99 days to go… before London loses its FinTech dominance

As much as there can be tradition in something that is less than five years old, London has ‘traditionally’ been considered to be the capital of financial technology (FinTech).

London provides a haven in which FinTechs have been able to grow operational expertise, supported by the combination of significant and sophisticated investment, tech-skilled talent, tech-minded people, a pragmatic and forward-thinking regulator, and a supportive government with its own strategy on FinTech. These have been the key ingredients in establishing the success of this new sub-sector This recipe has resulted in London becoming an echo chamber of its own FinTech success, which has now perpetuated the growth of the greatest number of unicorn FinTech companies in Europe. With 99 days to go until the UK is scheduled to leave the EU, it is more important now than ever for Britain to consider how to best retain its FinTechs.

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Mark Carney’s backdoor to the European financial system

Every month is probably a busy month for the Governor of the Bank of England, Mark Carney, but September and October seemed especially so. The quiet Remainer was asked in September by the Chancellor, Philip Hammond, to extend his tenure for a further seven months, which Mr Carney responded positively to. From Mr Hammond’s perspective, it is one way of ensuring some form of stability somewhere.

Mr Carney has so far managed to hold back from anything too outspoken, only pitching in on the odd occasion when he can’t help himself. It now seems that he has waited to feel secure in the job before really letting loose.

No sooner had news of the extension broken and the Governor was speaking out with a warning that a no-deal Brexit could be equal in severity to the 2008 financial crash.[1] By November, however, the whips had got to him as he provided some surprisingly quick and positive support for Theresa May’s draft withdrawal agreement and was even the one who suggested a possible extension to the transition period.

Whatever his reasons for the support, Mr Carney must have also come to the conclusion that adding to the backbiting cannot possibly be the strategy for which he should be remembered.

Stewarding a steady recovery from the recession and a “smooth and successful Brexit”[2] – now that’s more like it. But surely that can’t involve armchair commentary every now and again during the lead up to the UK’s departure?

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Federal Court denies SEC Injunction in Blockvest ICO

On November 28, 2018, the United States District Court for the Southern District of California denied the U.S. Securities and Exchange Commission’s (SEC) request for a preliminary injunction against Defendants Blockvest, LLC (Blockvest) and Blockvest’s founder and chairman Reginald Buddy Ringgold, III (Ringgold). Securities and Exchange Commission v. Blockvest, LLC, et al.[1]

The SEC alleged that Blockvest and Ringgold were offering and selling unregistered securities in the form of digital assets called BLV tokens. According to the SEC, Blockvest sold the tokens in an initial coin offering (ICO) that, according to the SEC’s complaint, began with pre-sales starting in March 2018.

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SEC settlement of two ICOs based on sales of unregistered securities: No fraud claims asserted

On Friday, November 16, 2018, the U.S. Securities and Exchange Commission (SEC) announced that it settled two cases against digital token issuers. The settlements, one with CarrierEQ Inc. (AirFox) and the other with Paragon Coin Inc. (Paragon), are the first time that the SEC has imposed civil penalties on companies solely for offering digital tokens in an initial coin offering (ICO) that allegedly violates the securities laws. In addition to agreeing to pay civil fines of $250,000 each, both companies agreed in the settlements to allow certain token purchasers to elect to receive a refund. The settlement agreements also require both companies to pursue registration of their digital tokens as a class of securities under section 12(g) of the Securities Exchange Act of 1934 by filing a Form 10.

In each case, the SEC’s enforcement action was grounded on the sale of unregistered securities. There were no assertions of fraudulent statements having been made in connection with the ICOs.

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SEC in First Enforcement Action Against Token Exchange

On November 8, 2018, the U.S. Securities and Exchange Commission (the “SEC”) settled its first case against an unregistered cryptocurrency exchange.  Zachary Coburn, founder of EtherDelta, agreed to pay $313,000 in disgorgement and interest, along with a civil fine of $75,000, in order to settle SEC allegations that EtherDelta was acting as an unregistered securities exchange.

