The following is a summary of the second round of tax developments implemented by the US Treasury. Please click the link to view the full article.
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Category: Perspectives
SEC Final Rules Regarding Conduct of Broker-Dealers and Investment Advisors
On June 5, 2019, the Securities and Exchange Commission (“SEC”) approved new Rules and interpretations regarding the standards of conduct of broker-dealers (“BD”) and investment advisers (“IA”). The rules and interpretations were adopted pursuant to a grant of rulemaking authority in Section 913(f) of the Dodd-Frank Act and reflect a heightened standard for quality and transparency, enhancing the investors’ relationship with BDs and IAs.
The rules and interpretations are:
- Regulation Best Interest: The Broker-Dealer Standard of Conduct (“Reg BI”).
- Form CRS Relationship Summary; Amendments to Form ADV (“Form CRS”).
- Commission Interpretation Regarding Standard of Conduct for Investment Advisers (“IA Conduct Interpretation”).
- Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser (“BD Exclusion Interpretation”.
Regulation Best Interest
Reg BI provides a new standard of conduct for BDs when making recommendations of securities transactions or providing investment strategy involving securities to a retail customer. The rule requires BDs to act in the “best interest” of their customers and place the interests of their customers ahead of their own or other interests. Broker-dealers must comply with four obligations when making recommendations to satisfy Reg BI. These four obligations are: (1) a disclosure obligation; (2) a care obligation; (3) a conflict of interest obligation; and (4) a compliance obligation.
The disclosure obligation requires the BD to provide in writing full and fair disclosure of (1) all material facts relating to the scope and terms of the relationship as well as (2) all material facts relating to conflicts of interest associated with the recommendation.
The care obligation requires BDs to exercise reasonable diligence, care and skill to (1) understand the risks, rewards, and costs associated with the recommendation and have a reasonable basis to believe that the recommendation is in the best interest of the customer; (2) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on the customer’s investment profile; and (3) have a reasonable basis to believe that a series of recommended transactions is not excessive and is in the best interest of the retail customer.
The conflict of interest obligation requires (1) identification and at a minimum disclosure or elimination of all conflicts of interests associated with such recommendations; (2) identify and mitigate any conflicts of interests that create an incentive for associated persons (“AP”) to place the other interests ahead of the interests of the customer; (3)(i) identify and disclosure any material limitations on the securities, and (ii) prevent such limitations and conflicts from causing the BD or AP to put other interests ahead of the interests of the customer; and (4) identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales specific securities or specific types of securities within a limited period of time.
Finally, the compliance obligation requires the BD to establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Reg BI.
Form CRS
Form CRS requires both BDs and IAs to provide retail investors with a short relationship summary document that provides certain information about the firm and the brokerage and/or investment advisor services it offers, including fees and costs, conflicts of interest, and whether or not the firm and its professionals have been disciplined. The Form CRS also includes specific instructions as to content, formatting, and length.
IA Conduct Interpretation
The IA Conduct Interpretation was issued to reaffirm and clarify its views on the fiduciary duties that investment advisers owe to their clients, including the Duty of Care and the Duty of Loyalty. This will apply to all investment advisers whether they are registered and/or have retail customers.
Under the duty of care, IAs have additional duties such as, the duty to provide advice that is in the Best Interests of the Client, the Duty to Seek Best Execution, and the Duty to Provide Advice and Monitoring over the Course of the Relationship. Each of these three duties place an emphasis on the IA putting the interests of their customers before their own or other interests.
BD Exclusion Interpretation
The BD Exclusion Interpretation clarifies the scope of the BD exclusion from the definition of “investment adviser” in the Investment Advisers Act of 1940. The SEC realized that this exclusion allowed BDs to provide substantial amounts of investment advice and therefore it set out clear definitive limits to this exclusion.
These limits include limitations on when a BD may exercise investment discretion and provide investment advice, which is only when it is in connection with their business to buy and sell securities. The investment advice cannot be the main goal of the transaction.
The SEC also clarified that a BD may voluntarily and without any agreement with the customer review the holdings in a customer’s account for purposes of deciding whether to make an investment recommendation.
Tax Law Updated, First Quarter 2019
The following is a summary of important tax developments that occurred in January, February, and March of 2019 that may affect you, your family, your investments, and your business. Please contact me for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
Estimated tax penalty relief. The IRS announced that it is waiving the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year. This waiver covers taxpayers whose total withholding and estimated tax payments are equal to or greater than 80% of their taxes owed, rather than the usual statutory percentage threshold of 90%. The provided relief expanded that initially offered by IRS; the earlier relief pertained to taxpayers who had paid 85% of their taxes owed. The relief was prompted by changes in the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017), some of the which might impact withholding (e.g., the repeal of the personal exemptions and many itemized deductions and the capping the state and local income tax deduction at $10,000). A Government Accountability Office (GAO) report estimated that nearly 30 million taxpayers could be underwithheld in 2018. IRS also provided procedures for requesting the waiver and procedures under which taxpayers who have already paid underpayment penalties but who now qualify for relief may request a refund.
For more information, see this IRS News Release.
