Author: AaronKrowne

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“Dinner is Being Recorded”: The Legalities of Meta Ray-Ban Recording Glasses

We were quoted in the The New York Times yesterday in an article entitled “Dinner Is Being Recorded, Whether You Know It or Not,” which revolved around privacy concerns while dining out in the face of consumer tech like Meta Ray-Ban glasses — which enable innocuous recording — beginning to proliferate. The quote blurb:

Some states, including California and Pennsylvania, have two-party consent laws that prohibit recording without express permission, but enforcing them hinges on whether someone has a “reasonable expectation of privacy” in a given setting, said Aaron Krowne, a New York City lawyer specializing in privacy and civil liberties. Restaurants fall in a legal gray area: They are privately owned, but open to anyone who walks in. Those protections haven’t been tested in cases involving smart glasses. “It has managed to stay out of the courts, which is quite shocking,” Mr. Krowne said. “I’m sure we’ll see more lawsuits soon.

I wanted to elaborate here a bit more on the legal points afoot (which I did touch on in conversation with the article’s author, but there’s only so much space in these articles, and they try not to get too technical).

For one, not mentioned in the article is a specific case that motivated my above comment: the current case of Project Veritas v. Schmidt, 125 F.4th 929 (9th Cir. 2025), in which the 9th circuit overruled Oregon’s two-party consent law as applied to public places, holding it contrary to the First Amendment. Now, the case is being petitioned to the Supreme Court, and whether it takes the case up or rejects certiorari, it will be a significant result for the law of surreptitious public recording (i.e., either a circuit split will be created which balkanizes the enforceability of state two-party consent laws over first amendment concerns around the country, or the Supreme Court will create a national-level rule).

At first blush, the same kind of legal conflict doesn’t seem to exist for one-party consent laws (i.e., that only one party to a conversation is needed to consent to allow its recording — applicable in states like New York.) Being more permissive, as far as both the recording action itself, and first amendment rights, doesn’t seem like a problem. However, intuition tells us that one-party consent rules cannot possibly allow recording in truly private situations. And indeed, there’s no argument that such laws could, for instance, override any of the four common law “privacy causes of action”: (1) appropriation of name or likeness for trade purposes; (2) publication of private facts; (3) false light; or (4) intrusion upon solitude.

Importantly, the social media posting aspect of today’s commonplace reality of using such consumer tech renders all the underlying rights concerns more acute (this connects back to, and heightens the “publication” aspect of the above privacy torts — though intrusion upon solitude doesn’t strictly require publication).

At the end of the day, recording consent laws should not be seen as enabling laws — they instead create a free-standing prospective statutory violation, and are otherwise cabined on one side by the first amendment, and on the other by privacy law (which is mainly common law, lacking as clear a constitutional basis as free speech). It’s these fundamental rights that are the main legal drivers of legal outcomes in this space, and balancing these rights is now having to be revisited as the proliferation of innocuous recording eyewear (with prospective social media posting) scrambles social practices and expectations.

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DFS Crypto “Coin Listing” Proposal Represents A Dramatic Expansion of the NY BitLicense

The comments below are in response to the New York DFS’s new proposed Coin Listing Policy Framework (the “Proposal” or the “Framework”) extension to the DFS Part 200 (the “BitLicense”) regulation, released on 12/11/2019 (available here. The DFS has provided only until January 27, 2020 to get comments in to innovation@dfs.ny.gov, so please read the Proposal and this post, and send them your thoughts ASAP).  The proposal consists, in main, of two prongs:

  1. A provision for DFS “listed” coins which will automatically be permitted to be used by BitLicense grantees (“Licensees”).
  2. A provision for self-certification of coins by Licensees which aren’t permitted under prong 1.

Little detail has been provided at this point, so the below comments reflect on the apparent main concepts of the Proposal, as well as interpret its general contextual and explanatory language.

As a reminder, the scope of the BitLicense is coverage only of those engaged in a “virtual currency customer business,” and so, the Proposal would apparently not effect either (a) non-business or (b) non-customer uses of cryptocurrencies (however, it’s worth noting that both limiting concepts could use more clarity in the context of the BitLicense).

  1. Issues with The First Prong.

The first (and main) prong of the Proposal uses the foundational language “list of all coins that are permitted for the Virtual Currency Business Activities of the VC licensees, without the prior approval of DFS.”

However, neither the BitLicense regulation itself nor the language of the Proposal makes it clear whether it will be permitted to utilize coins which aren’t expressly approved by the DFS (or aren’t approved under Prong 2: self-certification).  The alternative interpretation would be that of a “safe habor”: i.e., under which a Licensee could make use of non-approved coins in business, but would potentially receive less regulatory deference for them (or face some statutory limits under the safe harbor; e.g., limits in manner of use, type of customer, or scale).

My belief is that, on the wording of the Proposal, the DFS does intend to entirely prohibit dealings by Licensees in coins not approved under Prong 1 or Prong 2, rather than to create a new safe harbor.

If true, this would be striking, because it would represent a whole new dimension of the BitLicense: a ban on individual (non-approved) coins.  This requirement (which seems material to the BitLicense as a whole) is not spelled out in Part 200, nor, even, in the language of the BitLicense application materials (i.e., the language of the forms – which may typically go beyond the letter of the law, albeit, in a less-binding and more guidance-like capacity).

It appears, then, that ad hoc interactions between Licensees and the DFS regarding permissiveness of activities with respect to specific coins (by understandably-cautious regulated crypto financial companies) has been taken “to the next level” in a regulatory sense with this proposal.

The confusion is compounded by the use of the term “listing” in almost every place in the Proposal –except the one sentence quoted above, which seems to contemplate any type of virtual currency business activity.  The BitLicense itself does not define “listing”.  Thus, it is not clear if the Proposal is intended to encompass public listing activities of Licensees (i.e., by exchanges, such as Coinbase), or any dealings in coins (e.g., private custodial holdings,  private trading, payment processing, participating in a “utility token” ecosystem, etc.).

I believe this apparent quantum leap in the scope of the BitLicense deserves more public attention and scrutiny than it has thus far received.

To illustrate the impact of the regulatory shift, imagine you are a well-meaning crypto project starting up outside the U.S. — let’s say, Estonia.  You “do everything right” in terms of your project team, governance, and financing — and may explicitly follow applicable cryptocurrency or other regulations in your home country of Estonia, as well as potentially on cryptocurrency exchanges in other countries (which may themselves be licensed and have an explicit regulatory status — e.g., as Gibraltar provides).  You may even have what is on it’s face a “security token” – or choose to treat your coin as such, for regulatory certainty.

However, none of that “good citizenship” will result in your coin being listable – or perhaps even commercially-usable (i.e., in a custodial arrangement) by New York BitLicense holders.  This will simply not be possible unless your coin or token is explicitly permitted under the Proposal – either under Prong 1 (DFS listing), or more likely, Prong 2: Licensee self-certification of the coin.

And despite  the availability of Prong 2,   getting certified under it is one-off process, company by company (discussed further in the next section).  There are not a lot of parallels to this situation.  It would be as if every non-public stock had to be re-certified by every broker-dealer or exchange that wished to deal in it – and mind you, many of these crypto tokens will be regulatory securities, just like stocks.  This new Proposal, then, would represent a redundant layer of regulation for such instruments.

As for mainly “unit of exchange” crypto coins, these are more like currencies in view of the forex sector (which counts as its participants banks, speculative trading houses, and forex brokers).  Yet, none of the regulated players in the forex space are required to get approval for every single currency they deal in.

Note that, in both the cases of stocks and foreign currencies, the traded instruments may very well “implode”, despite all assurances, and best hopes. They also might suffer from varying levels of money laundering risk (something explicitly cited as a review factor in the Proposal with respect to crypto coins). But one of the core functions of the market is to “price risk” with respect to all manner of bad outcomes, including that fraud, insolvency, or some other form of risk (i.e., cybersecurity) might lurk within an instrument.

Thus, it is far from clear that a more restrictive, crypto coin-specific regime is appropriate – and such might even hinder the market in its risk-pricing function (which is also a risk-surfacing and mitigating function).

RECOMMENDATIONS:

  • Clarify the permissiveness of non-approved coins under the BitLicense (under either prong of the Proposal)
  • Create (or clarify) a safe harbor for one or both prongs (preferably covering both).
  • Clarify whether the coin use restriction is with respective to public trading listings, or any “virtual currency business” use of a coin.
  • Limit the coin use restriction to public trading listings, or at least, tailor the safe harbor in a manner respecting “public vs. private” use (one might follow securities exemptions/safe harbors in this respect – and for similar reasons).
  • Clarify which factors would trigger the DFS to even review a coin for the general list in the first place, and if under consideration, what the criteria would be (presumably, all the company self-certification criteria, plus some additional ones).
  • Exempt coins which are securities in entirety (with a foreign reciprocation regime).
  • Exempt coins which have any regulated status under any qualifying foreign recognized regulatory regime.
  • Require the DFS to consider coins for listing by any paying applicant, fully subject to administrative and judicial review (just as with the BitLicense itself).
  1. Second Prong Issues

The second set of issues I see is with Prong 2 in specific.  This is the self-certification provision.  The DFS has suggested numerous factors to be examined in a self-certification framework.  Though the factors mentioned are not definitive, at least the DFS plans to release a “model” framework, and certainly, having this means of  coin  approval at all somewhat counterbalances the “bottleneck” that would exist if requiring DFS approval for every single coin.  We can naturally expect that this will be the go-to provision for newer coins that haven’t yet garnered universal attention or acceptance, and therefore would not be under consideration for general listing under Prong 1.

