Stephen McKeon is an Associate Professor of Finance at University of Oregon and Chief Strategy Advisor at Security Token Academy. His research focuses on cryptoassets, security issuance, and M&A and appears regularly in top finance journals and major media outlets. His professional experience includes six years as a chief financial officer and involvement with several venture backed start-up firms and token projects as an advisor and board director. He has co-founded a venture fund, a real estate development firm, and Skyward, a commercial drone software company, which was acquired by Verizon. Prof. McKeon teaches valuation, FinTech, and venture capital at Univ. of Oregon, as well as blockchain regulation in UC Berkeley’s Blockchain Unlocked program.
Georgia Quinn is general counsel of CoinList a platform to introduce investors to deeply vetted token ICOs. CoinList also provides compliance services for many other token sales. She is also the co-founder of iDisclose, a legal technology company focused on the disclosure and legal document needs of small business and startup entrepreneurs. Quinn has been recognized each year since 2014 as a Top Female Attorney in New York City by Thomson-Reuters and as a "Super Lawyer" featured in the New York Times. Quinn is a senior contributor to Crowdfund Insider, an online crowdfunding publication. She is on the advisory board for NextGeneration Startups, an online resource for entrepreneurs. Quinn began her practice at Weil, Gotshal and Manges and later moved to Seyfarth Shaw before founding iDisclose. Ms. Quinn has presented to the Securities and Exchange Commission, Congressional staff-members, leaders of US and UK crowdfunding portals and peer-to-peer lending platforms, the American Bar Association, the American Banker P2P Conference, the Council of Development Finance Agencies, the Canadian Equity Crowdfunding Alliance, the New York State Bar Association, and the Small Business Administration. Ms. Quinn received a Juris Doctor from Columbia Law School, and received a Bachelor of Fine Arts from New York University.
Tatiana Koffman is a speaker, entrepreneur, VC and advisor passionate about bringing consumer technologies to life. With a focus on tokenized securities, Tatiana is the founder of Four Blocks Ventures, providing strategic advisory to several high profile issuances in the space, including Full Cycle Energy. Tatiana is also the founder of Crypto for Girls, a movement to engage more females in the blockchain industry.
Previously, Tatiana was a Venture Partner at DNA.fund investing in ICO’s across sectors. Tatiana was part of the founding team at Machine Shop Ventures, an early-stage venture capital fund started by the rock band Linkin Park, invested in Robinhood, Lyft, Riot Games, and Hyperloop One. Tatiana was also one of the first investors and advisors to Winston House, and founder at MARBL Media.
Tatiana holds a JD/MBA and spent the formative years of her career in Mergers and Acquisitions, and Fixed Income Trading with a focus on Swaps, Derivatives and Asset Backed Securities.
Tatiana is member of the New York State Bar.
Troy A. Paredes is the founder of Paredes Strategies LLC. From 2008-2013, Paredes was an SEC Commissioner, appointed by President Bush and confirmed by the U.S. Senate.
Paredes advises on financial regulation, compliance, risk management, corporate governance, and governmental and regulatory affairs. He also serves as an expert and advisor in regulatory enforcement investigations and in private litigation involving securities law and corporate law. Paredes has brought his extensive government, compliance, enforcement, and regulatory experience to bear in serving as an independent compliance consultant/corporate monitor.
Paredes was a professor of law at Washington University. Currently, he is a Distinguished Scholar in Residence at NYU School of Law and a Lecturer on Law at Harvard Law School.
Paredes co-hosts a podcast on fintech called “Appetite for Disruption.”
Paredes is a member of the board of advisors of Templum, a member of the board of advisors of StreetShares, a member of the compliance advisory council of Balyasny Asset Management, and a member of the board of directors of NAVEX Global.
So, I’ll let the panelists do their own introductions. This is a panel I’ve been looking forward to. As mentioned earlier, I’m the chief strategy advisor at Security Token Academy. I’m also an educator, and one of the subjects I teach is blockchain regulation, so I’m hoping to learn a lot myself that I can bring back to the classroom. So, Georgia, why don’t you start with your background?
Sure. So, Georgia Quinn. I’m the general counsel at CoinList, and you kind of got the full background this morning, but I’m a securities attorney, started my practice at a firm called Weil Gotshal, worked there for some time. Then I founded a legal technology company called iDisclose, and built that for about three years, and then I recently joined CoinList in January of this year.
