William Hinman, the Director of the SEC’s Division of Corporation Finance, delivered remarks on June 14, 2018 to attendees at the Yahoo Finance All Markets Summit: Crypto in San Francisco. Director Hinman’s speech provides significant insight into how the SEC is addressing developments in cryptocurrencies and other digital assets. The speech comes only ten days after the SEC named Valerie A. Szczepanik as the Division of Corporation Finance’s Senior Advisor for Digital Assets and Innovation, and only eight days after Jay Clayton, the SEC’s Chairman, provided additional cryptocurrency regulatory insights in a CNBC interview. These statements and the appointment of Valerie Szczepanik reflect the significant attention and resources that the SEC is committing to these technological innovations.
Director Hinman began by confirming what most industry participants already understand about how the SEC views a “traditional” initial coin offering (“ICO,”) scenario—ICOs generally involve the issuance of a security that falls under the purview of federal securities laws. Director Hinman explained that the ICOs he has seen typically involve a promoter raising capital by selling digital tokens or coins in order to build a distributed ledger network. Purchasers of these digital assets generally look to receive a return on their investment, which is typically generated by selling the digital assets in the secondary market once the distributed ledger network has been developed and has increased in value. As securities, the offering and sale of these digital assets must be registered under the federal securities laws, or must rely on an exemption from registration.
Importantly, Director Hinman went on to discuss whether a digital token or coin initially offered as a security may be later sold in a manner that does not constitute an offering of a security. He explained that the purpose of the Securities Act of 1933 is to remove the asymmetry of information between the promoter of a security and the investors in the security. The distributed ledger network on which the digital token or coin functions, however, may become decentralized to the point where purchasers no longer “reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts.” In that case, the “material information asymmetries recede,” disclosures by the issuer or promoter become less meaningful, and, therefore, transactions in the digital asset may no longer “represent a security offering.”
In that light, Director Hinman noted that, based on his understanding, the Bitcoin and Ethereum networks have become decentralized to the point that offers and sales of bitcoin and ether are not securities transactions under the federal securities laws, and that applying the disclosure regime of the federal securities laws to current transactions in those cryptocurrencies “would seem to add little value.” (This reference to bitcoin echoes statements made by Chairman Clayton during his CNBC interview, where he stated that, based on his understanding, bitcoin should not be considered a security under the federal securities laws.) Director Hinman also went on to confirm that there may be other instances where a distributed ledger network is sufficiently decentralized to the point where regulating those digital tokens or coins as securities is unnecessary.
It is important to note that Director Hinman’s speech does not represent a formal ruling, and that it does not bind the SEC—and, perhaps more importantly, any federal court—to agree with his views. His speech, however, does provide important insight into how the SEC is viewing developments in digital assets. For instance, Director Hinman stated that the “analysis of whether something is a security is not static and does not strictly inhere to the instrument,” meaning that even digital tokens or coins that are not securities in one instance may be considered securities in another instance if packaged and marketed in a particular manner. Also, Director Hinman’s comment regarding the cryptocurrency ether does not include other digital tokens and coins that function under various standards on the Ethereum network (e.g., the ERC20 and ERC223 standards), each of which should be assessed separately under the federal securities laws.
At the conclusion of Director Hinman’s speech, he recognized that market participants needed guidance on whether a digital asset transaction involved a security. Notably, he provided a number of non-exclusive factors for assessing whether an ICO is a securities offering. He also offered a number of non-exclusive factors that should be considered when structuring a digital asset as a consumer item (i.e., not a security).
Feature: FCA Attempts to Woo Sovereign Controlled Companies with Changes to Listing Rules
On June 8th, the U.K. Financial Conduct Authority (“FCA”) announced that it will forge ahead with plans to create a new category under its premium listing regime designed specifically for companies controlled by a sovereign country. The final rules, which the regulator published for consultation last July, aim to make premium listings, which include higher standards of investor protection, more attractive to sovereign controlled companies by addressing elements of the listing regime that present challenges to these types of companies, including requirements for a controlling shareholder agreement and the advance approval of transactions with the sovereign. The new listing category will become effective on July 1, 2018.
Under the new listing category, state-owned companies would be exempt from certain requirements that currently apply to other companies under the premium listing regime. First, sovereign controlled companies will not be required to seek an advance sponsor ”fair and reasonable” opinion for related party transactions, nor will these companies need to obtain prior shareholder approval before these transactions are completed. Instead, companies will be required to disclose related party transactions upon completion. Second, the sovereign would be exempt from the requirement to enter into a controlling shareholder agreement with the issuer, an exemption that the FCA justified due to the “impracticable” nature of these agreements for sovereigns and the wealth of information already available to investors regarding the relationship between the sovereign and the issuer. All other requirements of the premium listing regime will apply to the new category, including the need to demonstrate that a company is carrying on an independent business; the requirement to disclose information regarding the issuer’s compliance with the Financial Reporting Council’s Corporate Governance Code; proportionate voting rights; and adherence to the principles of pre-emption rights.
In response to comments on its consultation, which was met with skepticism by investors and corporate governance advocates, the FCA altered the final rules to include requirements for the election of independent directors to be subject to separate approval by independent shareholders and for the timely disclosure of transactions between the sovereign and the issuer. With respect to the independent director elections requirement, the FCA pointed out that, in the event independent shareholders reject the slate of nominated directors, the requirement for a 90-day cooling off period after which the election can proceed without the separate vote of independent shareholders would apply.
The modifications to the final rules did little to placate critics. In an editorial, the Financial Times said that the new listing category “risks damaging once more the UK’s historically highly regarded corporate governance regime … [which] has already taken a battering from the financial crisis, and from a series of corporate scandals since.” The Guardian reported that business and investment groups, including the Institute of Directors, the Investment Association, and Royal London Asset Management, opposed the new listing category on the grounds that it would weaken corporate governance requirements. The Investment Association called for a review of the rules after two years to address any “unintended consequences.” Andrew Bailey, the FCA’s Chief Executive, defended the changes in an op-ed published in the Financial Times, noting that “sovereign states will often differ from individuals or commercial entities in their motivations and behaviours. A tailored listing category that acknowledges these differences makes it more likely that companies will meet our valued corporate governance standards.”