ethereum White Paper;
The MUN Coin White Paper;
The PlexCoin White Paper;
Any and all recent statements, speeches or enforcement proceedings by the SEC; and
The White Paper and all relevant documents associated with the particular Digital Asset.

This blog and case study is limited to an analysis of the U.S. federal securities laws and does not include any state or international securities laws nor the applicability of any regulations promulgated under or enforced by any other U.S. regulators such as the CFTC, FinCEN or the IRS.

The Oldie Token

Facts

The Oldie Token was a fair launch without any presale, ICO, pre-mine or distribution to the Oldie Token Team. No central company or entity was in charge of the initial launch. An international group of developers, building on the idea of John Doe, the founder of the idea on which Oldie Token is based (the “Initial Founders”), created the core code for the Oldie Token. Members of the developer community donated bitcoin, fiat currencies, coin and their time in a collaborative effort to launch, develop and maintain the Oldie Token.

The Oldie Token Team released 10 million coins during its Proof-of-Work phase and has a total upper limit of 15 million coins. Following the initial release, a team of developers and hundreds of contributors launched the Oldie Token open-source code on Github, the Oldie Token switched from Proof-of-Work to Proof-of-Stake and began trading on several cryptocurrency exchanges. Tokens continue to be issued via mining and as compensation for on initial graphical works, website maintenance, code updates and other contributions to the Oldie Token project.

A few years after the initial issuance of the Oldie Token, the Initial Founders formed a Foundation to direct the continued development of the Oldie Token on open source blockchain. Over time developers have made changes and upgrades to the Oldie Token code including to the wallet, programming which enables user to register names on a server linked to the blockchain and send and receive Oldie Token, data storage and messaging. The Foundation also solicits donations to spend on further development on the open sourced Oldie Token blockchain. The Foundation is based in Switzerland.

Legal Analysis

As I’ve written about many times, the offering or sale of a security requires registration under the Securities Act and applicable state securities laws, unless it is able to fit within an exemption from registration. Registration under the Securities Act requires the issuer of the security to file a registration statement or offering circular in the case of Regulation A+ offerings, containing specified disclosure about the issuer, its management and business, including financial information. Likewise, the resale of a security by an existing security holder must either be registered or exempt from registration. The registration statement or offering circular is subject to review by the SEC before it can be used for the offer and sale of a security. The process can be both time-consuming and expensive.

Exemptions from registration under both the Securities Act and applicable state securities laws are generally designed for limited offerings of securities to qualified offerees, such as “accredited investors.” Broad-based solicitation without limits on the number or qualifications of offerees, or value of the offering, would make it difficult, if not impossible, to qualify for an exemption.

The registration requirements, or necessity to utilize an exemption, only apply to securities and accordingly, if Oldie Token is not a security, it could be issued or resold without compliance with the federal securities laws.

The Securities Act defines the term “security” broadly to include “investment contracts.” Several tests have been used by the SEC and the courts to determine whether an offering involves an investment contract and thus a security, with the most commonly used test being the “Howey test.” The SEC relied on the Howey test in its DAO Report in determining that certain offerings of tokens may be deemed securities.

As set forth below, I conclude that the Oldie Token is not a security requiring compliance with the federal securities laws.

The Howey Test

The US Supreme Court case of SEC v Howey, 328 U.S. 293 (1946) established the test for whether an arrangement involves an investment contract. An investment contract is a type of security. In Howey, the Supreme Court noted that the term “investment contract” has been used to classify those instruments that are of a “more variable character” that may be considered a form of “contract, transaction, or scheme whereby an investor lays out money in a way intended to secure income or profit from its employment.” The Howey test can be expressed as three independent elements (the third element encompasses both the third and fourth prongs of the traditional Howey test). All three elements must be met in order for a token or cryptocurrency to be a security, including (i) An investment of money, (ii) in a common enterprise, (iii) with an expectation of profits predominantly from the efforts of others. For more on the Howey test, see HERE.

(i) Investment of Money. Under Howey, and case law following it, an investment of money may include not only the provision of capital, assets and cash, but also goods, services or a promissory note. Given the broad definition of investment, Oldie Token distributed to developers for mining or other services to the Oldie Token Project may satisfy this part of the test, but it is also possible that a court might view the individual efforts of the miners or developers differently and conclude that no investment of money has occurred.

(ii) Common Enterprise. Different circuits use different tests to analyze whether a common enterprise exists. Three approaches predominate: (a) horizontal; (b) narrow vertical; and (c) broad vertical.