I’m Troy Paredes, and I have my own consulting firm focusing on a whole range of financial regulatory topics, including the ones that we’re talking about today. Before that, I’d been a commissioner at the Securities and Exchange Commission from 2008 in the summer to 2013. Before that, I was a professor of corporate and securities law, and at one point earlier in my career I happened to be a deal lawyer.
My name is Tatiana Koffman. My background is I’m a bar lawyer in New York, but nonpracticing, background in investment banking, derivatives, bonds, asset-backed securities, then moved over to venture capital. My claim to fame is that I worked for Linkin Park, the rock band, and started their early stage VC fund. We were very active. We actually invested in Lyft, Robinhood, Blue Bottle, Riot Games, Hyper Loop, so some really great deals.
Then I went off and did the consumer tech founder thing for a while, before ... I like to say crypto found me, and in a perfect bow tied up together the last decade of my career and brought me here. I spent some time at DNA Fund, which is Brock Pierce’s and Scott Walker’s fund, doing mostly utility token deals before realizing that my skillset was much more suited towards security tokens, and went off and started a boutique consultancy where I essentially help issuers navigate the Rubik’s Cube that the security token ecosystem is today.
I also write and speak on the subject quite a bit, and parallel to that, I’m also the chief token officer of a company called FullCycle Energy, and that will be an STO hitting the market in the next two months, and that is a token that will fund a series of renewable energy plants around the world that burn garbage and convert it into clear blue and gas, so we’re solving for the garbage problem and the climate problem, all while using the innovation that are tokenized securities, so ...
Fantastic. I thought, Troy, maybe I’d start with you just as a former regulator. Again, as mentioned earlier, we probably have some issuers in the audience and watching the videos. Maybe a general statement about what they should be thinking about in terms of regulatory compliance as they move through this process.
Yeah. I’ll try to be brief. I’m sure a lot of these points were made earlier in some version or another. One simple point, which maybe really encapsulates everything, is the following, and that is the SEC has indicated that at least so far they haven’t seen any, certainly not many, but perhaps any tokens that they don’t consider to qualify as securities. So, the point there really is just to underscore that to the extent, the SEC, there’s lots of other regulatory bodies to be concerned with, without question, but as far as the commission, the SEC, is concerned, once that commission decides, the SEC, that something is a security, guess what? You’ve now triggered the entirety of the federal securities law.
What that means is, going back to the prior panel, not just you have to think about it from a perspective of the offering itself, but you also have to think about all the different participants in the offering process, and what that means in terms of being a broker dealer, what that means in terms of investment advisors, what that means in terms of exchanges, ATSs, transfer agents, clearance, settlement. We can go down the list. Now, that’s not meant to be intimidating to folks. It’s just meant to give the high-level lay of the land.
What that then I think really means in more practical terms is it’s really important to have the right folks around the table helping you go through this process, and sometimes that’s going to be folks who have actual experience in the crypto space, but in many instances, it’s going to be folks who just have a lot of experience in the security space, or in the commodities space, or in the AML/KYC space. We can fill in the blanks. To put that a little bit differently, it’s the following.
There’s nothing, at least so far ... Again, I’ll talk in terms of the federal securities laws. There’s nothing so far that is by way of the regulatory regime specific to the crypto space, the token space, that it’s the regulatory regime as it has existed for a very long time now. We saw the clearest and cleanest, most straightforward articulation of that. Whether one agrees that this is the right approach or not, we can have that discussion later, but where the SEC just about a year ago, when the 21(a) report said, “Look. We’re going to apply the test we’ve been applying for decades to assess whether or not a token is a security,” and that case, as anybody in this room who’s familiar with it knows, that was a case talking about orange groves and service contracts. They said, “Look. That case was good then, and it’s good now.”
I think it’s a clear, again, concrete example of the overall approach of the regulator, and then the final point I’ll end on on this is whatever regulator you’re thinking about needing to engage or the regulatory regime of which may or in fact does apply, I do think it’s important to be mindful of the regulatory interest that the regulator has front and center, putting yourself in their shoes. That’s not to say you’ll always agree with where they come out. In fact, different individuals at different regulatory bodies themselves will often disagree as to where to exactly come out, but understanding their interest, understanding their objectives, understanding it from their perspective I do think is helpful. Again, whether or not you agree exactly with where they land, I do think that’s a useful lens to bring to bear.
