Legal Aspects of Issuance and Trading
Daniel Zelenko, a partner at Crowell & Moring, opened his panel with humor when he said “I represent misunderstood capitalists,” proving that the lawyer panel would not be near as dry as the title may lead you to believe.
Ralph Daiuto, the Chief Operating Officer & General Counsel of tZERO, started the discussion with an overview of the work that tZERO had done, working with the SEC on issuing digital shares for Overstock, and on working on a new (at the time) use case: blockchain meets capital markets.”Wouldn’t it be great if we could issue, trade, settle and clear the same day without a central counterparty?” Daiuto asked the crowd.
- Federal securities laws were applicable to ICOs on a facts and circumstance basis
- Token issuance must be in compliance: either a full registration or an exemption from that registration, such as Regulation A, Regulation D 506(c), Regulation Crowdfunding, and Regulation S
- Secondary trading of tokens can only occur in two ways: on a national securities exchange and on an ATS
Daiuto traced the roadshow he went on to meet with SEC regulators and discuss how the technology would work before moving into the near present, where Daiuto pointed out the three things he learned from the ICO craze in 2017:
Daiuto then discussed tZERO’s aspirations to be the first national exchange for security tokens through its joint venture with BOX Digital Markets. “Being a national exchange enables us to set listing standards, listing fees, the dissemination of market data. It’s a different level,” Daiuto said, one he believes can attract institutional participation in ways that an ATS cannot.
As the conversation moved to the rest of the panelists, the conversation became one of what do the regulators care about and are paying attention to? Kristen Howell, a partner at Fox Rothschild, noted that “the SEC is not used to having the possibility of someone stealing your shares unless you go back to 1950 when you had paper stored in a vault.” In other words, the SEC wants to know how this technology works and how investors will be protected.
While Regulation A companies aren’t technically publicly traded companies, they functionally are. The SEC wants to know you are going through the usual things with public companies: protecting against misuse of markets, going through KYC and AML, etc, Rothschild observed.
Marc Boiron, a blockchain & securities attorney at FisherBroyles, echoed that sentiment, “the SEC is very interested in secondary markets and what broker dealers are doing to make sure investors are protected.”
Steve Obie, a partner at Jones Day, who represents tZERO, made an important point that many regulators have fines and sanctions built into their budget, so there is a “perverse economic incentive,” in Obie’s words, for regulators to police financial markets. The second big question that Obie addressed is how do you audit the flow of money in a crypto market? Are participants participating in the market as unregistered broker dealers? How can you prevent actors from injecting bad data into the market to manipulate prices? With 50 states all interested in the answers to these questions, it is chaos.
The water is further muddied by what Boiron noted as the concept of “sufficiently decentralized,” which was first used in a speech by William Hinman, from the Division of Corporate Finance at the SEC. How do you determine when a blockchain is sufficiently decentralized in the eyes of the SEC and securities laws no longer apply, as was the case with Ethereum? There is no consensus on what that threshold is.
Similarly, Rothschild pointed to the fact that no secondary marketplaces are live yet. How those platforms will be regulated is yet another question without an answer. From this panel, it was clear that lawyers are waiting for answers just like the entrepreneurs.