Employer identification number (EIN). As part of its ongoing security review, the IRS announced that, starting May 13, only individuals with tax identification numbers may request an Employer Identification Number (EIN) as the “responsible party” on the application. Individuals named as responsible party must have either a Social Security number (SSN) or an individual taxpayer identification number (ITIN). Under Code Sec. 6109(a)(1), persons are required to include taxpayer identifying numbers on returns, statements, or other documents filed with the IRS. One of the principal types of taxpayer identifying numbers is an EIN. IRS generally assigns an EIN for use by employers, sole proprietors, corporations, partnerships, nonprofit associations, trusts, estates, government agencies, certain individuals, and other business entities for tax filing and reporting purposes. A person required to furnish an EIN must apply for one with the IRS on a Form SS-4 (Application for Employer Identification Number). The new change will prohibit entities from using their own EINs to obtain additional EINs. The requirement will apply to both the paper Form SS-4 and online EIN application.
As of May 13, 2019, only individuals with tax identification numbers may request an EIN. You can read the IRS press release here.
Electric car credit declines. IRS announced that, during the fourth quarter of 2018, General Motors (GM) reached a total of more than 200,000 sales of vehicles eligible for the plug-in electric drive motor vehicle credit under Code Sec. 30D(a). Accordingly, the credit for all new qualified plug-in electric drive motor vehicles sold by GM began to phase out April 1, 2019. Qualifying vehicles from GM purchased for use or lease are eligible for a $7,500 credit if acquired before April 1, 2019. Beginning Apr. 1, 2019, the credit will be $3,750 for GM’s eligible vehicles. Beginning Oct. 1, 2019, the credit will be reduced to $1,875. After Mar. 31, 2019, no credit will be available.
You can read the IRS press release on this issue here.
Deduction for back alimony. The Tax Court held that an ex-husband’s payment of alimony arrearages resulted from a contempt order by a Family Court was not a “money judgment”, and so qualified as deductible alimony. With respect to divorce instruments executed before Jan. 1, 2019, amounts received as alimony or separate maintenance payments are taxable to the recipient and deductible by the payor in the year paid. An alimony payment is one that meets the certain specific requirements, such as it must be made under a divorce or separation instrument and the payor’s obligation to make the payment must end at the death of the payee spouse. On the other hand, a money judgment is a document issued by a court stating that the creditor (or other plaintiff) has won a lawsuit and is entitled to a certain amount of money. A New York court found a taxpayer to be in contempt due to his failure to make his alimony payments and sentenced him to 150 days in jail unless he paid $225,000 to his former spouse. The taxpayer paid the $225,000 at issue and claimed an alimony deduction. The Tax Court found that the court’s order was not a money judgment, but rather a contempt order to achieve the payment of alimony arrearages which retained their character as alimony.
You can download the court’s opinion in the Siegel case, TC Memo 2019-11, here.
Qualified business income deduction: final regulations. The IRS issued final Code Sec. 199A regulations for determining the amount of the deduction of up to 20% of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate (the qualified business income deduction). The regulations cover a wide range of topics and discuss the operational rules, including definitions, computational rules, special rules, and reporting requirements; the determination of W-2 wages and unadjusted basis immediately after acquisition of qualified property; the computation of qualified business income, qualified real estate investment trust (REIT) dividends, and qualified publicly traded partnership income; the optional aggregation of trades or businesses; the treatment of specified services trades or businesses and the trade or business of being an employee; and the rules for relevant passthrough entities, publicly traded partnerships, beneficiaries, trusts, and estates.
IRS released in January of 2019 various guidance associated with the Qualified Business Income (QBI) deduction:
- A set of regulations, finalizing proposed regulations issued last summer, as well as a new set of proposed regulations providing guidance on several aspects of the QBI deduction, including qualified REIT dividends received by regulated investment companies
- A revenue procedure providing guidance on determining W-2 wages for QBI deduction purposes,
- A notice on a proposed revenue procedure providing a safe harbor for certain real estate enterprises that may be treated as a trade or business for purposes of the QBI deduction
Qualified business income deduction: calculating W-2 wages. IRS provided three methods for calculating W-2 wages under Code Sec. 199A, the qualified business income deduction, for purposes of the deduction limitation based on W-2 wages and for purposes of the deduction reduction for certain specified agricultural and horticultural cooperative patrons. Under Code Sec. 199A, W-2 wages include:
- The total amount of wages as defined in Code Sec. 3401(a) (dealing with income tax withholding);
- The total amount of elective deferrals (within the meaning of Code Sec. 402(g)(3));
- Compensation deferred under Code Sec. 457; and
- The amount of designated Roth contributions.
For any taxable year, a taxpayer must calculate W-2 wages for purposes of Code Sec. 199A using one of the three methods provided by IRS. The first method (the unmodified Box method) allows for a simplified calculation, while the second and third methods (the modified Box 1 method and the tracking wages method) provide greater accuracy. The Box numbers referenced under each method refers to those on the Forms W-2 (Wage and Tax Statement).
The IRS published Notice 2018-64, which explains the calculation of W-2 wages for purposes of Code Section 199A. You can download the Notice here.
