When is a Digital Asset a Security — Laura Anthony Esq. article republished by Ronald Woessner

On April 3, 2019, the SEC’s Division of Corporation Finance published a “Framework for Investment Contract Analysis of Digital Assets,” issued a No-Action Letter to Turnkey Jet, Inc. and made a statement on both. Although all guidance is appreciated, there is really nothing new or different about the analysis, which is firmly based on SEC v. W.J. Howey Co. (the “Howey Test”).  Moreover, as discussed below, even though the SECfound that Turnkey Jet did not need to comply with the federal securities laws in the issuance and sales of its tokens, the opinion and issued guidelines do not go far enough and still leave a great deal of uncertainty.

Framework for Investment Contract Analysis of Digital Assets

The SEC’s framework sets forth facts and circumstances to be considered in applying the Howey Test to determine if a digital asset is an investment contract and thus a security subject to state and federal securities laws in its issuance and subsequent re-sales. The U.S. Supreme Court’s Howey case and subsequent case law have found that an “investment contract” exists when there is (i) the investment of money (ii) in a common enterprise (iii) with a reasonable expectation of profits (iv) to be derived from the efforts of others. See by blog HERE for a general discussion of Howey HERE and HERE being applied to analyze a hypothetical token.

Howey doesn’t just examine the form of the asset or instrument itself (which, in the case of a digital asset, is computer code) but also the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold. The first prong of Howey, an investment of money, is usually easily satisfied as digital assets (or any investments) usually involve the exchange of money or other form of consideration. Case law progeny of Howey has long clarified that the “money” referred to in Howey can be any valid form of consideration or exchange of value.

In its framework analysis, the SEC points out that “bounty programs” also involve the exchange of value. As I discussed in this blog HERE, bounty programs are essentially incentivized reward mechanisms offered by companies to individuals in exchange for performing certain tasks. Bounty programs are a means of advertising and have gained in popularity in ICO campaigns. During a bounty program, an issuer provides compensation for designated tasks such as registering at a website, reading and sharing materials, or marketing and making improvements to aspects of the cryptocurrency framework.

The second prong of Howey, a common enterprise, also typically exists where there is an issuance or sale of a digital asset. That is, investments in digital assets usually involve a common enterprise because the fortunes of digital asset purchasers have been linked to each other or to the success of the promoter’s efforts.

The third element of Howey, a reasonable expectation of profits, involves a more in-depth analysis. Profits can include capital appreciation resulting from the development of the initial investment or business enterprise or a participation in earnings. Price appreciation resulting solely from external market forces impacting the supply and demand for an underlying asset generally is not considered “profit” under the Howey test. In analyzing whether there is a reasonable expectation of profits from an investment in a digital asset, the SEC considers:

  • Whether the digital asset gives the holder rights to share in the enterprise’s income or profits or to realize gain from capital appreciation. This could be from dividends or distributions or capital appreciation from secondary trading markets;
  • The digital asset is transferable or traded on or through a secondary market or platform, or is expected to be in the future (the SEC gives quite a bit of weight to this factor);
  • Purchasers expect the efforts of others to result in capital appreciation;
  • There is little apparent correlation between the purchase/offering price of the digital asset and the market price of the particular goods or services that can be acquired in exchange for the digital asset;
  • There is little apparent correlation between quantities the digital asset typically trades in (or the amounts that purchasers typically purchase) and the amount of the underlying goods or services a typical consumer would purchase for use or consumption;
  • More money is raised than is needed to establish a functional network or digital asset;
  • Money continues to be expended to increase and improve the value of the network or digital asset;
  • The digital asset is marketed, directly or indirectly, using any of the following: (i) the expertise of an Active Participant or its ability to build and grow the network or digital asset value; (ii) that the digital asset is an investment; (iii) intended use of proceeds is to develop the network or the digital asset; (iv) touting the future functionality of the network or asset; (v) the promise to build a future business or operations; (vi) secondary market or transferability; (vii) potential profitability of the network; or (viii) capital appreciation of the digital asset.
  • Related to a re-sale of a digital asset, further consideration should be given to (i) digital assets’ value separate from the continued development of a network; (ii) value of digital assets correlation to the good or service for which it can be exchanged; (iii) trading volume corresponds with level of demand for good or service for which it can be exchanged; (iv) whether network is built out and functionality of the digital asset; (v) whether economic benefit from appreciation is incidental to functionality; (vi) insiders’ access to material non-public information.

The fourth element of Howey, “derived from the efforts of others,” also involves a more in-depth analysis. When a promoter, sponsor, or other third party (i.e., “Active Participant”) provides essential managerial efforts that affect the success of the enterprise, and investors reasonably expect to derive profit from those efforts, then this prong of the test is met. A relevant portion of this inquiry is a review of the economic realities of the transaction, including the manner in which the digital asset is offered and sold.

The SEC focuses on two key issues:

  • Does the purchaser reasonably expect to rely on the efforts of an Active Participant?
  • Are those efforts “the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise,” as opposed to efforts that are more ministerial in nature?

In answering these two fundamental questions, the SEC guidance lists the following characteristics that support a finding that the purchaser is relying on the efforts of others:

  • An Active Participant is responsible for the development, improvement (or enhancement), operation, or promotion of the network;
  • An Active Participant will perform tasks and responsibilities rather than decentralizing performance to the community. This factor is not eliminated just because some tasks are decentralized, but rather an analysis is made as to the significance of the tasks;
  • An Active Participant creates or supports a market for, or the price of, the digital asset. This can include (i) controlling the creation and issuance of the digital asset; or (ii) taking other actions to support a market price of the digital asset, such as by limiting supply or ensuring scarcity, through, for example, buybacks, “burning,” or other activities.
  • An Active Participant has a lead or central role in the direction of the ongoing development of the network or the digital asset – for example, deciding governance issues, code updates, or how third parties participate in the validation of transactions;
  • An Active Participant has a continuing managerial role in making decisions about or exercising judgment concerning the network or the characteristics or rights the digital asset represents including, for example: (i) determining the compensation for service providers; (ii) determining whether or where the digital asset will trade; (iii) determining the issuance of additional digital assets; (iv) making or contributing to managerial level business decisions; or (v) responsibility for security of the network.
  • Purchasers would reasonably expect the Active Participant to undertake efforts to promote its own interests and enhance the value of the network or digital asset, such (i) the Active Participant retains ownership and has the ability to realize capital appreciation from the digital asset; (ii) the Active Participant distributes the digital asset as compensation or their compensation is tied to the value of the digital asset; (iii) the Active Participant owns or controls intellectual property rights related to the digital asset or network; or (iv) the Active Participant monetizes the value of the digital asset.
  • Related to a re-sale of a digital asset, further consideration should be given to (i) whether or not the efforts of the Active Participant continue to be important to the value of the digital asset; (ii) whether the network is fully functional such that the managerial efforts of an Active Participant are no longer essential; and (iii) whether the efforts of an Active Participant are no longer affecting the enterprise’s success.