However, the effectiveness of this prong seems limited by its “one-off” status.  I.e., a Licensee that self-certifies a coin hasn’t done anything to make that coin usable by any other Licensee.  So, each Licensee will have to “reinvent the wheel” in onboarding a new coin.

Or, alternatively, the onus will be on the progenitor of the coin to advocate for its self-certification by individual New York Licensees.  It’s not clear why our Estonian (or any other foreign token-issuing) venture should have to be this concerned with individual companies in New York — particularly if they have followed all local  regulations and those of major crypto-coin trading venues.  In a sense, it’s a sort of “non-fungibility” rule for crypto assets that (almost by definition) doesn’t really exist in the broader financial sector — or in a free market property system, for that matter (imagine, e.g., pawn brokers not only having to themselves be licensed, but being required to “certify” every single type of asset they took in).

From the perspective of our Estonian applicant, it’s probably not worth the effort to shepherd their coin through possibly dozens of prospective Licensees.  This will provide a competitive disadvantage to smaller or upstart projects, which will inevitably make New York less competitive.

RECOMMENDATIONS:

  • Make the Prong 2 prohibition a safe harbor (again).
  • Allow self-regulatory organizations to approve coins (this will presumably require some approval process in turn for the SRO – however, crypto SROs are indeed now in existence, such as the Association for Digital Asset Markets,  or ADAM).

III.  General Issues and Comments

  • Non-licensees who can still deal in crypto without a BitLicense under the DFS regulation; e.g., banks.  Apparently, these entities will have a unique advantage under this regime, as it appears they will not have to get coin-specific certifications.

    RECOMMENDATION: Clarify this (and preferably, do not establish this kind of differential treatment).

  • Regulatory Phase-ins. The BitLicense generally has no initial coverage threshold or “phase-in,” i.e., for small businesses or startups.  I view this as one of the most damaging shortcomings of the BitLicense broadly (and know of numerous clients and prospects who have avoided or pulled out of New York entirely because of it).  This has clearly created a preference for larger companies to deal in crypto in New York, and dramatically limited the choices of New York consumers and business.  Now, with coin-specific qualification, the lack of BitLicense phase-ins will be even more damaging.

    RECOMMENDATION: Allow businesses – subject to reasonable phase-in parameters (i.e., such as number of customers or revenue) – to be excluded from the BitLicense entirely, or subject to a general safe harbor.  Coincidentally, one doesn’t need to look far to find reasonably-tailored regulation in this sense effectively covering crypto companies in New York: the New York SHIELD privacy and data security law, which goes into effect in 2020 (indeed, most privacy and data security laws in the U.S. and worldwide phase-in thusly, so they don’t apply from dollar (or customer) number 1, and which would badly squelch commerce and innovation.  And arguably, crypto should have even more generous phase-ins, as most crypto clients make an affirmative choice and “know what they are getting themselves into” — unlike consumers generally using digital services).

  1. CONCLUSION

I am a big fan of the increased securing and professionalization of the crypto sector, of which government regulation is a major (though not the only) part. However, the Proposal, and the BitLicense generally, could use significant fine-tuning to make it more friendly to innovation, including small businesses and startups.  Until this is done, I believe New York is missing out on playing a larger and more constructive role in this important new sector, and this new coin-permitting Proposal (as initially-posed) will make the situation worse rather than better.

 

 

 

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A Tale of Two Token Offerings: Lessons from Blockstack (Reg A+) And Telegram (Reg D)

Telegram and Blockstack logos juxtaposed. See footer for rights and source attribution.

(*) Some of the biggest news of the past half-year on the US crypto regulatory front has been (1) Blockstack’s successful (qualified) “Reg A+” filing with the SEC and associated offering, and (2) the SEC’s lawsuit and injunction against Telegram, blocking distribution of their “Grams” tokens, sold pursuant to earlier “SAFTs” (Simple Agreements for Future Tokens, similar to SAFE notes).   Surprisingly, the latter came even though Telegram had filed a Form D for ostensibly-exempt private, accredited investor-only sales of the Grams/SAFTs under Regulation D, Rule 506(c).

It seems to me that neither event — let alone comparative lessons of the two — has been fully appreciated by the crypto community.   Thus, in this post, I wanted to highlight some main points of interest in each, and possible lessons in comparing and contrasting the two cases.

I. OVERVIEW OF “REG A+” AND BLOCKSTACK’S OFFERING

Blockstack was (in the US) a Regulation A (so-called “Reg A+”, since being expanded with the 2012  JOBS Act reforms) offering in the US which was qualified (“approved”) by the SEC on July 10, 2019 (see the offering circular here; filing index here).  Reg A+ allows for up to $50 million to be raised by an issuer per 12 months, not limited to accredited investors, in exchange for following somewhat scaled-back public company-like disclosures (thus, it is often called a “mini-IPO”).

In fact, a Reg A+ offering is, for most purposes, considered “registered” by the SEC (which will become key later in this post).  This is in contrast to offering exemptions, like the popular “private offering” (accredited investor-only) through Regulation D – Rule 506(c) offering.   Such exempt offerings are expressly not “registered”, and therefore, every subsequent transaction (i.e., resale) of the issued securities are presumed unlawful in the US, lacking any further exemption (or, simply, a registration, as in an IPO or Reg A+ filing).

This “all subsequent transactions presumed illegal” status is of course a heavy cross to bear, and many, many blockchain token issuers over the past few years (actual, and would-be; ICO and otherwise) have expended considerable resources (and incurred considerable brain damage) attempting to deal with this situation, and square it with their structure and plans (our clients, of course, have at least had some of their pain mitigated, and many have — in spite of the lack of bespoke regulations — had successful token raises).

Critically, this consideration has been front-and-center even for ostensible “utility token”-selling projects, because (1) “pre-sales” of utility tokens, or rights to them, prior to developing the promised network utility, are statutory sales of securities in the US under the Howey “investment contract” doctrine, and (2) even when network utility is created, it is almost never 100% clear if “sufficient utility” — not only in an absolute sense, but also relative to subjective purchaser (and SEC) expectations — has been established to mitigate any possibility of being deemed a security.

Add on top of that the fluid nature of blockchains and their coins/tokens globally, and the result is that a heck of a lot more ventures are worrying about US securities law than either their globally-facing posture or the nature of their blockchain tokens and networks might suggest.

Thus, a major blockchain token issuer that could “safely” permit general public token purchases and sales in the US (including resales) while still offering what is effectively a “utility token” would be a major breakthrough.

Enter Blockstack.   They were the first Reg A+ blockchain token offering of any kind to get approved by the SEC, and, quite fascinatingly, this was for a de facto utility token — not a security token, as nearly all observers had expected for the first approved Reg A+ project.  A security token would have been the “safe bet”.  But Blockstack (by all appearances) apparently really believed in the underlying model they had originally-envisioned, centered around the utility of their “Stacks” token, and its free-flowing role as critical to their network and constituent ecosystem — so they pushed to maintain their offering notwithstanding the token not really resembling a classical “security” on its fundamentals.

Now, I say “de facto” utility token because, what a Reg A+ offering (as with any securities exemption or registration) is expressly for is a security instrument.   Thus, technically, what Blockstack has done is file as a provisional security (in a “mini-IPO”), while fully-disclosing their plans to foster an evolution of the token to a pure “utility status” — at some indeterminate point in the future (implicitly, to the satisfaction of the SEC).  Their pathway to do doing such is moving the network to a “sufficiently decentralized” status.   (As far as a specific threshold condition, we don’t really know what “sufficiently decentralized” means in the SEC’s eyes in any precision yet — but Blockstack could very well be the first case wherein we find out.  On a related note, we’ve also argued here that being “sufficiently decentralized” shouldn’t be the only way for a blockchain token to become a non-security).

This indeterminate timing of the expected utility token status plus provisional treatment of the token as a security in the US is likely pretty important to the SEC’s approval of the offering.  Basically, Blockstack didn’t design their offering like a “ticking time bomb” — i.e., one which is (presumptively) a security now, but will “explode” at some specific point in the future (that is, explicitly circulate contrary to securities regulations) —  leaving the lawful securities trade status of potentially millions of (US) transactions in question.

When (and if) the Stacks token is ever deemed a non-security in the US, there will have already been a legal general public trading market for it in the US — as that is precisely what Reg A+ establishes.    In my read, this is the central concern of the SEC, much less so than whether the securities trading market infrastructure and associated panoply of compliance becomes redundant at some point in the future (because the token “is suddenly a utility token”).

Don’t get me wrong; it’s not as if Blockstack took a “no-brainer” option in undertaking a blockchain token offering this way — by their own recounting, they spent $5 million in legal and professional fees on getting this offering through (plus a 9-month review timeline — which likely doesn’t account for pre-filing lead-time during which internal discussions, legal and accounting advisory consultations, and informal interactions with the SEC were surely taking place).  (For comparison, $1-2 million for a traditional IPO is typical, so this was not “cheap” by virtually any standard).

But it was still a watershed accomplishment, and it will likely dramatically lower the cost for subsequent  Reg A+ blockchain token offerings (and simpler, plain-vanilla security token offerings, or STOs, will likely be even cheaper than offerings hewing closer to the Blockstack “model”).

