In July 2018, Coinbase – one of the largest cryptocurrency platforms — announced that it had won regulatory approval for a trio of acquisitions. This announcement generated a lot of publicity that Coinbase is on its way to creating the first marketplace on which blockchain-based tokens classified as “securities” can be traded. As it turns out, Coinbase never received regulatory approval for the acquisitions. However, the announcement was nevertheless a potentially significant event for the future of crypto trading.

In order to operate an exchange for securities, an entity must register as a national securities exchange or operate under an exemption from registration, such as the exemption provided for alternative trading systems (ATS) under SEC Regulation ATS. An entity that wants to operate an ATS must first register with the SEC as a broker-dealer, become a member of a self-regulating organization, such as FINRA, and file an initial operation report with the SEC on Form ATS.

Because Coinbase is neither registered as a national securities exchange nor operates under an exemption, it cannot operate an exchange-based trading platform for blockchain-based securities. However, the recently announced acquisitions indicate that Coinbase may be headed in that direction. The three companies acquired by Coinbase were:

  • Venovate Marketplace, Inc. (registered as a broker-dealer and licensed to operate an ATS)
  • Keystone Capital Corp. (registered as a broker-dealer)
  • Digital Wealth LLC (registered as an investment advisor)

By acquiring companies with the proper licenses already in place, Coinbase may be able to speed up its plan to create an exchange-based trading platform for blockchain-based securities as a regulated broker-dealer.

What exactly are blockchain-based securities anyway?
Continue Reading Coinbase takes steps toward first blockchain-based token exchange

Wyoming Blockchain
Photo by Kenneth Vetter

While Bitcoin initially paved the way for the introduction of blockchain and distributed ledger technology in the mainstream, most would agree that the potential applications of this relatively new technology goes far beyond just cryptocurrencies.

Blockchain technology, at its core, is merely a set of linked records that form an immutable ledger. Information is added in “blocks” which are linked to the prior information on the block by a cryptographic hash of all of the prior information. The information on the blockchain is secure because any attempts to change information in an earlier block would result in a different “hash” that would be easily detected by the network, which would reject that version of the blockchain as being unauthentic (there are several articles about how cryptographic hash functions work, but at the most basic letter, these functions take an input of any size and convert it to an alphanumeric output of a specified length). Furthermore, because the blockchain is distributed among multiple computers, each operating as a node running the underlying software, there is no single centralized entity or system responsible for maintaining the blockchain. Rather, the collective nodes maintain the blockchain pursuant to the underlying software code.

The potential applications of blockchain technology are seemingly endless. For example, digital representations of shares of stock of a corporation could be tokenized and traded on a blockchain, which would allow companies to maintain a corporate stock ledger without the need for a transfer agent. These shares of stock could also be traded on a decentralized exchange that would provide liquidity to shareholders without the burden of applying to be listed on a national securities exchange.

Several states have taken steps to facilitate these kinds of applications for blockchain technology. For example,
Continue Reading Wyoming leads the way on facilitating blockchain technology

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Initial Coin Offerings, or ICOs, have generated a lot of buzz recently as a new method by which companies can raise capital to fund their businesses. At the same time, the SEC has been cracking down on ICOs that involved the offer or sale of a security that was not registered or structured to comply with an exemption from registration. For example, the SEC announced last week that it halted a $600 million ICO by AriseBank, which allegedly involved the offering of a coin that was a security without properly registering the transaction. Despite the apparent scrutiny of ICO transactions by the SEC, there’s much uncertainty in the space as to when securities laws may or may not apply to a specific ICO transaction.

Currently, we are seeing two primary types of ICOs – those that involve the sale of a “security token” and that are intended to be offerings of a security and those that involve the sale of a so-called “utility token,” which do not involve the offer or sale of a security. The primary difference between these two types of tokens is that a utility token is designed such that it has some intrinsic value that is not based upon prospective price appreciation. For example, a cloud computing company might sell utility tokens that are redeemable with the issuer for storage space on the issuer’s servers. In this sense utility tokens are not unlike gift cards where a purchaser is acquiring something that can be redeemed for products or services from the issuer in the future. Like gift cards, an incentive to purchase a utility token could be that the token offers a discount to the normal price for the issuer’s goods and services. While a secondary market for the utility token might develop, just like there are secondary markets for the purchase and sale gift cards, issuers usually intend for these tokens to fail the Howey test, which is the test that is used to determine whether something constitutes an “investment contract” (which would be a security) for federal securities law purposes.
Continue Reading Is your Initial Coin Offering a securities offering?

