Webcast: Virtual currencies and the regulatory environment – a look around the globe



good afternoon welcome to the Evershed Sutherland webcast virtual currencies and the regulatory environment a look around the globe if you have any questions during the webcast please submit them via the ask a question text box on your viewing console daily credit is proof for this webcast in California Georgia New York Nebraska and Texas and is pending in Illinois and Virginia if you'd like to receive CLE credit for this webcast please download and submit the CLE sign-in sheets and evaluation forms we will provide you with the confirmation code for you to enter on your sign-in sheet this webcast is being recorded and the final version will be posted on the error shade Sutherland website within the next week oh now I'd to turn it over to Greg Kaufman partner at ever shed Sutherland thank you very much and thank you everyone for joining today my name is Greg Kaufman I'm a partner in the Washington office had ever shed Sutherland in the Securities and commodities litigation group on the webinar with me today is Andrew Henderson he's a partner in our London office in the financial institutions practice and then we also have on the line Duncan watt he is a consultant in our Hong Kong office and he is also in the Financial Institutions practice but also in the subgroup financial services disputes an investigations team so what could be more fitting than to have this presentation today when we learn that over the weekend the block one IC o—- completed its fundraising efforts for its EAS token and they raised four billion dollars the fifth most valuable cryptocurrency out there right now they did not have a live product when the IC o—- completed they do now a blockchain application platform and they're off and running so it is a fast moving and kind of a wild environment that we're in right now and if there's any better example than I think that block 1 ICO is a good one so with that we're going to hand it off to Andrew to talk about the UK perspective on virtual currencies in the regulatory environment Greg thank you very much first off I've just clicked the slide to another words initial coin offerings and introduction thought should show up so I trust it does what I'm going to do is to say a few words by way of introduction particularly do that we were able to explain what we mean when we talk about cryptocurrencies we talked about talk about blockchain and then also really to just go through some of the discussions around the ico process teasing out some of the the themes we we will something I will touch on some of the the definitional issues we have in the UK and Europe but really that the point of these first 20 minutes or so are mainly to to just put I think a lot of what follow is into into context so I think the first point really moving on the next slide is just to talk about the ICO process and and just to be clear about terminology starting really with what we mean when we we talk about cryptocurrency and it's widely used term perhaps little understood but we say that key point about a cryptocurrency is that it is a digital virtual currency and the term virtual currency is actually a legal term of art amongst European Union lawmakers that uses cryptography for security and one of the advantages is that it's difficult to counterfeit because of the security feature so defining feature of a cryptocurrency and arguably its most enduring allure is its organic nature it's not issued by any central authority and this means that theoretical its immediate it's immune to government interference or manipulation now the most famous example arguably of a cryptocurrency is Bitcoin I won't say anything more about that I think a second point to note however is that these terms have been scrutinized a lot more closely and we start saying that what becomes important is to look at the various functions of a cryptocurrency it's common to refer to covet can see as it as if it as a single concept however this is misleading because there are over a thousand cryptocurrencies and they all perform a vast range of functions having said I wasn't going to mention Bitcoin again I shall but Bitcoin for example is really designed to act as a cash substitute and its value is really derived from its usefulness or utility and this is why we sometimes hear people talking about utility coins or utility tokens there are other crypto currencies which really act as a mechanism for facilitating the operation of decentralized structures for example script occurrences such as etherium which are very flexible and can be used of a variety of of structures now a more functional approach would by you look at not on something's called but what it does is also important when we start getting to the question of whether or not a cryptocurrency ought to be classified as something akin to a transferable security or whether it is more correct to think about it as a a virtual currency or whether there's some third type of of application and we have talked about it a crypto fuel which is essentially used to to power for example a blockchain and really this is the the the third point that I I wanted to to come on to to talk about and that is the the use of of the blockchain and the importance of the blockchain now central to the appeal of a lot of cryptocurrencies is the blockchain technology and this is essentially used to store online ledger of all the transactions that have ever been conducted in the particular cryptocurrency so this provides a data structure the ledger and it's exposed to limited threat from hackers and can be copied across all computers running the particular the particular crypto software what we say is exciting and certainly when clients have come to us with blockchain technology but what is exciting in a financial instruments context is the fact that people are all the users of the blockchain are given visibility of what is on a blockchain and the blockchain itself becomes or means or place that exchange can occur and I think this is important as we begin to unpack some of the ideas about how things actually happen on the blockchain and I think this in turn makes it easier for us as as lawyers and consultants to advise I think for clients then to use these techniques so with with that almost five minute introduction in mind I think it's important just to not turn to the initial coin offering process and think what we say to clients really is is that their four main points here the first is the idea and asking question why use an ICO then as law as always we're keen on the documentation the third point is around marketing and the fourth point which is very important not an overlook this is what happens after the offering and has occurred and I think it's important also that to just think about this term offering