Under the horizontal test, a common enterprise is deemed to exist where multiple investors pool funds into an investment and the profits of each investor equal a prorated portion of the total profits of the pool. See, e.g., Curran v. Merrill Lynch, 622 F.2nd 216 (6th Cir. 1980). Whether funds are pooled appears to be the key question, and thus in cases where there is no sharing of profits or pooling of funds, a common enterprise may not be deemed to exist. For example, a court has found that a discretionary trading account was not an investment contract because there was no pooling of funds.

Under the horizontal test, the Oldie Token may be considered a common enterprise — notwithstanding the absence of a pooling of funds — where the reward for work, through mining or the contribution of other services, correlates to the reward received by the miners, developers or other members of the Oldie Token community receiving Oldie Token. Thus, although the Foundation has some control over the protocol, the rewards in the form of Oldie Token would likely be correlated.

Under the narrow vertical test, the key is whether the profits of an investor are tied to the promoter. For example, a court has found that the imposition of profit limitations on investors through requiring a promoter to receive an excess return rate tied to the investors return, satisfied this test. This test generally relates to income earned by a promoter from profits derived from participants.
Under the broad vertical test, the critical fact is whether the success of the investor depends on the promoter’s expertise. If there is such a reliance, then a common enterprise is deemed to exist.

Under either of the vertical approaches, however, a common enterprise may not exist given the decentralized nature of the Oldie Token blockchain framework. This is because those who receive Oldie Tokens depend on their own efforts (mining or otherwise), rather than on any expertise of the Foundation or the Oldie Token Team (even though the Foundation may in some cases control or influence technical permission or changes to the protocol). The key is the degree of control exerted by the Foundation; where there is less reliance on the Foundation’s expertise, there is less likelihood that the Oldie Token blockchain would be viewed as being part of a common enterprise.

The law on what constitutes a “common enterprise” is unclear and a definitive conclusion is not possible. Nevertheless, given that at no time has the Oldie Project received any funds from the issuance of the Oldie Token, and instead relies on donations, including donations made to the Foundation, to create, support and maintain the Oldie Token blockchain, a court would not be likely to find that the common enterprise element is satisfied. This is all the more the case since there was no presale of the Oldie Token or distribution to members of the Oldie Team.

An alternative test, sometimes called the “risk capital test,” focuses on whether the holder of an investment may be deemed passive, and in being passive, relying on the efforts of others. This test has four parts: (i) are any funds raised for use by a venture or enterprise; (ii) who is the target investor (i.e., is it the public generally, or a group comprised only of those with specialized interest or expertise in the area relating to the investment); (iii) how much influence do investors have on the success of the enterprise; and (iv) is the investor’s investment substantially at risk? The risk capital test does not seem applicable to the facts and circumstances of the Oldie Token distribution since it generally applies only in a limited number of jurisdictions, and typically is applied only in the context of “startup” capitalization for a business. Cases relating to the risk capital test generally relate to memberships in a club-like organization that does not allow commercial exploitation for profit, but only create a right of personal use. To the contrary, our fictional Oldie Token blockchain is an open-source system which allows for exploitation of the system by the Oldie Token owner. The Oldie Token Project does not receive funds from the issuance of Oldie Token. Moreover, the target investor in Oldie Token is the Oldie Token developer community, rather than the general investor class.

(iii) Expectation of Profit from the Efforts of Others. Under this element of the test, profit refers to the type of return or income an investor seeks on their investment (rather than the profits that might be earned from using the Oldie Token blockchain). This could refer to any type of return or income earned from being the owner of an Oldie Token, but for purpose of the Howey test and a securities law analysis would only include profits earned passively from the efforts of others. In other words, it is the essentially passive nature of the return, utilizing the efforts of others, that results in an “investment contract” and determination of the existence of a security, rather than a simple contract which in itself would not be a security.

In determining whether profits arise from the efforts of others, courts have been flexible including situations where there is significant or essential managerial or other efforts necessary to the success of the investment. An expectation of profits resulting from receipt of an Oldie Token primarily relates to whether the holder receives (i) rights or (ii) investment interests. While the holder of an Oldie Token may receive some form of financial incentive inherent in the Oldie Token’s current and potential value, these incentives are primarily derived through the efforts of the holder of the Oldie Token, whether obtained by mining or by providing other services, or whether developed outside of the open-source blockchain protocol.

