Takeaways on the Regulation of Crypto Assets from Late 2018 Comments of Several SEC Officials

by Perkins Coie
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On Wednesday, December 12, 2018, the D.C. Bar hosted a panel to discuss current developments in the world of crypto.  Among the panelists were two senior SEC officers: Jonathan Ingram, Deputy Chief Counsel, Division of Corporation Finance, and Jennifer Leete, Assistant Director, Division of Enforcement.  Also participating on the panel was Era Anagnosti, a former senior manager in the Division of Corporation Finance of the SEC who in part oversaw the process relating to, among other things, various crypto-related registration filings.  The following is a summary of certain topics discussed at the panel regarding both corporate finance and enforcement as well as some key takeaways.

Corporation Finance

Remarks by Jonathan Ingram

In his remarks, Mr. Ingram addressed issues relating to digital assets and fundraising under the federal securities laws.  As an initial matter, Mr. Ingram explained that SEC staff in the Division of Corporation Finance have spoken to many issuers and potential issuers, in the crypto space.  Based on those conversations, he suggested that when considering whether a token or coin or other similar digital asset is a security, people start with the presumption that if there is fundraising involved, then the token is a security; to date, he said he has not seen one that is not.

Mr. Ingram also explained that the SEC staff has seen many models and approaches, and of the ones they’ve seen, the digital assets that do not appear to be securities have had several common traits:  (a) they are in no way tied to fundraising; (b) they are issued on fully functional ecosystems; and (c) the business is independent of and would survive without the tokens.  In other words, the tokens merely provide an enhancement to an existing business.  Mr. Ingram shared that many people have approached the SEC arguing that their token issuance—which was or would be tied to fundraising in some shape or form—is not a security because of its utility, decentralization, and/or functionality.  However, the SEC staff has found these arguments unconvincing.  To quote Mr. Ingram, “If it starts off as a security, it must register as such or be exempt from registration.”

Mr. Ingram provided a series of observations on characteristics of digital assets that do not appear to be investment contracts:

  • Fundraising and timing:

o   Fundraising occurred prior to the digital asset issuance and was done via traditional methods.  In other words, the company behind the token conducted a registered or exempt issuance of debt or equity to fundraise.

o   The token issuance occurred after the token’s ecosystem was fully functional.

  • Secondary markets and valuation:

o   The token has diminishing, little, or no value outside of the ecosystem.  Specifically, there is no potential for the token to increase in value outside of the ecosystem (e.g., Chuck E. Cheese’s tokens outside of a Chuck E. Cheese’s location are worthless; there is no economic incentive to take them outside the Chuck E. Cheese’s ecosystem).

o   Secondary market trading is little to none.

  • Utility and purpose:

o   Purchasers are purchasing the digital assets for consumption, not investment.

o   Tokens are not primary to the business and the business would continue to operate without them.

o   Tokens only provide efficiencies to the business and are an additional feature.

Mr. Ingram was asked when the SEC would provide additional information expounding on Division of Corporation Finance Director William Hinman’s meaning with regards to mutability.  He responded that Director Hinman’s speech needed to be taken in context and, in short, the SEC does not have a view that mutability alleviates the initial registration requirements.

Remarks by Era Anagnosti

Era Anagnosti, a former senior manager in the Division of Corporation Finance, shared additional insight into what should be included in corporate securities filings with the SEC relating to crypto securities.  Specifically, Ms. Anagnosti addressed what may be required on Form 1-A or S-1 to achieve effective registration in the crypto context.  She stated that there have been numerous crypto securities registrations filed with the SEC and some have been publicly filed.  The publicly filed registrations include eight 1-A filings and two S-1 filings, none of which have been declared effective. She noted that these 10 public filings are all self-underwritten best efforts offerings.

Based on a review of the crypto filings to date, Ms. Anagnosti shared her thoughts on what a token issuer should include in a corporate securities filing:

  • Descriptions:

o   The intersection between the business and the technology must be fully assessed and described.

o   The terms of the token must be sufficiently described.  Attention to detail is key.

o   What the token represents must be described in clear comprehensive detail (i.e., debt, equity, asset).  (Of note, Mr. Ingram provided a different take from Ms. Anagnosti on this point, merely stating “debt or equity” regarding what a token may represent.  The SEC has yet to issue any specific guidance stating that the interest must be limited to equity or debt, however.  Practitioners should be aware of this and assess whether the interest being offered may be a factor in an effective registration.)

  • White Papers:

o   White papers should be submitted in the exhibits as part of the registration filings.

o   Outside counsel should be aware that the SEC staff generally views white papers as an offering document.  (Of note, Mr. Ingram and Ms. Leete each came back to this point and stated that what is represented in the applicable white paper must be consistent with the information provided both verbally and in writing to the SEC and to investors.)

Finally, with regard to providing detailed information in the filings, Ms. Anagnosti recommended reviewing the CFTC “Primer on Smart Contracts.

Enforcement

Remarks by Jennifer Leete

Ms. Leete provided an overview on the SEC’s previous enforcement actions in the crypto context and then sought to highlight several key points:

  • In terms of strategies for dealing with the Division of Enforcement, Ms. Leete stated that cooperation and self-reporting are substantial factors in mitigating liability. Both are strongly encouraged.
  • Regarding the recent Airfox and Paragon actions:

o   They are two unrelated cases that the SEC staff purposefully announced together to send a message.

o   The settlements do not cure the respective Securities Act of 1933 Section 5 violations (for failing to register a securities offering).

o   In the wake of each entity registering its securities under Section 12(g) of the Securities Exchange Act of 1934 via filing Form 10, the registration is slated to automatically go effective 60 days post-filing and Airfox and Paragon will become reporting companies.  Mr. Ingram added that it is unlikely that these two entities will drop below 300 holders (the threshold to cease being a reporting company) because of the decentralized nature of the trading.

  • Finally, Ms. Leete discussed the SEC’s enforcement strategy in the crypto context:

o   She stated that enforcement in this area will continue to be vigilant and vigorous.

o   She explained that even though she is not in the Division of Enforcement’s Cybersecurity unit, her work on crypto-related cases is one example of how the Division of Enforcement continues to allocate additional resources to this particular area outside of the specifically assigned Cybersecurity unit.

Upcoming Items for 2019

During the panel, Mr. Ingram provided several announcements about things to expect in 2019:

  1. The SEC will host a Crypto Forum sometime in 2019.
  2. The SEC expected to issue plain language guidance specific to crypto securities compliance by early 2019 (however, this was stated prior to the current government shutdown).
  3. Mr. Ingram, currently Deputy Chief Counsel, has been named Chief Legal Officer for Digital Assets and Innovation within the Division of Corporation Finance, where he will continue to work closely with Valerie Szczepanik, Senior Advisor for Digital Assets and Innovation.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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