and translating across say to a initial public offering of securities we always talk about the offering really been the the act of inviting people to treat inviting people to subscribe for that which you are offering to them so it really is a kin to the marketing process and hence the importance of of tying it to documentation and I think it's important of these concepts because people will often talk very loosely about regulating Isis isn't ico regulated and they're generally speaking in the language around marketing or raising the type of that a securities lawyer would would use but there's a there's a further aspect that is important and that is really the aspect what what I guess one referred is the broker-dealer investment advisor aspect and that is that are their activities being carried on by those advising the ico provider those providing the technology both for the the initial purchase and then subsequent purchases is there also room to say that they ought to be regulated nothing but as two forms of regulation are are very important now diving into the the actual I see a none and I should have moved to the next slide and the first question we will put to clients as well why why do you want to use an ICO or why why use the blockchain and and what is important really has to understand the proof-of-concept or the unique selling point which in a sense will go to the commercial reason for wanting to issue a and we're going to use just to use the term krypter krypter token because that will take an occurrence he'll take in the security it will take in the fuel why use that why not for example just simply use a normal fund raise plants Khan doesn't says well we we require money for our company you know either in the form there could the ordinal form of debt and we said well why don't you just do that often they will say and no we have another another idea we actually want to create almost a closed architecture whereby the coins we all the tokens were selling are actually utility tokens within this closed architecture people can buy and sell things others will simply say no this is a form of financing but actually there is a genuine investor demand for for crypto assets rather than conventional assets essentially crypto securities rather than securities and we are working with certain science are also looking at how the tokenization of securities can lead to smoother transactions cheaper transactions for example if you have a share that individually has great value by tokenizing that share you can divide it into say ten parts for example I could then sell Apple shares to those who couldn't afford them in any sensible amount or berkshire hathaway shares so there are a lot of a lot of potential applications that way i think other questions we will ask besides saying why this this route is who do you have on your team and it's important to make sure that vitally important are the coders one point we really would emphasize here we really said that the reason we think of crypto currency or crypto assets such as because of the cryptography for security it is the role of cyber security I know it's a much used term and that it is vitally important one of the biggest threats to the success of an ICO of people being able to to hack in and disrupt all we're still actuals actually commit theft and then you will serve ich is run marketing we also throw in there legal advisers because by definition they're important of course but really making sure that those coming to – – marketers were are serious about the business we also find ourselves having to advise people on basic governance structures sometimes saying that if you're going to be taken seriously you want to have a viable business so these are all these all important points next is the question really of of what is being offered I moved on to the next next slide and this is where the classification piece becomes important and great I know that you're going to talk more about that because I think that has a particular significance in in the United States in Europe we will really look to the function of the particular crypto token as I mentioned and ask the questions about what what is it that it does rather than what is that we are calling it and one of the first questions now will ask is whether it's a transferable security or naturally is and European Union term the significance of that is that if something is a transferable security you will require an approved prospectus unless you do it by way of a private placement and the private placement it is is someone way a form of offering that you can do to particular types of investors and we do talk in a similar way having States to creditors investors or else offering to a small number of people and but that really has a significance there I had also mentioned earlier in addition to the really securities law or offering question of when I refer to the broker dealer question but the question of whether those carrying on activities and connection of the offering would also need to be regulated now in the the United Kingdom the the financial conduct authority which is the closest and loved to be the SEC in the US or all the Securities and Futures Commission in in Hong Kong and they issued a statement really warning investors of the dangers of investing in as they called it crypto currency but at the same time saying that cryptocurrency was not necessarily regulated unless it happened to be an investment designated investment or translating into a transferable security again that's that questioner on the functional thing becomes important and so that is going to be a threshold question some of our clients and we've been able to argue that what they're offering is more in the form of the utility token actually used almost as a currency substitute or transferring value rather than a security but one set of clients at least are looking essentially to to tokenize or digitize shares not just for recording but also for trading and those shares in the blockchain so it's clear that those are securities we will make the necessary disclosures people get regulated and we're actually working together with the FCA and taking clients through their program the second question is whether it could be said that the tokens amount to a a fund or or investment contract and this becomes trickier I mean in essence asking questions around whether there is a cooling of of the sharing in in capital or profits and again in the u.s. they also talked about whether something could be an investment contract and the danger there is that you would be subject to restrictions on on a how it has actually managed the issuer or people advising you sure having to become investment advisors the type of people to whom the Queen at least rather the the Arthur can be offered being limited so that piece of classification becomes