Thank you so much. So, let’s dive into alphabet soup. So, we’ve got all these different regulatory exemptions. We’ve got Reg D, and Reg S, and Reg CF, and Reg A, and on, and on, and on. I’d like to unpack those, probably not in great detail, but at least briefly, so happy for any of the panelists to jump in, but maybe we’ll start with Georgia. Could you just kind of describe what type of it, where we’ve seen the most traction, and what sorts of issuers might use one exemption versus another?
Sure. So, I’ll dive in. I’ll go through all of the different regulations and exemptions from full registration of securities offerings, and I’ll kind of start with what most people are using and probably the easiest path, and then move up the regulatory hurdles. So, the first thing, and this is what you’ve probably been hearing a lot about today, is Regulation D, and that is a typical private placement exemption, and what people are most frequently using is Rule 506(c), which allows you to generally solicit so you can conduct a full publicly marketed offering, but you may only accept accredited investors as your investors, so you have to ... Although you can market it to a broad base of people, you can only have accredited investors actually provide you with funds, and when you do that, you have to verify that they are indeed accredited.
There are certain reasonable steps that are safe harbored that you can take and ensure that you’ve taken those steps. Those steps are providing documentation, verifying people’s net worth or income, or providing a letter of attestation from an attorney or ... Jor actually spoke about this. This is one of the great services that his company kind of automates and provides. So, that’s really what we’re finding. I’d say like 98, maybe 99% of all ICOs are really using that exemption.
Another exemption that people are using is Regulation S. Regulation S is for foreign offerings of securities, and it basically is just the SEC saying, “Well, if you’re offering your securities to people that aren’t US residents and don’t live here, and you’re not marketing it in the US, we don’t really have jurisdiction, so okay, you can do that.” What I think a lot of people misunderstand about Regulation S is that it doesn’t mean you are now legally offering your securities in foreign countries. It just means you’re complying with US securities laws. All of those countries have their own securities laws that you should be reviewing and making sure you’re comfortable with. So, just because you’re doing something complying with Regulation S, which really doesn’t mean much, doesn’t mean you’re actually complying with securities laws and conducting a compliant offering.
Regulation S does have its own rules, which are basically you can’t then allow those securities, and there are certain rules and holding periods, but you understand the point, that you wouldn’t want those securities that are sold to foreign people to then flow back into the US, because it’d just be an easy end run around US securities laws. So, you have to make sure you manage the secondary transactions of those securities as well. So, that’s Reg D and Reg S, and that’s really what most people are using.
Other alphabet soup options are Reg CF, which is a crowdfunding offering. The issue with that is that you can only raise up to a million, 70,000 dollars in a 12-month period, so for these kind of blockbuster raises, that just really doesn’t cut it. The nice thing about that type of offering is that you can offer it to unaccredited investors. So, if you’re really trying to do something to promote your user base and you want to really be able to target those retail investors, or you want to tack it onto a Reg D deal, you could do a side-by-side Reg D offering for accreds, and then offer up to a million to unaccreds. That’s a way to be able to kind of tap into those retail investors.
Reg CF has more regulatory hurdles, obviously because you’re offering to retail investors, and we want to make sure that we protect those people. There are ongoing recording requirements, initial filing requirements, financial statement requirements, so it does provide another hurdle, but again, those aren’t really insurmountable.
The next type of offering that you may be hearing about is Regulation A or Regulation A+, and what is quite interesting about this type of offering, a lot of people call it a baby IPO, and you are allowed to offer to retail investors. The securities are freely tradable, which is something that is really exciting and useful, and we’ll kind of go back and talk about what that means for the other offerings, but the filing process and the reporting process, the ongoing reporting process is much more onerous than any of these other types of exemptions.
So, to do a Reg A+ deal, you have to file a Form 1-A. It’s pretty much the first part of a Form S-1, which is what companies have to file in a full-blown IPO. You have to file audited financial statements, and then there is the SEC approval, and it’s not ... A qualification process. I don’t want to call it approval, where you will have back-and-forth comments from the SEC. They’ll actually be reviewing each word that you’ve put in this form and making sure that they’re comfortable with it before qualifying you and allowing you to go live with your deal, and then again, ongoing reporting that you’ll have to continue as long as those securities are outstanding.