That is, owners of an Oldie Token can utilize, contribute to or even license their own contribution to the Oldie Token blockchain in various ways, none of which would be considered a passive investment. Owners of Oldie Token received by mining or for services would be better viewed as active participants, like franchisees or licensees. Although the Foundation may have some managerial oversight over the Oldie Token blockchain, including the distribution of the Oldie Token, the Foundation seeks the consensus of the Oldie Token community to make changes to the protocol, again making the owners active participants.

The appreciation in the value of the Oldie Token after issuance, due to secondary trading, should not affect the analysis of whether an Oldie Token is an investment contract and thus a security. Other rights that are not investment contracts or securities, such as loyalty points, airline points, licenses and franchise rights, can increase in value over time due to the secondary market for those assets.

The manner in which the Oldie Token is distributed to developers and miners, particularly the promotion and marketing, likely affects the “expectation of profits” analysis. For example, we assume that since the Oldie Project’s public statements do not include words like “returns” or “profits” derived from the Oldie Token.

Reves and the Family Resemblance Test

An analysis of Reves and the “family resemblance test” as formulated by the Supreme Court in Reves v. Ernst & Young is only appropriate when determining whether a loan is a security under the Securities Laws. Reves focused on the term “note” rather than the term “investment contract” as such terms are included in the definition of a security under the Securities Laws. There is nothing about the Oldie Token that suggests it could be a debt obligation or that any party has an obligation of repayment. That is also generally the case with any token or coin. For more on the Reves test, see HERE.

License/Contract Right Considerations

Providing access to the open-source Oldie Token blockchain can be analogized to the grant of a license. Because software licenses are typically governed by contract law, one possible analysis would be to focus on the rights associated with the license that are granted by the licensor to the licensee. For example, the licensor’s rights would include the ability to grant or distribute all, some or none of the rights attached to the use of the software code (originally the licensor’s intellectual property), as well as the right to exclude certain parties from using any of those rights. Thus, the licensee would receive all of these rights, or a portion of these rights depending on what the licensor grants.

In the context of a license of the Oldie Token blockchain, if any, the Foundation would act as the licensor of the system, which includes the right to use the Oldie Token blockchain, but which does not include most other proprietary rights, including the right to assign or sublicense the Oldie Token blockchain or transfer any rights, other than those created by the developer/miner (licensee) by its independent contribution to a side blockchain, albeit one which builds on the public open-source Oldie Token blockchain. There are no voting rights inherent in the Oldie Token or provided to donors or other members of the Oldie Token community (other than, of course, the Board of the Foundation); at best there is an expectation that decisions will be made by consensus, and that users may use the Oldie Token blockchain for their own purposes, independent of the Foundation. Thus, of the bundle of rights, the only right is to use the Oldie Token blockchain, like any other open-source code. This limitation could be used to argue that the right is more analogous to a limited contract right rather than a security.

The DAO Report

The SEC has advised that tokens may be securities in certain circumstances, generally when involving raising capital for the issuer or seller of the tokens. On July 25, 2017, the SEC issued the DAO Report detailing its investigation into whether the DAO (an unincorporated “decentralized autonomous organization”), Slock.iotUG (“Slock.it”), its co-founders, and intermediaries violated the federal securities laws. Utilizing the Howey test, the SEC determined that the tokens issued by the DAO are securities under the Securities Laws and advised that those who would use distributed ledger or blockchain-enabled means for capital raising must take appropriate steps to comply with the Securities Laws (e.g., register the offering or qualify for an exemption from registration).

The DAO Report emphasized that whether a particular investment transaction involves the offer or sale of security is not dependent on the terminology used, but rather on the facts and circumstances, including the economic realities of the transaction. For more on the DAO Report, see HERE.

As detailed in the DAO Report, the concept of the DAO was memorialized in a white paper (the “DAO White Paper”) authored by the Chief Technology Officer of Slock.it. In the DAO White Paper Slock.it proposed an entity (a DAO entity) that would use smart contracts to attempt to solve governance issues it describes as inherent in traditional corporations. Slock.it organized a DAO as a crowdfunding contract to raise funds to grow a company in the crypto space. The DAO was a for-profit entity where participants would send ETH to the DAO to purchase DAO tokens, which would permit the participant to vote and entitle the participant to “rewards.” The White Paper described this as similar to “buying shares in a company and getting . . . dividends.” The DAO was to be “decentralized” in that it would allow for voting by investors holding DAO tokens. All funds raised were to be held at an Ethereum Blockchain “address” associated with the DAO and the DAO token holders were to vote on contract proposals, including proposals to the DAO to fund projects. Based on the vote of the DAO token holders, the DAO would use any “rewards” from the projects it funded to either fund new projects or distribute them to the DAO token holders. The DAO was intended to be “autonomous” in that project proposals were in the form of smart contracts that exist on the Ethereum blockchain and the votes were administered by the code of the DAO.