Qualified business income deduction: rental real estate safe harbor. The IRS provided a safe harbor under which a rental real estate enterprise will be treated as a trade or business for purposes of the qualified business income deduction under Code Sec. 199A. That Code provision provides a deduction to non-corporate taxpayers of up to 20% of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship, as well as a deduction of up to 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. Solely for this purpose, a rental real estate enterprise will be treated as a trade or business if:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
- For tax years beginning prior to Jan. 1, 2023, 250 or more hours of rental services were performed per year with respect to the rental enterprise; and
- The taxpayer maintains contemporaneous records on the hours of all services performed; a description of all services performed; the dates on which such services were performed; and who performed the services. (This contemporaneous records requirement doesn’t apply to tax years beginning before Jan. 1, 2019).
You can download IRS Notice 2019-07 here. It explains the IRS views on the safe harbor. Observe that the question of whether triple-net leases qualify as a trade or business for purposes of Section 199A remains unanswered, although it appears they will not qualify under the safe harbor.
Options for those unable to pay taxes due. The April 15th deadline for filing 2018 income tax returns (for most taxpayers, at least; April 17 for Maine, Massachusetts, and the District of Columbia) has recently passed. The IRS advised taxpayers who don’t have cash to pay the balance due on their returns, that taxpayers can avoid penalties but not interest if they can get an extension of time to pay from the IRS. However, such extensions merely postpone the day of reckoning for the period of the extension (generally, six months). The IRS has described other ways in which financially distressed persons may be able to defer paying their income taxes, including installment agreements (a short-term 120-day payment plan and a long-term payment plan) and an offer in compromise with the IRS.
The IRS offers brief explanations of some of the payment alternatives available to taxpayers:
https://www.irs.gov/payments/alternative-payment-plans-hardship-information
These notes are intended only for clients and friends of my law practice. These notes illustrate general principles only and are not intended as legal or tax advice. The reader is cautioned to discuss his or her specific circumstances with a qualified professional before taking any action. In some jurisdictions, this newsletter may be considered attorney advertising.
Technology Regulation in the Federal Securities Market
Pastore & Dailey LLC has an extensive RegTech practice, and Jack Hewitt, a P&D Partner, is one of the country’s authorities in this area. In line with this, P&D is pleased to announce that Bloomberg BNA has just published Mr. Hewitt’s new treatise, Technology Regulation in the Federal Securities Markets.
The treatise is structured into three major segments – cybersecurity, the new market technologies and blockchain. The cybersecurity segment provides a comprehensive review of all applicable federal and state regulations and guidelines while the market technology segment addresses, among others, the Cloud, robo-advisers and smart contracts. The final segment, Blockchain, includes cryptocurrency, tokens and ICOs. Mr. Hewitt, whose expertise extends to virtually all major business sectors, regularly reviews client cybersecurity and technology procedures and would be pleased to discuss performing one for your firm.
Please use the below link to view the Table of Contents and the chapters on Information Security Programs and ICOs of the new treatise.
https://s3.amazonaws.com/pdlaw-cdn.sitesdoneright.net/userfiles/WebSample.pdf
International Trademark Registration
For businesses operating in the United States, registering a trademark or tradename is a method of protecting your reputation and integrity within your market. Registration with the United States Patent and Trademark Office (“USPTO”) provides such benefits as the right to use the ™ symbol, to file a federal infringement lawsuit, to seek attorney’s fees and treble damages, to halt the application of similar marks with the USPTO, and to serve as a basis for international applications.1 Such benefits, however, are only available within the United States, unless your business exercises the last benefit listed above and registers its trademark internationally.
International registration offers several important benefits to a business operating in an online marketplace. Primarily, it allows your business to protect its intellectual property outside the United States if it is selling its product or offering its services in more than one country. It also allows your business to enforce its trademark against foreign imposters who are intentionally operating in a foreign market to take advantage of the limited reach of United States’ trademark protection.
While foreign registration will not offer protection in every country, registration with the World Intellectual Property Organization (“WIPO”) allows for application in 90 countries affiliated with the international treaty known as the Madrid Protocol.2 As noted above, federal registration within the United States can serve as a basis for international registration with WIPO. The United States registrant submits the WIPO application, which must apply the mark to the same goods as the United States application and must be for the same or a lesser scope.3
Just as a business must weigh the costs and benefits of federal trademark registration, a business should also balance the costs associated with international registration, in order to determine whether such protection is worth the investment. Clearly, businesses operating in other countries should consider international registration in those countries in which they operate; but what about United States business operating online? If your business is selling its product or service on an online marketplace to international consumers, it should inquire into the volume of business it is achieving and in which countries, in order to determine which countries, if any, it should be seeking registration. Another consideration should be the susceptibility of your product to counterfeiters or imposters and whether registration would be beneficial in countries notorious for producing such products.
We encourage businesses considering international operations to discuss the costs and benefits of international trademark registration with our attorneys. For a list of countries which accept the WIPO application, please visit the WIPO webpage at the link below.4
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- Andrew Stockment, Trademarks 101 Part 2: The Benefits of Federal Registration (August 27, 2013), https://www.americanbar.org/groups/young_lawyers/publications/the_101_201_practice_series/trademarks_101_part_2_the_benefits_of_federal_registration/.