So, going back to this concept of freely tradable securities, this is a big part of tokenizing securities, tokenizing assets, wanting to be able to have this liquidity, being able to trade them 24/7 on these digital markets. So, Reg D and Reg S both have holding restrictions, and Reg CF for that matter. So, for the most part, those securities are going to be locked up for a year, and you’re not going to be able to trade them.
We haven’t seen this being a huge problem to date because most of these are issued using what’s called a SAFT, and so the tokens actually aren’t even in existence yet, so people are issuing basically an investment contract, a SAFT, which gives you the right to hold the tokens once they’re actually developed by the entity, and so we’re not seeing this outcry that people can’t exchange their SAFTs, but I do feel that once these holding periods of the SAFTs start to wear off and people get these tokens in their hand, the exhangeability is going to become a real issue, and I know we’re going to be talking about that shortly.
Absolutely. So, Tatiana, you have Four Blocks Ventures, and maybe you could talk about why a VC fund would consider tokenization, sort of fund structures, and which of these exemptions they might be likely to use.
Sure. So, you’re looking to add basic security token structure, similar as you would in security structures. In a fund perspective, traditionally VC fund are locked up seven to 10 years, so the really big innovation that’s happening is that we’re really unlocking this liquidity. So, even if you’re locked in a for a year, as Georgia would say, a year is still a lot better than seven to 10 years. Right? So, you’re issuing these under Reg D and Reg S, for the most part, and for me, as an accredited investor, let’s use the example of 22X Ventures, which is a securitized project.
They’re doing investments in 500 Startups. Right? So, previously, unless I wanted to write a sizeable check and actually build a relationship with 500 Startups, I couldn’t do so. Now, theoretically, I’d be able to go onto this platform and either buy these tokens on issuance, or buy them on secondary market, and participate in an established venture capital fund.
In terms of limits on investors, so that’s something that’s being talked about a lot, if you’re doing a VC fund structure, traditionally you’ve been limited to 99 investors under the Reg D, and then 2,000 investors globally. The 2,000 number comes from having to file as a public company once you surpass that number. Since the new bill that just went through, I think it was two weeks ago, with the Dodd-Frank rollback, that number has actually changed from 99 to 250, so it’s slightly more favorable, and what that actually effects in a business sense is you can lower your minimums, because previous, if you’re raising a sizeable fund and you can only take 99 investors, then you have to adjust your investor minimums accordingly. So, that’s a very interesting structure that’s currently in development.
The other main structures that I’ve seen, first, would be the tokenized equity. A lot of people are just doing the equity rounds on the blockchain now. A subset of that is revenue share. That can be either equity or debt. The interesting thing is if you do any kind of debt offering, you’re actually not subject to that 2,000 investor limit or the 99 investor limit. So, a lot of folks will structure their revenue share offerings to look and smell like debt for that particular reason.
A deal that’s on the market right now is lottery.com. I’m sure many of you are familiar with that, and that’s an example of a revenue structure that’s not subject to investor limits. Yep. Go ahead. Another spinoff of that would be crypto bonds. We actually haven’t seen a lot of crypto bonds in the market. There’s a municipal bond out of Berkeley that’s coming out. There’s a couple smaller ones in development. There’s actually an entire exchange, secondary exchange being developed called FIC Network that’s just going to be for bonds, so this market is very much coming into development, and those bonds will look very similar to what we’re used to seeing from bonds. They’ll have ratings. It may not be an SMP or a Moody’s rating, but it will be credit support from a different agency that will draw on traditional evaluation factors, and it’ll have a coupon rate and a repayment period.
Then finally, the asset-backed structure, and I think a lot of these kind of get lumped into the asset-backed structure, but a true asset-backed structure is one where the value of the token is really tied to a certain asset, so an example of that would be real estate, energy plants, art, commodities. So, we’re seeing some of those, but very few are true asset structures. One true asset structure is Slice, which is a company out of Israel, and they’re tokenizing real estate on the blockchain, so they will actually take a building out of Manhattan and say, “Okay. We’re going to issue X amount of tokens, and it’ll represent this value of the building.