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September report details UK digital currency regulations

Last month (September 2018), the House of Commons Treasury Committee issued a report on its inquiry into the regulation of crypto-assets. The inquiry examined, amongst other subjects, the role of digital currencies in the UK; the impact of distributed ledger (blockchain) technology; and how these should be regulated. The report recommends improvements to consumer and anti-money laundering protections (AML) when dealing in crypto-assets. The improvement will be achieved in part by extending the Financial Services and Markets Act (Regulated Activities) Order 2000 (RAO) to crypto-assets and associated activities.

Read the full report on our sister site, the Technology Law Dispatch.

German criminal court defies regulatory practice of the financial regulator (BaFin) ruling that Bitcoins are not financial instruments

Unlike in most other European jurisdictions the regulatory practice in Germany has been to treat Bitcoins as units of account and as such financial instruments pursuant to Section 1 German Banking Act (Kreditwesengesetz, “KWG”). The practical consequence of this is that most commercial services surrounding Bitcoins and other cryptocurrencies (including trading, brokerage, operating exchanges, investment advisory etc.) will be regulated activities, requiring the relevant authorisation (licence) of the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, “BaFin”). A person conducting banking business or providing financial services without the necessary authorisation will usually be ordered to immediately cease business operations and may be punished by a term of imprisonment of up to five years or a fine (Sections 37 and 54 para. 1 No. 2 KWG).

The decision:

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Federal Regulation of Virtual Currency and Digital Tokens: Preemption, Jurisdiction, and Clarity. But will States Push Back?

In September of this year, certain congressmen expressed their intention to preempt state regulation of virtual currency regulation.  Rep. Darren Soto (D-Fla.) expressed a need for “partial federal preemption” of state laws and Rep. Warren Davidson (R-Ohio) plans to introduce a bill that may seek federal preemption of state licensing and oversight requirements of virtual currency exchanges.

We have seen state push-back on attempts by the federal government to regulate parts of the FinTech space, in addition to other areas of regulation. For example, in March 2018, a group of 32 attorneys general wrote a bipartisan letter to the U.S. House of Representatives expressing concern that a draft bill places consumer reporting agencies and financial institutions out of the reach of state enforcement (please see Reed Smith blog post here). Does the federal government have enough momentum to continue its advancement of regulating virtual currency and digital tokens?

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Virtual Currencies and Digital Assets: NFA Disclosure Requirements Further Evidence of Increasing Attention from Self-Regulatory Organizations

In March of this year, the NFA issued a notice reminded futures commission merchants (“FCM”), introducing brokers (“IB”), commodity pool operators (“CPO”) and commodity trading advisors (“CTA”) that trade in, solicit or accept orders in virtual currency products (spot and derivatives) of their ongoing obligation to notify the NFA of such activities by amending the annual questionnaire (please see Reed Smith client alert here).  More recently, the NFA issued an August 2018 Interpretive Notice (“Notice I-18-13”) effective on October 31, 2018, establishing the disclosure requirements for NFA Members engaging in virtual currency derivatives activity.

What does this mean for NFA Members and how does it reflect broader regulatory concern over virtual currencies and digital assets?

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Regulation A+: A Path to Market for Crypto Companies?

Most companies considering an Initial Coin Offering to U.S. purchasers have resigned themselves to the fact that their proposed token or coin offering is likely to be considered an offering of securities by the Securities and Exchange Commission (“SEC”) and must be made in compliance with U.S. securities laws. The logical next question then becomes – “what are my options?”

Traditional IPO

A traditional initial public offering (“IPO”) of equity securities usually requires extensive meetings with underwriters, accountants and lawyers, the preparation of audited financial statements and the filing of voluminous and detailed documents with the SEC.  In addition, once a company has completed an initial public offering, it must comply with extensive ongoing SEC disclosure requirements.

Reg. D Private Placements

The sale of securities (including securities tokens) may also be conducted as a private placement under Regulation D of the Securities Act, particularly Rules 506(b) and (c).  Rules 506(b) and (c) of Regulation D allow issuers to raise an unlimited amount of funds from “accredited” investors.[1]

Issuers conducting their offering under Rule 506(b) may allow, in addition to the accredited investors, up to 35 sophisticated but non-accredited investors to participate in their offering, but there are heightened disclosure requirements that apply; there are no exceptions for Rule 506(c) offerings, which may be made only to accredited investors.