important in the United Kingdom there's a very broad and almost ancient definition of something called a unregulated collective investment scheme and there's a danger that that certain offerings may be caught in that the third point is to ask about whether it's it's a payment services mechanism and when we read through something is what is it the case that actually all that is happening is that we haven't got a virtual currency but we have a real currency that's simply been digitized and people are using say using the blockchain in the guise of a cryptocurrency to simply transfer currency from A to B that is a regulated activity in Europe under something called the the payment services directive and again if the substance of of what has actually been done is that I think we'd make the argument that you would need to then say that you are actually a payment service and the fourth point is round a commodity and again I know Greg is going to talk about the u.s. meaning of that word but certainly in Europe we are are talking about something that is is physical I mean other the quintessential commodities would be and would would be precious metals and like and certainly here the the rule is that although you can have and you can have the derivatives on commodities regulated and they are in and of themselves not regulated I think the final point is we talked about the three economic types of tokens I touched on this but really talking about the crypto transactions of cryptocurrency those designed to transacting value Bitcoin an example we use the crypto to buy and sell things on the blockchain the crypto certificate or voucher and we would say that that really corresponds with the security is is it the case that actually what has been transacted on the blockchain we'll give you the right to claim a claim on the capital of a real company either in the in the equity or in the debt and then a final unusual category what we call referred as crypto fuel are already the togas designed to enable the creation of blockchain support applications the the things that can run the blockchain or that tripartite classification is actually something we as a law firm put into the UK Parliament that is looking very carefully at how this is all that this is all dealt with but certainly I think the question around what spin-off it becomes important we come back to this point about let's look at the function what are the thing being used for not not how are we describing it and I think one point to to note in passing is there's of course a very big focus on the regulatory classification of of crypto tokens but there are also issues and setting as being quite a lot of thinking done and we've had to give some advice on what their treatment is under the law of property for example can you what sort of security could you can you take over crypto assets how could you pledge them for example are they held and trust while they're held under some some ancient form of ailment all these sorts of questions and I think that the view very much firstly is that the the crypto assets uniformly are a form of of real property rather than a than a money substitute and as such it is argue that you could declare a trust over them and certainly take security fixed or floating over them there has become quite important I think in the context of the more advanced advanced transactions but I think it's important never to lose sight of of those basic legal questions what is the thing and you know how is it lost hearthstone um moving on then to talk a bit about the documentation and this is more about just getting familiar with with the the terminology but also understanding some of the risks firstly the development agreement will be a key piece which really goes to to the proof of concept the white paper and that is the term of art that is really used to describe the offering document I have got in trouble with for some US colleagues by describing it as a prospectus but that has a particular meaning but in essence it is it is a document that that describes what has been done the terms and conditions the could also be a subscription form that actually tell the participants in the ICO what it is they're getting and how it works what the types of Rights all that attached to it we also have to look at websites they're very important parts of both of general way that investors come to it data privacy that's a particular bug a bear and an annoyance in in Europe particularly after something called the general data protection regulation and the fpn s stands for fair processing notice but increasingly of you your website is going to be available in in Europe to make sure that said and then the final point to run any associated marketing planning the important point in all of that is that the main area of risk in the ico Israeli that of miss selling or fraud and and their commercial aspects we we simply say to to apply to be very clear about what you're telling people and so they know what they're getting and understand it and be better for your business and they'll be less scope for for complaint or even worse claims I think moving on to the question around the risk and governance of the blockchain this is an important question that does arise and the question has been asked by our regulators of clients looking to use use crypto assets and blockchain technology for the the holding exchange of those assets is really the governance around the actual blockchain itself is the is is the network around the blockchain determined by a single entity or group of users or firms and what role do those participants have and in the governance of the of of the of the blockchain the term DLP just in passing reverse distribution ledger technology which is an alternative form I think that that the parents will say there's a slight difference but I think we use those terms interchangeably and there are also issues about interests of end-users there are number of other I think concerns just about the manner in which the blockchain is actually maintained the word too big to fail I started crawling back into the lexicon of terms in finance when referring to the blockchain so I said it's just too vast to fail but said any questions we have appliances is there a backup blockchain for example if you were concerned that that it might term the break dollars maybe oversimplifying it but certainly if we think about it as being the the place where where security assets are exchanged for for cryptocurrencies and vice versa and well the transactions occur not seen and this idea that the distribution and the multi-view obviously the integrity of that block chain becomes very important and it is likely going forward that that is something it will become more more scrutinized as as more and more business dumped on the on the blockchain and I think also just just following