It’s really interesting. Equity gets a lot of attention. We got a whole panel on equity tokens later today, but the debt markets are huge, and it’s interesting to hear that there’s all this activity around leveraged products.
Yeah. I think what you have to remember is that in 10 years everything that you could do in traditional securities markets you’ll be able to do in these markets. This is the beginning. This is a little bit more of a decentralized way to issue capital. It includes less middleman. It includes more automation, which means lower legal fees, lower accounting fees, lower tax bills, and it takes the power away a little bit from the traditional institutions at the moment, but in 10 years this will be the norm.
That’s interesting. So, I want to come back to this Reg A idea, and maybe this question’s for Troy since you’ve experienced it at the SEC. So, Reg A actually requires something on the part of the SEC, right? There’s a review, essentially. My understand is there haven’t been a ton of Reg As in history, but it might be that now that becomes something that is a lot more interesting in this particular space. How would the SEC handle, or are they sort of staffed to deal with if all of a sudden the volume of Reg As went up substantially?
So, historically Reg A had a five-million-dollar limit, so it wasn’t particularly attractive. They increased that with JOBS Act to 50 million, so that just gives a lot more room, and that’s going to open up as a possibility, but as everybody said, the action has been on the Reg D front, particularly when you get 506(c) and the ability to generally solicit. So, whatever we’re talking about, frankly, in this space, whether it’s thinking about it from the perspective of Reg A or Reg A+, or just as a general proposition, look. When I was at the SEC from ‘08 to ‘13, this was not the thing. The thing, quite frankly, then was the financial crisis and the aftermath.
So, when I think about it from the agency’s perspective, any agency’s perspective, you consider the fact that they have all of this stuff that they’ve had for the duration of their existence, just about, and all of a sudden you throw all of this into the mix, and while, as I was saying before, when you think about the regulatory regime, you talk about 506(b), 506(c), A, A+, NMS, ATSs, this, that, and the other, those are the same things people have been talking about, again, forever, and yet at the same time, I think you can’t overlook the fact that you do have new technology, you do have a marketplace which is moving very quickly, you do have new questions that come, you do have the need to understand not only the technology, but the dynamism.
Those are real challenges for regulators, and one of the things that is, I think, always, to that point, a particular challenge is when you’re trying to regulate a market that has its new features, has its complexities and its challenges, and has its dynamism and is moving very quickly, to say, “All right. How do we make sure we’re bringing the right regulatory regime to bear, at least when it comes to the details, even if we’re not going to jettison fundamental features and structures?”
One thing that I think you want to try to guard against as a regulatory is saying yes to something, only then looking back and saying, “Oh, my gosh. I can’t believe we said yes to that. Look at all the problems that that has spawned.” At the same time, saying no to things can spawn its own problems. Saying no to things can compromise the ability of the market to continue to grow, to innovate, to be dynamic, and bring in new opportunities for investors and new opportunities for entrepreneurs, new opportunities for the marketplace that on net have the opportunity to increase our standard of living and make our lives better off day in, day out.
Well, striking that right balance is really challenging. To be candid, I think a lot of the folks in this room, probably everybody in this room and maybe folks listening to the extent they’re inclined, can be really helpful in helping the regulators themselves continue to understand what’s going on in the marketplace, and even if the regulators, as I said, aren’t prepared to jettison foundational and fundamental features of the regulatory regime, the details matter, and being particularized in terms of the asks of the regulators, so they can say, “All right. Maybe we’re not going to get rid of something, but there are things that we could do to continue to move things on in a healthy, and in particular, to try to ring needless uncertainty out of the system.”
So, that’s just to simply say I can think about myself. The ability to benefit from the collective expertise and knowledge of all the folks in this room, as you as a policymaker are trying to wrap your arms around something is extraordinarily helpful, so you can try to strike these balances, both in terms of the big picture, but the big picture at some point gets down into the details. The language in any rule doesn’t just kind of come out of thin air. Those are real human beings who are sitting down, trying to say, “All right. I’d like to achieve this objective. I’d like to protect against this risk. Now I need to figure out what the language is that’s going to be in the books that all the lawyers and others are going to look to.” There’s a lot that has to happen in terms of that process, and again, the knowledge of folks in this room I think can be very constructive and helpful to helping policymakers figure that stuff out.
Terrific. So, diving a little bit back into alphabet soup with some different letters-
I have the best job.