Also, the offering did raise $23 million under Reg A+ (i.e., in the US), so it did “pay for itself”, and thus, was “rewarded” in the marketplace.  (Further, Crunchbase reports Blockstack raised a total of $93.8 million in 10 rounds, at least some of which was likely from Regulation S “offshore” sales, and so would not be counted along with the Reg A+ raised amount).

II. OVERVIEW OF TELEGRAM’S OFFERING AND SEC ENFORCEMENT

Telegram, the popular messaging app, went another direction with their blockchain token offering.  They did go to market well after the SEC’s July 2017 “DAO Report” (essentially warning the ICO sector that it was presumed-regulated, and that enforcement was coming).  And like many projects, Telegram responded by going the  path of performing their “pre-sale” of tokens (that is, their sale of presumptive utility tokens — but before the network and companion utility was developed) within the US in a manner meant to mollify the SEC, by (1) limiting the sales to accredited investors, (2) filing a Form D declaration pursuant to Regulation D Rule 506(c), and (3) requiring US purchasers (and to some extent, offshore purchasers) to agree to contractual resale restrictions and lock-ups for an initial period.

After this initial phase — specifically, upon a hard deadline of October 31, 2019 (if not postponed under certain conditions), Telegram was to deliver its “grams” tokens to all pre-sale investors and the general public, worldwide.

(A general note: Telegram — thanks to Regulation S of the Securities Act — was not generally restricted in pre-selling such token interests to non-US persons — and itself enjoys somewhat-limited SEC jurisdictional reach, given its status as a non-US company.  But in many ways, it clearly entered into US SEC jurisdiction.  I’ll touch on jurisdictional considerations again below).

By hopes, and at first-blush appearances, this plan was expected to insulate Telegram from charges of violating securities laws in the US with its pre-sale agreements — in particular, with respect to US purchasers of the SAFT interests (all of whom were limited to being accredited).  But as you probably can guess if you’re aware of the SEC’s lawsuit and injunction against Telegram of DATE, things did not go quite as planned.

The SEC took extraordinary action against Telegram with its suit filed on October 11, 2019 (complaint here ; cited as “Complaint” hereunder), seeking a TRO to completely enjoin (halt) Telegram’s distribution of Grams tokens worldwide until the merits of the offering were adjudicated.

(As a point of procedural detail, the court technically never granted the SEC’s requested TRO; on October 21 , Telegram and the SEC agreed to a stipulation and consent order that Telegram would voluntarily not “not offer, sell, deliver, or distribute ‘Grams’ to any person or entity” until the conclusion of a Feb. 18 & 19 2020 court hearing in the case.  I think it’s safe to assume that the SEC would have obtained the TRO even if it relied upon the unilateral power of the court — but perhaps not in time for the October 31st planned Grams distribution date.  Telegram’s SAFT purchasers also agreed to voluntarily postpone the distribution of Grams until after this hearing — sidestepping both questions of whom, if anyone, could still receive Grams, as well as whether the postponement could be unilaterally invoked by Telegram.)

(Please note that in all of the below, I am relying upon the SEC’s complaint for a recounting of the facts; which may not precisely hold.  Telegram has not yet filed a full answer which might dispute some material facts.  However, if even most of the facts are accurate, I believe the analysis and comments below are still on-point).

The SEC’s suit, at its core, is based upon two key concerns, which (in my own terms) boil down to:

  1. the Grams token has virtually no way to be a full “utility token” by the October 31, 2019 delivery deadline, relative to how Grams was promoted and the offering was conducted (and probably also in any absolute sense; i.e., of meeting some basic threshold of utility); and
  2. Telegram promoted and positioned the offering in such a way as to encourage — if not effectively guarantee — that many purchasers would act as mere “underwriters” for the initial offering; i.e., quickly “flipping” the tokens for a transnational profit, rather than as an investment in the inherent value of the token.

Addressing the first, and (I’d say) threshold concern: Telegram seems to have badly fumbled in making a strong “utility token” case, in both their communications and actual steps taken.  This left them “wide open” to the SEC’s charges.  See, e.g.,:

  • “Grams are not a currency because they have no realistic currency uses at this time” (Complaint, p. 14);
  • “Telegram sold and will deliver Grams in amounts that far exceed any anticipated ‘use’ on the TON Blockchain. For example, all but three of the United States Grams Initial Purchasers bought more than 2.5 million Grams each. Nor did or will Telegram restrict sales only to individuals who would actually “use” Grams (Complaint, p. 14);
  • “The Whitepaper .. contained a detailed list of projects and steps that Telegram and its principals would take to make TON a reality. This included describing at length Telegram’s plans for the TON Blockchain … [it] also described a long list of services that Telegram would develop to improve the functionality of Messenger and of the TON Blockchain after its launch, but that … Telegram had no reasonable prospect for completion in advance of the delivery of Grams.” (emphasis mine; Complaint, p. 18);
  • “The Whitepaper spoke of potential future products and services that investors could use in connection with Grams, but also made clear that these products were not available at the time the Offering began and would not be available by the time Defendants delivered Grams to Initial Purchasers.” (emphasis mine; Complaint, p. 24);
  • “Like other Offering Documents, the Primers made clear that that Telegram’s work would continue for some years after delivery of Grams on the new TON Blockchain and would remain critical for the foreseeable future. Both documents, for example, included a timeline specifying that the ‘[l]aunch of TON Services, TON Storage, and TON Proxy’ would occur in the year after the ‘[l]aunch of Telegram Wallet.’ The 2017 Primer explained that Telegram’s vision will not be ‘implemented and deployed’ until ‘2021,‘ and that even then ‘the continuous evolution of the TON Blockchain will be maintained by the TON Foundation.'” (emphasis mine, Complaint, p. 19; see also p. 24);

As we always reiterate around here, if you do one thing in pitching a utility token offering, don’t state that you won’t get the utility done by the time you distribute the tokens (at least, if its to, or within reach of US purchasers).

Also fairly damning, the SEC observed that far more money was raised than even Telegram itself claimed it needed to develop the blockchain per se, and indeed, Telegram was completely open about the fact that a very large portion of the money would go to other purposes, e.g.:

  • that Telegram would spend a large chunk of the raise on the core (non-blockchain) Messenger app which already exists: “… the $1.7 billion raised in the Offering so far exceeds what Defendants project they will need to develop the TON Blockchain… Defendants stated in offering documents … that Telegram would spend $520 million—or one-third of the funds raised—on Messenger alone between 2019 and 2021.” (Complaint, p. 14);
  • “The 2017 Primer described Telegram’s need for ‘about $620 million to support continuing organic user growth’ for Messenger … ” (Complaint, p. 16);
  • “The 2018 Primer similarly explained that Telegram intends ‘to use the proceeds raised from the offering for the development of the TON Blockchain, for the continued development and maintenance of Telegram Messenger, and for general corporate purposes.'” (Complaint, pp. 16-17)

This represents a significant tactical error, as funds not going to bringing about the initial core “utility” of the constructed blockchain network and token must inherently be a part of some long-term, generalized investment.

(For what it’s worth, I do not place great weight on many of the other “common enterprise” — as well as reliance upon “managerial and entrepreneurial efforts” — points made by the SEC; just because a venture is clearly a common enterprise per se managed by an inside team, it doesn’t mean that a token-purchaser is not purchasing for the sheer utility of that instrument.  This, and related points, are discussed further in this post. But the damage is clearly done with the above complaint points, most based upon express admissions of Telegram itself.)

Even assuming Telegram hadn’t made any of the missteps discussed above, it would still have a problem with respect to delivering grams tokens in an unrestricted, global public offering.  This would be based upon the reality that even if they assert the token was at the time of public delivery a utility token, any doubt as to such (especially in the mind of the SEC) would mean they are potentially unlawfully issuing a security publicly.  And if such is done globally, that means the US general public could be included (and, giving the regulators the benefit of the doubt, therein harmed).

As the SEC put it : “Defendants have committed to flood the U.S. capital markets with billions of Grams by October 31, 2019 … without filing a registration statement for the Grams as they are required to do under the Securities Act of 1933… [selling] billions of securities that will quickly come to rest in the hands of U.S. investors” (Complaint, pp. 1-2).

This is where it becomes apparent that having an exempt US offering of securities, i.e., which is a one-time, non-public event — and/or ostensibly restricted to non-US purchasers — falls short of what is needed to properly enable  US general public transactions (including resales).

III. COMPARATIVE DISCUSSION

Rule 144 under the Securities Act sets forth the holding period of “restricted securities” (most commonly, 1 year), and conditions for their permitted resales.   Rule 144 dovetails with the all-important Section 5 general prohibition on unregulated securities sales, combined with Section 4‘s carve-out of “transactions by any person other than an issuer, underwriter, or dealer,” to create an avenue for allowable resales for un-registered, “private” issuance securities,  as would presumptively be the case for the SAFTs sold by Telegram (and also, potentially, for the subsequently-distributed Grams tokens).

Further, after the 1 year restricted period, one would think these rules imply that restricted securities could trade freely in a “secondary market” (i.e., one consisting of resales, and resales of those resales, etc.)  — and, ignoring for a moment individual US state/territorial securities laws, they can — in principle.

