On October 11, 2019 the U.S. Securities and Exchange Commission (SEC) filed an emergency action in the United States District Court for the Southern District of New York, and obtained a temporary restraining order against Telegram Group Inc. and its wholly-owned subsidiary, TON Issuer Inc. According to the SEC’s complaint, the two offshore entities were conducting an unregistered offering of securities in the form of digital tokens in the U.S. and overseas that has raised more than $1.7 billion to finance the companies’ business, including the development of their own blockchain—the “Telegram Open Network” or “TON Blockchain”—and the popular mobile messaging application Telegram Messenger. In addition to the temporary relief already obtained, the SEC seeks, among other relief, an order preliminarily and permanently enjoining defendants from engaging in the conduct alleged, directing defendants to disgorge their ill-gotten gains, with interest, and imposing civil money penalties.
In a recent decision, the U.S. District Court for the Southern District of New York invalidated Western Express Bancshares, LLC’s (Western Express) U.S. Patent No. 8,498,932 relating to a method of transferring funds through a bankcard. The court’s decision nixed Western Express’ assertion of patent infringement claims against Green Dot Corporation (Green Dot) for the sale and offering of CashBack Visa® Debit Cards, Reloadable Prepaid Visa® Cards, Load Go Prepaid Visa® Cards, and Reloadable Prepaid Mastercard® Cards. Green Dot moved to dismiss the action on the ground that the ’932 Patent is invalid under the landmark 2014 U.S. Supreme Court decision in Alice Corp. v. CLS Bank. That case held that patent claims directed to an abstract idea without any inventive concept are ineligible for a patent under Section 101 of the U.S. Patent Code.
The court in Western Express found that the ‘932 Patent is “broadly directed to a ‘method of funds transfer […]’ [and that the] concept of transferring money through a bankcard is similar to other ‘fundamental economic practices’ that the Supreme Court and the Federal Circuit have held [to be unpatentable] abstract ideas.” Western Express Bancshares, LLC v. Green Dot Corporation, No. 19-cv-4465, 2019 WL 4857330, at *5 (S.D.N.Y. Oct. 2, 2019). The court also found that the patent lacked an inventive concept because it “relies on existing technologies and infrastructures that are inherent to the industries of banking and retail.” Id.
This decision comes on the heels of the Patent Trial and Appeal Board (PTAB) of the U.S. Patent and Trademark Office invalidating five Nasdaq patents relating to electronic securities exchanges under the Alice test. These recent PTAB and district court decisions demonstrate that FinTech patents may not be grounded within the contours of patentable subject matter under Alice and its progeny, and may provide defendants with some measure of protection against charges of infringement.
Miami International Holding Inc. et al. (MIAX) attained five victories within two weeks before the Patent Trial and Appeal Board (PTAB) of the U.S. Patent and Trademark Office. In successive final written decisions issued in October, the PTAB declared that five Nasdaq patents related to electronic securities trading systems are invalid under 35 U.S.C. Section 101. Section 101 defines patent-eligible subject matter. The PTAB determined that all five Nasdaq patents (U.S. Patent Nos. 6,618,707; 7,246,093; 7,921,051; 7,747,506; and 8,386,371) were directed to abstract ideas, which are excluded from patent protection under the statute. MIAX awaits the PTAB’s decision on an additional patent (U.S. Patent No. 7,933,827) challenged by MIAX. One remaining related Nasdaq patent is still under review by the PTAB.
The PTAB’s proceedings were triggered by Nasdaq’s assertion of patent infringement claims against MIAX in the U.S. District Court for the District of New Jersey in September 2017. Nasdaq alleged that MIAX had violated the challenged Nasdaq patents and used Nasdaq trade secrets to launch MIAX’s competing options exchanges.
MIAX has vigorously disputed all of Nasdaq’s claims, and the NJ District Court has stayed all of the litigation pending final determination of the Nasdaq patents.
In an unrelated lawsuit, Nasdaq has sued yet another exchange, Investors Exchange (IEX), claiming that IEX infringes other Nasdaq patents related to electronic securities trading. That case was filed in March 2018 and is also pending in the U.S. District Court for the District of New Jersey. IEX is also challenging Nasdaq’s patents under Section 101. The five PTAB decisions in MIAX’s favor may help to pave the way for IEX as well as help sharpen the focus of what is and what is not patent-eligible in the FinTech industry for FinTech companies seeking patent protection or defending themselves against infringement allegations involving FinTech patents.
In Securities and Exchange Commission v. ICOBox et al, the Securities and Exchange Commission (“SEC”) alleges that defendant ICOBox and its founder, Nikolay Evdokimov violated Sections 5(a) and 5(c) of the Securities Act by selling $14.6 million in unregistered securities within and outside the United States. ICOBox bills itself as an ICO incubator that provides legal, technological, and marketing support to blockchain-based startups and sold its own tokens, “ICOS,” beginning in August 2017 to fund its consulting activities. The SEC alleges that defendants, in helping other entities offer and sell securities, also violated Section 15(a) of the Exchange Act by operating as an unregistered broker. The defendants touted the value of the ICOS tokens as “discount cards” that allowed holders to swap their “ICOS tokens at a roughly one-to-four rate for tokens that would be issued during future ICOs by ICOBox’s clients.”