As described in the DAO Report, Slock.it was the promoter of the DAO and its tokens because it launched a website to describe and facilitate the DAO token sale, solicited media attention by posting updates on websites and online forums, communicated to the public about how to participate in the DAO token sale and retained the right to choose the “curators” that would determine what proposals to put to a vote by DAO token holders.

In applying the Howey test, the SEC found that the DAO’s investors relied on the managerial and entrepreneurial efforts of Slock.it, its co-founders, and the DAO’s curators to manage the DAO and generate profits.

Generally, the Oldie Project has a substantially different focus than that of the DAO. The DAO was focused on providing incentives for investment and promoting sales of the DAO token. Slock.it did this by emphasizing the DAO token’s potential for profits by distributions/dividends and appreciation in value. Oldie Tokens are not sold for other currency, fiat or virtual, but are issued for the contributions made by the miners/developers to the Oldie Token blockchain from which they benefit themselves. Moreover, the role of the Oldie Team and the Foundation is different from that of Slock.it, primarily in that, unlike Slock.it, neither the Oldie Team or the Foundation receive payment for their role and neither actively promotes the Oldie Token as an investment.

The Munchee Order

On December 11, 2017, the SEC issued a cease-and-desist order against Munchee, Inc. (“Munchee”) to stop Munchee’s ICO and require it to return to investors the funds it collected through the sale of its MUN token. The SEC found that Munchee’s token sale constituted an offering of securities in violation of the Securities Laws.

In applying the Howey test to the offering of the MUN token, the SEC gave little weight to the fact that Munchee characterized the MUN token as a “utility” token because of their functional use in connection with the business model of Munchee. Instead, the SEC focused on the manner in which the offering of the MUN token was marketed. In connection with the ICO, Munchee described how MUN tokens were expected to increase in value, especially as the result of Munchee’s future efforts. The SEC noted that Munchee made statements in its White Paper, on blogs, podcast and Facebook posts that suggested that investors would profit from purchasing MUN tokens. In addition, Munchee endorsed statements made by other commentators that highlighted the opportunity for profit through the purchase of MUN tokens, including, for example, by linking their public post on their Facebook page about the offering (“199% GAINS on MUN token at ICO price!”) to a YouTube video in which the person featured claimed that if investors got in early enough on ICOs they would make a profit. Munchee also stated in a blog post that investors could count on the burning of MUN tokens by Munchee from time to time to increase value.

In the Munchee Order the SEC noted that in its White Paper, Munchee said that they would work to cause MUN tokens to be listed on various exchanges to ensure that a secondary trading market would exist for MUN tokens. The SEC viewed such statements as priming “purchasers’ reasonable expectations of profit” and that “[p]urchasers would reasonably believe that they could profit by holding or trading MUN tokens, whether or not they ever used the Munchee App or otherwise participated in the MUM ‘ecosystem,’ based on Munchee’s statements in its MUN White Paper and other materials.”

In addition to concluding that purchasers of MUN tokens would have a reasonable expectation of profits based on Munchee’s states, the SEC concluded that those profits would be based primarily on the future efforts of Munchee. In the Munchee Order, the SEC said:

The proceeds of the MUN token offering were intended to be used by Munchee to build an “ecosystem” that would create demand for MUN tokens and make MUN tokens more valuable. Munchee was to revise the Munchee App so that people could buy and sell services using MUN tokens and was to recruit “partners” such as restaurants willing to sell meals for MUN tokens. The investors reasonably expected they would profit from any rise in the value of the MUN tokens created by the revised Munchee App and by Munchee’s ability to create an “ecosystem” – for example, the system described in the offering where restaurants would want to use MUN tokens to buy advertising from Munchee or to pay rewards to app users, and where app users would want to use MUN tokens to pay for restaurant meals and would want to write reviews to obtain MUN tokens.