As I was asking people in preparation for this panel, “Hey, I’ve got a regulation panel. What should I be asking,” they said, “Well, a lot of focus is on the regulations that are applicable to issuers, but you’ve got all these exchanges through the day. Maybe you could touch on regulations that pertain to exchanges, so Reg NMS or Reg SCI.” Do you think those will be in play at all?
I want to know who you are talking to that even knows Reg NMS and SCI. So, I think ... We just had a great panel about exchanges and some of the rules that are applicable to exchanges. For the most part, these exchanges will not be national securities exchanges, so NMS won’t really apply. NMS is a rule to ensure that investors are protected during the course of an exchange and that they get the best pricing mechanism, and it’s really ... This is for publicly traded securities, so making sure that brokers aren’t seeking out poorer performance and poorer pricing in order to get a greater cut for themselves. So, not really applicable here.
SCI, actually quite applicable because it does apply to ATSs, but again, this is about your compliance and your technology and infrastructure, and making sure that you have policies in place to deal with technical threats and cybersecurity, and so that’s a no-brainer. Based on our last panel, I think you got the message there. So, I think if you’re not complying with that, you’ve got even bigger problems. So, those rules I’m not super worried about.
The things I am worried about are that we have a lot exchanges out there that are not regulated at all. They are operating without any sort of regulatory overlay. They’re not being regulated as money transmitters. They’re not being regulated as broker dealers. They’re not ATSs. They’re just online portals for the exchange of things. I don’t know what they are. So, I think we saw an initial wave of enforcement a couple months ago coming down on issuers, and I think we’re getting ready to see another wave of enforcement coming at these exchanges, and I just want to touch upon something that Troy mentioned about the burden of the regulator and worrying about saying yes and worrying about saying no.
The other thing that saying no does is it sends people to other jurisdictions where we can’t control what they’re doing, we don’t have the authority to regulate it, and we can’t extradite people to punish them. So, I think that that’s another thing that we need to think about. If we are concerned about the US being a center for capital formation and having the best and most efficient markets, which argue whether or not you believe that, this is something that we really have to think about because there are a lot of other places in the world that people can go to.
Can I just ... I think you were spot on, and just want to underscore that, that the importance for regulators to understand, I think they do understand, but the importance for you to understand is that, look, in the markets we have, that there are choices, you have choices, others have choices, and that people are going to make their judgements, and that then means that the regulators in addition to everything else they’re considering, it strikes me, need to be mindful of that as well. Is that a new thing to be mindful of? No. I mean, I’ve had these discussions for a very long time about all kinds of other types of instruments, but it is part of the discussion, I think you’re exactly right, that needs to be front and center. Again, I think regulators understand that point, but I think sometimes there are people going, “Well, are people really going to leave?” Well, it turns out people are really going to leave-
Yeah, they do.
... and that you need to be mindful as you’re thinking about crafting a regulatory regime. The other thing, very, very quick, to say is as we’ve gone through, and I think the explanation and summary on the rules and regs has been terrific and very succinct and probably one of the best I’ve seen in terms of marching through and kind of the guts of each one of those, but even if you don’t have to worry about section five of the ‘33 act and you have a good 506 offering, and if you don’t have to worry about NMS or SCI, even these are entirely aside from the following. You can’t commit fraud. Right?
So, an exemption from section five of the ‘33 act, because you have the ability to fall within Rule 506, it may give you an exemption from the registration requirements of section five of the ‘33 act. It does not exempt you from fraud, and that probably, when you hear it, is obvious, but I do think it’s an important point just to underscore, that fraud is a bad thing and you should not be doing it, and don’t let the other analysis distract from that core basic point in terms of your disclosures and not being fraudulent.
I think folks just need to stop doing things that are counterintuitive. I think in the ICO market in 2017, a lot of what we saw was issuers saying, “Oh, I need to raise some capital, and an easy way for me to do that is to create a utility token that’ll function on a fictional software network ecosystem, and that’ll be a great way for me to raise.” Right? Now we’re seeing somewhat the opposite of, “Oh, well, if I want to raise in the US, I really should have a security token, so let me figure out how I can do an asset-backed security for my network,” and folks just need to kind of issue what they need to issue and do so in a compliant way. So, if you need to issue a utility token, issue a utility token. Just make sure it complies with security’s laws, and don’t try to make it an asset-backed security, and if your token really hinges on your cashflows, then make sure it’s an asset-backed token and not a utility. So, that would be my number one advice.
