Question 1

How the SEC &#8220;regulates&#8221; blockchains and digital tokens

Accepted Answer

The SEC defines everything from cryptocurrencies such as Bitcoin and Ethereum to digital tokens that are tracked on the blockchain as "digital assets" that may be regulated as a security. Learn more about our blockchain practice here. SEC's Cryptocurrency Suppression Program The SEC has engaged in a program to require registration of digital assets as securities on the Enforcement side but refuses to permit such registration when companies attempt to register with Corporation Finance. Learn more about the SEC's cryptocurrency suppression program here. What Do We Do For Blockchain Clients? Watch this short video discussing the regulatory landscape with which we assist our clients. What About Non-Fungible Tokens? There is no articulated difference between the types of digital assets the SEC has already attempted to suppress and Non-Fungible Tokens (NFTs). Click here to learn more about how NFTs are defined by the SEC. How Should Companies Address This? Running away from the SEC's program or hoping the agency will leave a company alone long enough for its digital tokens to attain "utility" won't work. Standing pat is not an option, unless digital asset producers want to allow the SEC to shut down a promising, nascent industry of unlimited potential or allow themselves to be driven off-shore. We share some thoughts in the video here or learn more about our blockchain practice area.

Question 2

How the SEC Defines Digital Assets

Accepted Answer

Digital assets are based on blockchains, which are chains of transaction blocks. They include cryptocurrencies, which use their own blockchains, and “crypto tokens [that] are built on an existing blockchain.” Cryptopedia, Digital Assets: Cryptocurrencies vs. Tokens (Mar. 23, 2021) (“Digital Assets”). A “token” can be defined as an instrument (tool) that is (1) perceptible using one or more senses, (2) representative of a stored value and useful as a medium for exchange in a particular market or system of markets, and (3) exchangeable, at some fixed or changeable ratio, for other value, such as a good or service, within that market or system of markets.      In the first part of the definition, (1) above, the token can be perceptible as a tangible object, such as a coin, stamp, ticket, coupon, gambling chip, or only visually, as on a computer monitor or in a company’s ledger.      The second prong, (2) above, includes tokens that have stored value that is either “intrinsic” in that the value derives solely from the token’s acceptability in transactions in the system of markets or “extrinsic” insofar as the token’s value is pegged or linked to another specific asset. A token’s perishability and replicability obviously impact its value. A banana makes for a poor token because it will decompose over time. Although the weight of a cylindrical piece of metal will diminish through abrasion over time, coins are perhaps the optimum token. The ability to create more units of value creates a fear and possibility of inflation, which creates more units even though the inventory of items that can be purchased has not increased.      Under the third part of the definition, (3) above, the number and types of transactions and markets within which the token’s value is recognized can be used to determine the scope and value of the token. The key difference between a token, as defined, and money is the scope of the transactions and markets—the micro-economy—in which each is accepted and used. This is a difference in degree, not in kind.       A distinction can be made between currency tokens and utility tokens, based on the scope of the transactions and markets in which they can be used, and between cryptocurrencies and crypto-tokens, based on their relationship to a blockchain. The difference between a currency token and utility token can soon break down, as the latter can become the former; in some sense, they both constitute money. Some tokens have their own blockchains, and other tokens use others’ blockchains.      All items of value are social constructs, including digital tokens, securities, and money, whether a cryptocurrency (private digital money) or fiat currency issued by governments. Although not tangible, each “unit” has its own origin and history. Hard collectibles, digital collectibles, and digital currency or digital assets are all investments in the sense that—if a secondary market exists—one may, upon resale, be able to recover one’s purchase price and a profit as part of the total resale price. Also, these items are all usable in the same way as any asset is usable. They may be flipped for a quick gain, held to increase in value, used to secure loans, or traded for other assets of the same class or otherwise.        The SEC defines a financial product to include but not be limited to “stocks, bonds, derivatives, and currency," and this definition includes both a unit of cryptocurrency and a security. As discussed above, digital currency functions as a currency, either as its sole function or in a limited capacity as a token within a micro-economy. The cryptocurrency producer may be formally organized (as a corporation, partnership, limited liability company) or organized informally. Often, the producer of cryptocurrency is also the seller of the digital tokens. Similarly, any entity whether a formally or informally organized enterprise, may issue a security, such as a unit of stock (a share) or a dollar-denominated bond, and the security will be sold by the issuer.   Having compared the digital token to the concept of a “security,” some of the dangers inherent in the SEC’s ongoing campaign to regulate cryptocurrencies become apparent. Because there is so little to distinguish a cryptocurrency from other types of digital tokens and because the SEC has chosen to disregard the numerous differences between digital assets and securities, any form of digital token risks being swept into the SEC’s regulatory scheme and regulated as a security.