The SEC focused on the ongoing efforts by Munchee after the token sale. However, in most cases token issuers intend to use at least a portion of the proceeds from the sale to further develop the token ecosystem. In the Oldie Token context, the work done by developers and miners, and other contributors to the Oldie Token project is rewarded with Oldie Tokens. I do not think that the SEC intended by its statements in the Munchee Order to require an issuer of cryptocurrencies to refrain from any ongoing development and promotional activities for its blockchain once it issues a cryptocurrency coin.

I believe that had the Munchee ecosystem been built and usable at the time of sale and had Munchee not marketed and promoted the MUN tokens in a manner that focused on the future profit and investment potential of MUN tokens and had instead focused on how the MUN token would be used in Munchee’s ecosystem and why the token was an important component of using and accessing the ecosystem, the SEC may not have found the token to be a security.

The SEC noted that Munchee focused on people interested in investing and making profits, not current users of the Munchee app or “people who, for example, might have wanted MUN tokens to buy advertising or increase their ‘tier’ as a reviewer on the Munchee App.” This is different from the Oldie Team and Foundation’s focus on miners/developers and members of the Oldie Token community who can contribute to the development of the Oldie Project (ecosystem) and not on the profits that may be derived from holding and investing in Oldie Token.

Realistically, in most cases, the developers and team involved in the creation of the cryptocurrency coin, such as is the case for the Oldie Team, will continue to play some form of role in supporting and developing the blockchain. This, in and of itself, is not a fatal fact. However, if the cryptocurrency has little or no functionality at the time of sale, as was the case with Munchee, the SEC may view this as indicative that the initial purchasers are passive investors hoping to make a profit as opposed to those desiring to participate in the development of the blockchain or to gain access to the products or services that will ultimately be provided through the blockchain’s ecosystem.

SEC Cryptocurrency Statement

Concurrently with the release of the Munchee Order, the SEC’s Chairman, Jay Clayton, released a statement on cryptocurrencies and ICOs that provides some additional insights into the SEC’s mindset in reviewing cryptocurrencies. He stated that “I believe that initial coin offerings – whether they represent offerings of securities or not – can be effective ways for entrepreneurs and others to raise funding, including for innovative projects.” He also reemphasized in his statement that “replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a block chain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.”

SEC v. PlexCorps

On December 1, 2017, the SEC’s newly created Cyber Unit filed a civil enforcement action in federal court against PlexCorps in connection with its ICO or the cryptocurrency “PlexCoin.” On December 4, 2017, the court granted the SEC’s request for an emergency freeze on PlexCorps assets. The PlexCoin White Paper written by PlexCorp characterizes PlexCoin as “the new Bitcoin.” It states that it is comparable to bitcoin but with faster confirmation speeds. However, in the PlexCorps White Paper, PlexCoin promised an investment return of 1,354% for presale purchasers. The SEC viewed these as fraudulent misrepresentations designed to promote the purchase of over $15 million in PlexCoins.

Although the PlexCorp litigation and the facts of the case have some similarities with that of the Oldie Token Project, there are significant differences, most notably the manner in which Oldie Token has been promoted, as a tool for the developer community and those who use the Oldie Token blockchain for their own business purposes, apart from the Oldie Team and the Foundation. I do not think this changes the analysis or warrants the finding that the Oldie Token blockchain as directed by the Oldie Team and the Foundation would be deemed a security.

Conclusion

Based on this analysis, I would be comfortable concluding that the Oldie Token is not a security requiring compliance with the federal securities laws. In the next chapter in this three-part blog series, I will set forth facts and analyze how a new token could be created and issued without being a security, and facts and circumstances which sway the argument in the other direction.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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« SEC Strategic Plan Securities Token Or Not? A Case Study – Part II »

Wyoming’s Blockchain Legislation

Posted by Securities Attorney Laura Anthony | July 31, 2018 Tags: 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 ethereum, used within Wyoming from money transmitter laws and regulations subject to providing certain specified verification authority to the Wyoming Secretary of State and Wyoming Banking Commissioner. The specified verification authority includes representations, warranties and undertakings by the issuer of “utility tokens” to confirm beneficial ownership of the token and to prevent unauthorized or fraudulent duplication of the token by third parties.

HB 19 defines a “virtual currency” as “any type of digital representation of value that: (i) is used as a medium of exchange, unit of account or store of value; and (ii) is not recognized as legal tender by the United States government.”

As a reminder, 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 or manipulation, the CFTC generally does not oversee “spot” or cash market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing. Rather, these “exchanges” are regulated as payment processors or money transmitters under state law.