In addition to the Howey factors, the SEC provides a list of other relevant considerations, including:

  • Whether the digital asset is offered and sold for use or consumption by its purchasers;
  • Whether the network is fully developed and operational;
  • Whether holders of the digital asset can immediately use its functionality;
  • 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, limiting use within the network);
  • Prospects for appreciation in the value of the digital asset are limited;
  • With respect to a digital asset referred to as a virtual currency, it can immediately be used to make payments in a wide variety of contexts, or acts as a substitute for real (or fiat) currency;
  • With respect to a digital asset that represents rights to a good or service, it currently can be redeemed within a developed network or platform to acquire or otherwise use those goods or services;
  • There is a correlation between the purchase price of the digital asset and a market price of the particular good or service for which it may be redeemed or exchanged;
  • The digital asset is available in increments that correlate with a consumptive intent versus an investment or speculative purpose; and
  • Restrictions on the transferability of the digital asset are consistent with the asset’s use and not facilitating a speculative market.

Turnkey Jet No-Action Letter

In the first SEC No-Action letter on the question as to whether a particular token distribution would be required to register as a security, the SEC opined that TurnKey Jet, Inc. could offer and sell its token without the need to register under the federal securities laws.  The SEC’s conclusion was supported by the facts that (i) no funds from the sales would be used to develop the network which would be fully operational at the time of any sales; (ii) the tokens would be immediately usable for their intended functionality; (iii) the tokens could not be transferred outside the Turnkey system and thus no secondary market can develop; (iv) the tokens will have a fixed price; (v) if Turnkey repurchases the tokens, it will only do so at a discount to their face value; and (vi) the tokens are marketed for functionality and not investment.

Turnkey’s No-Action Letter is not surprising in its result – it seems from a reading of the company’s letter to the SEC that it checked every box to avoid a finding that it could be considered to be engaged in a securities offering.  The issue is that the letter, together with the SEC guidance, continue to leave questions for those operating tokens that do not “check all the boxes.”

Turnkey’s letter to the SEC made several representations regarding the token including that “[A]t no time will Token sales include a rebate program, rewards program, or similar or otherwise allow for the monetization of an economic benefit or bonus for buying Tokens.” My question is, what if it did include a reward program?  In the SEC guidance it lays out an example of a retail point system, concluding that such a system would weigh in favor of not requiring compliance with the federal securities laws.  In particular, the SEC example is as follows:

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.

The SEC’s example of a point system and the basis for its opinion in Turnkey does not match with the reality of loyalty or reward points in the consumer world. The fact is that there is a large secondary market for airline and other loyalty points, as I discussed back in June 2018 (see my blog HERE).  Anyone with an American Express card knows they can trade and transfer points among many different award systems and even use the points for cash on Amazon.com, Walmart, Saks Fifth Avenue and a list of other partner providers. Although a particular point provider may fix the value for issuance of the point, the value that same point gets when traded for other points in other systems fluctuates. Points are generally marketed and sold or distributed for consumer consumption and not for their value appreciation, but not completely.

The SEC also puts weight on the fact that Turnkey is not using the tokens to raise working capital, but rather as a form of selling their product (purchasing air charter services); however, the entire loyalty point industry uses the proceeds from the sale of their points for working capital. According to its Form 10-K for the FYE December 31, 2018, Delta Airlines generated $2.651 billion from the sale of loyalty travel awards in 2018, representing approximately 15% of its total passenger revenue.

As I talked about back in 2018, online platforms such as www.points.com and www.webflyer.com operate using contractual partnerships with entities that issue loyalty points.  In fact, points.com is owned by Points International Ltd., which trades on the TSX and Nasdaq and refers to itself as “the global leader in loyalty currency management.”  In a 6-K, Points has this to say about the loyalty industry:

Year-over-year, loyalty programs continue to generate a significant source of ancillary revenue and cash flows for companies that have developed and maintain these loyalty programs. According to the Colloquy group, a leading consulting and research firm focused on the loyalty industry, the number of loyalty program memberships in the US increased from 3.3 billion in 2014 to 3.8 billion in 2016, representing an increase of 15% (source: 2017 Colloquy Loyalty Census Report, June 2017). As the number of loyalty memberships continues to increase, the level of diversification in the loyalty landscape is evolving. While the airline, hotel, specialty retail, and financial services industries continue to be dominant in loyalty programs in the US, smaller verticals, including the restaurant and drug store industries are beginning to see larger growth in their membership base. Further, newer loyalty concepts, such as large e-commerce programs, daily deals, and online travel agencies, are becoming more prevalent. As a result of this changing landscape, loyalty programs must continue to provide innovative value propositions in order to drive activity in their programs.

Points’ recent annual report provides that “[T]he Loyalty Currency Retailing segment provides products and services designed to help loyalty program members unlock the value of their loyalty currency and accelerate the time to a reward. Included in this segment are the Corporation’s buy, gift, transfer, reinstate, accelerator and status miles services. These services provide loyalty program members the ability to buy loyalty program currency (such as frequent flyer miles or hotel points) for themselves, as gifts for others, or perform a transfer of loyalty currency to another member within the same loyalty program.”

I also have trouble differentiating loyalty reward programs with bounty programs. Like in a bounty program, a loyalty reward is issued as compensation for an action such as shopping at a retail outlet, using a credit card, or staying at a hotel.

In Vanderkam & Sanders (January 27, 1999), an unnamed operator of an Internet-based auto referral service proposed to issue free stock to anyone who registered at the company’s website or who referred others to it. Visitors would complete a simple registration form and would not be required to provide cash, property or services for their shares. The SEC ruled that “the issuance of securities in consideration of a person’s registration on or visit to an issuer’s Internet site would be an event of sale” and would be unlawful unless “the subject of a registration statement or a valid exemption from registration.”

In Simplystocks.com (February 4, 1999), a web-based provider of financial information proposed to distribute free stock from a pool of entrants who logged in to the company’s website and provided their name, address, Social Security number, phone number and email address and then chose a log-in name and password. Visitors would receive one entry in the stock pool for each day they logged in to the website. After 180 days, the stock would be randomly allocated among the entrants in the stock pool. The SEC stated that the Simplystocks.com stock giveaway would be unlawful unless registered or exempt from registration.