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For several years we’ve been advocating that state-chartered banks that do not require a bank holding company should ditch the holding company structure. It now appears that several banks are paying attention. This morning, The Wall Street Journal published an article spotlighting banks that have recently dispensed with their bank holding company in an effort to reduce their regulatory burden.

Bank holding companies previously gained popularity as a means by which banks could conduct business across state lines when states had rules about interstate banking. Banks also used holding company structures to bolster their regulatory capital, including through the issuance of trust preferred securities. However, with the passage of Dodd-Frank, which effectively eliminated prohibitions on interstate banking and the ability of banks to count newly issued trust preferred securities for regulatory capital purposes, the reasons for smaller banks to maintain a holding company structure are fewer and farther between now more than ever.

Stand-alone bank structures can offer several advantages over bank holding company structures. For example, as compared to a bank holding company, banks can raise capital at a substantially lower cost due to the exemptions available under the Securities Act of 1933 for securities issued by a bank. Related to this, banking organizations that are publicly held, or are seeking to become publicly held, have the advantage of filing their Exchange Act filings and reports with the FDIC as opposed to the SEC. Among other advantages, the FDIC’s reporting system does not require the payment of any fees and is available 24 hours a day, seven days a week. Certain filings with the SEC require the payment of filing fees and may only be filed during the times that the EDGAR filing system is open. Speaking of EDGAR, one of the other benefits of not filing with EDGAR is that it is more difficult for plaintiff lawyers to monitor the FDIC’s filing system to bring strike suits in connection with announced mergers. There are several software programs or services that can be used to monitor merger-related filings on EDGAR, but we aren’t aware of any such programs or systems for the FDIC’s system.

Reducing regulation, or at least the number of regulators, is also a key advantage to operating as a stand-alone bank. A publicly held bank holding company with a state-chartered non-member bank
Continue Reading Our organizational suggestions for bank holding companies has gone mainstream!

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Last year, Congress required the SEC to review the public company disclosure requirements in Regulation S-K and make detailed recommendations as to how those rules might be changed to modernize and simplify the requirements while still requiring disclosure of all material information. The ultimate goal was to reduce burdens on public companies while improving readability and navigation of public company filings, including through reducing repetition in such filings. On November 23, 2016, the SEC released its initial recommendations in a report (the “2016 Report”). The 2016 Report which served as the basis for proposed rules, which were set forth in a 253 page rules release on October 11, 2017. While the proposed rules largely implement the recommendations from the 2016 Report, the proposed rules deviated in certain respects from the recommendations in the 2016 Report. Specifically, the release contains proposed changes to the following provisions under Regulation S-K:

  • Description of Property (Item 102);
  • Management’s Discussion and Analysis (Item 303);
  • Directors, Executive Officers, Promoters, and Control Persons (Item 401);
  • Compliance with Section 16(a) of the Exchange Act (Item 405);
  • Outside Front Cover Page of the Prospectus (Item 501(b));
  • Risk Factors (Item 503(c));
  • Plan of Distribution (Item 508);
  • Material Contracts (Item 601(b)(10)); and
  • Various rules related to incorporation by reference.

Additionally, Some of the proposed amendments would require additional disclosure or incorporation of new technology. These include proposed changes to:

  • Outside Front Cover Page of the Prospectus (Item 501(b)(4));
  • Description of Registrant’s Securities (Item 601(b)(4));
  • Subsidiaries of the Registrant (Item 601(b)(21)(i)); and
  • Various regulations and forms to require all of the information on the cover pages of some Exchange Act forms to be tagged in Inline XBRL format.

While somewhat underwhelming with regard to the actual relief provided, the proposed changes are certainly a step in the right direction for improving the disclosure requirements for public companies. Nevertheless, the proposals seem to be relatively minor in nature and won’t likely do much for public companies as far as reducing their disclosure burdens. Below is a summary description of the material changes proposed in the release:
Continue Reading SEC’s Attempt to Modernize and Streamline Disclosures for Public Companies Falls Short

Photo by Patricia J. Lovelace © All rights reserved
Photo by Patricia J. Lovelace © All rights reserved

This week, the SEC published a series of new Compliance and Disclosure Interpretations (“CDIs”) related to the newly revised Regulation A, which became effective on June 19, 2015. While many of the new CDIs addressed procedural and interpretational issues under the new rules, there was an important development that could make Regulation A that much more useful for companies.