However, despite the Wyoming state law exemption, businesses which issue or exchange these tokens would still be subject to FinCEN’s regulations and the requirements to comply with the Bank Secrecy Act (BSA). The BSA requires virtual currency exchangers and administrators, including those businesses that issue a virtual currency in exchange for other virtual currencies, fiat currency or types of value, to complete anti-money laundering (AML), know your customer (KYC) and other procedures to combat the financing of terrorism and prevent or detect the abuse of virtual currency to facilitate cyber-crime, money laundering, terrorist financing, black market sales of illegal or illicit products and services and other high-tech crimes. For more on FinCEN and the BSA, see HERE.

HB 70

Wyoming House Bill 70 removes utility tokens from specified securities and money transmission laws. In particular, any person that develops, sells or facilitates the exchange of an open blockchain utility token would not be required to comply with specified securities and money transmission laws subject to providing specified verification authority. The purpose of the statute is to make clear that utility tokens issued for non-investment purposes, are exempt from the Wyoming securities laws including registration and exemption provisions and broker-dealer registration requirements.

HB 70 defines an “open blockchain token” as a digital unit which is: (i) created (a) in response to the verification or collection of a specified number of transactions relating to a digital ledger or database, (b) by deploying computer code to a blockchain network that allows for the creation of digital tokens or other units, or (c) using any combination of (a) and (b); (ii) recorded in a digital ledger or database that is chronological, consensus-based, decentralized and mathematically verified, especially related to the supply of units and their distributions; and (iii) capable of being traded or transferred between persons without an intermediary or custodian of value.

HB 70 provides that the purpose of the token must be for “a consumptive purpose, which shall only be exchangeable for, or provided for the receipt of, goods, services or content, including rights of access to goods, services or content.”

Furthermore, HB 70 would not apply where the developer or seller of the token sold the token to the initial buyer as a financial investment. The requirement that the token not be an investment can only be satisfied if: (i) the developer or seller does not market the token as a financial investment; and (ii) at least one of the following is true: (a) the developer or seller reasonably believed that it sold the token for a consumptive purpose; (b) the token has a consumptive purpose that is available at the time of sale and can be used at or near the time of sale; (c) if the token does not have a consumptive purpose at the time of sale, the token is prevented from being resold until the consumptive purpose is available; or (d) the developer or seller takes other reasonable precautions to prevent the buyers from purchasing the token as a financial investment.

The SEC has been clear in numerous statements that it believes that tokens that are issued for the purpose of capital raising and an increase in value, are securities offerings that must comply with the federal securities laws. The SEC’s position relates to factors such as the method of issuance and sale of the tokens, use of proceeds, investment intent and expectation of profit, ability to increase value, whether the “utility” has been built out or established, and ability for secondary trading. The SEC has specifically not taken into account the ultimate utility value of the token, nor directly answered the oft asked question of whether a token that is issued in a securities offering, can then morph into a commodity or other asset class, not subject to the securities laws. It is my view, and the general view of the marketplace, that “utility tokens” can be sold in a “securities offering.”

Although the Wyoming statute attempts to address the investment intent, and even appears to attempt to address the SEC main criteria, I would suggest that issuers of any tokens should continue to comply with the federal securities laws until there is further guidance and certainty at the federal level.

SF 111

SF 111 provides that virtual currency is not subject to taxation as “property” in Wyoming. That is, virtual currency would be treated as personal property, not subject to Wyoming property taxes. SF 111 amends a prior statute that exempted money and cash on hand, currency, gold, silver and related items by adding virtual currencies. Like HB 19, SF 111 defines a “virtual currency” as “any type of digital representation of value that: (i) is used as a medium of exchange, unit of account or store of value; and (ii) is not recognized as legal tender by the United States government.”

HB 101

HB 101 allows for the maintenance of corporate records of Wyoming entities via blockchain that utilizes electronic keys, network signatures and digital receipts. In particular, the Act authorizes the use of electronic networks or databases for the creation or maintenance of corporate records, authorizes the use of a data address to identify shareholders, authorizes the acceptance of shareholder votes if signed by a network signature that corresponds to a data address and specifies the requirements for the use of electronic networks and databases. In addition, the Act requires the secretary of state to review and update its rules for consistency.

HB 126

HB 126 allows the creation and use of “series LLC’s.” Delaware is well known for its series LLC statute. Series LLC have become popular in the blockchain space and accordingly it is thought that this will attract blockchain-based businesses.