The biggest catch, however (which was roundly invoked in the enforcement against Telegram), is the “underwriter or dealer” part.  If, in actuality, some of the private accredited purchasers (or the offshore purchasers) intend to re-sell their interests in grams to general-public US individuals, they are clearly falling outside the exemptions set up by Rule 144 and Section 4.   Worse, because there is no benefit of the doubt (and no safe harbor) as to not being an underwriter, the burden of proof is on the issuer as to whether every single sale instance is not to a de facto underwriter.  That means (1) it requires litigation (or exhaustive administrative back-and-forth) to prove this to the SEC, and (2) the only practical way to do so is to have procedural protections in place that make it impossible, or at least, vanishingly unlikely, for any purchaser to act as an “underwriter”.

This is where the SEC’s invocation of Telegram’s manner of sale is so devastating in its operation against them, especially that:

  • The lock-ups didn’t run the entire 1 year in any instance (“Round One purchasers agreed that they could not, without Telegram’s prior written consent, offer, sell, or contract to sell Grams that they purchased except in a series of 25% tranches starting three months, six months, twelve months, and eighteen months after they received Grams. Round Two Gram Purchase Agreements included no such restrictions”; Complaint, p. 14);
  • “Telegram also led the Initial Purchasers to expect profits by selling Grams to them at deep discounts from the price Telegram told them to expect on the day of launch, thereby encouraging those purchasers to immediately distribute Grams to the public… Under Telegram’s Formula, Defendants would price the first Gram at $0.10, and every subsequent Gram at an amount one-billionth higher than the prior sales price. As such, Telegram designed the price of Grams to increase ‘exponential[ly].’ Indeed, Telegram sold Grams to Initial Purchasers at a deep discount to an expected market price of $3.62 at launch.” (Complaint, p. 21);
  • On at least one instance of pitching to a prospective purchaser in early 2018, “Telegram spoke of the ‘chance for 0x-50x’ returns on the investments,” a prospect which was explicitly cited by the investor in agreeing to purchase $27.5 million worth of Grams “that had no use and would have no use at the time of launch, demonstrating its intent to profit from the potential increase in value of Grams.” (Complaint, p. 23);
  • “Telegram touted a readily available trading market for Grams, including one leveraging its hundreds of millions of Messenger users; sold Grams to Initial Purchasers at deeply discounted prices from its own projected secondary market price at launch; and promoted the future transferability of Grams into a liquid market”  and”[Telegram] told investors to expect a listing of Grams ‘at the major cryptocurrency exchanges’ in ‘January – March 2019,’ immediately after the ‘December 2018 [p]rojected date for [Grams] to be issued to all investors,’ making Grams almost immediately sellable in open markets, including to United States investors…” (Complaint, pp. 19-20);
  • Many sales to offshore individuals lacked any meaningful tracking of the buyer’s identity, let alone their positioning with respect to the purchase; and grams trading activity was to be allowed — and indeed, promoted as being available on — offshore on run-of-the-mill cryptocurrency exchanges, complete with inadequate KYC of buyers (including, in some cases, not even blocking US individuals!) (see Complaint, p. 3, see also p. 28).

Even worse, the SEC argues (based in part upon the points above) that Telegram affirmatively launched the issuance as an underwriter issuance — in which case, purchasers subjectively not seeing themselves as underwriters is no defense!  (I think, when the SEC cites Telegram’s secondary market listings and touts of such (as well as its hyping of resales), it is at its strongest in making this argument.  But when it claims (as it does on page 26) that the Grams token cannot even become decentralized without underwriter-like resales, I think its case is on the weakest footing.  Similarly, I am also skeptical when it argues that lock-ups are actually evidence of users’ desires to resell, as it does on page 14 — this seems a bit like “having it both ways”).

(And, for what it’s worth, I do not believe the SEC’s repeated complaints of Telegram’s having 170 million users at the outset — and even criticisms of Telegram observing such explicitly as driving “value” or “demand” — are particularly strong.   One could just as easily argue that having such an established user base, scale, and experience of practice imply that the issuer is a mature business, and hence, token purchasers won’t need securities protections.  Compare to how a contract for a new cloud service by Google or its peers is not treated like a security, even if the service is novel.  Nevertheless, there were plenty of other defects, as discussed above).

In theory, all of the above issues would be nullified by the gram’s being, without a shadow of a doubt, a non-security, as of the planned release date of October 23, 2019.  But with any doubt as to its being a pure “utility token”, the above issues compounded the damage for Telegram, and in effect, handed the SEC justification to call for a worldwide halt to the grams distribution — even though the SEC can generally only enforce with respect to securities activity within the US!

These defects render in stark relief the securities compliance pathway taken by Blockstack.  With a Reg A+ filing, Blockstack nullified the temporal question of Stacks’ security status, while simultaneously “sterilizing” the US market with respect to all secondary market resales (whether originating within the US, or offshore — i.e., from run-of-the-mill cryptocurrency exchanges listing Stacks).

Having done a Reg A+ filing, secondary market resales of Stacks are simply allowed;  explicitly, what is issued in the original sale are not considered “restricted securities”.  As a result, the SEC (in my read) essentially doesn’t care whether the Stacks tokens trade on crypto exchanges overseas, because that is clearly not a public market in the US — and if US residents happen to be able to access these exchanges, that is no different than the same persons acquiring the tokens on the secondary market within the US (which, again, is allowed, under Reg A+).

The “catch” is that any organized, formal market-based trading of Stacks taking place in the US will have to be on a regulated securities exchange (at least, until such time as the SEC gives clear guidance that the Stacks token is no longer a security).   No such exchange exists and carries Stacks as of this writing, so only informal trading is allowed in the US in the meantime.  (A related, apparently-prophylactic practice I’m aware of, is that while Blockstack is indeed engaging professional crypto market-makers overseas, they are contractually-agreeing to terminate such relationships the moment a regulated securities exchange becomes available for Stacks tokens in the US.  My guess is that this eliminates potential claims that the issuer is unlawfully “conditioning the market” for the subject security in the US).

IV. CONCLUSION

All in all, for the amounts of money we are looking at being at stake in these two offerings, Reg A+ seems to be an overwhelmingly attractive pathway to address the Securities Act as applied by the SEC to the issuance of a pre-network, but prospective utility blockchain token.  While one can argue that the non-US company Telegram “shouldn’t have to care” about some obscure, untested (again, as applied) US regulatory election to their planned global blockchain token offering, the economics of the situation argues otherwise (particularly after initial funds were raised from US accredited and offshore investors to the tune of tens of millions of dollars).

Indeed, perhaps now that Blockstack has “blazed the way”, the SEC will work out a deal with Telegram that involves wrapping the (now-paused) Grams issuance in a Reg A+ offering (likely plus a fine).

Reg A+ as an affirmative “ICO” pathway aside, the cases of Telegram and Blockstack certainly have made vastly more apparent some important areas of SEC concern having to do with the “market-conditioning” aspects of global blockchain token offerings, as discussed above.

(* Article images courtesy of Wikimedia Commons; CC-by-SA 4.0.  Links here and here).

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“Decentralized” No More — SEC Drops Proposed Blockchain Test?

Another takeaway of mine from the SEC’s April 3rd releases was noting a striking shift in gears from the SEC.  Namely, there was a conspicuous lack of emphasis on the “degree of decentralization” of blockchain token-issuers as applied to the security-vs-utility analysis of their tokens (I didn’t mention this in my earlier post, to keep it as short as possible).   Despite a focus all through 2018 on decentralization by top SEC officials, “decentralization” was only mentioned once in the SEC’s 4/3 “Digital Asset Framework” — and then only as a secondary factor, barely in passing.

Recall that SEC Director Hinman had proffered an overriding decentralization-based test and elaborated sub-factors related to it in a major June, 2018 speech (in which he famously expressed the view that Ethereum was no longer a security).    Then at Consensus Invest on November 27, 2018, SEC Chair Jay Clayton underscored these factors, using an analogy of tickets sold to Broadway plays as being securities before a show first opens, but not afterwards — because at that point “the situation becomes decentralized” (I was in the audience, among those scratching my head upon hearing this).

“Decentralized Broadway shows” no more, these considerations seem to have now taken a back seat.  (And indeed, what Clayton seems to have really been getting at with the Broadway example was that, after opening, the value of tickets sold is no longer speculative).

I think this is a good turn, despite how compelling the possibilities for decentralization that blockchain enables are.  As I’ve commented before, the element of decentralization isn’t a traditional securities factor, nor does it “map” directly to any of them; thus, to the extent it is relevant, it makes more sense for it to take a secondary role in the overall analysis.

What may be going on here is the SEC recognizing that, to the extent a token-issuing project is (or becomes) little more than open source software (with a similarly open blockchain network or networks), it is clearly not within traditional securities purview.  However, to the extent a project more resembles a speculative enterprise, for which the ultimate “test” is success or failure on business merits and acumen, a more conventional analysis applies.  And such a conventional analysis wouldn’t have much to do with how “decentralized” the project or the promoter group are.

This de facto bifurcation in the analysis is visible not only in the SEC’s “Digital Asset Framework”, but in the TurnKey Jey no-action letter granted on the same day.

TurnKey Jet was operating a tokenomics-based platform that was avowedly not decentralized — TurnKey specifically referenced how it would closely manage and control the platform, only allowing certain commercial partners to participate privately (and in that, even citing antitrust concerns — as if it didn’t truly want to have any partners at all!).