In Andrew Jones (June 8, 1999), the promoter proposed to issue free stock to the first one million people who signed up or referred others to sign up. Shares would be claimed either by sending a self-addressed stamped envelope to the company along with the person’s name, address and email address, or by visiting the company’s website and providing the same information. The company said the information provided by shareholders would be used solely for corporate purposes and would not be sold or given to others or used for advertising purposes. The SEC ruled that “the issuance of securities in consideration of a person’s registration with the issuer, whether or not through the issuer’s Internet site, would be an event of sale” and would be unlawful unless registered or exempt from registration.

Certainly in those cases the companies were issuing common stock which is defined as a security without needing to reference the Howey Test; however, more recently, in the Matter of Tomahawk Exploration LLC, the SEC found that Tomahawk’s issuance of tokens under the Bounty Program constituted an offer and sale of securities because the company provided tokens to investors in exchange for services designed to advance Tomahawk’s economic interests and foster a trading market for its securities. In other words, the services required in the bounty program were a valid consideration. It has long been established that value for securities can be in the form of services, cash, property, or anything that a board of directors reasonably determines as valuable. Tomahawk received value in the form of online marketing and promotion, and by the creation of a secondary public trading market for its token.

I see the need for further guidance from the SEC on tokens vs. rewards as the “token economy” continues to flourish and develop.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journalop-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a review of the CFTC’s role and position on cryptocurrencies, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and the need for even further guidance in this space, see HERE.

For a discussion of William Hinman’s speech related to ether and bitcoin and guidance in cryptocurrencies in general, see HERE.

For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.

For a review of Wyoming’s blockchain legislation, see HERE.

For a review of FINRA’s request for public comment on FinTech in general and blockchain, see HERE.

For my three-part case study on securities tokens, including a discussion of bounty programs and dividend or airdrop offerings, see HEREHERE and HERE.

For a summary of three recent speeches by SEC Commissioner Hester Peirce, including her views on crypto and blockchain, and the SEC’s denial of a crypto-related fund or ETF, see HERE.

For a review of SEC enforcement driven guidance on digital asset issuances and trading, see HERE.

For information on the SEC’s FinTech hub, see HERE.

The Author

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

+++++++++++++++++++++++++++++++++++++++++++++++++

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the NasdaqNYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.comCorporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

 

 

SEC Rules For Disclosure Of Hedging Policies — Laura Anthony Esq. article republished by Ronald Woessner

Smaller reporting companies and emerging growth companies must comply with the new disclosure requirements in their proxy and information statements during fiscal years beginning on or after July 1, 2020. All other companies must comply in fiscal years beginning July 1, 2019. As foreign private issuers (FPI) are not subject to the proxy statement requirements under Section 14 of the Exchange Act, FPIs are not required to make the new disclosures.

New Item 407(i) of Regulation S-K will require a company to describe any practices or policies it has adopted regarding the ability of its employees, officers or directors to purchase securities or other financial instruments, or otherwise engage in transactions that hedge or offset, or are designed to hedge or offset, any decrease in the market value of equity securities granted as compensation, or held directly or indirectly by the employee or director. The disclosure requirement may be satisfied by providing a full summary of the practices or policies or by including the full policy itself in the disclosure.

The disclosure requirement extends to equity securities of parent and subsidiaries of the reporting company. The rules regulate disclosure of company policy as opposed to directing the substance of that policy or the underlying hedging activities. The rule specifically does not require a company to prohibit a hedging transaction or otherwise adopt specific policies; however, if a company does not have a policy regarding hedging, it must state that fact and the conclusion that hedging is therefore permitted.

The Senate Committee on Banking, Housing, and Urban Affairs stated in its report that Section 14(j) is intended to “allow shareholders to know if executives are allowed to purchase financial instruments to effectively avoid compensation restrictions that they hold stock long-term, so that they will receive their compensation even in the case that their firm does not perform.”

Background

Currently disclosure requirements related to hedging policies are set forth in Item 402(b) of Regulation S-K and are included as part of a company’s Compensation Discussion and Analysis (“CD&A”). CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers. Item 402(b) only requires disclosure of hedging policies “if material” and only for named executive officers. Moreover, CD&A is not required at all for smaller reporting companies, emerging growth companies, closed-end investment companies or foreign private issuers.

Hedging transactions themselves may be disclosed in other SEC reports. For example, Form 4 filings by officers, directors and greater than 10% shareholders would include disclosures of hedging transactions involving derivative securities. Hedging transactions involving pledged securities would be included in disclosures related to the beneficial ownership of officers, directors and greater than 5% shareholders in SEC reports such as a company’s annual report, registration statements or proxy materials. However, there is currently no rule that specifically requires the disclosure of hedging policies and that encompasses all reporting issuers.

New Item 407(i) of Regulation S-K

The SEC determined that disclosure of hedging policies constitutes a corporate governance disclosure and, as such, should be contained in Item 407, keeping all corporate governance disclosure requirements in one rule. As indicated above, the final new Item 407(i) of Regulation S-K will:

• require the company to describe any practices or policies it has adopted, whether written or not, regarding the ability of employees, officers, directors or their designees to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds), or otherwise engage in transactions that hedge or offset, or are designed to hedge or offset, any decrease in the market value of company equity securities granted to the employee, officer, director or designee or held directly or indirectly by the employee, officer, director or designee;
• a company will be required either to provide a fair and accurate summary of any practices or policies that apply, including the categories of persons covered and any categories of hedging transactions that are specifically permitted and any categories that are specifically disallowed, or to disclose the practices or policies in full;
• if the company does not have any such practices or policies, require the company to disclose that fact or state that hedging transactions are generally permitted. Likewise, if a company only has a practice or policy that covers a subset of employees, officers or directors, they would need to affirmatively disclose that uncovered persons are permitted to engage in hedging transactions;
• specify that the equity securities for which disclosure is required include equity securities of the company or any parent, subsidiary, or subsidiaries of the company’s parent. Moreover, the disclosure is not limited to registered equity securities, but rather any class of securities;
• require the disclosure in any proxy statement on Schedule 14A or information statement on Schedule 14C with respect to the election of directors. Disclosure is not required in a Form 10-K even if incorporated by reference from the proxy or information statement; and
• clarify that the term “employee” includes officers of the company.

The essence of Item 407(i) is to disclose any allowable transactions that could result in downside price protection, regardless of how that hedging is achieved (for example, purchasing or selling a security, derivative security or otherwise). Accordingly, the rule specifically does not define the term “hedge” but rather is meant to cover any transaction with the economic effect of offsetting any decrease in market value.

Similarly, the Rule does not define the term “held directly or indirectly” but rather will leave it to a company to describe the scope of their hedging practices or policies, which may include whether and how they apply to securities that are “indirectly” held. To the extent that it is undefined or a person may not be covered based on the definition, again, a company would disclose that hedging is permitted as to those that are not covered.