Question 3

How to Determine the &#8220;Right&#8221; Lawyer for Individuals

Accepted Answer

Finding the "right" lawyer changes with the context. Insurance—Directors & Officers (“D&O”) Insurance  Most companies of any size will have considered purchasing a D&O insurance policy and most corporate insurers will suggest such a policy as a prudent investment. As discussed further below, most corporate by-laws require the company to indemnify and advance to its directors and officers legal costs incurred in a lawsuit or investigation related to their service as corporate board members or executives. A D&O policy is one way for the company to offset or mitigate its liability for the costs of defense of these individuals if and when a lawsuit is filed or an investigation commenced.     Employee Representation  One fraught area can be the decision whether and when to secure separate counsel for individual company employees. Separate counsel is required when the company’s and the individual’s interests materially diverge and the firm representing the company cannot ethically represent the employee as well. Sometimes this is apparent right away and at other times this only becomes apparent later during the course of an investigation. In either event, the lawyer that ends up representing an employee (or, sometimes, a group of employees) must be as qualified and well-versed in the relevant legal issues and have experience with investigations of the same type, or there could be serious missteps, to the detriment of both the individual employee and the company. No one is well-served if the lawyer taking on the representation is not qualified to do it.     Many company executives hesitate to retain their own, separate counsel, whether concerned about expensive legal fees and costs or worried that having their own lawyer will make it appear to either their employer or the government that they “have something to hide” or aren’t a “team player.” Generally speaking, such concerns are usually misplaced.      First, the government is never surprised when an individual is represented by counsel and, in our experience in government as well as private practice, no conclusions are ever drawn on the basis that an individual has retained a lawyer.      Second, a good lawyer will make it his or her business to communicate early and often with counsel for the company to ensure that the employee’s position is clear, that cooperation with the company is facilitated where appropriate, and that the employee’s personal interests are not forgotten in the midst of the company’s strategy to address and get beyond whatever issue prompted the government investigation to begin with.      Finally, with respect to fees and costs, most companies’ corporate by-laws (or an LLC’s operating agreement) require the company to indemnify and advance costs and fees incurred by an officer of the corporation in connection with an investigation and/or litigation related to the officer’s job responsibilities for the company. Moreover, even an employee who is not an officer often may have such fees and costs indemnified and advanced by the company on a discretionary basis. In either case, the lawyer an employee speaks with should be able to determine the company’s indemnification obligations at the outset and gain clarity from the company early on in the representation.     Below are some specific issues we’ve considered from the unique points of view of certain categories of employees we have represented in the past.      Chief Executive Officer   A company’s CEO, who in some instances may also be Chair of the company’s Board of Directors, is in a unique position because, almost by definition, what he or she says or does is attributable to the company under the doctrine of respondeat superior. Often, this means that defending the CEO’s interests may almost be identical to defending the company’s interests, at least for past statements and conduct.      However, at times, the Board or the Board committee that orders an independent investigation may take the view that there was misconduct on the part of the CEO (and/or other executives) and will take the step of firing the CEO in order to put distance between the company (on a going forward basis) and the CEO and to underline the fact that the company has “cleaned house” by terminating those responsible for prior bad actions. This admittedly drastic action has the benefit (to the company) of providing government investigators with a ready target for the purpose of assigning liability. Not inconsequentially from a Board’s point of view, this also may signal to the government that the Board was not aware of what was going on and, having asserted control over the situation, the Board will take steps to avoid repetition.     From the point of view of a CEO, the above scenario is less than optimal . . . and generally not what the CEO signed up for. Most CEOs do not go into that role believing that such an outcome is likely or even possible. But when things go badly wrong, a scenario such as the above happens more frequently than one might think. Because the CEO should have the benefit of independent advice, it is never a bad idea to retain separate counsel at an early stage of any investigation which might involve the company’s senior-most executive. Even if there is no need for counsel to interact with the government and the CEO is never in real danger of termination, it is prudent to have counsel with whom the CEO can consult to ensure that his or her interests continue to align with the company’s and to permit active cooperation with the investigation. Sometimes referred to as “shadow counsel,” this may be particularly appropriate if the company learns that there may be criminal interest (that is, the Department of Justice begins conducting an investigation, with or without the involvement of a grand jury).     Almost universally, legal fees and costs of representation will be subject to a right to indemnification and advancement for a CEO (along with other company officers or directors). In addition, it is very likely that D&O insurance coverage will be available as well—in either event, the company’s D&O insurance carrier should be alerted at the first sign of a government investigation.      Chief Financial Officer   In any investigation that involves potential errors or misstatements in a company’s financial statements filed with a company’s periodic reports to the SEC, the CFO’s role will be a critical area for review, both in the internal investigation and certainly in any investigation by the SEC or Department of Justice.      