SUMMER 2018 SPEcial topic
Cryptocurrency, Blockchain, & the SEC's Actions
To understand why governments are interested in regulating cryptocurrencies, background about their potential function is necessary.
To understand why governments are interested in regulating cryptocurrencies, background about their potential function is necessary.
Corporate boards face increasing compliance responsibilities and must consider how best to handle those responsibilities. There are various sources of the increasing burdens and pressures being placed on corporate boards. Among them are the traditional legal duties of due care, good faith, and loyalty placed on directors, with possibly severe consequences if directors fail to fulfill those duties. Included in the duty of care is the especially challenging duty of establishing and monitoring internal controls, the so-called Caremark duty, which lies at the heart of fulfilling the board’s compliance responsibilities.
The Securities and Exchange Commission (SEC) held a roundtable on November 15 to discuss whether the SEC’s current proxy voting rules and procedures should be updated. (Chairman Jay Clayton, SEC Announcement). According to the announcement, the evidence and testimony presented at the roundtable will aid SEC staffers in making their recommendations about what changes should be made. (Andrew Ramonas, Bloomberg Law). The roundtable is scheduled to discuss several topics, including the voting process, retail shareholder participation, shareholder proposals, proxy advisory firms, technology and innovation, and other actions. (Chairman Jay Clayton, SEC Announcement).
Blockchain and cryptocurrency are now mainstays in financial markets and initial coin offerings (“ICO’s”) are giving companies and firms a new avenue to raise capital. Within the cryptocurrency market, “stablecoins” offer a unique form of cryptocurrency to investors. Stablecoins are cryptocurrencies pegged to real-world assets such as the dollar (“USD”) or gold. (Oscar Williams-Grut, Business Insider). Breaking from the volatility seen in other cryptocurrency markets, stablecoins are an attempt to combine the benefits of digital transfer offered by cryptocurrency with the stability of mainstream currency. (Oscar Williams-Grut, Business Insider).
On September 20th of this year, fashion industry giants Michael Kors Holdings Limited (“Michael Kors”) and Gianni Versace S.p.A. (“Versace”) issued a joint press release announcing that Michael Kors would purchase Versace for $2.12 billion. (Katina Metzidakis, Business Wire). The transaction is expected to be completed in Michael Kors’ fourth quarter, which ends April 1, 2019. (Michael Kors Holdings Limited, 2018 Annual Report). When the transaction is complete, the company will be renamed Capri Holdings Limited (“Capri”), after the famed Italian island “long recognized as an iconic, glamorous and luxury destination.” (Katina Metzidakis, Business Wire). This post provides an overview of the transaction and its anticipated effects.
Countries around the world are being forced to decide what role, if any, cryptocurrencies and initial coin offerings (“ICOs”) will play in the future of their financial markets. Russia is no exception. Russian officials’ initial actions included proposals that would prohibit private investors from investing, ban cryptocurrencies altogether, and even imprison users (Maria Prusakova, Medium). Recently, however, changes appear to be on the horizon as Russian President Vladimir Putin began pushing for legislation addressing cryptocurrencies, crypto mining, and ICOs. While the official drafts are still working their way through Parliament, the proposed regulations will allow for some form of ICOs and digital asset trading. (Id).
Vertical mergers, unlike more-litigated horizontal mergers, are governed by few guidelines from antitrust regulatory organizations and, until recently, had never been challenged in federal court. The approval of a vertical merger between AT&T and Time Warner (“The Merger”), despite protests from the Antitrust Department of the U.S. Department of Justice (DOJ), has shed some light on merger control rules for vertical mergers. This post provides an overview of: (1) vertical merger laws; (2) The Merger; and (3) the governing principles that have emerged since the approval of the AT&T transaction. (Noah Brumfield, Antitrust & Trade Regulation Report (BNA)).
Following the appointment of Chairman Joseph Simons to the Federal Trade Commission (FTC), large tech companies including Google, Facebook, and Amazon should expect tougher enforcement against anti-competitive behavior. In recent years, the FTC has become increasingly concerned that these large tech companies may be violating antitrust law and limiting competition in the market by acquiring small startups or otherwise vertically integrating.
Simons’ appointment comes at a time when mega-mergers among technology companies are commonplace.