The SEC granted TurnKey’s request to issue tokens without being subject to enforcement, even though it was the exact opposite of decentralized in most respects, because of controls and limitations going to more traditional securities factors (i.e., TurnKey is a completely “closed” platform on a private blockchain, with no ability to “remove” tokens, and no use of token sale proceeds for general development).

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Initial Impressions On The SEC’s Big “Digital Asset Framework” and Token No-Action Letter Releases

Important note: While I have read both of the releases discussed below in full, the following still represents a “first take”, and in any case, does not constitute legal advice.

Yesterday was a big day in blockchain legal news, as the SEC put out two releases (combined here) that arguably constitute the biggest advances in token-sale securities law policy since the DAO Report in 2017.

The two releases were a “Framework for ‘Investment Contract’ Analysis of Digital Assets” by the SEC’s new FinHub (providing a guide for determining if a proposed token sale is a security), and a no-action letter (NAL) granted to TurnKey Jet, Inc., for its sale of non-security tokens (i.e., “utility tokens”).

These releases do represent a major categorical step forward, as the SEC is showing it wants to “move the needle” in this area and be of use to entrepreneurs attempting to develop in the space, and because the SEC has not previously granted any blockchain-related no-action letter requests (and I am aware that many have been submitted since 2017).   It is particularly good that the SEC is signaling that they will look at specific projects and give a “yes or no” regulatory coverage answer (presuming the request is formulated clearly and there aren’t too many unknowns, and of course, subject to the SEC’s workload).

However, when looking at the details, the degree of advancement is quite modest, as the substance of the releases doesn’t add much to the state of thinking of counsel working actively in the space (if my experience is typical).

Taking the two releases in turn, starting with the Framework:

1. The Digital Asset Framework

The framework represents an incremental step forward in the process of determining whether a token is a security in that it makes explicit various points mentioned in SEC staff speeches over the past 1-2 years, and considerations close followers in the industry had been hypothesizing about, but it’s not revolutionary.  Mainly this is because, even while introducing some “new” useful factors to the analysis and formalizing some prior proposed ones,  it introduces a lot of implicit uncertainty about the weighting of factors.  Indeed, the FinHub staff explicitly disclaim any binding or specific aspect of the analysis (from footnote 1):

This framework represents the views of the Strategic Hub for Innovation and Financial Technology (“FinHub,” the “Staff,” or “we”) of the Securities and Exchange Commission (the “Commission”). It is not a rule, regulation, or statement of the Commission, and the Commission has neither approved nor disapproved its content.

and footnote 4:

It is not an exhaustive treatment of the legal and regulatory issues relevant to conducting an analysis of whether a product is a security, including an investment contract analysis with respect to digital assets generally. We expect that analysis concerning digital assets as securities may evolve over time as the digital asset market matures. Also, no one factor is necessarily dispositive as to whether or not an investment contract exists.

Thus, despite being the first “end-to-end” compilation of factors by the SEC, it is really still more a tool for it discussion and understanding the SEC’s thinking, rather than providing any sort of determinative yardstick, and thus raises almost as many questions as it answers.

That said, here’s a sample of some of the positive detail of the framework:

Although no one of the following characteristics of use or consumption is necessarily determinative, the stronger their presence, the less likely the Howey test is met:

The distributed ledger network and digital asset are fully developed and operational.

Holders of the digital asset are immediately able to use it for its intended functionality on the network, particularly where there are built-in incentives to encourage such use.

The digital assets’ creation and structure is designed and implemented to meet the needs of its users, rather than to feed speculation as to its value or development of its network. For example, the digital asset can only be used on the network and generally can be held or transferred only in amounts that correspond to a purchaser’s expected use.

Prospects for appreciation in the value of the digital asset are limited. For example, the design of the digital asset provides that its value will remain constant or even degrade over time, and, therefore, a reasonable purchaser would not be expected to hold the digital asset for extended periods as an investment.

Verbiage like that seems almost tailor-made for projects that have very carefully considered how to separate “utility” token sales from “security” aspects and roles, and to take proactive measures to limit unwanted speculative behavior towards tokens (as some of my clients have, including in discussions with the SEC).

A major thematic downside, in my view, was that the SEC reiterated repeatedly points such as that continued “development” of an blockchain network was a factor counting towards a security.  I hope that gets clarified more, because  a factor like this could be taken to effectively mandate that a blockchain digital service provider can’t keep improving their network/service offering in the usual course, which would place such efforts below standard non-blockchain enterprises.

Other mentioned factors of concern include (where “AP” means the project or associated persons):

The digital asset is transferable or traded on or through a secondary market or platform, or is expected to be in the future.

Purchasers reasonably would expect that an AP’s efforts will result in capital appreciation of the digital asset and therefore be able to earn a return on their purchase.

Purchasers would reasonably expect the AP to undertake efforts to promote its own interests and enhance the value of the network or digital asset, such as where […] AP retains a stake or interest in the digital asset. […] or the AP’s compensation is tied to the price of the digital asset in the secondary market.

These are very broad and open-ended, and the SEC did not make clear to what extent disclaimers might be adequate to dispel such expectations or notions of purchasers (as generally), or whether technical measures would be required, or whether it would require active preventative measures or outright prohibitions of related conduct or features to avoid any of these factors rendering a token sale a security.

An overriding legal concern is that — while it seems reasonable to introduce “new” legal factors in a sector as novel as blockchain — many of the SEC’s suggested factors are not traditional securities law analysis factors, and have little to no basis in statute or case law, so it’s not clear how well they will hold up (but for now, those that don’t plan on challenging them in court have to treat them with the same deference as traditional factors).

Of course, as the SEC said, no one factor is dispositive, but no weighting was provided — explicitly.  This is the sort of lingering ambiguity that makes it clear that even with such a “Framework”, at this stage, token sellers will still be left with no option but to request a NAL in every single case of “utility” token sale.

Finally, here’s an example of a specific non-security token example given by the SEC in the Framework that is, in my view, quite a bit less helpful than at first glance:

… Digital assets with these types of use or consumption characteristics are less likely to be investment contracts. For example, take the case of an online retailer with a fully-developed operating business. The retailer creates a digital asset to be used by consumers to purchase products only on the retailer’s network, offers the digital asset for sale in exchange for real currency, and the digital asset is redeemable for products commensurately priced in that real currency. The retailer continues to market its products to its existing customer base, advertises its digital asset payment method as part of those efforts, and may “reward” customers with digital assets based on product purchases. Upon receipt of the digital asset, consumers immediately are able to purchase products on the network using the digital asset. The digital assets are not transferable; rather, consumers can only use them to purchase products from the retailer or sell them back to the retailer at a discount to the original purchase price. Under these facts, the digital asset would not be an investment contract.

This seems good at first blush, but all the SEC is doing here is describing an internal loyalty points system with blockchain factors stripped out.  But not only does such eliminate most of the innovative elements we have questions about, this is answering a question that really wasn’t asked — which is “are loyalty points systems with no transfers permitted securities.”  The operative question is  more like: “to what extent can you add blockchain transferability to a consumer points system without the digital asset becoming a security?”

Unfortunately, until some of the avowedly-helpful factors that the SEC introduced and reiterated in this Framework receive something closer to a bright-line (or really any line) rule, most of the uncertainty in the space bearing on the “security vs. utility” question will remain (and even worse, the introduction of new factors to “watch out for” might have a chilling effect).  That is because — as the guidance repeatedly makes clear — the final determination integrating all of the factors is just an overall balancing analysis.   In other words, until there is more on-point legislation or judicial opinion, it is simply about the comfort level of the SEC.  And that is not a terribly comfortable place for most entrepreneurs to be.

2. The TurnKey Jet NAL

It represents great progress that the SEC has now granted a NAL to a token seller — and even better that it is for a “utility” token.

However, it is my sense after going through the TurnKey Jet NAL request and response that it was actually a very limited-scope NAL.  In essence, it just requests no enforcement action for a locked-in points platform that happens to be based on a blockchain instead of some other shared database technology (amongst the private network partners).  True, it also has the attributes of (1) a 1-1 token “soft peg” to USD, and (2) a “secondary market” whereby users can resell tokens to each other on the platform, so it goes a little beyond most (but not all) proprietary consumer points systems.  However, because the “lock-in” is rather extensive, namely:

  • tokens cannot be removed from the private network’s wallets (to say nothing of being listed on 3rd party exchanges)
  • tokens may only be re-purchased by the company at a discount
  • tokens will correspond to literal USD balance on deposit
  • token proceeds will not be used for any development or for general purposes (i.e., “overhead” or otherwise)

it’s not clear how much this advances regulatory clarity for a wide swathe of the utility token sector.  Importantly, the SEC explicitly hit on all of the above limiting points in their NAL response, showing that they “cared” about them quite significantly.

Thus, I find this to be a “conservative” grant on the part of the SEC — they are doing little more than assenting to a closed consumer points system that happens to be implemented with blockchain.  They arguably have to do that, because of the “economic reality” dictum of securities law.  Still, such a conservative move as a first step on the NAL front is probably to be expected, and isn’t much of a surprise.

Indeed, the biggest point of substantive regulatory progress the NAL represents may be that it validates that something like a non-security “stablecoin” — at least in the utility token (rather than financial product) context — can be a non-security.