The new Rule only requires disclosure of policies and practices and not hedging transactions themselves. CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers. The new Rule adds an instruction to Item 402(b) related to CD&A such that the required disclosure can be satisfied by the new disclosure required by Item 407(i).

Section 14(j) specifically referred to any employee or member of the board of directors. The final rule clarified that officers are also covered in the disclosure. The Rule covers all employees, regardless of the materiality of their position. As the disclosure is about policies and practices, and does not mandate required policy or practice, the SEC saw no benefit in limiting the disclosure requirement to only certain covered persons. Consistently with the concept of allowing a company to define terms and scope in their adopted policies and practices, the definition and scope of “held directly or indirectly” will be left to a company to describe in its policy, if any, and associated disclosure.

The Author

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

+++++++++++++++++++++++++++++++++++++++++++++++++

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the NasdaqNYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.comCorporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

 

 

Why Is Austin Such a Promised Land for Food Entrepreneurs? — republished by Ronald Woessner

Article originally published by the Austin Chronicle here.

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Why Is Austin Such a Promised Land for Food Entrepreneurs?

The land of milk and honey and consumer packaged goods

Daniel Barnes (Photo by John Anderson)

 

It’s not the picturesque Hill Country views, or Austinites’ penchant for patio cocktails, or even the gushing venture capital streams that are driving the local consumer packaged goods industry, explains Leigh Christie, senior vice president of Global Technology and Innovation at the Austin Chamber of Commerce.  So what exactly is it that makes Austin an oasis for sought-after consumer packaged goods (CPG) companies?

Austin, an entrepreneurial mecca, finds itself at the delta of a national phenomenon in consumer preference: Consumers are demanding more traceability and simplicity in their products but also more convenience and innovation. People across the country are dreaming up new food-centric products in response, with high hopes of hitting the CPG jackpot, and an uncanny number of the success stories hail from right here in River City: EPIC Provisions, creator of all-natural meat/fruit bars, was born here and then acquired by General Mills; Amplify Snack Brand, which makes SkinnyPop Popcorn, is an Austin native and was acquired by Hershey; Chameleon Cold Brew and Briggo, the on-demand coffee bar, are also local brands. Siete Family Foods, a Mexican-American food brand created by the local Garza family, makes grain-free chips and tortillas, hot sauces, and dairy-free cashew queso, and just received a $90 million investment in February.

Daniel Barnes – mastermind behind Treaty Oak Brewing and Distilling, Waterloo Sparkling Water, and Mighty Swell – suggests that it’s mostly the community’s spirit that’s driving the scene: “I believe that a lot of it stems from a creative base and the creative culture in Austin, and that to me is more important than the VCs that are here.”

Leigh Christie (Photo by John Anderson)

 

In fact, many of the VCs, or venture capitalists, that fund Austin-based companies are only just beginning to invest their capital into packaged goods. “We’re seeing more VC and active investors wanting to learn about CPG because it’s not something they’ve invested in previously,” says Christie. “We’ve got more and more CPG companies who are relocating to Austin” – thereby raising awareness about the industry and its potential.

The city of Austin’s Economic Development Department calculated the food industry’s total economic impact in Austin to be $4.1 billion, or 0.45% of the city’s GDP, and food manufacturing only makes up $738 million of this industry. Still, “we have a strong need in the market, [and] we’re seeing that grow,” explained the department’s Global Business Expansion Manager David Colligan. Both the city of Austin and the Austin Chamber of Commerce have made the consumer packaged goods industry a target market for economic development, which basically means their goal is to bring more food companies to town.

James Brown (Photo by John Anderson)

 

So why is it not happening faster? Simple: There are no active incentives from the city for CPG companies looking to move to Austin. Still, the lack of state income tax and oft-lauded “affordable” standard of living make it an attractive place to settle in and build a business. According to James Brown, Barton Springs Mill owner/founder, there are quite a few grants and incubators around town willing to assist upstart companies. “We just won the Austin Food and Wine Alliance Grant,” he explained. “They usually give away half a dozen grants every year to local and regional food and beverage enterprises, ranging from $5,000 to $15,000.” Whole Foodsand Wheatsville also add to the allure, and coupled with the Food+City Challenge Prize and SKU, one of the nation’s leading CPG accelerators, Austin is quite a nurturing environment for introducing innovative products to the public.

South by Southwest in particular has played a unique role in creating buzz around Austin’s growing CPG scene. With every conceivable kind of creator making an appearance during those 10 Festival days, Brown says, “It’s an amazing experience to behold and to see the cross-pollination of all of these different thoughts and ideas. It does certainly have a huge effect on the food scene at that time.”

Barnes agrees, saying, “There’s no denying that SXSW has played some sort of a role in that [growth].” He also maintains that it’s the wealth of imagination, not the money, flowing through the Festival that makes it so influential on local companies. “When you’re constantly surrounded by inspiration and innovation, it just pushes you to drive your own creativity further and further,” he explained.

Creativity culture does not stop when SXSW ends, though. The Clayton Christophers (Sweet Leaf Tea; Deep Eddy Vodka) and the Tito Beveridges (Tito’s Vodka) of the food world greatly influence the development of companies by making themselves accessible. “They still go out of their way to have meetings with people who are on their way up. That responsiveness and that family mentality toward creating products here is remarkable,” said Barnes. Christie echoed his thoughts and explained that the chamber has seen a similar ecosystem being built around these companies because success begets success. “The CPG industry in town seems to support each other very well,” she said. “They seem to mentor, fund, and support one another.”

But while there’s no shortage of great ideas, raising capital is another story. Kirstin Ross, managing director of SKU, explained that convertible notes and angel networks are some of the limited options for companies looking to grow. Familiar names in venture capital firms like Cavu and LiveOak rarely offer financial support to businesses with less than $5 million in revenue, but with more Austin companies attracting the attentions of Fortune 100 companies, some industry insiders are taking it upon themselves to bridge the gap and give more CPG startups a chance. Genevieve Gilbreath recently launched Springdale Ventures, a VC fund that is dedicated to writing $500,000 checks to help companies through the bootstrapping stage. One of their first investments was Mason Arnold’s Cece’s Veggie Co. The hope, she explained, is to give burgeoning companies another option as they scramble to grow during the difficult stage between $500,000 and $1.5 million in sales.