Terrific. I want to touch on the idea of accredited investors, so Reg D and Reg S, or Reg D specifically we were talking about is being heavily used. So, how binding is this constraint of only marketing to accredited investors, and maybe a question for Troy is ... We define it with a wealth test. Is there any other way we could be defining it, or should we be defining it some other way?
Yeah. So, are there other ways? Sure. Yeah, there are other ways, and the commission, for a few years now, the SEC has been kind of reassessing the definition of accredited investor, and so without kind of unpacking all the different possibilities, one of the reasons for having quantitative thresholds, whether it’s income or wealth, is that you have the certainty that comes with an absolute number, as compared to the way this statutory framework works, which is whether or not investors are able to, quote, fend for themselves.
Of course, you’ll go, “What does it mean to be able to fend for themselves?” Well, all of a sudden you get Reg D to say, “Well, we’re going to give you some certainty as to what it means to in effect be able to fend for yourself, and we’re going to focus on quantitative financial thresholds,” which of course are just imprecise. How can they not be imprecise? They exclude some folks who probably can fend for themselves, and perhaps they allow some folks in who may not have the experience in terms of investing that would lead us to make that judgment.
So, there has been an effort to reassess and think about things like what kind of profession is somebody in. Are they a licensed broker dealer, investment advisor, what have you? Maybe there should be some sort of a test, as you suggest, in terms of financial literacy, perhaps. In addition to a net wealth test, you have an investments test, because wealth can come by many ways other than your investment experience. There hasn’t been a rulemaking launch, but there’s a lot of interest on the part of a lot of folks for the commission to broaden out this definition.
At the same time, a lot of folks say, “Look. The financial thresholds have been on the books for a very long time. Perhaps those need to be reassessed.” So, unclear where this will all land. I think with the current makeup of the commission, there is a lot of interest in capital formation. I think there’s a lot of interesting in trying to make sure that investors have the opportunity to invest, not just in public companies, but in companies that really have the opportunity to grow a lot because of the early stage nature.
As I said, there are competing perspectives on all of this, but that’s kind of the summary of the lay of the land for me personally. I’d like to see the commission undertake a rulemaking and try to expand the definitely in sensible ways to give more opportunity for investors to participate in early stage companies, so we’ll see if that’s where they ultimately go.
Just a funny anecdote on the definition of accredited investor. Once in conversation with SEC Commissioner Gallagher, he noted that he himself at that time in his life, because he’d been making a government salary, was actually not an accredited investor, so probably one of the most knowledgeable people in the world on US securities laws would not have been able and would not have been deemed sophisticated enough to invest in securities.
That’s interesting. So, we’re at about eight minutes left, and a topic I did want to cover was airdrops. So, airdrops are something people are thinking about a lot recently. I know CoinList is involved in airdrops. Could you maybe speak to the regulation around airdrops and this question of is it a security issuance or isn’t it, and what you can do internationally versus the US?
Sure. So, for those of you who aren’t familiar, airdrops really just mean the giving away of your tokens to the public users, whomever you choose. The thing to remember is that if your tokens are a security, so if we’re talking about a security token, something that is being deemed as security, you can’t actually just give it away for free. That is still the offer or sale of securities. There’s a lot of case law going back to the ‘90s and the tech boom when people were issuing their securities, their equity securities in order to get more users, and so if you would come on and join their network and register a domain name or do something, you would receive equity in the company, and that is deemed the offer and sale of security, and you have to register that or find an exemption.
So, again, because people are trying to drop these tokens to retail investors and not go through the procedures of making sure that these people are accredited and doing a private placement, most of the airdrops that you see out there are completely illegal. At CoinList, we have developed a methodology to compliantly delivery these securities into the hands of user, and again, you just have to go back in time to the first alphabet soup I was going through, and it doesn’t matter if you’re giving them away for free. You have to figure out one of those criteria to be able to issue them to your holders, your users. I mean, frankly, they’re your investors at that point.
So, a lot of people think, again, well, if I’m doing this internationally, it’s not a problem, and if you’ve done the analysis in every jurisdiction that you’re giving those away and you can determine that their laws aren’t similar to the US and there’s no problem with giving away securities in those jurisdictions, you’re accurate, but I highly doubt you’ve done that.