In sum, the SEC releases yesterday are more of a “small step” than “a giant leap”, which raise the question of what the next big foray of the SEC in the token space will be — and likely more immediately, what will become of Kik’s Wells Notice response and prospective litigation with the SEC.  The latter will inevitably answer some of the factor-“dividing line” questions implicated by the releases and discussed above.

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No, Airdrops Weren’t Just “Legalized” in the U.S.

Airdroppin’: Maintain extreme caution when doing this with blockchain tokens in the U.S. (Source: U.S. Air Force photo/Staff Sgt. Brian Ferguson via Wikimedia Commons).

A November 27, 2018 order in the case of ICO-gone-wrong SEC v. BlockVest, LLC (SoCal U.S. District Court), caused quite a buzz, for the ostensible holding that it (tentatively, of course, as this was not a final order) deemed the “airdrop” method of token distribution (i.e., free giveaways) permissible in the U.S.  The order denied an asset freeze that had been requested by the SEC as part of a preliminary injunction.

Undoubtedly, the SEC not being granted the asset freeze was a little bit of fresh air for the beleaguered blockchain fundraising space.  But I have now had a chance to review the BlockVest order of 11/27, and I have to say, there seems to be almost no basis to read into the decision that it is an “approval of airdrops,” or anything even remotely similar.

Indeed, I find it hard to glean from the order anything other than a recognition that substantive, evidence-based objections were raised to the SEC’s allegations of reliance on BlockVest representations by the buyers/token recipients, and against the offer as a de facto security, and consequently, the court was merely denying the SEC the privilege of having its allegations carry for the purposes of a preliminary injunction (which is a very high standard).

In other words, for an injunction which includes an asset freeze, and thus impinges upon the accused’s ability to hire counsel to defend itself, the SEC isn’t entitled to have its view of the facts, and associated legal conclusions, mechanically adopted by the court.

Unfortunately,  it is likely that the presumptions on the same questions will swing the other way for overall case disposition on the merits (assuming no new facts are unearthed), as courts will give a wide berth to a regulatory organization within its own subject domain.  So don’t get out the champagne just yet.

Further, I don’t even see much basis for the construction of the actions underlying the case as “airdrops,” or really, very comparable to them at all.  Many of the alleged investors actually did pay something to BlockVest, and indeed wrote checks (with annotations indicating that these funds were for token purchases); others deposited funds (in the form of major cryptocurrencies) on the platform in exchange for “test tokens.” So not only was monetary consideration provided by many buyers (unlike in actual airdrops), but the tokens weren’t even “live” tokens intended for eventual general public circulation — clouding the basis for the “airdrop” interpretation on two additional counts (and take heed: a future, inchoate issuance of securities can be the basis for application of securities regulation; [1]).

There are other facts that undermine the “airdrops permissible” interpretation of this decision, such as BlockVest’s claim that it knew all the token recipients personally and invited them directly to test the platform (hardly a “general distribution” of tokens, for sure).

Perhaps this order is another brick in the wall in the trend against asset forfeiture, but at the end of the day, it may reflect little more than standard jurisprudence of a court that, refreshingly, didn’t allow itself to get caught up in anti-ICO hysteria.

Footnotes.

[1] Under § 2(4) of the Securities Act (15 USC § 77b(4)) (which refers to “one who proposes to issue any security”), a person is an “issuer” when such person promotes the sale of shares in to-be-created ventures. E.g.  publishers of “Mining Truth” were “issuers” of securities, where magazine included a paper to be signed by interested parties, labeled “indication of possible acceptance,” indicating that the signer may accept shares of stock in the proposed corporation;  SEC v Starmont (1939, DC Wash) 31 F Supp 264.

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House Financial Services – Monetary Policy and Trade Subcommittee Hearing (7/18/18): “The Future of Money: Digital Currency”

Below is a rough auto-transcript of a hearing held last week entitled “The Future of Money: Digital Currency” (video available at previous link).

The witnesses were:

  • Dr. Rodney J. Garratt, Maxwell C. and Mary Pellish Chair, Professor of Economics, University of California Santa Barbara
  • Dr. Norbert J. Michel, Director, Center for Data Analysis, The Heritage Foundation
  • Dr. Eswar S. Prasad, Nandlal P. Tolani Senior Professor of Trade Policy, Cornell University
  • Mr. Alex J. Pollock, Distinguished Senior Fellow, R Street Institute

We have not yet gone through the hearing record exhaustively and produced a selection of “pull quotes” of interest. However, the transcript with links to the hearing video is reproduced here anyway, as it might be useful to some.  (Watch this space for further excerpts and comments, once we analyze the record fully).

TRANSCRIPT GUIDE  AND ADVISORY:

  • The transcript was produced by a text-to-speech process performed automatically by a third party service outside of our control.
  • KrowneLaw does not vouch for its accuracy; indeed, we guarantee it is inaccurate.
  • As such, each snippet of translated text is linked directly to the point in the video at which it occurs (popup in separate window/tab).   Please use this functionality to confirm exactly what was said in each case.
  • The hearing may cover a wide variety of topics; thus, cryptocurrency/blockchain-related terms have been highlighted to assist in quick location of the relevant passages (this highlighting is by no means exhaustive, however).
  • The breaks in the text coincide roughly with changes in topic/changes in Congressperson leading the questioning.  They do not correspond to changes in speaker; thus, each block usually represents multiple speakers, including those on “opposing sides.”  You must listen to each particular segment in the video to determine who is speaking and to get the full context (and therefore, meaning).

Scroll box with transcript follows:

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House Agricultural Committee Hearing (7/18/18): “Cryptocurrencies: Oversight of New Assets in the Digital Age”

Below is a rough auto-transcript of a hearing held last week entitled “Cryptocurrencies: Oversight of New Assets in the Digital Age” (video available at link).

The witnesses were:

  • Mr. Joshua Fairfield, William Donald Bain Family Professor of Law, Washington and Lee University School of Law, Staunton, VA
  • Ms. Amber Baldet, Co-Founder and CEO, Clovyr, New York, NY
  • Mr. Scott Kupor, Managing Partner, Andreessen Horowitz, Menlo Park, CA
  • Mr. Daniel Gorfine, Director, LabCFTC and Chief Innovation Officer, CFTC, Washington, DC
  • The Honorable Gary Gensler, Senior Lecturer, MIT Sloan School of Management, Brooklandville, MD
  • Mr. Lowell Ness, Managing Partner, Perkins Coie LLP, Palo Alto, CA

Here are a few “pull quotes” and exchanges of interest (this is by no means exhaustive):

    • Rep. Soto (@1:42:08): “I’m more concerned though about being able to avoid money laundering for terrorism, drug trafficking, human trafficking, tax evasion — so I’d love to hear from each of you in one sentence on what we could do to stop money laundering and having Bitcoin and other cryptocurrencies be the choice of terrorists, drug traffickers, and those evading taxes.”

      Mr. Fairfield: “Trust FinCEN to do their job.”

      Ms. Baldet: “Rely on other law enforcement mechanisms that work around strong cryptography — we do not weaken roads to add potholes to them.”

      Mr. Kupor: “Bitcoin is actually the worst tool to money launderer because every transaction is registered and fully recordable so it’s actually law enforcement’s best friend”.

      Mr. Gorfine: “While the technology can be peer-to-peer, most activity takes place through a new type of intermediary where you can apply AML and KYC rules.”

      Mr. Gensler: “On top of that, rigorously require crypto exchanges to register — and you may need to pass a law to do that — but to make sure they register and that all the AML, anti-money laundering and know-your-customer is being done there.”

      Mr. Ness: “The alleged Russian hackers were caught because they used Bitcoin.”

    • Rep. Faso (@1:45:01): “I’m wondering if for the benefit of our viewers at home across the country who are watching this hearing and are trying to understand the impact of the crypto currencies and what the future holds if if perhaps miss Baldet and Mr. Kupor could tell us where you think from a five to ten year view point where this is going to be the role that these currencies are going to have in our economy and how might this affect average consumers — right now it’s the market participants are mostly very sophisticated people do you see this insinuating itself into the broader economy?”

      Mr. Kupor: “Thank you yes so we believe that this really is gonna create a whole new set of of infrastructure on which all kinds of new applications are going to be built — some which we may not even know about today. So if you think about all the benefits we’ve reaped from you know Facebook and Google and all the kind of you know internet properties have been built today.”

      Rep. Faso: “… and negatives …”

      Mr. Kupor: “… and negatives — I think what the beauty of this technology is is it gives us a new set of platforms and again very critically those platforms are not controlled or governed by centralized corporations; they’re controlled and governed by community, and so you can imagine all the utility that we have today but where the consumer actually has ownership of data the consumer has the ability to actually ensure that data is shared in a manner in which they want to be shared and the consumer also can capture the economic rents from use of that data; so we think the opportunity in that respect is endless.”

    • Rep. LaMalfa (@1:51:30): “Would you touch upon what what would look like if that token is determined to be a security?…”

      Mr. Ness: “Yeah I think the issue really comes down to friction and while we can get to a status of free trading securities by registering them, even when you do get to that status there are all sorts of ancillary friction[s] in and around the transfer of a security — you need to have broker dealers involved, and you need to have suitability requirements met and other potential disclosure issues and so forth that are ongoing; and so when we’re talking about trying to create the next generation of decentralized protocol layer kind of apps on top that are all interoperably-interacting with each other and transferring value at the speed of software to deliver a service to a consumer — it may it may be all transparent to the consumer that this is all happening under the hood –but you can’t have fundamentally the transfer of value at the speed of software if it’s a security.