Stephanie McClenny (Photo by John Anderson)

 

Plenty of Austin companies aren’t looking for explosive growth, though. Brown has turned down offers for investment in Barton Springs Mill and his “exit strategy” is something along the lines of “I don’t know, I’m going to die at some point?” Stephanie McClenny, owner of beloved local jam brand Confituras, created a small, but stable company that is able to weather the fickle winds of consumer taste: “We are a small, quiet company, and we work hard on building community and rely on word of mouth to strengthen our support rather than purchasing it.”

But with consumers’ short attention spans and social media driving people to constantly scour the landscape for the next best thing, Austin must continue to nourish upstart CPG entrepreneurs’ ideas. That’s a surefire way to satisfy taste buds while also boosting the city’s industry growth. After all, as Barnes put it, “The big guys aren’t ever going to be as good at innovation as the smaller guys are.”

Keep up with all our SXSW coverage at austinchronicle.com/sxsw. Sign up for our South By-specific newsletter at austinchronicle.com/newsletters for news, reviews, and previews delivered to your inbox every day of the Fest. And for the latest tweets, follow @ChronSXSW.

A note to readers: Bold and uncensored, The Austin Chronicle has been Austin’s independent news source for almost 40 years, expressing the community’s political and environmental concerns and supporting its active cultural scene. Now more than ever, we need your support to continue supplying Austin with independent, free press. If real news is important to you, please consider making a donation of $5, $10 or whatever you can afford, to help keep our journalism on stands.

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VC Funding Is Hard to Come by If You’re a Female Founder — republished by Ronald Woessner

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OTC Markets: Community Bank Regulations Should Foster Main Street Growth — republished by Ronald Woessner

See below for an article of OTC Markets that appeared at this link.

Banking regulation tends to be a partisan issue, but there’s one thing lawmakers are certain to agree on: America’s community banks are the backbone of the country’s economy.

Community banks serve a unique purpose. These institutions make over half of all U.S. small business loans, providing capital to entrepreneurs seeking to start businesses, and the financing needed for local businesses to grow. They provide jobs, help families buy homes and serve as the financial core for communities nationwide.

Policymakers and regulators should consider a tailored approach to capital requirements, data reporting and other requirements to keep community banks alive and thriving as the economic engines of U.S. communities. More dramatic changes to regulatory structures would fall harder on small banks, as they don’t have the compliance teams that can rapidly implement changes the way large banks can.

According to a recent survey by the Federal Reserve and Conference of State Bank Supervisors, community bank compliance costs have increased by nearly $1 billion in the past two years to roughly $5.4 billion, or 24% of community bank net income.

The banking industry is thriving and we hope that any regulatory changes considered will take into account a community banks most important customer — Main Street.

The remainder of the article appears  here.

Mr. Woessner’s Linked In bio appears here

 

David Weild: The Collapse of the Small IPO is Undermining Entrepreneurship, Tokenization May Help Fix the Problem | Crowdfund Insider

The article below was originally published by Crowdfund Insider on February 26, 2019, at this link.

This article discusses a recent speech by David Weild, Father of JOBS Act 1.0.  Several other of my published articles discuss the themes of  he disappearing US public companies, lack of capital for smaller-cap companies, the dying of US entrepreneurship, and the consequent loss of upward mobility that appear in Mr. Weild’s published work.

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Last week Crowdfund Insider attended the KoreSummit in Miami – a security token focused event. The opening presentation was delivered by David Weild, a former Vice Chairman of NASDAQ and now CEO of his own firm Weild & Co.

Weild, a staunch proponent of the JOBS Act, has long championed the benefits of entrepreneurship and the smaller initial public offering (IPO) market – a sector that has dramatically declined in recent years. He believes that misguided policy decisions have crushed the small to mid-market IPO and thus undermined access to capital and wealth creation in the US.

Today in the US, much of the innovative entrepreneurship takes place in hotbeds of creativity like Silicon Valley or Silicon Alley – to the exclusion of most of the country. Weild believes this is a shortcoming that must be addressed and the loss of small-cap IPOs have accelerated the decline in entrepreneurship.

Additionally, part of the economic impact due to this concentration of innovation is that the concept of upward mobility has been undermined. For much of the country, it is harder to get ahead. The wealthier get more wealthy while the poor and middle class struggle to make ends meet.  Opportunity and access to capital, is not being equally disseminated across the country. Now, Weild is no social democrat. As he explains:

“I do not begrudge the rich getting rich. I begrudge the people getting left behind.”

Weild is on a mission. He believes that education, access to capital, company formation, and “exitability” are all essential for upward mobility. Fostering a robust entrepreneurial ecosystem is vital.

He has advocated on behalf of the concept of creating a venture exchange: a marketplace for smaller firms to raise capital, provide liquidity, and create an exit opportunity.

Currently, Weild believes that blockchain technology and tokenization may be the best path forward to take friction out of the innovation ecosystem, lower costs, and reinvigorate entrepreneurship in the US. The technology may streamline primary issuance as well as secondary transactions.

“Instead of us having a one size fits all stock market that is really geared towards trading … and ignores the needs of the companies and intermediaries this would be one that really balances all of the interests.”

Weild believes the problem with the current market structure is that interests are out of balance. He is critical of the existing options. Weild calls OTC Markets efforts to be the US venture market “lunacy” and says we need a complete remake:

“OTC Markets is a stock held exchange. I seriously doubt that any model will work unless it is a member owned exchange.”

He believes the tick size pilot, an experiment launched by the SEC to boost liquidity for smaller cap firms, was flawed due to the participation of the exchanges as they were incentivized by their own profitability. Weild believes that small investment banks and those who make markets and commit capital must be part of the equation.

“You don’t get that optimization, that balancing of interests. Investment banks have to worry about being on the right side of the investors and the right side of the companies they serve and they have to get it right.”

NASDAQ and NYSE just care about their quarterly earnings as public firms, according to Wield. He also believes that the SEC set up the tick pilot to fail from the beginning. In fact, Weild sent a letter to SEC Chair Jay Clayton telling him just that.

Bullish on Entrepreneurs

Weild notes that jobs are created by small businesses – a statement that has been born out in multiple reports. Most innovation takes place in startups and early-stage firms as well. It is vital that policy and regulation support these types of firms – even if many of them inevitably fail.

“You gotta get that right or you don’t have a future,” says Weild.

So what about private markets? Today, there is an ocean of private money looking for great deals. As public markets have declined in relevance and viability, private money has stepped in to fill the void.

Weild believes private markets are not that efficient. He asks the question as to how many entrepreneurs do you run into that are struggling to raise money. This point is buttressed by a slide from his presentation that shows the decline in entrepreneurship that has hit fly-over country.

“They don’t know who to talk to, they can’t find it. It’s a chronic disease of US public markets … there is a have and have not world and the vast majority of the United States is have not … we are in the lowest startup rate in 40 years…”

In effect, venture capital has become a substitute for public markets.