- Josh Gerben, International Trademark Filing Strategies: How, When & Where to File a Trademark Outside the U.S. (Jan. 14, 2019), https://www.ipwatchdog.com/2019/01/14/international-trademark-filing-strategies/id=104779/ (noting that many South American and Middle Eastern countries are not participants in the WIPO application process).
- Id.
- https://www.wipo.int/madrid/en/madridgazette/remarks/2013/4/gaz_st3.htm.
The New Partnership Audit Rules: Two Ways Out
The new changes imposed by the Bipartisan Budget Act of 2015 established new rules for how partnerships will be audited and how they are assessed liability for federal taxes due after an examination. These new rules require that every entity that could be treated as a partnership to examine, and when needed, revise its governing documents to be able to comply with the rules. This article delves further into the new BBA rules and how partnerships may opt-out to avoid the full effects of the new consolidated partnership audit rules and push-out the adjustments to income, gain, loss, deduction, or credit to each partner of the partnership for the reviewed year by following a prescribed process. For those considering purchasing or selling partnership interests should be aware of the current responsibilities implemented by these new rules and review their partnership agreements.
Initial Coin Offerings: The New (Controversial) Way to Raise Capital
With Bitcoin exploding in market value to over $19,000 per coin at the close of 2017, investors are intrigued by the alluring concepts of cryptocurrency, blockchain, and the decision of whether to invest in startup companies utilizing cryptocurrency.[1] Recently, initial coin offerings (ICOs) have been the primary way for cryptocurrency startup companies to raise capital, and most notably, avoid the high costs associated with the traditional initial public offering (IPO). In 2017, over $4 billion was raised through the use of initial coin offerings, and that figure was forecasted to rise significantly.[2] This article will summarize what an initial coin offering is, why it is controversial, and what the near future may hold regarding regulation for this method of raising capital.
What is an Initial Coin Offering?
An initial coin offering is a means for cryptocurrency startup companies to raise capital through crowdfunding. There are two primary reasons to create an initial coin offering: first, to create a new kind of cryptocurrency (different from Bitcoin) that has its own blockchain, or, second, to fund a project that requires a new unique currency to be effective. Most ICOs involve the second type, known as token generation events (TGE). To begin the process of an ICO, the issuing company publishes a whitepaper detailing their company business model, projections, fundraising goals, what type of currency is accepted in the offering, company timelines, and other information to incentivize investors. Upon making the decision to participate in the ICO, investors use cryptocurrency (or fiat currencies like U.S. dollars (hereinafter, “cash”), in some cases) to purchase coins, or “tokens,” from the coin issuing company. Bitcoin is the most commonly used form of cryptocurrency by investors in ICOs. Tokens purchased by the investor do not necessarily represent shares of ownership in the company, but they are similar in varying respects. Technically, they reflect a percentage of the total amount of the initial cryptocurrency produced and can be redeemed or sold on secondary markets for cash value (or Bitcoin) once the issuing company meets its funding benchmarks and launches the venture.
In a nut shell, investors are simply being offered the opportunity to “get in on the ground floor” and purchase coins for a significantly lower price than the coin is projected to reach in the whitepaper. Should the company not meet its funding benchmarks, these tokens are supposed to be refunded for the principle price paid in the currency used by the investor. Ultimately, the decision to invest in an ICO depends on the investor’s prediction on whether the issuing company will successfully attain funding milestones to produce a viable cryptocurrency that will increase in value over time, or at least will be able to return all investments made by the investor should the benchmarks not be reached.
Ethereum is an example of a successful ICO that generated a substantial return on investment for those who participated. Ethereum uses Ether as its cryptocurrency, which was issued in 2014 at $.40 per Ether, translating to roughly $18 million in Bitcoin at the time.[3] Ethereum’s project went live in 2015, and as of today the cryptocurrency trades at $873.72 per Ether, and is the second most successful cryptocurrency to date behind Bitcoin.[4] Returns like Ethereum make headlines across the nation, and are a focal point in driving investors to take a hard look into the “cryptocurrency bubble.”
Securities Regulation of ICOs
ICOs are quite similar to a traditional IPO, save for one major aspect: enforced regulation. On July 25th, the SEC issued its first sweeping statement (a “21(a) Report”) regarding the transfer and sale of digital currency like “tokens” sold in ICOs, declaring that the federal securities laws may apply to ICOs after its investigation into The DAO.[5]
The DAO was a decentralized autonomous organization (“dao”) that used distributed ledger or blockchain technology to operate as a virtual entity, and sold tokens representing interests in the company to investors in exchange for cryptocurrency. In the 21(a) Report, the SEC confirmed that cryptocurrency in the form of tokens or “coins” sold in ICOs can be a security, and that ICO issuers and ICOs may be subject to federal securities regulation law.[6] How these laws will be applied and when further enforcement will go into effect are uncertain at this time, but the signs of SEC movement on the issues of cryptocurrency transactions are present.