on from that all those same questions about responsibility for establishing maintaining a reasonable business continuity plan to the network again the alternatives and issues also run conflicts of interest in the operational participation in the network if I am operating the blockchain but also transacting on it so that somehow give me an unfair advantage and also she's run errors and omissions I mean the blockchain is just a a large ledger and and should ready reflect absolute truth but the difficulty is if there are fraudsters or hackers about whether what is being seen as a a misrepresentation and that really brings us onto to the the final bit around what happens when it goes wrong I think issues are on governance and and responsibilities who is responsible for the covent who's responsible for what is said during the ICO issues around applicable law and then I mentioned also the whole thing about a property claim over crypto assets how they're classified under the law of property if if one has some type of claim in in relation to them the role of the law of trusts is very important and I must say one of the exciting things in a lot of work we're doing is about how we're taking these very ancient concepts and Trust law and applying them in the context of crypto assets because I mean one thing we're all agreed on is a crypto acid is incorporeal it's the material it's a piece of code and I'm certainly having value it is something we say that can be held on trust and the final piece ready to run is the round settlement finality being absolutely clear that the transactions that are undertaken on the blockchain the purchases and sales are indeed final and shown as such and that has been transfer of value all of those concepts and well well legal concepts but now finding an application in this new environment and really the the final point I think around the global the global aspect obviously we mentioned cyber risk and and cyber fraud and a lot of people say well that's all very dull and and and we know what about that but we can't emphasize enough that so much turns on that deaf cryptography aspect and making sure that that works issues around market volatility interconnectedness and we talk about new pockets of risk I mean something that is important to to recognize as how a lot of risks we traditionally seen in finance market risk counterparty credit risk and increasingly now shifted onto question on operational risk and we talked about the the role of people understanding technology kyt know your tech and in the same way that the executives that were in charge of bearings Bank when it failed due to a rogue derivatives trader said they didn't understand derivatives so an advert akin to ask for that so to be the case that where large financial institutions using technology and say they never understood it they will be held to account for that and some of the issues I think that we list their competition and orderly markets the extent to which a lot of technology will be encouraged because of competition convenor concerns similarly technological issues and common stands of government think we've we've all touched on and really they're the the final final points is on that diagram is looking at how the roles of of those involved in finance will change look there relate a depiction of the blockchain shown as these number of modes and how the buyers and sellers come together essentially exchanging crypto assets for cryptocurrency and with those were those those those ownerships being been been been reflected and the change also just in the role of custody and one of the key aspects around the cryptography is really the so-called key to one's identity the fact being that what will be held in custody going forward won't be the actual financial instruments themselves but rather the key to unlocking one's rights or planes on those and certainly I think we're already seeing the potential for a lot of disruption big changes to middle officers interesting questions around the role of even regulatory reporting so I think all of that gets thrown into this new world with these new terms but still we say giving rise to a lot of the old and traditional legal concepts and certainly a number of traditional risks I think I've probably gone on for about five minutes too long and so Greg I'm going to hand over to you Duncan it's to you thank you Greg so I heard talk about the approach of the Hong Kong regulators to crypto assets and ICS and so on and I think it's very pleased to give an Asian perspective this talk because I think it's fair to say that the regulatory regimes across Asia since early biggest mood in recent months in terms of regulation in this area and the obvious starting point is the is the outright ban in China but other countries across Asia are taking steps as well while in the focus on Hong Kong which particularly since the the ban that's been imposed in China is increasingly becoming more of a a regional hub for crypto assets and you can see it on the streets whether in the form of crypto mining equipment being brought across the border for sale at all indeed in terms of the activity in the exchanges in Hong Kong itself and that in turn increases the importance from the rig from the Hong Kong regulator's perspective of making sure that I SEOs and crypto assets are appropriately regulated so that in mind what's the approach of the Hong Kong regulate has been to date and with two relevant regulators in Hong Kong the Hong Kong Monetary Authority which is principally a regulator of banks in Hong Kong and the Securities and Futures Commission which is the the Hong Kong's closest equivalent to the SEC the HKMA has taken a a very hands-off approach to date that's fair to say they've published a single press release in which they confirmed that the HK age is not considered a crypto currency but instead use them as virtual commodities and the usual disclaimers in terms of warnings to consumers are obviously complained how interesting is the the indirect manner in which HK major regulations have impacted actors in this space and in particular in Hong Kong at the moment we're going through the process of the fat evaluation in relation to Hong Kong's ante million laundering tent areas in finance and controls and that as that has resulted in upsurge and regulation on the banks and the indirect impact of that regulation has been on the Bitcoin exchanges operating in Hong Kong they simply have found it very difficult to obtain banking services of more Hong Kong Bank and that in turn effectively causes some real practical difficulties in operating as an exchange elite having access to a fiat currency you can't really stay in business and so turning about the so the points that Andrew was talking about even where there is not a direct from regulate regulation of crypto assets or