Policymakers need to get ahead of the curve. They need to figure out how to get the heartland back to creating jobs and you cannot do it if you have to be a $500 million company before it is reasonable to take it public.

So where does tokenization fit into all of this? And is the hype getting ahead of reality?

Weild says yes, the hype always gets ahead of the story. But the technological shifts are always overestimated over the short term, or the hype phase, and underestimated in the long term. Weild draws a parallel to the rapid rise of the internet and the first market entrants that largely failed. Inevitably hugely successful companies will arise from the “primordial ooze.”

“Security tokens technologically are really interesting because they can take a lot of cost out of the system. It is not just a token, it is not just a block and general ledger, its this integrated system that includes this software layer that can do whatever, ultimately, they are programmed to do.”

Weild sees a system that is amazingly efficient where you can take out intermediaries – like a bank.

“Look at what JP Morgan just did announcing their own stablecoin.”

Sure. There are plenty of Luddites and naysayers that don’t believe in blockchain tech but in Weild’s experience, we are in the trial and error phase where we are going to work out the kinks. He would be surprised if, at some point in the future, we are not holding securities very differently.

Even DTCC is working on a blockchain project.

Weild says that a lot of the transactional costs will be stripped out of the system.

Securities on blockchain will create a level of innovation we have yet to experience in the past, says Weild. It will transform securities but there will be an interim step where traditional and digital will be interchangeable but eventually, it will all be tokenized.

Weild acknowledges there are still many issues that need to be worked through such as custody. But eventually, major Wall Street firms will be compelled to change and adapt.

Of course, the change is not going to be instantaneous. Weild sees it shifting over the next five years at best.

JUMP Coalition: Jobs Upward Mobility and Making Markets Perform

One of Weild’s newer projects is the Jump Coalition that will be a bi-partisan lobbying group/think tank. The goal is to advocate politically for creating incentives that work for most people. He mentioned both Representative Maxine Waters and former Representative Jeb Hensarling as pursuing supportive legislation in Congress. Representative Waters, now the Chair of the powerful House Financial Services Committee, is on the record supporting the JOBS Act 3.0 – an entrepreneur/small business friendly act of legislation.

Ultimately, Weild wants to see everyone on a path to a better future – not just the lucky few.

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Mr. Woessner  mentors, advises, and helps companies in the start-up and smaller-cap company ecosphere raise capital via Regulation Crowdfunding (CF) and otherwise.  He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. See here for more information on Mr. Woessner’s background.

 

 

Tribute to the Late John Dingell — republished by Ronald Woessner

February 8, 2019 |Washington, D.C. – House Republican Leader Kevin McCarthy (CA-23) honored John Dingell, the longest serving member of the House in history, and his dedication to public service.

“I also rise to commemorate the incredible life and career of John Dingell – the former Dean of this House.

“Few individuals have amassed a record of public service that could rival John’s, and I will bet no one will ever match it – 59 years as an elected representative.

“In fact, his interest in politics began during his time as a Congressional Page, where he personally witnessed FDR’s “A Day That Will Live in Infamy” Speech from this very podium.

“Take one moment to think of the life that this man had witnessed on this floor.

“John taught us that public service is not a sprint, but a marathon. There are many lessons in his life that we can learn from, but I hope we take that lesson every day when we come to work here.

“Another lesson I hope we learn is the one of how I first met John.

“He was an icon before I got here. But I watched the respect, not from his own colleagues in his own party, but the respect from across the aisle.

“They went to John for advice.

“When he walked on the floor, there was many on our side that stood around him – they’d question him where we thought we could go. He believed in this House. He believed in this country.

“He had great passions – passions for his constituents, passion for his committee; energy and commerce. He loved this committee so much he thought there needed no other committee in this House. It wasn’t until his retirement that we got jurisdiction back in other places.

“But he understood an ever-changing world, if you can only imagine serving that long.

“He was able to adapt – which we should learn from too. Yes, the new world of social media, many would think would pass him by because of his age. But he was one of the first I would follow on Twitter.

“This is a lesson this House, in a bipartisan manner, should take. It’s one of my favorite tweets from John.

“It came on the day of July of 2017. He wrote, ‘I’ve been trying to repeal and replace the United States Senate since 1955 […] No luck.’

“Yes we are sad today, but he lived a life we can admire.

“I may have difference in opinion and philosophy with him but I admired his will to fight for what he believed in. I admired the way he treated people who had different beliefs and I admired the way he believed all sides should be heard.

“I speak for everyone on this side of the aisle to convey our deepest sympathies – and to Debbie.

And I ask that we lift up in our prayers to God for his soul to rest peacefully and to remember what he truly believed:

“Public service matters. This country matters – and the ability to work together so all Americans will have a better tomorrow.”

Who is Ronald Woessner?

Mr. Woessner of Dallas, Texas has worked in the smaller-cap company ecosphere for 25+ years in the capacity as general counsel to two NASDAQ-listed companies and advisor to others.  He currently mentors, advises, and helps start-up and smaller-cap companies raise capital through Regulation Crowdfunding (CF) and other means. He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. Mr. Woessner, a certified Toastmaster, speaks and writes about US public and private capital markets topics and his articles are published by equities.com and elsewhere. You may contact him about a speaking engagement at Linked In here.

The SEC’s Strategic Hub For Innovation And Financial Technology — republished by Ronald Woessner

See article below of Laura Anthony, Esq. which originally  appeared at this link.  Information about Ms. Anthony and her law firm appears below following the article.

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Responding to the growing necessity, in mid-October the SEC launched a Strategic Hub for Innovation and Financial Technology (FinHub). The FinHub will serve as a resource for public engagement on the SEC’s FinTech-related issues and initiatives, such as distributed ledger technology (including digital assets), automated investment advice, digital marketplace financing, and artificial intelligence/machine learning. The FinHub also replaces and consolidates several SEC internal working groups that have been working on these matters.

According to the SEC press release on the matter, the FinHub will:

  • Provide a portal for the industry and the public to engage directly with SEC staff on innovative ideas and technological developments;
  • Publicize information regarding the SEC’s activities and initiatives involving FinTech on the FinHub web page;
  • Engage with the public through publications and events, including a FinTech Forum focusing on distributed ledger technology and digital assets planned for 2019;
  • Act as a platform and clearinghouse for SEC staff to acquire and disseminate information and FinTech-related knowledge within the agency; and
  • Serve as a liaison to other domestic and international regulators regarding emerging technologies in financial, regulatory, and supervisory systems.