At the Senate Committee on Banking, Housing, and Urban Affairs hearing on February 9, 2018, SEC Chairman Jay Clayton was quoted as saying, “You can call it a coin, but if it functions like a security, then it’s a security,” and, most notably, “A note for professionals in these markets: those that engage in semantic gymnastics … are squarely within the crosshairs of our Enforcement Division.”[7] In most types of ICOs listed today, if one were to apply the “Howey test” (from the landmark 1946 U.S. Supreme Court decision that helped clarify what defines an “investment contract,” which itself is part of the definition under the Securities Act of 1933 of a “security”), the tokens offered would most likely be interpreted by the SEC to be securities, in that they are “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”[8]
Clayton’s comments in February echo the sentiments of his statement from December 11, 2017regarding cryptocurrency’s treatment under the Howey test and the 21(a) Report, in which he stated, “In the 21(a) Report, the Commission applied the longstanding securities law principles to demonstrate that a particular token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, we concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
Recently, there has been a growing number of public statements from prominent figures regarding online market trading regulation, which indicates a possible regulatory turf war between the SEC and the CTFC. On March 7, 2018, the SEC published a statement detailing considerations both investors and market participants should assess regarding online market exchanges for ICO-based coins and tokens.[9] In addressing investor considerations, the SEC urged investors to utilize national exchanges, broker dealers, or other traditional platforms that are heavily regulated. Specifically, the SEC made it clear that even though many of these online trading markets call themselves “exchanges,” they are, in fact, not as heavily regulated at this present time the same way as traditional national exchanges. Regarding whether or not all online trading exchanges shall be subject to regulation, the SEC states:
“Some online trading platforms may not meet the definition of an exchange under the federal securities laws, but directly or indirectly offer trading or other services related to digital assets that are securities. For example, some platforms offer digital wallet services (to hold or store digital assets) or transact in digital assets that are securities. These and other services offered by platforms may trigger other registration requirements under the federal securities laws, including broker-dealer, transfer agent, or clearing agency registration, among other things. In addition, a platform that offers digital assets that are securities may be participating in the unregistered offer and sale of securities if those securities are not registered or exempt from registration.” (Id.)
This statement suggests that certain circumstances and types of transactions occurring in the online market platforms will determine what kinds of regulation requirements will be enforced, but most importantly, that there will be forthcoming enforcement on a large scale.
The SEC’s statement was issued on the heels of an opinion from the District Court for the Eastern District of New York, which on March 6, 2018 held that the CTFC had standing to bring a lawsuit for fraud and to oversee cryptocurrency (including Bitcoin and the similar Litecoin, but not necessarily including ICO-based coins and tokens), for it is within the plain language definition of a “commodity.”[10] The CTFC initially determined in 2015 that cryptocurrency was a commodity, and this Federal District Court holding strengthens the CTFC’s claim to regulatory jurisdiction over cryptocurrency.
Both the SEC and the CTFC will issue regulations on cryptocurrency, and the turf war over this hot topic will ensue for the foreseeable future as the market for virtual currency continues to grow. On March 14, Congress held its first hearing on ICOs, where “House Financial Services Committee members asked questions about such topics as hacking, use of digital currencies by criminals, defining securities, and protecting investors.”[11] Also of note, the Governor of the Bank of England gave a statement in which he said, “The time has come to hold the crypto asset ecosystem to the same standards as the rest of the financial system. Being part of the financial system brings enormous privileges, but with them great responsibilities…In my view, holding crypto asset exchanges to the same rigorous standards as those that trade securities would address a major underlap in the regulatory approach.”[12]
This regulatory crackdown by the SEC and the CTFC comes as no surprise, as there are numerous market factors that triggered the initial SEC and CFTC investigations and that continue to command the regulators’ attention, including the explosion of token offering companies and investors participating in ICOs, the exponential increase in value of cryptocurrencies, and ICO scams that defraud investors.[13]
ICO Scams Defraud Investors
ICO scams are of particular concern to the SEC, as the underlying premise of the federal securities laws are to protect investors from being deceived, by mandating public companies to file numerous types of disclosures for investor transparency. These scams occur when news spreads that startup cryptocurrency companies forecasting massive growth are preparing to launch an ICO, which prompts scammers into setting up fake website domains and portals that deceive investors. The scammers will utilize social media sites like Facebook and Twitter to quickly capture non-sophisticated investors who are researching the ICO. Once the investor submits their cryptocurrency investment into the scammer’s system, any effort to try and reclaim that investment is futile as it recedes into the dark web.
Telegram is a current example of immense market backlash from scammers hijacking ICO market anticipation. Telegram is hosting a widely anticipated ICO beginning in March, but already has faced a prominent scam that stole millions of dollars worth of cryptocurrency from investors who thought they were buying into Telegram’s ICO. English and Russian versions of the actual whitepaper were leaked, and hosted by these scammer websites, of which Gramtoken.io was the most prominent. Gramtoken.io posted project road maps, copies of the whitepaper, and information regarding the ICO to trick investors into depositing their cryptocurrency into their system. Once Gramtoken.io reached its fundraising goal of $5 million dollars, the website went dark, and the investments through Gramtoken.io cannot be located.
The difficulty in protecting cryptocurrency investments is the driving force behind these scams and is a serious concern for investors. Cryptocurrency transactions are tremendously hard to track for several reasons. First, traditional financial institutions are not involved with cryptocurrency transactions, making traceability of the flow of currency unusual. Second, cryptocurrency transactions are happening on an international scale, which restricts what information the SEC, CFTC and/or other federal and state regulators can compile on the transactions, depending on where the issuing entity is located. Third, there is no central authority or market for cryptocurrency transactions and collection of user information at this time. Finally, law enforcement has no current ability to freeze any cryptocurrency transactions, as cryptocurrency is encrypted and cannot be held by a third-party custodian like a traditional security. Together, these factors significantly impede federal, state and private legal actions and remedies for investors in cryptocurrency transactions.