The CFO (like the CEO) attests each quarter that the company’s financial information included with its periodic reports to the SEC do not contain any material misstatements or omissions, fairly represent the company’s financial condition and results of operations, and the company’s internal controls are properly designed and effective to inform the CFO (and CEO) if there are any material issues with the company’s financial information. Unlike the CEO, however, the CFO usually is the direct supervisor of the company personnel responsible for preparing and finalizing the financial statements. As such, he or she is in a unique position to oversee the financial statements, a position which often places the CFO squarely in the crosshairs of an SEC or government investigation into potential financial fraud.     An SEC financial fraud investigation often begins with a restatement of a company’s financial statements. When a company initiates such a restatement, it is at least an acknowledgment that the original financial statements were misstated (contained an “error”) by a material amount. The objective of the investigation is usually at least in part to determine whether the misstatement was deliberate or accidental (by definition, the correction of a prior period financial statement by a restatement is “material” to the company’s financial statements). In the case of a restatement, the investigation generally attempts to determine who or what caused the misstatement, who knew of the relevant facts at the time, and what was their state of mind—was the misstatement a result of negligence, recklessness, or was it intentional or willful? In the case of simple negligence, there is no securities fraud, but where the misstatement was at least reckless, this would constitute securities fraud and subject those responsible to civil liability, whereas a knowing, intentional violation may also be prosecuted criminally in addition to civilly. The main difference between civil and criminal liability, of course, is that the former is mainly about monetary damages and injunctions whereas a criminal conviction can include stiff periods of imprisonment.     Even where no restatement occurs, a company insider may report his or her suspicions that the financial statements are materially wrong based on misconduct by executives at the company. In such cases, the CFO will also be a prime candidate as a subject of investigation due to the central role he or she plays in assembling and overseeing the company’s financial reporting.     In any investigation of a company’s financial statements, the CFO should consider retaining independent counsel to provide advice and assist the CFO with considering options at each stage of the investigation. As in the case of the CEO, when things go terribly wrong, it is often expeditious for a company’s Board to terminate the CFO and move forward with a new person in that role (preferably someone from outside the company who had no involvement in whatever precipitated the investigation). When this happens, a CFO needs a good lawyer to navigate what comes next and, for this reason, the earlier a lawyer is retained, the better.     Almost universally, legal fees and costs of representation will be subject to a right to indemnification and advancement for a CFO (along with other company officers or directors). In addition, it is very likely that D&O insurance coverage will be available as well—in either event, the company’s D&O insurance carrier should be alerted at the first sign of a government investigation.     Other Executives and Employees   What about other "C-suite" executives and other employees? Any “officer” of a corporation is likely to enjoy a right to retain their own attorney and to be indemnified for such expenses and, usually and under most modern corporate by-laws, to receive, in advance of indemnification, payment of legal fees and costs within a reasonable period of time from when incurred. “Indemnification” means the corporation is ultimately liable for the fees and expenses whereas “advancement” means the corporation must pay the fees and costs when incurred rather than waiting until the conclusion of the matter. In either event, the indemnification obligation is usually conditioned on the individual officer not ultimately being found to have engaged in criminal or fraudulent conduct. This determination is only made, however, after the conclusion of all investigations and litigation (which, in Delaware and most other states, is not until the exhaustion of the last appeal available to the officer).     Companies sometimes contest whether an executive is an “officer” of the company. Generally, in public companies, anyone with the title of vice president or higher will be viewed as an officer for purposes of the indemnification and advancement provisions of the by-laws. However, certain firms, like banks, throw around “vice president” titles to individuals who have no real role in the management of the bank. Delaware has, of late, indicated in such circumstances that even an employee with the title of vice president might not qualify to be considered an officer of the corporation. As with many things, these are fact-specific considerations and an attorney would need to look at the corporation’s by-laws, whether the employee exercises corporate responsibilities, how the corporation holds out that individual publicly, and other factors.     Finally, even if an employee is not an officer and therefore cannot require that the corporation indemnify and advance legal fees and costs, most corporations may do so anyway, either as specifically authorized in the by-laws or in using prudent business judgment, since an unrepresented employee may do or say things that are neither in that individual’s best interests or, more importantly from the company’s point of view, in the corporation’s best interests. Retaining counsel to save an employee from him or herself may help the company avoid liability or at least ensure that liability is not made unnecessarily worse.      Whether required to indemnify or not, a corporation should require any officer or employee whose legal fees and costs are going to be indemnified and/or advanced to first sign an undertaking that, should they ultimately be found to have engaged in a crime or fraud, they will repay the corporation for the amounts expended. As a practical matter, the decision about whether or not to recoup these expenses is made at the conclusion of the case and it is very rarely pursued, both because in the usual case someone who has been adjudicated as guilty will not have sufficient assets left to recoup these costs after paying restitution or other fines and penalties and because pursuing such a recovery might be just as expensive as the underlying costs the corporation is seeking to recoup; in either case, pursuing recovery is usually judged to be uneconomic (i.e., not worth the time and expense).