Although I’m sure FinHub supports engagement in all FinTech areas, the website itself is broken into four categories: (i) blockchain/distributed ledger; (ii) digital marketplace financing; (iii) automated investment advice; and (iv) artificial intelligence/machine learning. Under each category the SEC has tabs with information such as regulations, speeches and presentations, opportunities for public input and empirical information.

                Blockchain/Distributed Ledger 

Blockchain and distributed ledger generally refer to databases that maintain information across a network of computers in a decentralized or distributed manner.  Blockchains are often used to issue and transfer ownership of digital assets that may be securities, depending on the facts and circumstances.

Clearly illustrating the need for regulatory initiatives, the “regulation, registration and related matters” tab under blockchain/distributed ledger is limited to public speeches, testimony and pronouncements, and enforcement actions, and not regulation (as none exists). Although certainly we in the community give public statements weight, they actually have no binding legal authority. The speeches, testimony and pronouncements that the SEC lists in this tab, and as such the ones that the SEC gives the most weight to, include (i) Chair Clayton’s testimony on virtual currencies to the Senate banking committee (see HERE); (ii) William Hinman’s speech on digital asset transactions (see HERE); (iii) statement on potentially unlawful online platforms for trading digital assets (see HERE); and (iv) remarks before the AICPA National Conference of Banks & Savings institutions (see HERE and HERE).

Providing more legal guidance are the enforcement proceedings. The SEC has provided a running list of all cyber enforcement actions broken down by category including digital asset/initial coin offerings; account intrusions; hacking/insider trading; market manipulation; safeguarding customer information; public company disclosure and controls; and trading suspensions.

Digital Marketplace Financing

Digital marketplace financing refers to fundraising using mass-marketed digital media – i.e., crowdfunding. In this category, the SEC includes traditional Title III Crowdfunding under Regulation CF and platforms for the marketing of Regulation D, Rule 506(c) offerings for the offering of debt or equity financing. Under the Regulation tab the SEC includes Regulation CF and the SEC’s Regulation CF homepage, including investor bulletins.

The SEC does not include a link to Rule 506(c) or Section 4(c) of the Securities Act, which provide an exemption for advertised offerings where all purchasers are accredited investors, and the platforms or web intermediaries that host such offerings, respectively. However, many securities token offerings are being completed relying on these exemptions from the registration provisions – in fact, more so than Regulation CF which is limited to $1,070,000 in any twelve-month period. In my opinion, this is a miss on the site layout.

This area of the FinHub website also provides a link to one of the first published SEC investor bulletins on initial coin offerings, including some high-level considerations to avoid a scam. Finally, this area provides a link to a Regulation CF empirical information page published by the SEC. Unfortunately I do not find the data to be user-friendly and could not determine how many, if any, Regulation CF offerings have included digitized assets or FinTech-related issuers.

Automated Investment Advice

Automated investment advisers or robo-advisers are investment advisers that typically provide asset management services through online algorithmic-based programs. Since their introduction, the SEC has been involved with regulating these market participants. Under this section, the SEC provides links to guidance related to robo-advisors.

Robo-advisers, like all registered investment advisers, are subject to the substantive and fiduciary obligations of the Advisers Act. However, since robo-advisers rely on algorithms, provide advisory services over the internet, and may offer limited, if any, direct human interaction to their clients, their unique business models may raise certain considerations when seeking to comply with the Advisers Act. In particular, the Advisors Act requires that a client receive information that is critical to his or her ability to make informed decisions about engaging, and then managing the relationship with, the investment adviser. As a fiduciary, an investment adviser has a duty to make full and fair disclosure of all material facts to, and to employ reasonable care to avoid misleading, clients. The information provided must be sufficiently specific so that a client is able to understand the investment adviser’s business practices and conflicts of interests. Such information must be presented in a manner that clients are likely to read (if in writing) and understand.

Since robo-advisors provide information and disclosure over the internet without human interaction and the benefit of back-and-forth discussions, the disclosures must be extra robust and provide thorough material on the use of an algorithm. The SEC’s guidance on the subject contains a fairly thorough list of matters that should be included in the client information.

Artificial Intelligence/Machine Learning

Machine learning and artificial intelligence refer to methods of using computers to mine and analyze large data sets. The SEC includes links to a few speeches and presentations under this tab. The SEC uses machine learning and AI in numerous ways, including market risk assessment and helping identify risks that could result in enforcement proceedings such as the detection of potential investment adviser misconduct.

Further Reading on DLT/Blockchain and ICOs

For a review of the 2014 case against BTC Trading Corp. for acting as an unlicensed broker-dealer for operating a bitcoin trading platform, see HERE.

For an introduction on distributed ledger technology, including a summary of FINRA’s Report on Distributed Ledger Technology and Implication of Blockchain for the Securities Industry, see HERE.

For a discussion on the Section 21(a) Report on the DAO investigation, statements by the Divisions of Corporation Finance and Enforcement related to the investigative report and the SEC’s Investor Bulletin on ICOs, see HERE.

For a summary of SEC Chief Accountant Wesley R. Bricker’s statements on ICOs and accounting implications, see HERE.

For an update on state-distributed ledger technology and blockchain regulations, see HERE.

For a summary of the SEC and NASAA statements on ICOs and updates on enforcement proceedings as of January 2018, see HERE.

For a summary of the SEC and CFTC joint statements on cryptocurrencies, including The Wall Street Journal op-ed article and information on the International Organization of Securities Commissions statement and warning on ICOs, see HERE.

For a summary of the SEC and CFTC testimony to the United States Senate Committee on Banking Housing and Urban Affairs hearing on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission,” see HERE.

To learn about SAFTs and the issues with the SAFT investment structure, see HERE.

To learn about the SEC’s position and concerns with crypto-related funds and ETFs, see HERE.

For more information on the SEC’s statements on online trading platforms for cryptocurrencies and more thoughts on the uncertainty and the need for even further guidance in this space, see HERE.

For a discussion of William Hinman’s speech related to ether and bitcoin and guidance in cryptocurrencies in general, see HERE.

For a review of FinCEN’s role in cryptocurrency offerings and money transmitter businesses, see HERE.

For a review of Wyoming’s blockchain legislation, see HERE.

For a review of FINRA’s request for public comment on FinTech in general and blockchain, see HERE.

For my three-part case study on securities tokens, including a discussion of bounty programs and dividend or airdrop offerings, see HERE; HERE; and HERE.

For a summary of three recent speeches by SEC Commissioner Hester Peirce, including her views on crypto and blockchain, and the SEC’s denial of a crypto-related fund or ETF, see HERE.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

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Mr. Woessner  mentors, advises, and raises capital for companies in the start-up and smaller-cap company ecosphere.  He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. See here for more information on Mr. Woessner’s background.