Celebrity ICO Endorsements and Differing Perspectives
On February 27th, Microsoft founder Bill Gates was asked for his opinion on cryptocurrency during a question and answer session on the popular website Reddit, and responded with, “The main feature of cryptocurrencies is their anonymity. I don’t think this is a good thing. The government’s ability to find money laundering and tax evasion and terrorist funding is a good thing. Right now, cryptocurrencies are used for buying fentanyl and other drugs, so it is a rare technology that has caused deaths in a fairly direct way. I think the speculative wave around ICOs and cryptocurrencies is super risky for those who go long.”[14] Other high-profile individuals have made public statements that appeared to be endorsing specific ICOs, especially pop culture celebrities. Floyd Mayweather, DJ Khaled, Paris Hilton, Jaime Foxx, and other celebrities have made public social media endorsements of a variety of ICOs.[15] These endorsements are problematic and could potentially lead to violations of securities law regarding proper disclosures and solicitations of investors if these celebrities are interpreted to be promoters of the ICO.
Conclusion
Initial coin offerings have become the most prevalent way for cryptocurrency companies to raise capital. With the advent of cryptocurrency (including ICO-based coins and tokens) taking markets by storm, it appears they are here to stay for the foreseeable future as well. The SEC’s statements are clear that securities regulation law will be applied to coins and tokens arising out of ICOs, but numerous investor rights issues regarding traceability, jurisdiction, and lack of central authority over all cryptocurrency render enforcement challenging. While ICOs in their current form are a hot ticket item for now, a massive legal and regulatory overhaul for United States cryptocurrency transactions is undoubtedly in the works.
[1] Coindesk, Bitcoin (USD) Price (last visited Feb. 26, 2018) https://www.coindesk.com/price/
[2] Forbes, ICOs In 2017: From Two Geeks And A Whitepaper To Professional Fundraising Machines (Dec.18, 2017) https://www.forbes.com/sites/outofasia/2017/12/18/icos-in-2017-from-two-geeks-and-a-whitepaper-to-professional-fundraising-machines/#40e99c4e139e
[3] Investopedia, Breaking Down Initial Coin Offerings (ICO) (Feb 26, 2018) https://www.investopedia.com/terms/i/initial-coin-offering-ico.asp
[4] EthereumPrice, Ethereum (USD) Price, (last visited Feb 26, 2018) https://ethereumprice.org/
[5] Divisions of Corporation Finance and Enforcement, Statement by the Divisions of Corporation Finance and Enforcement on the Report of Investigation on The DAO (July 25, 2017) https://www.sec.gov/news/public-statement/corpfin-enforcement-statement-report-investigation-dao
[6] Id.
[7] Joseph Young, SEC Hints at Tighter Regulation for ICOs, Smart Policies for “True Cryptocurrencies”(Feb. 9, 2018) https://cointelegraph.com/news/sec-hints-at-tighter-regulation-for-icos-smart-policies-for-true-cryptocurrencies
[8] “In other words, an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.” S.E.C. v. W.J. Howey Co., 328 U.S. 293, 66 S. Ct. 1100, 1104, 90 L. Ed. 1244 (1946)
[9] Divisions of Enforcement and Trading and Markets, Statement on Potentially Unlawful Online Platforms (Mar. 7, 2018) https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading
[10] Brenden Pierson, Virtual currencies are commodities, U.S. judge rules, THOMPSON REUTERS (Mar. 6, 2018) https://www.reuters.com/article/us-usa-cftc-bitcoin/virtual-currencies-are-commodities-u-s-judge-rules-idUSKCN1GI32C
[11] Kia Kokalitcheva, Congress holds first hearing on initial coin offerings, AXIOS (Mar. 14, 2018) https://www.axios.com/crypto-ico-congress-1521059028-8807c852-22de-461a-8c9e-8a8a9f85d452.html
[12] John D’Antona Jr., BoE Push for Cryptocurrency Regulation Can Boost Markets, TRADERS (Mar. 14, 2018) http://www.tradersmagazine.com/news/cryptocurrencies/boe-push-for-cryptocurrency-regulation-can-boost-markets-117387-1.html?ET=tradersmagazine:e3646:1189431a:&st=email
[13] Jon Russell, Scammers are cashing in on Telegram’s upcoming ICO, TECHCRUNCH (Jan. 20, 2018) https://techcrunch.com/2018/01/20/telegram-ico-scammers/
[14] Reddit, I’m Bill Gates, Co-chair of the Bill and Melinda Gates Foundation. Ask Me Anything (Feb. 28, 2018) https://www.reddit.com/r/IAmA/comments/80ow6w/im_bill_gates_cochair_of_the_bill_melinda_gates/
[15] Jonathan Burr, The Bubble in Celebrity Cryptocurrency Endorsements, CBS NEWS (Nov. 6, 2017) https://www.cbsnews.com/news/bitcoin-celebrity-endorsements-cryptocurrency-sec-warning/
Cryptocurrency Technology Is Driving Innovation
Interest in cryptocurrency and its underlying technology has steadily rose over the past several years. The final week of 2017 alone saw the debut of over a dozen new cryptocurrencies within the market. Moreover, Bitcoin’s explosive increase in value in 2017 from $1,000 to almost $20,000 has made “Bitcoin” and “cryptocurrency” household terms.[1] The accelerating rate of creation of new currencies and the fluctuation in value of various existing currencies have provided investors with substantial profit opportunities. Unsurprisingly, the financial services industry is making significant investments in the underlying block-chain technology. From individual programmers to large fintech firms, there is a race to secure the intellectual property rights for all aspects of block-chain and cryptocurrency technology.
