By: Michael W. Zarlenga*
In my December 13, 2017 Blog, I asked whether statements in early December by the Director of the Securities and Exchange Commission's (SEC) Division of Investment Management foreshadowed possible SEC intent to regulate the trading of tokens and other cryptocurrencies in a secondary market and, therefore, held by publicly traded funds. As expected, on January 18, 2018, Director Blass issued Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings. The letter sets forth a number of questions the Division of Investment Management poses regarding the administration of a fund which holds cryptocurrency or cryptocurrency related assets. The letter, in short, institutes a moratorium on registering cryptocurrency funds and prevents existing funds from holding substantial amounts of cryptocurrency or cryptocurrency related assets. The letter states:
Until the questions identified above can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products, and we have asked sponsors that have registration statements filed for such products to withdraw them. . . . If a sponsor were to file a post-effective amendment under rule 485(a) to register a fund that invests substantially in cryptocurrency or related products, we would view that action unfavorably and would consider actions necessary or appropriate to protect Main Street investors, including recommending a stop order to the Commission.
Mutual funds and exchange traded funds must value their assets each business day in order to strike a net asset value. A big concern of the SEC is the basis for the valuation of fund assets. Valuation plays a key role in everything from disclosures regarding fund performance to determining the daily price for purchases. In light of the lack of reliable public information regarding most cryptocurrency assets (which would allow a fund to value these assets), the SEC has serious questions regarding how a fund holding these assets will strike an accurate net asset value. Most of the questions, however, seem to culminate in the ultimate motive of the SEC, namely preventing potential manipulation of the market for these funds.
The SEC also released the remarks of SEC Chairman Jay Clayton from a speech he delivered at the opening of the Securities Regulation Institute on January 22, 2018. He strongly admonished securities professionals involved with cryptocurrencies. He stated:
My first message is simple and a bit stern. Market professionals, especially gatekeepers, need to act responsibly and hold themselves to high standards. To be blunt, from what I have seen recently, particularly in the initial coin offering ("ICO") space, they can do better.
These remarks are not surprising. The SEC has had to step in to prevent a number of unregistered securities offerings involving tokens and coins. In December, Chairman Clayton threw the securities professionals a bone by stating the obvious, namely the preeminent question for all ICO market participants is whether or not the coin or token is a security. Chairman Clayton's current comments seem to announce the SEC's disappointment in the legal profession for failing to properly advise clients. The legal analysis set forth with regard to The DAO (a investor-directed virtual venture capital fund operating as a decentralized autonomous organization) and the further action taken recently regarding Munchees, Inc., highlight Chairman Clayton's view that a competent securities professional should have no problem determining what is or is not a security. Further, he believes that too often "lawyers appear to provide the 'it depends' equivocal advice, rather than counseling their clients that the product they are promoting likely is a security."
Among Federal and state agencies, the SEC is particularly interested in the topics of cryptocurrencies and other Blockchain assets. Chairman Clayton has announced that he is putting the SEC "on high alert for approaches to ICOs that may be contrary to the spirit of our securities laws and the professional obligations of the U.S. securities bar." The future regulatory landscape is anything but clear. Bergstrom Attorneys continues to monitor developments and advise clients in the cryptocurrency, coin and token offering, and distributed ledger network arena. Let us know if we can help you.
* Michael W. Zarlenga is Of Counsel to Bergstrom Attorneys, PLLC. Mr. Zarlenga has extensive securities law experience, including both public and private placements of securities totaling in excess of $2 billion. In addition, Mr. Zarlenga has advised clients ranging in size from start-up companies to Fortune 500 in such diversely regulated fields as biotech, hi-tech, financial services, and insurance.