Question 4

You&#8217;re an investor and you lost money

Accepted Answer

Have I been defrauded? Just because you've lost money in the markets does not mean that you've been defrauded. Markets go up, but they go down, too. The question is whether or not the investment professional who advised you placed you into investments that were not suitable for your profile as an investor, whether they engaged in unauthorized trades, too-frequent trades, or outright stole funds from your account. It may take some analysis to figure out why you lost money and whether or not you have a legal case to be made against the firm or the adviser. We can help you with that. What do I do now? This depends on the underlying facts. If your funds were invested in an account with a FINRA-regulated broker-dealer, then there's a very good chance that when you opened your account your contract with the firm requires you to submit your claim to binding arbitration with FINRA Dispute Resolution Services. If your funds were invested through a registered investment adviser, there is still a good chance that you have agreed to binding arbitration, but his may be before the American Arbitration Association (AAA) or a similar group, such as JAMS. Or there may not be an agreement to arbitrate, in which case you may file a lawsuit in the appropriate court. We have experience in all potential scenarios and can help you analyze what courses of action are available to you and how to address each option.  Is litigation the only option? Of course not--it is always possible that the firm or financial adviser will step up and do the right thing without needing to file a case. But in our experience, being ready, willing, and able to litigate serves only to increase the chances that you will be able to settle early. Of course, we can never guarantee whether the other side will be reasonable--which is why we're always getting ready to try the case. Get in touch Learn more about our investment disputes practice or get in touch with us to discuss your options.

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