With the revolutionary technology known as blockchain quickly spreading across the globe, regulators are struggling to find an ideal balance between regulation and innovation. The critical question is whether cryptocurrencies and initial coin offerings (“ICOs”) are unique enough to warrant the creation of a new categories or if they should be considered securities and therefore subject to existing securities laws and requirements. Because new cryptocurrencies do not require government backing, many leaders in the cryptocurrency arena fear additional regulatory delay, or excessive regulations, will lead many cryptocurrency founders to take their innovation and multibillion dollar businesses overseas to countries with more established and favorable regulations (Kate Rooney, CNBC).
The emergence of cryptocurrency and blockchain poses questions for financial regulators around the world. Regulators are struggling to understand both where cryptocurrency fits within their regulatory framework and how to set up parameters for transparency and investor integrity. (Bob Pisani, CNBC). Recently, American regulators increased scrutiny for broker-dealers working with cryptocurrency. (Benjamin Bain, Bloomberg). Financial powers in other countries are also responding individually to the crypto-movement, and France exemplifies a recent response.
In SEC v. Cade, No. 2:18-cv-01323-JEO (N.D. Ala. Aug. 17, 2018), the SEC filed an initial complaint against Catlin Cade (“defendant”) alleging a violation of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and SEC Rule 10b-5 by trading shares of Golden Enterprises, Inc. (“Golden”) on the basis of material nonpublic information.
According to the allegations, a director of Golden learned of nonpublic information pertaining to a contemplated merger between Golden and a second company. The director separately owned and controlled a different privately held company (“Director’s Company”)
Last month the Securities and Exchange Commission (SEC) obtained a permanent officer-and-director and penny stock bar against Tomahawk Exploration LLC founder, David T. Laurance, for perpetrating a fraudulent initial coin offering. (SEC Press Release). On its face, the decision shows the SEC merely enforcing its previous statements that anything resembling a security will be labeled as such and regulated under the Securities Act. The ruling, however, extends the umbrella of SEC oversight to explicitly include “Bounty Programs”—a mainstay practice for many initial offerings.
Crypto exchanges—which operate much like traditional stock exchanges—are online platforms where crypto currencies are traded. Traditional exchanges deal almost exclusively with exchanging fiat, or legal tender currency, for highly regulated securities, such as stocks and bonds. Similarly, crypto exchanges primarily deal with trading one cryptocurrency for another. It is unclear which agency has, or should have, authority to regulate this arena because these exchanges primarily trade one currency for another. Regulating crypto exchanges is difficult because of the subtly different and often overlapping definitions surrounding initial coin offerings (ICOs) and cryptocurrencies (Michael del Casillo, Forbes). The unprecedented growth and increasing number of new crypto exchanges and cryptocurrencies is another factor making unified regulation increasingly difficult.
The Public Company Accounting Oversight Board (PCAOB) is a nonprofit entity that was created with the passage of the Sarbanes-Oxley Act of 2002 and established by Congress to oversee the audits of public companies with the goal of protecting investors and the public's interest by promoting accurate and independent audit reports (About the PCAOB). In addition to its oversight of public company audits, the PCAOB also oversees the audits of brokers and dealers (About the PCAOB). Much like the Securities and Exchange Commission (SEC), the PCAOB's mission is to protect investors.
As cryptocurrency and blockchainbecome more prominent in today’s financial markets, regulators around the worldare coping with how to maintain transparency and legitimacy in the market. Recently, the Securities and Exchange Commission (SEC) and its new cyber unit began requesting specific information about cryptocurrency brokerage and Initial Coin Offerings(ICO’s) for enforcement purposes. (Josephine Wolff, Slate; Benjamin Bain, Bloomberg). The results of the requests remain unclear, but the probe for information sheds light on the SEC’s suspicion of misconduct.
On August 7, Elon Musk made an abrupt announcement regarding his plan to take Tesla private. Mr. Musk claimed that this Twitter announcement came after he had “secured” funding from the Saudi Arabian sovereign wealth fund. (Ben Bain and Matt Robinson, Bloomberg). After the announcement, Tesla’s shares rose in value to over $381 per share, from $342 (the closing price on August 6). (Mark Matousek, Business Insider). Nevertheless, the share price dropped dramatically over the next few weeks to as low as $263 on September 7.