Aside from the unlimited offering potential, one other big advantage for many issuers using the Rule 506 exemptions is that the securities issued do not have to be registered with the SEC and therefore there is no SEC review process.  Aside from a short Form D that must be filed with the SEC within 15 days of the first sale of securities with basic details of the offering (i.e., maximum dollar amount of securities being offered, number of investors, industry group, etc.), there are no other SEC filing requirements and no ongoing disclosure requirements.

Issuers using one of the Rule 506 exemptions will typically provide prospective investors with offering documents such as a private placement memorandum (which is subject to antifraud liability), but the costs, both financial and timewise, associated with Rule 506 offerings are significantly less than a traditional public offering.  Of course, there also are drawbacks to conducting an offering under Rule 506.  For example, we mention above that under Rule 506, securities may only be sold to accredited investors (barring the limited exception provided under Rule 506(b)). But perhaps the most significant drawback of Rule 506 offerings is that the securities offered and sold in a Rule 506 offering are deemed to be “restricted” securities under U.S. securities laws and must generally be held by the purchaser for one year before they may be resold.  In addition, while Rule 506(c) offerings permit general solicitation and advertising, issuers conducting 506(b) offerings may not participate in any general solicitation or advertising.

Reg A+ Offerings

There is an alternative path that has been gaining a lot of attention in crypto circles recently, and that is the exemption provided by Regulation A+ of the Securities Act, deemed by some the “mini-IPO.”

Regulation A+ was passed under the JOBS Act as an improvement to the predecessor Regulation A exemption and provides for a more streamlined process than the typical IPO.  Like an IPO, Regulation A+ permits eligible issuers to offer securities to the general public, not just to accredited investors. Issuers relying on Regulation A+ are required to file a Form 1-A with the SEC, which is subject to SEC review and approval (unlike Regulation D offerings, which are not reviewed and issuers do not need to wait for approval prior to issuance).

The crux of the Form 1-A is the offering circular, which must contain financial statements and other information similar to but less extensive than what would be required in a registration statement (albeit significantly more extensive than what is typically included in an ICO white paper).

Aside from the ability of the issuer to offer securities to the general public under Regulation A+ (subject to the non-accredited investor caps imposed by Tier 2), one of the most significant advantages of Regulation A+, as compared to Regulation D, is that securities issued in a Regulation A+ offering are not “restricted” securities and are freely tradable. However, we note that the potential for a trading market actually developing, and the potential for real liquidity, particularly for tokens and coins, should be evaluated.  Another benefit to Regulation A+ is that it allows issuers to “test the waters” or solicit interest in a potential offering either before or after the filing of the Form 1-A, subject to certain conditions.  However, Regulation A+ offerings are subject to offering caps, unlike Rule 506 offerings, as described below.

Regulation A+ consists of two offering categories – Tier 1 for offerings up to $20 million and Tier 2 for offerings up to $50 million. Aside from the price differential, the other significant differences between the two offering tiers are that Tier 2 offerings require audited financial statements, ongoing SEC disclosure requirements (albeit to a lesser extent than those required in connection with an IPO) and an investment cap for non-accredited investors.  Tier 2 offerings, but not Tier 1 offerings, also preempt state securities regulatory review (similar to Rule 506 offerings), a significant improvement over the predecessor Regulation A.

So, is Regulation A+ the answer for crypto companies?  Maybe, maybe not.  To date, only six issuers have filed a publicly available Form 1-A for a token offering, and none of these filings has been qualified by the SEC.

As noted above, perhaps the most significant advantage to Regulation A+ is that investors receive unrestricted securities that are freely tradable.  But how soon will a truly robust secondary trading market develop for the tokens and coins being offered by most crypto companies?  And why would a crypto company subject itself to the filing requirements and ongoing disclosure requirements of a Regulation A+ offering, when it could instead offer unlimited securities (albeit to accredited investors only) under Rule 506 with limited filing requirements, not to mention no SEC review, and no ongoing SEC reporting obligations?  The best alternative will, of course, be issuer specific, which is why it is critical for issuers to weigh the pros and cons with experienced legal counsel.


[1] An “accredited investor,” in the context of a natural person, includes anyone who: (i) earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year; or (ii) has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence.  Entities such as banks, partnerships, corporations, nonprofits and trusts with total assets in excess of $5 million also qualify as accredited investors.