Although ICOBox’s token-sale is relatively unremarkable (i.e. touting potential profits for purchasers, offering early purchase discounts, etc.), the complaint is notable for several reasons. First, the SEC highlights that the defendants were on notice that their tokens were securities because their ICO took place after the SEC issued its DAO Report in July 2017. This demonstrates the SEC’s unwillingness to accept ignorance of the legal status of digital tokens and its commitment to rejecting unfounded claims of a token offering “utility.” Second, the action highlights the SEC’s growing willingness to target non-fraudulent entities—the ICOBox platform launched and functioned as intend, though it did not generate as much business as defendants promised it might. Finally, the complaint alleges that one of ICOBox’s clients was Paragon Coin, the target of an earlier SEC enforcement action in which Paragon eventually settled with the SEC and agreed to register its tokens as securities. This certainly suggests that the SEC is focused on scrutinizing industry activity with ties to its early enforcement targets.
 Case No. 2:19-cv-08066 (C.D. Cal. filed Sept 18, 2019) (“ICOBox”). A copy of the SEC’s complaint can be found here: https://www.sec.gov/litigation/complaints/2019/comp-pr2019-181.pdf.
 The SEC defines an ICO or “initial coin offering” as a “fundraising event in which an entity offers participants a unique ‘coin,’ ‘token,’ or ‘digital asset,’ in exchange for consideration, often in the form of virtual currency—most commonly bitcoin and ether—or fiat currency. The tokens are issued and distributed on a ‘blockchain’ or cryptographically secured ledger.” See ICOBox, ECF No. 1, ¶ 21.
 The defendants’ tokens are now allegedly trading at 1/20th of the average purchase price.
 ICOBox, ECF 1 ¶ 46.
. Paragon Coin, Inc., Securities Act Release No. 10,574, Admin. Proc. File No. 3-18897 (November 16, 2018), available at https://www.sec.gov/litigation/admin/2018/33-10574.pdf.
Howard Womersley Smith, a Partner in Reed Smith’s FinTech practice recently published an article regarding EBA Outsourcing Guidelines and Operational Resilience, and gives his suggestions on what FinTech companies should be prioritizing in this current market.
Read the full article on FinTech Futures.
On 31 July 2019, the United Kingdom Financial Conduct Authority (“FCA”) published its final guidance on the types of cryptoassets that fall within the FCA’s current regulatory framework, clarifying the resulting obligations for firms and regulatory protections for consumers (“PS 19/22” or “the Policy Statement”).
The Policy Statement provides market participants welcome pointers as to how the FCA applies the regulatory perimeter to different types of cryptoassets. It remains the case that definitive judgements as to the regulatory classification of specific cryptoassets can only be made by assessing each cryptoasset on a case-by-case basis, taking into account its particular features.
Reed Smith Partner Herb Kozlov and Counsel Jeff Silberman recently appeared on a segment of “Innovators with Jane King” to discuss the United States regulatory landscape and future outlook regarding digital assets. The segment can be found here.
On July 8, 2019 the U.S. Securities and Exchange Commission (the “SEC”) and the Financial Industry Regulatory Authority (“FINRA”) (both, the “Regulators”) published a Public Statement titled, “Joint Staff Statement on Broker-Dealer Custody of Digital Asset Securities” (the “Joint Statement”). The Joint Statement follows many months of discussions with certain digital asset securities industry participants seeking registration with the SEC as broker-dealers.
The Joint Statement noted the Regulators’ discussions with these industry participants have contributed to the Regulators’ ever-evolving understanding of how certain federal securities laws and FINRA rules may affect or be applicable to those industry participants. Many of these discussions were focused on finding a custody solution for digital asset securities that would meet the possession or control standards prescribed in the SEC’s Customer Protection Rule. As a result, the Joint Statement explored the importance and potential applicability of the Customer Protection Rule to industry participants.
On 3 July 2019, the United Kingdom Financial Conduct Authority (the “FCA”) published its consultation paper on a proposed ban on the sale, marketing and distribution to retail clients of derivatives that reference certain types of cryptoassets (“CP 19/22”).
On June 21, 2019 the Financial Action Task Force (the “FATF”), published its long-awaited Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (the “Guidance”). The FATF is tasked with setting standards and promoting effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system.
U.S. Treasury Secretary Steven Mnuchin noted in his remarks that the Guidance “will enable the emerging fintech sector to stay one step ahead of rogue regimes and sympathizers of illicit causes searching for avenues to raise and transfer funds without detection.” The Guidance will have far-reaching consequences for virtual currency exchanges, wallet providers, and other virtual currency companies and natural persons transmitting similar value as a business if implemented by the FATF’s participating government bodies.