Financial Services
The block-chain technology functions to increase security and decrease inefficiencies regarding cyber transactions. The software accomplishes this by securely hosting a transaction between two individuals without the requirement of a third party to transfer and record the exchange of funds (i.e. banks, credit card companies, etc.). The transactions are then publicly memorialized in a distributed ledger as a link in the chain’s archive. At its core, the block-chain model is a peer-to-peer system; because of this, the software has the potential to revolutionize the financial services industry by reducing the number of parties required to send and receive payments. This decentralized model is one of the characteristics that makes block-chain unique, and financial firms have recognized the tremendous value of the software.
As the value of the block-chain model became more apparent, the United States Patent and Trademark Office (“USPTO”) was flooded with new patent applications concerning block-chain and cryptocurrencies. At the end of 2017, Bank of America, Mastercard, Paypal and Capital One were leading the field in research and development, and represented the top four patent holding entities in the realm of block-chain and cryptocurrencies.[2] The primary technological focus of these top four firms has been financial forecasting, digital data processing and transmission of secure digital data.[3] In fact, Bank of America was recently issued its latest patent from the USPTO, which outlined a cryptocurrency exchange system that would seamlessly convert one digital currency to another.[4] It may be no coincidence that the top four firms leading research and development on block-chain are those that stand to lose the most from the elimination of third-parties in cyber transactions. It is important, at this point in block-chain’s development, that such firms secure a position on the new playing field if cryptocurrency does displace traditional transaction models.
Internet Data Usage
The sprint to secure intellectual property rights does not, however, solely focus on the current block-chain technology; firms are also looking ahead on how to improve the software and how to benefit from future developments and applications. Several firms are focusing specifically on the distributed ledger aspect of block-chain in order to create a personal virtual identity for each of the software’s users.[5] This concept has significant potential to allow individuals to begin to profit off of their personal data. Currently, websites such as Google, Amazon and Facebook track individual’s internet usage and gain considerable value from their personal data with little to no benefit to the user. The creation of an online avatar that hoards this data in a ledger, and makes it available only with the user’s permission, could bring significance to an individual’s internet browsing data. Users could begin to charge companies a fee to gain limited access to this information, even in miniscule amounts. Cryptocurrency effortlessly weaves itself into the system because currencies like Bitcoin are divisible to the hundredth of a millionth degree. This divisibility makes it possible for you to extract value from as little as 0.00000001 of a Bitcoin for a company to see that you have been looking at Volkswagens on Craigslist all afternoon.
This virtual identity system may not be too far off. In 2017, the state of Illinois launched a block-chain pilot for the digitization of personal data, such as birth certificates.[6] The system has the potential to be the framework for the digital identities discussed above, and could further establish an extraordinarily convenient method of sharing verified personal documents.[7] Although this system immediately raises the question of cybersecurity in the minds of most, block-chain technology is, in fact, vastly more secure than our current systems.[8]
Cyber Security
In 2017, Equifax saw one of the largest cyber security breaches in history. The current method of storing millions of individuals’ personal data is piling it together on the same system, which is then encrypted and secured. The issue, as illustrated by Equifax, is that once the security mechanisms are breached, the cyber burglar then has access to the entirety of the stored data.[9] Block-chain, however, stores each individual’s data separately in its own encrypted and secured space. If a hacker wished to steal data from a block-chain, they would be required to decrypt each of the individual’s data separately; in the case of Equifax, the hacker(s) would have been required to bypass 140,000,000 encryptions.[10] For this reason, cyber security firms are becoming increasingly involved in block-chain technology as well.
Mobile Applications
The cyber security and financial services industries are not the only industries honing in on the cryptocurrency craze. It is also worth mentioning the flood of new applications from the mobile software market. The rapid origination rate of mobile applications, no matter how redundant or superfluous they may seem, is compelling United States intellectual property filings. Cryptocurrency mobile applications can provide a wide range of services for their users: market information through applications such as zTrader, Bitcoin Checker and Bitcoin Price IQ; portfolio services through Cryptonator, CoinDex and Mycelium; and trading platforms through Coinbase, CEX.IO and CoinCap. More significantly, many of the most popular websites which provide mobile application support are beginning to accept cryptocurrency as a payment method. Notably, online retailer Overstock.com, online dating service OkCupid.com, electronics retailer Newegg.com, and travel booking agency Expedia.com are among the firms now accepting bitcoin as payment for their services.[11] Cryptocurrency also has the potential to transform the mobile gaming industry.