The positive news comes in the form of the SEC staff’s response to Question 182.07 which asks whether issuers would be able to use Regulation A in connection with merger or acquisition transactions that meet the criteria for Regulation A in lieu of registering the offering on an S-4 registration statement. Based on the SEC’s final adopting release, it did not appear that Regulation A would be available for use in these types of business combination transactions. However, the interpretation published yesterday clarifies that issuers may, in fact, use Regulation A in connection with mergers and acquisitions. The one exception is that Regulation A would not be available for business acquisition shelf transactions that are conducted on a delayed basis.

This is a very positive development for issuers that want to issue equity in connection with acquisitions of other companies, but do not wish to become a public reporting company under the Exchange Act. Previously, these issuers had very few
Continue Reading More Positive Regulation A News

Director fiduciary dutiesA recent case out of the Delaware Court of Chancery could result in heightened scrutiny of equity award grants to non-employee directors. Although this decision was rendered at the procedural stage of the case and the merits of the claims have yet to be fully analyzed, this case potentially affects directors of Delaware companies and those advising them on compensation-related matters.

In this case, a stockholder of Citrix, Inc. (“Citrix”) brought a derivative lawsuit against the Citrix board of directors alleging a number of things, including breach of fiduciary duty by the board of directors in awarding significant equity compensation awards. Specifically, the plaintiff alleged that restricted stock units (“RSUs”) granted to non-employee directors (who constituted eight of the nine Citrix board members) under the Citrix equity incentive plan, were excessive.

Because the non-employee directors who received the RSU grants in question constituted eight of the nine members of the Citrix board of directors, the plaintiff was successfully able to rebut the business judgement rule presumption and the defendants bear the burden of proving to the court’s satisfaction that the RSU grants were the product of both fair dealing and fair price (i.e., the “entire fairness” standard of review).

The defendants argued that
Continue Reading Chancery Court Holds Board to Heightened Fiduciary Duty Standard in Connection with Equity Awards

Is the SEC making a wrong turn by regulating corporate governance?
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In the wake of the recent financial crisis, the Dodd-Frank Act created the SEC Investor Advisory Committee with the stated purpose of advising the SEC on (i) regulatory priorities of the SEC; (ii) issues relating to the regulation of securities products, trading strategies, and fee structures, and the effectiveness of disclosure; (iii) initiatives to protect investor interest; and (iv) initiatives to promote investor confidence and the integrity of the securities marketplace. In other words, the committee is to advise on matters historically within the purview of federal securities laws. While this is fine and good, there is some indication that the SEC may again be considering the use of disclosure rules to indirectly regulate matters that are not federal securities law matters (see, e.g., conflict mineral rules, Iran-related disclosure rules, CEO pay ratio disclosure rules, etc.).

The new potential area of regulation for the SEC may be internal corporate affairs. The committee’s agenda for the October 9, 2014 meeting of the SEC Investor Advisory Committee will include a discussion of
Continue Reading Wrong turn?: Is the SEC looking to further expand its regulatory jurisdiction through the disclosure process?

Should you incorporate in Delaware or Florida?There is an attraction for companies to incorporate in Delaware, likely due to the abundance of well-known publicly traded corporations that have chosen to incorporate there. However, it is not necessarily true that the Delaware General Corporation Law (“DGCL”) is better than corporate laws of other states; it is just more developed due to the abundance of case law interpreting it. This usually provides for greater certainty, which is often looked upon favorably by not only directors and management, but investors as well. On the other hand, it is generally more expensive to incorporate and maintain a Delaware corporation. Unless your company has a physical presence in Delaware, you’ll need to pay for a registered agent who is physically located in the state and who can accept service of process on behalf of your company. Delaware also imposes a franchise tax based on a corporation’s capitalization, which is generally higher than similar fees and taxes imposed by other states (for example, Florida’s annual report fee, the only corporate fee that is required to be paid to the state each year to maintain corporate status, is only $150). 

Thus, while there may be good reasons for incorporating or reincorporating in Delaware (e.g., because a private equity investor requires it as a condition for investment), the costs of using a Delaware corporation are probably not justified
Continue Reading Delaware vs Florida: Where should you incorporate?