      Rep. LaMalfa: “Please touch on the importance of increasing the access to the speediness of those types of trans transactions — why is that important?

      Mr. Ness: “Well I mean, to get a little philosophical I suppose I mean you know ledger technology is fundamental to Commerce, right, and double-entry accounting was an amazing innovation and ledger technology that, you know, pulled Europe out of the … Dark Ages, and the same thing can happen in in in a amazingly more robust way when we start to literally not just allow parties to trust each other through standard mechanisms of reconciliation, but when we remove the reconciliation or the need for it all together… and that is simply a philosophical point of view I suppose but it goes to this issue that we’re at early stages of this, we don’t know where it’s gonna, go but speed is probably a good thing.

      Mr. Gensler: “Could I just say I’m an optimist I agree with what mr. Ness says, but maybe it’s the MIT in me now, I think that the beneficial ownerships will be able to be tracked in a matter of milliseconds and nanoseconds — not yet, it might take five years — but we’ll get there; technology’s pretty neat how it grows and helps us.”

    • Rep. Davis (@2:01:54): “I want to ask you a quick question sir; based on the way current law is written, it’s not cut and dry whether cryptocurrency should be regulated by the SEC or the CFTC.  If Congress attempts to come up with a workable definition for cryptocurrencies that are more similar to commodities — you know call them as we’ve heard blockchain commodities — what should we be looking at to guide us?”

      Mr. Gorfine: “You know I the one thing I would say is that — and I mentioned this in my opening statement — that it’s important that we’re not hasty in terms of figuring out what the right contours are of applying… securities laws and then the the commodities framework. I do think that the SEC has in due course been providing additional clarity — there was recently Mr. Hinman over at the SEC, gave a well-received speech kind of outlining some of the SEC’s thinking as to how they would apply the securities law framework — and some of the things that I think you’ve heard are factors around decentralization, you know are their expectations of return based on meaningful work of others… Rhese are important elements that — of course are not you know I’m not saying that these are the only elements — but these are some of the things that you start to look at in terms of figuring out well when does it make sense to be applying the securities laws framework that includes things like required disclosures, it requires regulations around you know the offering of securities, and the intermediaries involved in securities, and when does that perhaps not fit the product. So I think that this discussion is ongoing, and I think that in due course, and being thoughtful you’re starting to see additional clarity and uncertainty coming out. But certainly those are some of the factors that we’ve we’ve heard talked about a fair amount.”
      …
      Ms. Baldet: “To tag on to kind of the last question but also the the concern about regulatory framework, you know what I was mentioning is about a need for clarity more so than the, not so much the bright lines that we’re talking about with security versus commodity, as much as more interest in safe harbors for innovators; especially because we’re seeing the market adapt to this in that new disruptors are at an advantage versus incumbent institutions who are waiting for regulatory clarity to engage. And so in a way, in the absence of that, it’s not it’s not necessarily that incumbents are incapable of innovating or they don’t understand the technology, but they have to take a sidelines approach because they have traditional businesses to lose.”
      …
      Rep. Davis: “Well thank you… We want to make sure that we devise a regulatory structure that allows this industry to continue to grow, but allows to us to address many of the law enforcement problems that have been brought up here by many of my colleagues — so I can’t wait to continue to work with you; thanks for your time.”

Again, we have not yet gone through the hearing record exhaustively. However, the transcript with links to the hearing video is reproduced here anyway, as it might be useful to some.  (Watch this space for further excerpts and comments, once we analyze the record fully).

TRANSCRIPT GUIDE  AND ADVISORY:

  • The transcript was produced by a text-to-speech process performed automatically by a third party service outside of our control.
  • KrowneLaw does not vouch for its accuracy; indeed, we guarantee it is inaccurate.
  • As such, each snippet of translated text is linked directly to the point in the video at which it occurs (popup in separate window/tab).   Please use this functionality to confirm exactly what was said in each case.
  • The hearing may cover a wide variety of topics; thus, cryptocurrency/blockchain-related terms have been highlighted to assist in quick location of the relevant passages (this highlighting is by no means exhaustive, however).
  • The breaks in the text coincide roughly with changes in topic/changes in Congressperson leading the questioning.  They do not correspond to changes in speaker; thus, each block usually represents multiple speakers, including those on “opposing sides.”  You must listen to each particular segment in the video to determine who is speaking and to get the full context (and therefore, meaning).

Scroll box with full transcript follows:

Posted on

Doubts Emerge Regarding SEC Director Hinman’s “Decentralization” Token Security-Criteria

On June 14th, 2018,  at the Yahoo! Finance All Markets Summit, the SEC’s Director of the Corporate Finance Division, William Hinman, made a “speech heard ’round the world” — best known for its bombshell conclusion that Ether coin (or “ETH”, of the Ethereum blockchain network) should not be considered a security [1].  While this sort of speech  is (surprisingly, to most) not an official pronouncement of the SEC [2], the blockchain world nonetheless breathed a sigh of relief, as the fate of a huge swathe of the sector could be in legal peril if present, day-to-day transactions involving Ether were deemed unlawful, and Director Hinman is the head of the SEC division responsible for making such determinations proactively.  Direct to point, Hinman stated:

… putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required. And of course there will continue to be systems that rely on central actors whose efforts are a key to the success of the enterprise. In those cases, application of the securities laws protects the investors who purchase the tokens or coins.

That statement is pretty clear regarding Ether, and the market’s jubilation on that particular aspect is likely justified.  Indeed, Hinman also stated:

… this also points the way to when a digital asset transaction may no longer represent a security offering. If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.

which fairly-directly addresses the separate, but related burning question of whether transition from a security (token) to non-security status is really possible — and does so in the affirmative.

However, look a little beyond the Ether-specific application of these remarks, and additional, thorny questions quickly arise.

For one, Hinman seems to hinge the Ethereum de facto determination on the fact that Ethereum is (now) “decentralized;” even generalizing this criterion, where he says “there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required” and “where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts ,” and, conversely, that “systems that rely on central actors whose efforts are a key to the success of the enterprise” are protected by “application of the securities laws.”

These portions of Hinman’s remarks did not seem to stir many feathers in the blockchain nest, likely because the blockchain world is “all about” decentralization of social and entrepreneurial functions (preferably, as “disruptively” as possible).

However, from a securities law perspective, the remarks are somewhat unorthodox, because “decentralization” does not exist as concept in the existing main body of law.  Now, new criteria are not entirely alarming when taking into account that so much about blockchain and ICOs is new, and intuition has it that the decentralization aspect should factor into the legal analysis somehow — but then the questions become: (1) is such a neologism really appropriate, and (2) if so, is it being delineated and applied correctly?

There are already hints of trouble in blockchain-land in attempting to make use of the “Hinman criteria” (as preliminarily sketched thus far) — i.e., cries have already gone up that “if Ether is not a security, shouldn’t Ripple also not be?”; or “if Ether is not a security because it is sufficiently-decentralized, shouldn’t Ripple, conversely, be a security, because it is not?”

And, more generally, what is sufficiently decentralized, anyways, for the purposes of “not being a security”?

These sorts of concerns in light of the state of extreme diversity of the blockchain ecosystem lead us to question whether the SEC might be headed down the wrong path if intending to weigh decentralization of blockchain tokens/coins qua securities in a manner embodied by Hinman‘s June 14th remarks.

Specifically, the expressed concern is the extent to which a centralized group or body is managing or controlling the network and its development, i.e., exerting “managerial or entrepreneurial efforts” that predominate over other activities in the network.

However, that is not what we take “managerial or entrepreneurial efforts” to mean in the broad body of securities law: it is evidently less of a determinative factor or characterization of the nature of the overall regulated-investment relationship than a dicta providing a broad qualitative descriptor of the sort of things promoters of a venture are doing when investors entrust capital with them to bring a venture to first fruition.

Indeed, the term “managerial or entrepreneurial efforts” didn’t appear in the touchstone SEC vs. W.J. Howey case (“Howey”) [3] — it actually appeared first in United Housing Found., Inc. v. Forman [4] (to be discussed below).  In Howey, rather, the court stated (emphasis added):

Thus all the elements of a profit-seeking business venture are present here. The investors provide the capital and share in the earnings and profits; the promoters manage, control and operate the enterprise. It follows that the  arrangements whereby the investors’ interests are made manifest involve investment contracts, regardless of the legal terminology in which such contracts are clothed. [5]

The first bolded passage parallels Hinman’s emphasis.  However, it appears to us that the stress on “making the investor’s interests manifest” in the second bolded passage has been lost in Hinman’s focus on decentralization of the “management, control” and/or “operation.”  I.e., it seems that a critical part of the investment contract-securities determination should be (and has always been) whether promises made to investors by contract have been made manifest.  In other words, whether the initial, commercially-viable version of the project or enterprise has been delivered.

It is not clear how decentralization of management, control or operation has any relevance after this point: dozens of times a day, all of us make use of commercial services that are managed, controlled or operated by a single entity, without this arrangement constituting “a security” or otherwise invoking securities regulation (indeed, they aren’t even un-regulated — they are the purview of state consumer protection agencies and the Federal Trade Commission).  Thus, it isn’t clear how simply recasting such relationships into “token form” could render them “investment contracts” for securities  law purposes.  At least, that outcome seems like it could not possibly be the desired result.