cryptocurrencies in a particular jurisdiction does not mean that there's not an impact of the existing regulatory framework and I think we can see more of that in terms of the approach of the Securities and Futures Commission in Hong Kong they have not rolled out a specific regulation to address clip to assets and ICS instead they have tasted their faith in existing securities laws in fact at some time it wasn't at all clear whether the security features commercial interested in Krita assets at all it wasn't until the end of last year when it became clear that the SSC was going to seek to seek to regulate an ICS where appropriate using these existing securities laws and the means by which they do so is very similar to the description and reuse in terms of the approach in in UK the SSC is looking to see whether or not the tokens which are the product of the ica might represent shares debentures or the rather arcane and collective investment scheme interest I share word from from an SSC perspective they were looking for whether or not to take and receive dividends in some way or was the potential beneficiary of the proceeds of a winding up of the of the issuing company debenture it as evidence that the the token be repaid at some point in the future protector investment scheme is slightly more nuanced but I'll come back to that in a moment but essentially what the regulator is looking for is whether or not the token represents a a evidence of participant 8 uppers uppers uppers participation in a share of a of a approved investment scheme of some core project for which and redemptions in the future would be received and if any of those is true or with a share debate or collective investment scheme and then that would fall then the remit and the security of features orders and dealing in these securities of advising in those securities would become regulated activities that would require license I'd make some features contracts as well because we see we now have derivatives of of cryptocurrencies and they would also form in the ambit of the SFO and again dealing or advising in relations those futures contracts would be would be a regulatory requirement he done so far well as I said they work up to the concepts of I SEOs and I input to us at the end of last year since then they've actually been quite active in taking action against I showing the considered to be security or collective investment schemes all underneath the exchanges on which they are traded and the SS is publicized its attempt to take ICS and exchanges the tasks in this regard and the SSE tells us that they have been successful in persuading i ciose to not market their i co to hong kong in circumstances where the SSC considers the ico is a security and in terms of the future security defeats core group however the most well-publicized example of SSC action is in relation to a ICO launched by black cell technology which is actually a Hong Kong company this ICA was was designed to fund the movement that from the firms a mobile application called crops which was a agricultural market place and the IC oak web white paper should have immediately caused alarm bells to any lawyer that was looking at it because it refers to itself as the world's first agricultural market proscriptive equity ICO and indeed the white paper goes on to explain that the the crop coins which were the tokenized the tokens of the ICO were capable of being redeemed into black gem technology a share capital and depending upon how the crops marketplace was developed this would seem to be a pretty clear example of an IPO that fell afoul of the Securities and Futures ordinance and unsurprisingly as a result the SFC took action and black sell at haunted the ICO info file approached Hong Kong's our market participants now what's interesting is why did the SSE act in relation to this is you when there's others that might have similar features and I think the reasons it reason can be drawn in a couple of places firstly as I said black cell technology was a company incorporated in Hong Kong so very much on the SFC stomping ground and easier with take active in forces actually goes evenly the road and then secondly the ICO was being actively marketed in Hong Kong it was an ICA oh that was very publicly marketed and as a result would also have come on CSS Lee's radar for that reason and thirdly of course it didn't take long from reading Lee at the white paper to to see the words equity which would have no doubt raised concerns on the part of the regulator I said I was going to talk about collective investment schemes a bit more detail and it was actually the collective investment scheme bucket that the SSC used as as it's used as the basis for bringing the the crops ico within the remit of the Securities and Futures owners and the the reason I'd call that the the CAS bucket the collective investment scheme bucket is effectively a depository for a range of different types of investment scheme which require prior approval from the SSC before they can be advertised in Hong Kong and as a result it's a great tool for the regulator's to keep control over paisios and other types of investment in Hong Kong because they need to see it and approve it first and I think when you look at the features of what collective investment scheme is you can see that they they will apply or have potential to apply in many of the IPOs that we see coming onto the marketplace today particularly some of those which are looking to push the boundaries of what what features and what benefits of kokand can bring to the holder for a collective investment scheme to operate in Hong Kong it must be an arrangement will inspect the property and the participants of the collective investment scheme don't have day-to-day control over the property that is managed by either someone else or with a view to pooling the participant money with a view to giving the project with some form of redemption or profit as a result of that positive positive that part of the participation as you can see that looking at the Coptic couple example in that case the the collective investment with in relation to the mobile application technology the the profit or the return and was was the redemption of the black cell technology black black cell technologies shares hence falling within the collective investment scheme bucket I suspect this will be the means by which the SFC will look to take action against other ICS in the future because it's got its a fairly liberal earth and watered concept and together with the fact that in Hong Kong at least and I think there is some case law in the UK in Hong Kong collective investment schemes to date have not had their parameters closely confined by the course and so it's that it's right for the regulator to try and push the boundaries in that particular direction that was always going on