Understanding Short Sale Activity by Cromwell Coulson OTC Markets Group — republished by Ronald Woessner

See below for an article by Cromwell Coulson, President, CEO and Director of OTC Markets Group, regarding “Understanding Short Sale Activity.”

Quality data is essential to well-functioning markets. Improving the availability, relevance and usefulness of data aligns with OTC Market Group’s mission to create better informed, more efficient financial markets.  In our experience, short selling remains one of the most highly-debated topics among academics, companies, investors, market makers and broker-dealers. As a market operator and company CEO, I believe it’s critical to address the misconceptions that still exist around short sale data and the correlation to a stock’s fundamental value.

Short selling, the sale of a security that the seller does not own, has long been a controversial practice in public markets.  Advocates for short selling believe it builds price efficiency, enhances liquidity and helps improve the public markets, while critics are concerned that it can facilitate illegal market manipulation and is detrimental to investors and public companies.  Given the diverse range of opinions and opposing views, we believe the first step is to take a deeper dive into the data and help separate out the noise.

“The Reliable” – FINRA Equity Short Interest Data

The most accurate measure of short selling is the data reported by all broker-dealers to FINRA on a bi-weekly basis.   These numbers reflect the total number of shares in the security sold short, i.e. the sum of all firm and customer accounts that have short positions.

This information is available on www.otcmarkets.com on the company quote pages.  As an example, OTC Markets Group has a few hundred shares sold short on average, which represents a fraction of our daily trading volume and shares outstanding.

OTC Markets Group (OTCQX: OTCM) SHORT INTEREST Data

DATE SHORT INTEREST PERCENTAGE CHANGE AVG. DAILY SHARE VOL DAYS TO COVER SPLIT NEW ISSUE
9/28/2018 97 11.49 5,551 1 No No
9/14/2018 87 8.75 4,423 1 No No
8/31/2018 80 100.00 6,818 1 No No
7/31/2018 103 -48.24 3,197 1 No No
7/13/2018 199 -27.64 2,124 1 No No
6/29/2018 275 166.99 3,239 1 No No
6/15/2018 103 24.10 2,739 1 No No
5/31/2018 83 -72.33 3,925 1 No No
5/15/2018 300 1.69 3,944 1 No No
4/30/2018 295 100.00 4,278 1 No No

FINRA Rule 4560 requires FINRA member firms to report their total short positions in all over-the-counter (“OTC”) equity securities that are reflected as short as of the settlement date. In 2012 FINRA clarified that firms must report short positions in each individual firm or customer account on a gross basis under FINRA Rule 4560. Therefore, firms that maintain positions in master/sub-accounts or parent/child accounts must calculate and report short interest based on the short position in each sub- or child account.

Since this data is part of a clearing firm’s books and records, it is of high quality and FINRA regularly inspects broker-dealer compliance with the rule.  Of course, it would be great if this data was collected and published daily (with an appropriate delay).

“The Misleading” – Daily Short Volume

In contrast, the most frequently misinterpreted data is the Daily Short Volume, sometimes referred to as Naked Short Interest.  This data shows the percentage of published trade reports (called media transactions in FINRA Rules) that were marked short.   As an example, the recent data for OTC Markets Group shows that up to 90% of the trading volume comes from short

selling on some days.   If we did not carefully track our bi-weekly Short Interest, we could easily be led to believe that short selling is rampant in our stock.

Historical Short Volume Data for OTC Markets Group (OTCQX: OTCM)

DATE VOLUME SHORT VOLUME PERCENTAGE of VOL SHORTED
Oct 18 3,341 1,399 41.87
Oct 17 5,989 3,198 53.40
Oct 16 16,120 7,509 46.58
Oct 15 24,155 12,991 53.78
Oct 12 6,297 4,914 78.04
Oct 11 4,059 1,553 38.26
Oct 10 2,185 999 45.72
Oct 9 7,473 4,556 60.97
Oct 5 880 525 59.66
Oct 4 492 200 40.65
Oct 3 2,041 801 39.25
Oct 2 4,786 1,560 32.60
Oct 1 3,973 2,607 65.62
Sep 28 244 23 9.43
Sep 27 882 805 91.27
Sep 26 259 189 72.97
Sep 25 3,085 2,250 72.93
Sep 24 967 571 59.05
Sep 21 2,350 825 35.11
Sep 20 7,164 6,453 90.08
Sep 19 297 202 68.01

 

Seeing the above data can be alarming for public companies and their investors, until they understand the inner workings of how dealer markets function and broker trades are reported—which render the data virtually meaningless.

Since this data also comes from FINRA, what gives?  The daily short selling volume is misleading because market makers and principal trading firms report a large number of trades as short sales in positions that they quickly cover. For market makers with a customer order to sell, they will temporarily sell short (which gets published to the tape as a media transaction for public dissemination) and then immediately buy from their customer in a non-media transaction that is not publicly disseminated to avoid double counting share volumes.  SEC guidance also mandates that almost all principal trading firms that provide liquidity at multiple price levels, or arbitrage international securities, must mark orders they enter as short, even though those firms might also have strategies that tend to flatten by end of day. Since the trade reporting process for market makers and principal trades makes the Daily Short Volume easily misleading, we do not display it on www.otcmarkets.com.

Making daily short reporting data easily-digestible and relevant is not hard. On the contrary, it should be easy to aggregate all of the short selling that is reported as agency trades, as well as all of the net sum of buying and selling by each market maker and principal trading firm.  This would paint a clear picture for investors of overall daily short selling activity. Fixing the misleading daily short selling data would bring greater transparency and trust to the market.

 “The Missing Piece”– Short Position Reporting by Large Investors

There is ample evidence that short selling contributes to efficient price formation, enhances liquidity and facilitates risk management.  Experience shows that short sellers provide benefits to the overall market and investors in other important ways which include identifying and ferreting out instances of fraud and other misconduct taking place at public companies.  That said, we agree with the New York Stock Exchange and National Investor Relations Institute that there is a serious gap in the regulation of short sellers related to their disclosure obligations.   We understand that well-functioning markets rely on powerful players who cannot be allowed to hide in the shadows.  Since we require large investors, who accumulate long positions, to publicly disclose their holdings, why aren’t there disclosure obligations for large short sellers?   This asymmetry deprives companies of insights into their trading activity and limits their ability to engage with investors.  It also harms market functions and blocks investors from making meaningful investment decisions.

One point is clear, we all need to continue to work collaboratively with regulators to improve transparency, modernize regulations and provide investors with straightforward, understandable information about short selling activity.  We want good public data sources that bring greater transparency to legal short selling activity as well as shine a light on manipulative activities.  All while not restricting bona fide market makers from providing short-term trading liquidity that reduces volatility.