Earlier this year, the Securities and Exchange Commission (SEC) amended Rule 15c2–12 (17 C.F.R. § 240.15c2–12). Rule 15c2-12 ensures that underwriters secure an agreement with states, cities, and other governmental entities issuing municipal securities that those entities will disclose information about the issued securities to the Municipal Securities Rulemaking Board (MSRB) on an ongoing basis. This information is intended to inform interested parties on the financial standing or other condition of the state government that may have an effect on the bonds.
The precipitous rise of cryptocurrencies has numerous implications for securities trading, the most fundamental of which is when, and if, any given cryptocurrency exchange is required to become a registered exchange as defined by the SEC.
A cryptocurrency is a digital currency that can be traded and exchanged (Ian King, Investopedia). One defining feature of cryptocurrency is that it is decentralized, meaning it is not issued by a central bank or regulatory agency. Id.This foundational aspect of cryptocurrencies is desirable to investors because unlike traditional fiat currencies that are subject to governmental control and manipulation, cryptocurrencies and their values operate independently from a central authority.
An initial coin offering (ICO) is a capital raising mechanism whereby companies sell bitcoins to investors or buyers in exchange for funds. (Usman Chohan, Initial Coin Offerings (ICOs): Risks, Regulation, and Accountability). An ICO is different from traditional capital raises. Rather than selling shares of stock in a company, an ICO offers digital currencies or cryptocurrencies. In addition, most ICOs do not offer equity or a stake in the company’s projects. The concept of using ICOs to raise capital has grown exponentially in recent years as they pose a cost-efficient way of conducting transactions with little regulation. ICOs, however, also pose a greater risk of fraud due to their place in the unregulated market.
The regulatory landscape for cryptocurrencies is fast paced, ever-changing, and hard to pin down (see Element Group report). To understand why governments are interested in regulating cryptocurrencies, background about their potential function is necessary. Cryptocurrencies enormous potential comes from the use of “public ledgers” which, through a complicated application of cryptology and software, reduce transaction costs associated with value transfer by creating independently verifiable transaction validations. The public ledger system, however, only documents transactions and ownership. The only identity recorded on the ledger is "a set of letters and numbers . . . representing the [user's] public cryptocurrency address."
Unlike other currencies and monetary systems that rely on a centralized authority, such as banks, to track transactions, maintain records, and ensure balances remain accurate and current; cryptocurrencies operate without any type of centralized reporting system. Instead, cryptocurrencies, such as Bitcoin, utilize a decentralized network to verify and confirm transactions, track balances, flawlessly store and maintain records, and even generate new currency. While the exact manner in which this is accomplished is extremely technical and complex, it essentially boils down to giving every node, or peer, on the network access to all the records, including balances.
With the popularity and growth of cryptocurrencies many companies are using initial coin offerings (“ICOs”) to raise capital. ICOs allow investors to exchange typical currency for a coin or token. The ICO market continues to grow—in 2017 an estimated $4 billion was raised through ICOs. (Jay Clayton, U.S. Securities and Exchange Commission). So far, 2018 has seen $2 billion raised through ICOs. (David Sacks and Josh Stein, Harbor). Funding a venture through a cryptocurrency gives companies and individuals the ability to make transfers regardless of geographic location, and it has lower transaction costs than traditional financing methods. Using cryptocurrencies, however, also has drawbacks—mainly anonymity of purchasers and sellers coupled with a lack of government regulation.
The rise of blockchain and cryptocurrency has taken the financial world by storm. In 2017, various companies and financial firms raised capital through initial coin offerings(“ICO”). As cryptocurrency becomes more politically popular, world economic powers are faced with an important question: how do we regulate cryptocurrency? Currently, regulatory approaches vary from country to country. Outside of the core desire to remove anonymity and push adherence to tax laws, government actions have been anything but consistent. (see Element Group report). While the current cryptocurrency regulatory landscape is in flux, this article addresses recent trends and responses to the crypto explosion around the globe.
According to CoinMarketCap, as of July 24, 2018 the total market capitalization of all cryptocurrencies was just shy of $303 billion with Bitcoin’s market capitalization at $140 billion (17.1 million coins in circulation), down from a high of $828 billion and $294 billion, respectively, in early January 2018.