for Hong Kong but Greg is going to walk us through the virtual currency landscape as it applies to the United States Thank You Duncan and before I jump into my portion of the presentation the public service announcement if you are interested in receiving CLE credit for today's presentation please write in the confirmation code virtual currency on your CLE sign-in form which you will find on your viewing console thank you so I'm going to talk about the evolving regulatory landscape here in the United States and boy do we have a long way to go so the Bitcoin Genesis block was released in January of 2009 so here we are a little over nine years later and I think it's safe to say here in the United States we have no coherent regulatory direction other than some vague promises that something will happen soon but every day in the news and I don't know if I suspect I'm no different than most of the people on the phone when I open up my email every morning and I have all those newsletters that I like to look at to see what's in the legal news and the areas I practice in there are articles about hacks and staffs and massive amounts of money raised price volatility market manipulation investigations fraud warnings from our financial regulators class-action filings and there's so much happening in this space but there's frankly little Direction being given by a hodgepodge of regulators we have here in this country which I'm somewhat envious of my colleagues in the UK and Hong Kong who have far less cooks in the kitchen it seems to me there is certainly a view of our regulators that these assets these coins these tokens have risk and that's no surprise we've talked about that a little bit already today the lack of oversight lack of safety and soundness measures you know what happens if there's a mistake or a theft who you turn to to try to remedy that and there's obviously no Deposit Insurance either no FDIC insurance in this space it's all about investor protection and frankly our regulators are trying to figure out how to apply in very many cases old laws to a brand new asset class that I think you could safely say about our Securities Exchange Commission and our Commodity Futures Trading Commission they never saw this coming and now here it is for them to deal with we have a ton of overlapping jurisdiction here in the United States we have the criminal Authority the Department of Justice Commodity Futures Trading Commission which is really derivatives and commodities the FinCEN our Treasury Department Financial Crimes enforcement network is involved the exchanges both the the the spot or cash exchanges the coin based type exchanges as well as our derivatives exchanges because as as Andrew mentioned we have futures and options contracts on Bitcoin trading on the CME and we'll have others there's more coming I'm sure of it we have our individual states attorneys general the criminal authorities in each of our individual 50 states plus the District of Columbia Puerto Rico and the other you know non-state entities in the United States we have our security Exchange Commission the Internal Revenue Service and then we have state regulators as well state securities regulators in all 50 states so we've got a lot of people who who have a stake in this area and can issue regulations and enforce the law so what is it what are these things are they currency are they securities and in this country it would really be there's a quite a long definition of what a security is but people have pretty much agreed that if it's security it's going to fall into the category of being an investment contract very broad category in the definition of a security is a commodity is it property and then the other question that's out there that is yet to be resolved is who's going to regulate this industry is it going to be a government or regulator or is it going to be a self-regulatory organization and there is a push amongst the exchanges to develop a self-regulatory organization along the lines of the National Futures Association for the commodity side of the world or FINRA which is our our secure our self-regulatory organization in the securities field what we've seen recently is the CFTC and the North American securities administrators Association which is state securities regulators as well as provincial regulators in Canada entering an information sharing agreement really largely focused around crypto assets the feeling is there is so much fraud out there that that our government or regulators at the federal level simply can't handle it and need the assistance of the states and then we just recently heard an announcement that our Department of Justice and the CFTC have launched a criminal investigation into price manipulation of Bitcoin it's unclear whether it involves Futures the derivative side of it it appears to be spoofing or washe trading in the spot or that or the best call to spot market rather than introduce cash into this equation but that's obviously a big fears that those prices can be manipulated in the in the spot market which could potentially have an effect on the price of the derivatives as well so what do we know so far we know that the IRS has said crypto assets are property they are not currencies we have the CFTC who have said virtual currencies are commodities under the Commodity Exchange Act and by definition that virtual currencies are goods exchanged in a market for a uniform quality and value that's the definition of the CFTC looked at and said yes these are commodities we have a court who has agreed with them in the case the CFTC versus McDonald this year the judge said virtual currencies are commodities in that case he made the judge made no distinction between coins and tokens and in the case really what he was focused on was the jurisdictional issue does the CFTC have jurisdiction over a cash or spot market transaction with no Nexus to a futures contract and what the court found is in the case of fraud or manipulation the CFTC has direct jurisdiction over spot transactions in virtual currency markets pretty significant development here in the United States and then of course we've got the SEC who has said essentially most people say bitcoin is not a security and that's pretty much what we've heard from the SEC in this space regarding Bitcoin but then again when you get away from the Bitcoin type products and more into the token offerings the icos the statement from the chairman was he hasn't seen a token offering that is not a security and that that's a pretty strong statement but we still haven't seen much in that area we have a case pending before a judge in the Eastern District of New York where it's a fraud case against the defendant and the defendants argument is the the SEC the u.s. doesn't maybe doesn't have jurisdiction over him because the tokens from the ICO are not