Sounds good. So, we have about five minutes left. I thought maybe we can do forward-looking statements in terms of where we see regulation going or what we think is ... I guess maybe we would start with airdrops. Do you think ... So, ICOs were sort of booming in 2017. They started coming under regulatory scrutiny, and it started tamping it down, at least to some degree. Do you think the same thing might happen with airdrops?
Yes. I think airdrops are a fantastic way for companies to build their networks, to grow their user base, to show appreciation to their early adopters. It is exactly in the spirit of this technology. It’s exactly in the spirit of what we’re trying to do, and at CoinList we’ve figured out a way to make it within the spirit of the law as well, and the letter.
Troy, maybe in terms of looking forward, there’s always this question about do we need new regulation, or do we just need to better apply the regulation we have. Do you have any sort of view about how might that play out in terms of ... Is this an industry that needs new regulation?
Well, I’m going to focus on the federal securities laws here.
Stick with that.
Yeah. So, what I would say is, look. I think that we have the regimes. As we said, obviously they’ve been in place, and no indication right now that those regimes in kind of funnel respects are going to be set aside. All right. So, let’s just kind of take that, and I see that as being the approach that persists at the commission space for a good, long while. I think where the change may come is in the following sense. What are those areas where given the technology, given some of the economics, given some of the governance, where the current details of the regulatory requirements simply don’t fit? Right?
Where it’s just flat out mismatch, where the regulator can provide some tweak, refinement, accommodation, whether that’s through FAQs, interpretive guidance, no action relief, or whatever it is, to say, “Look. We can continue to meet our regulatory objectives. We could continue to meet our big picture mission as the regulator, and in fact, we will be able to do that all more effectively if it will provide this accommodation, not because we’re backing away from the regime and fundamental respects, not because we’re setting aside our overall objectives and mission, but rather, because we understand that there is in the particularities a misfit, something that just doesn’t work or doesn’t make sense.”
I think there, there’s a lot of opportunity for there to be, I’ll just call that kind of progress, along those lines where it’s a win-win all the way around. I think very much related to that are those areas where folks are sitting back saying, “Look. We want to get it right. We’re trying to comply, but we’re just not sure what that means. We’re not sure where the line is. We’re not sure the difference between a do, or a don’t. We could make a judgment, and we could make a good faith judgment with counsel and advisors and all the rest sitting around the table, but we’re concerned that if our judgment ends up being different from your judgment, what does that means in six or 12 or 18 or 24 months from now. So, we’re trying to get it right, but can you help us by giving us some additional certainty and clarity, not necessarily telling us every last thing that’s an okay or not okay, but at least if our zone of uncertainty is this, can you, the regulator, help the zone of uncertainty at least become this?”
I think those are real opportunities as well, but as I said, that’s getting into the details and into the particularities, and that’s where I think folks like yourselves and the other panelists here who are working with folks on those details and particularities can be very constructive, because no longer is it, hey, regulator, can you just kind of come up with a whole new regime for us. It’s hey, regulator, here are five things that are causing a lot of difficulty and a lot of uncertainty. Can we find a way collectively to constructively get to a good outcome that allows you to meet your objectives and allows for this new innovation to go forward, and actually be beneficial to a whole lot of different market participants, and quite frankly, society as a whole?
Great, and Tatiana, you get the last word in terms of where do you see this space going from a regulatory standpoint, or otherwise.
Yeah. So, I think I touched on it a little bit. I think the first thing that we’re going to tackle is this unlocking of the 1.6-trillion-dollar private placement market that we have in this country, and we’re going to do that through Reg Ds, and then it’s going to move on to public trading on the blockchain. Nasdaq is already incorporating blockchain technology into their exchange. I don’t think it’s going to be too long before other exchanges try to do that as well, and we’ll see a big institutional move in the next three to five years. So, I think this is a really exciting time because we get to be the pioneers of something, and right now it may feel somewhat small, but I think we’re on the precipice of something great, and if you look at the context of some of the issues that have happened in the financial industry over the last couple of decades and the financial crisis, a lot of those things can be solved, and a lot more transparency can be created with this innovation.
Terrific. Well, ladies and gentlemen, join me in thanking the panelists.
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