A recent report in the Financial Times indicates that there are approximately 1,600 individual investors (generally thought to be high net worth individuals), known as “Bitcoin whales” who hold one-third of the Bitcoins in circulation, and of those, approximately 100 investors own between 10,000 and 100,000 Bitcoin each in their wallets.
A Decentralized Autonomous Organization (DAO) is an organization in which the traditional business management scheme is replaced by blockchain technology. While DAOs function like corporations in some ways, they replace board members with code and leave business decisions up to token-holders who exist as nodes along the blockchain. No single entity owns the DAO, and the organization’s day-to-day operations are executed via smart contracts. This note introduces readers to DAOs, provides insights into how major industry players and regulators are interacting with them, and speculates on how DAOs may influence the future of corporate law.
By late 2017, the value of Bitcoin (BTC) had risen to an unprecedented $19,843 per coin after trading below $1,000 just a year earlier. Though it has fallen well below those highs, Bitcoin’s value — and the value of other cryptocurrencies like Ethereum — has continued to remain much higher than anyone expected.
Where does this value come from? Among the many potential factors is supply and demand. Bitcoin, for example, is limited to a total of 21 million coins. By now, more than eighty percent of those have already been mined (Molly Jane Zuckerman, CoinTelegraph).
In Stoddard v. S&N Logging, Inc., No. 35038-0-III (Wash. Ct. App. Jan. 25, 2018), S&N Logging, Inc. (“S&N”) and Newman Logging, Inc. (collectively “Defendants”) moved for summary judgment against Roy B. Stoddard (“Plaintiff”) for failure to claim a remedy from the dissolution of a corporation within the time allowed by the statute of limitations. The Washington State Court of Appeals affirmed the trial court’s grant of summary judgment.
By Megan Herr & Thomas Dyer
Innovators have a tendency of identifying problems and subsequently creating a solution instead of the inverse. Great ideas do not make historic innovations; creative solutions to problems do. Cryptocurrency arose out of the identified problems contained in “traditional” fiat currencies. Transactions involving fiat currencies are often traceable by parties who should not otherwise have access to that information. Cryptocurrencies effectively address both of these problems, along with a handful of others through innovations including blind algorithms and the related blockchain technology.
Initial coin offerings (ICOs), also sometimes called token sales, have exploded as the fastest growing segment of the world-wide capital markets. ICOs gained prominence in 2016 following a $160 million raise by an entity called “The DAO.” (Connie Loizos, TechCrunch) ICO fundraises grew from an estimated $263 million in 2016 to north of $5 billion in 2017. (Oscar Williams-Grut, Business Insider) The trend has continued in 2018, with an estimated $9.5 billion raised through the first five months of the year. (Coinschedule; see also Katie Rooney, CNBC) Despite this growth, there is still considerable legal uncertainty as to the status of ICOs and whether they are subject to regulation as securities in the United States.
In Cohen v. Kitov Pharmaceutical Holdings, Ltd., No. 17 Civ. 0917 (LGS), 2018 BL 94656 (S.D.N.Y. Mar. 20, 2018), the United States District Court for the Southern District of New York denied in part and granted in part a motion to dismiss a putative class-action suit against Kitov Pharmaceutical Holdings, Ltd. (“Kitov”), CEO Isaac Israel, and CFO Simcha Rock (collectively “Defendants”) brought by lead plaintiffs Rotem Cohen and Jason Bruening (collectively “Plaintiffs”). The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Act”). The court denied the motion to dismiss with regard to defendants Kitov and Israel but granted the motion to dismiss concerning defendant Rock.
Smart contracts are self-executing transactions that are written in computer code often utilized to “facilitate, execute, and enforce agreements between two or more parties.” While the term might sound new to some, the phrase was actually coined in 1994. The concept behind a smart contract is rooted in basic contract law; offer, acceptance, and consideration are all necessary, but smart contracts are enforced by different means. A key advantage of using smart contracts is efficiency. Once uploaded to the blockchain, smart contracts do not rely on a third party for recordkeeping or enforcement. Because they are self-executing and stored on a shared platform, smart contracts could potentially eliminate the manual effort currently necessary to execute domestic and international financial transactions.
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