securities and you cannot apply securities laws to him so that issue is directly before the judge are these particular tokens in this case a security or not and I described that as a potential registration tripwire because if that judge says yes their securities and it's a very broad opinion not narrowly tailored to the actual token at issue it could really cause a lot of registration issues in this country we see a lot of class actions being filed in this area now class-action plaintiffs and there's one that was just filed recently in ripple labs token XRP where they're arguing this token has all the hallmarks of an unregistered security offering without a an exemption under rule 144 so they're saying essentially that these are under the illegal sale of unregister cura tees and that's a pretty common claim now that we're seeing class action bar plaintiffs bringing so what has the SEC actually told us about this so far there is the case of the Dow the decentralized autonomous organization it was an offering it actually went bankrupt and was investigated it's a decentralized venture capital fund the SEC looked at it in to it and issued a report they ended up not taking any action against the Dow but they did issue a report an investigation it was kind of like here's how we view icos and are they subject to the securities laws and of course in this case they said yes Dow tokens are securities under the 70 year old how we test and that's an example here we are applying 7 year old law to this new asset class and it's a very straightforward written investigation report but I'm afraid that it's it may not be right there's a lot of criticisms that the report didn't get it right that's why I say maybe on this slide the analysis of the facts and legal issues and the applicable 'ti of the conclusions frankly are questionable so what is the how we test in terms of the investment contract is an investment of money in a common enterprise with the expectation of profits solely from the efforts of the promoter or a third party so that's the test that they applied to the Dow and they said yes it is an investment contract yes it is a security I could get into discussions of horizontal broad vertical and strict vertical commonality I think I fear putting everyone to sleep if I did that but I'm happy to answer any questions offline about what those particular categories mean but important for our analysis here is that in the white paper or in the investigative report the SEC said okay first of all it's an investment of money need not be in cash it could be in another cryptocurrency so that satisfies the first prong of the test and then they said oh yeah these are investments in a common enterprise but they gave no analysis no discussion of those various different types of a common enterprise and I think that was a failing and then they said Dow investors expect profits in the reliance of managers and entrepreneurial efforts of others and that's really a questionable finding as well because the way the Dow was structured is it was really a decentralized structure no one held ultimate decision-making authority all the token holders could withhold their contributions in funding investments and the promoters of it had the exact same rights any token holder there is no real dependence on any special skills or expertise of the promoters so it's really frankly their attempt to shine a light into this area I would argue had the opposite effect so why do you want to say a little bit about about our SROs are our self regulatory organizations FINRA and the NFA which I mentioned before so FINRA has said in their 2018 priority exam letter that they may review firms member firms compliance mechanisms where digital assets and ICS are deemed securities where IC is involved the offer and sale of security of sale of security so basically what they said is if somebody tells us it's a security we're going to do what we normally do which is make sure that people are registered they're supposed to be registered and are abiding by their compliance obligations this was and still today is the first statement that FINRA is given to any members prior statements were all to the investing public warning them of the dangers of these products so if tokens are securities listing exchanges are going to have to register or operate as alternative trading systems or register as broker dealers become members of FINRA so that's out there the NFA which covers the security side of excuse me the commodity side of the world has has it a little easier frankly because we do have the CFTC say these are commodities so the NFA says any new commodity pool operator I should say any commodity pool operator or any commodity trading advisor that's EPO and CTA on the screen engaging in virtual currency transactions has to abide by certain reporting requirements and it's really just identifying the number of pools or managed accounts so that the NFA knows who's in this space and can conduct their audits and investigations of those firms as they see fit so those are our SROs and then we've got the states all 50 of them a few others I would say most states are just waking up to this area they range from totally non-existent in terms of enacting any legislation or regulation in this area to actually establishing some frameworks for virtual currency businesses many of them many states require money transmitter licenses where there's an exchange of work virtual currency for real currency other virtual currency of other or other value so money transmitter licenses are many many many entities now have those licenses some of them enacted legislation saying you state revenue authorities have to accept payment of taxes in Bitcoin so some have gone that way and others have started blockchain initiatives really in an attempt to attract this new asset class these new businesses to their state to make them business friendly so are they securities well that issue still hangs out there if they are securities and we're still waiting for clarity on that then they those securities will be subject to each state's blue sky loans which are essentially state securities laws and in the in that area there is no federal jurisdiction preemption you are subject to both state and federal securities laws so that hangs out there as well a couple quick examples and then we'll break for a couple questions but I'll just identify New York because I think it's probably the not surprisingly the most out front of any of the states in this area and they in 2005 started offering through their Department of Financial Services a bit license most financial currency businesses are required to have this license to engage in business in New York or with New York customers so far only four there are only four license holders out there some have just decided rather than go through the owners process