To illustrate the looming paradox here, consider other commonplace arrangements that do not strike one as (or are typically considered not to be) a regulated securities “investment contract” arrangement:

  • A Microsoft Office 365 subscription (whereby continued access, ongoing updates, and cloud services are provided exclusively by one company, Microsoft);
  • A subscription to any software-as-a-service (“SaaS”) delivered entirely by a cloud services company (with no decentralization);
  • More conceptually, a coin-op (or internal credit-based) laundromat under service contract from the company that built it, financed originally by selling to investors pre-paid laundry “tokens” (or house credits) (A hypothetical scenario from SEC Chairman Clayton’s recent public remarks [6]).

In any of these scenarios, clearly, the arrangement prior to delivery of the initial commercial service is one of a regulated securities investment. But after first viability and public release of the service, it seems evident that this status should be reversed, and new, or even continued contracts, or the transaction of “tokens” or “house credits,” should be treated as commercial services sales in lieu of regulated securities issuances.

That proposition per se (i.e., evolving from security-investment to utility-purchase) seems significantly less controversial after Hinman’s remarks. But why, then, should it matter whether the provision of the commercial service is “decentralized” after that point? It is in none of the above examples.

We contend that the ultimate standard for deeming blockchain token sales to be regulated sales of securities should instead involve how decentralized the efforts of producing the initial commercially-viable version of the blockchain network (and associated services) are, with respect to those who invested by buying tokens.  That is, the proper concern is whether those individuals are protected members of the investing public, or are instead sophisticated co-venturers (i.e., better associated with the venture/promoter group itself), and hence, are not protected as being on the “other side” of an investment contract which is subject to the “information asymmetries” Hinman mentions.

A further, (ostensibly) confounding aspect of the blockchain token-sale/ICO/utility token situation is that the arrangement may evolve from one of clear passive investment to one of direct use by the same original purchaser (indeed, in the blockchain case, often ultimately involving functional use of the actual instrument of sale itself, i.e. the blockchain token).

But, this situation of some fluidity between the two roles turns out to not be unprecedented in securities law and practice.

For example, SEC Notice 33-5347 [7] (which is actually cited by Hinman in his June 14th written remarks) deals with the question of when real-estate contracts are securities versus non-securities.  This is germane to the present discussion because you can either profit from real estate (i.e., passively, with other parties managing the arrangement) , or live in it (i.e., glean utility), and the status of the sale contract (or lease) as a security depends on the details.  Relevantly, Notice 33-5347 states (emphasis here):

If the condominiums are not offered and sold with emphasis on the economic benefits to the purchaser to be derived from the managerial efforts of others, and assuming that no plan to avoid the registration requirements of the Securities Act is involved, an owner of a condominium unit may, after purchasing his unit, enter into a non-pooled rental arrangement with an agent not designated or required to be used as a condition to the purchase, whether or not such agent is affiliated with the offeror, without causing a sale of a security to be involved in the sale of the unit. Further, a continuing affiliation between the developers or promoters of a project and the project by reason of maintenance arrangements does not make the unit a security. [8]

The first bolded segment supports the argument that a “consumptive” purpose in acquiring a token can override hallmarks of a (passive) investment contract (even if, as in this example, the contract’s “maturing” into a security was also a possibility), to end up with a “utility”-type transaction (here, the vending of real estate for direct use/enjoyment).  So “going from security to utility” is not as legally “revolutionary” as might be assumed at first blush.

The second bolded segment harks back to a the marquee question raised by Hinman’s June 14th proposal (as discussed above), and seems to contradict it:  here, a continuing “service-type” relationship — managed by the very promoters themselves — has no per se bearing  on whether the original transaction contract was a security.

This brings us back to Forman.  Hinman in fact cites Forman, for the proposition that whether a sale transaction is a securities-regulated investment contract hinges on the expectation of functional use by the purchasers (“Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchasers. When someone buys a housing unit to live in, it is probably not a security.” [9]).  Yet, let us trace further.  The Forman Supreme Court, in interpreting and applying Howey, stated (emphasis added),

This test, in shorthand form, embodies the essential attributes that run through all of the Court’s decisions defining a security. The touchstone is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. By profits, the Court has meant either capital appreciation resulting from the development of the initial investment, as in Joiner, supra (sale of oil leases conditioned on promoters’ agreement to drill exploratory
well), or a participation in earnings resulting from the use of investors’ funds, as in Tcherepnin v. Knight,  supra (dividends on the investment based on savings and loan association’s profits). [10]

This is where that handy phrase “entrepreneurial or managerial efforts” comes from.  But notice how the court then bifurcates the application of this criteria into (a) capital appreciation from the development of the initial investment, or (b) participation in earnings.  Nowhere present in this rubric is incidental capital appreciation, or any other forms of value gleaned from ongoing entrepreneurial or managerial (or any other sorts of) efforts by the contractual counterparties.

This is all in the context of a discussion of shares giving the right to use housing, i.e., a “utility versus security” discussion, and the above passage immediate precedes the Forman court’s more well-known rule (internal quotes and citations removed and emphasis added):

… when a purchaser is motivated by a desire to or consume the item purchased — to occupy the land or to develop it themselves — the securities laws do not apply. [11]

Immediately at the conclusion of the above passage, the court cites SEC Release No. 33-5347 (discussed above) as support, bringing this discussion neatly full-circle.

So it appears that when the SEC and Supreme Court together last looked at an analogous situation (i.e., a contract that can “mature” into either economic returns or direct “personal use”), they came to much the same conclusion that we have regarding decentralization vis-a-vis continued management/control/servicing.  That is, the import of “the degree decentralized” of management has on the securities status of ongoing or even vested purchases is categorically limited; what matters far more is whether people are buying the instruments under a bargain whereby a separate group of promoters promises to turn the buyers’ principal into an ongoing economic return, or from an inchoate idea into a viable commercial product or service.  We hope the SEC does not lose sight of that when advancing in this sector.

-AK

Citations

  1. William Hinman, “Digital Asset Transactions: When Howey Met Gary (Plastic),” Securities Exchange Commission, June 14, 2018 (hereinafter, “Hinman0618”), available at https://www.sec.gov/news/speech/speech-hinman-061418.
  2. I.e., the first footnote of of the written version of Hinman’s remarks reads: “The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners or other members of the staff”; id, Fn 1.
  3. SEC vs. W.J. Howey,  328 U.S. 293 (1946).
  4. Id. at at 300.
  5. United Housing Found., Inc. v. Forman, 421 U.S. 837 (1975).
  6. The SEC has posted no transcript or official written remarks of these speeches, but see, e.g., Nikhilesh De and Mahishan Gnanaseharan , “SEC Chief Touts Benefits of Crypto Regulation,” CoinDesk.com, Apr 5, 2018 , available at https://www.coindesk.com/sec-chief-not-icos-bad/; or Erin Arvedlund, “SEC chair Clayton promotes ‘harmonizing’ conflicting rules over brokers, advisors,” Philly.com, May 2, 2018, available at http://www.philly.com/philly/news/breaking/sec-chair-clayton-promotes-harmonizing-conflicting-rules-brokers-advisors-20180502.html.
  7. SEC Notice 33-5347, GUIDELINES AS TO THE APPLICABILITY QF THE FEDERAL SECURITIES LAWS TO OFFERS AND SALES OF CONDOMINIUMS OR UNITS IN A REAL ESTATE DEVELOPMENT, Jan. 4, 1973, available at https://www.sec.gov/rules/interp/1973/33-5347.pdf.
  8. Id at 4.
  9. Hinman0618, at citation of fn. 6.
  10. Forman at 852.
  11. Id. At 852-853.
Posted on

House Financial Services Subcommittee Hearing: Cryptocurrencies and Illicit Financing (6/20/18)

Below is a rough auto-transcript of a hearing held yesterday entitled “Illicit Use of Virtual Currency and the Law Enforcement Response”.  The House Financial Services Subcommittee had officials from USCIS (ICE), FinCEN (Treasury) and the Secret Service on the stand, ostensibly to testify on the above-titled topic.  However, due to the contemporaneous border family separation debacle, a large portion of the hearing was pre-empted by this issue, so virtual currencies did not get the full treatment originally expected.   Nevertheless, the transcript with links to the hearing video is reproduced anyway, as it might be useful to some.  (Watch this space for further excerpts and comments, once we analyze this record fully).

TRANSCRIPT GUIDE  AND ADVISORY:

  • The transcript was produced by a text-to-speech process performed automatically by a third party service outside of our control.
  • KrowneLaw does not vouch for its accuracy; indeed, we guarantee it is inaccurate.
  • As such, each snippet of translated text is linked directly to the point in the video at which it occurs (popup in separate window/tab).   Please use this functionality to confirm exactly what was said in each case.
  • The hearing covers a wide variety of topics; thus, cryptocurrency/blockchain-related terms have been highlighted to assist in quick location of the relevant passages (this highlighting is by no means exhaustive, however).
  • The breaks in the text coincide roughly with changes in topic/changes in Congressperson leading the questioning.  They do not correspond to changes in speaker; thus, each block usually represents multiple speakers, including those on “opposing sides.”  You must listen to each particular segment in the video to determine who is speaking and to get the full context (and therefore, meaning).

Scroll box with transcript follows:

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