A dimension of mobile applications which has received a lot of negative publicity over the past few years is predatory in-app purchases. Many mobile gaming applications, which are typically marketed to children and teenagers, are free to download and play, but incentivize frequent micro-transactions from the user. These aptly dubbed “freemium” games result in cases of young users racking up a bill in the range of several hundreds of dollars, to their parent’s surprise. In fact, many applications offer purchases of in-game currencies up to $99 per transaction. This model may change, for better or for worse, with the rise of cryptocurrency. As discussed above, the Bitcoin is divisible to the hundredth of a millionth degree. The mobile gaming industry could see a transition from incentivizing young players to make frequent large transactions, to mobile games charging a fraction of a Bitcoin per minute (or second) of game time. The application would likely request access to your Bitcoin wallet and simply deduct fragments of a Bitcoin for as long as the game remains active. Whether this will be a welcome change is to be determined.
Conclusion
Cryptocurrency and block-chain technology are causing us to rethink our current financial and cyber-social systems. The characteristics that make block-chain unique—the decentralized model, distributed ledger, individual security, sense of virtual identity—are quickly being applied in new and innovative ways. The result is a surge in new intellectual property from forward thinking firms as we move into what may be an important technological shift for many of our country’s industries.
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[1] Coindesk, Bitcoin (USD) Price, Coindesk (last visited Jan. 2, 2018) https://www.coindesk.com/price/.
[2] Jay Sharma, How Bitcoin Became a Game Changer Overnight, IPWatchdog (Dec. 4, 2017), http://www.ipwatchdog.com/2017/12/04/bitcoin-game-changer-overnight/id=90519/.
[3] Id.
[4] Nikhilesh De, Bank of America Wins Patent for Crypto Exchange System (Dec. 7, 2017, 3:00 UTC), https://www.coindesk.com/bank-of-america-outlines-cryptocurrency-exchange-system-in-patent-award/; the Bank of America patent granted by the USPTO is identified by United States Patent No. 9,936,790.
[5] Michael Mainelli, Blockchain Could Help Us Reclaim Control of Our Personal Data, Harvard Business Review (Oct. 5, 2017), https://hbr.org/2017/10/smart-ledgers-can-help-us-reclaim-control-of-our-personal-data.
[6] Michael del Castillo, Illinois Launches Blockchain Pilor to Digitize Birth Certificates, Coindesk (Aug. 31, 2017, 23:00 UTC), https://www.coindesk.com/illinois-launches-blockchain-pilot-digitize-birth-certificates/.
[7] Id.
[8] See Mainelli, supra note 5.
[9] See Mainelli, supra note 5.
[10] Id.
[11] Mariam Nishanian, 8 surprising places where you can pay with bicoin, Business Insider (Oct. 11, 2017 6:00 PM), http://www.businessinsider.com/bitcoin-price-8-surprising-places-where-you-can-use-2017-10/#expediacom-1.
The Federal Criminal Forfeiture Statute: Reining in the Government’s Previously Unbridled Ability to Seize Pretrial Assets
Abstract
American organized crime movies are synonymous with a climatic raid and seizure of illegal assets – typically drugs and guns. But what is really encompassed within the Government’s grasp; what are the “illegal assets”? The truth is that the Government has a wide reach and the criminal seizures don’t end when the screen goes black and the credits roll. The Federal Criminal Forfeiture Statute, as applied to RICO and CCE cases, typically entails the forfeiture of any asset connected to the underlying crimes. Given that criminal forfeiture penalties have ethical and constitutional considerations, it is not surprising to learn that a recent United States Supreme Court decision has scaled back the Government’s power over its ability to seize. This Note will provide an overview of the Federal Criminal Forfeiture Statute, as well as RICO and CCE in order to provide context, will detail the case law history of the statute in application, will examine the ethical and constitutional considerations, and will question the future of the controversially applied law.
Click Here for full article
Orginally Published in Pace Law Review
Kristyn Fleming Francese, The Federal Criminal Forfeiture Statute: Reining in The Government’s Previously Unbridled Ability to Seize Pretrial Assets, 38 Pace L. Rev. 634 (2018)
Available at: https://digitalcommons.pace.edu/plr/vol38/iss2/10
Non-Practicing Entities & Patent Reform
Abstract
The patent system is designed to promote innovation and supply a blueprint for innovative minds to improve upon, but the behavior of some patent owners is contrary to these principles. Non-practicing entities obtain patent rights, and rather than produce the product claimed in the patent, they assert their exclusionary rights broadly and aggressively against businesses producing similar products in order to induce settlement or licensing payments. These assertions account for a significant percentage of infringement claims and threaten a potentially innocent business with expensive litigation. The actions of these entities have a substantial effect on the patent system and have been the motivation behind reform and recent Supreme Court decisions. Each of the three branches of government has significant influence over the patent system, and each has the potential to promote change to reduce the impact of non-practicing entities on the United States patent system and on the United States economy.
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Originally Published in Pace Law Review
Nicholas Douglas, Non-Practicing Entities & Patent Reform, 38 Pace L. Rev. 608 (2018)
Available at: https://digitalcommons.pace.edu/plr/vol38/iss2/9