of getting this license and being regulated under it just avoid New York it does exclude consumers and merchants so that's an important point and it really just applies the kind of normal compliance obligations that a broker dealer or a bank would would understand you know anti-money laundering cybersecurity having a complaint process but in business continuity plans record-keeping marketing regulations consumer protection nothing surprising there but that's New York and then quickly Arizona and Wyoming which are really states that are opening their arms to this business and saying please come here Arizona open the first regulatory sandbox saying you know in to the point of saying that a energy companies offering power in the state of Arizona cannot discriminate against blockchain nodes in residence you know basically saying please come here and create Bitcoin and other things like that and then Wyoming is trying to become the Silicon Valley of blockchain you can file certain forms in blockchain your Bitcoin is exempt from property tax virtual currencies you don't need a money transmitter license there and they actually went as far as to say utility tokens something Andrew talked about are exempt from securities regulations so we have this massive hodgepodge of regulators existing regulations trying to apply to this new asset class and frankly I think we would all agree that we need some clarity here and I don't think we're likely to get it anytime soon but I do think some of the pending court cases and some of the directions from our federal judges in particular will start to move the ball but I think I think we'd also all agree that judicial rulemaking may not be the best way to regulate an industry and that our regulators and our legislators really need to step in and fill the void so with that I'll pause and if anyone has any questions we do have you there is one and I wonder if Andrew or or Duncan could speak to the view of regulators in say Singapore Hong Kong on I co buyer sanctioned screening is that something that are my colleagues can speak to I'm happy to chime in I think if we if we take if we take a step back and we have found the question that the token which has been offered is subject to to a regulatory regime then it would follow that the need to undertake proper due diligence on that would include the need to screen for sanctions or any other potential issues I think a point that that is worth noting is that the anti money laundering laws in Europe and Sydney are looking to deal with the question of application – they putted virtual currency I think acknowledging the virtual currency in and of itself is is something irrespective of which AML screening certainly would be required and and you could and that very take in taking the currency in and of itself if we go one step further and what we're talking about are our crypto assets that are deemed to be within the financial services or securities regime then the general requirements will will apply we want one of the key commercial issues with with the ICO is is really the the compilation of so-called whitelist that is all of the individuals that will have access to – to the blockchain on which tokens are going to be offered and a key thing in granting that access is thorough and complete kyc know your customer due diligence and Sydney what would be included within that is sanctions we we acted on the first-ever ICO in the UK and for example we said to our clients and this was none regulated this is an unregulated I said reserved it was a a coin utility token but we said to them for example we we don't like the idea of you allowing people to transact on an agency basis or dare submit trust basis he or she who subscribes must be all the person shown on honors and must must be the actual person so I think those issues do arise and we would say that that even if not mandated by law regulation if you're able to squeeze the target of is either category and it is something that it would be prudent always done to take great and if people want to hang on there's a few additional questions which I think I can try and quickly address and then if the people who asked the questions would like more information they can certainly email the three of us our emails are at the end of the presentation there they are and and we'd be happy to answer those questions but the first one talks about whether the sec is close to bringing an action against any ICO for failing to register of course SEC investigations are confidential so we wouldn't necessarily know the answer to that but I think it's I think it's fair to say that the SEC is definitely looking into whether particular icos are offering securities and should have been registered I would be utterly shocked if that's not the case so I believe that probably within the next year we will see some public announcement of some enforcement action by the SEC and then another question it should broker-dealers being addressing Bitcoin in written supervisory procedures by specifying registered reps are not allowed to sell to clients or other clarification even if the regulators have not yet spoken on this issue and I think the answer to that the prudent answer and I think my colleagues would agree even if it was not us regulations would be yes your written supervisory procedure should address this until there's some additional clarity here in this space so great great can I can I also add on that I think one of the interesting issues is of course if a token is is classified as a transferable security or security you're also throw into issues around insider dealing laws and Makarov is a miss mark manipulation but I think a lot of those processes around personal account dealing and monitoring and all of that suddenly become important too but the you know if there is a jurisdiction that has taken in the context say of initial offering then I think they're all the issues around secondary trading and RSA getting custom investor protection and fiduciaries you see those kinds of things may will serve rise and I think if you're selling if you're a registered rep and you're selling to clients you open yourself up to all of the types of issues we see in class-action cage cases which is you're promoting these you said it was safe you said I could liquidate it anytime you said you know didn't need to be registered now I think it did so I think you really open yourself up to essentially all the claims you see in ico class actions that are really picking up steam with that we thank you all for listening and attending again if you have any questions for for Andrew for Duncan or myself please feel free to email us at the email addresses on the screen there and we'd be happy to to answer your questions directly thank you very much bye-bye bye-bye

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