THE CROWDFUNDING LAWYERS

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CryptoMom versus the Machine

The Securities and Exchange Commission (SEC) hatched from the New Deal’s heady days.  Many thought unfettered capitalism was done, disinterested technocrats could smooth free-market excesses and regulate economic affairs more fairly and efficiently. FDR and many others—wrongly as it turned out—blamed the 1929 market crash on insufficient government oversight.

Hester Peirce, CryptoMom

The SEC now has a $1.6 billion budget, over 4,500 employees, and eleven regional offices. It typifies federal agencies with its pedigree: old, slow, bloated, obsessed with credentialism, self-importance, and arrogance.

In Life After Google, George Gilder wrote about America’s decaying Ivy institutions:

Feeding on the air of entitlement of fading upper-class institutions that accomplish “little with a lot” of other people’s funds, the Harvard initiative reflected the increasing inebriation of elite American education. Focusing on stopping progress, barring new power plants, dismantling chemical facilities, mobilizing against Israel, and other reactionary pursuits, Ivy institutions are pursuing fancies of a declining intellectual and business elite, full of chemophobic nags and luddite lame-ducks quacking away on their miasmic pools of old money as the world whirls past them.

When bright but indoctrinated young minds graduate from these formerly august institutions many move to Washington, DC. They come to work at places like the SEC and other name-brand agencies. They come to enforce the dogma they learned, they come to oversee the American experiment without any responsibility for the results, they come to feed the Machine.

SEC chairman Jay Clayton typifies this path: Ivy league undergraduate to Cambridge, back to the Ivy League for law school, a federal clerkship, a big law firm and adjunct Ivy League teaching position, and finally to head a federal agency. Mr. Clayton undoubtedly worked hard for his success as did those that came before and after him. But no one who takes this path starts a business, takes out a business loan, meets a payroll, files for bankruptcy, or goes without lunch because of the first four. The question is who benefits and at what cost?   

Jay Clayton, pledging fealty to the Machine

The SEC’s culture as with the rest of the federal government is one of buck passing, lack of responsibility, and no accountability. Every public appearance by a Machinist starts by stating they don’t speak for their agency, that what follows is personal opinion. It’s a little thing and a legal obligation but it insulates them from their words, what they are disclaiming is responsibility.   One sees it in the myriad reports they author evaluating their performance. Here is how the SEC states it will improve on a poor performance metric. It exemplifies responsibility-less gobbledygook that above all disclaims accountability:

Plan for Improving Program Performance: To address the issue of timeliness in investigations, the Division is taking measures that include emphasizing expediency in quarterly case reviews, promoting best practices regarding efficiencies in various phases of the investigative process, leveraging data analytics capabilities, and conducting training on tools that expedite investigations.

And if all this “emphasizing,” “promoting,” “leveraging,” and “conducting” doesn’t work, no worries they’ll come up with more things to emphasize, promote, leverage, and conduct in the next budget request. Overall though, ask the Machine and they’ll tell you they’re doing a bang-up job. In that same report here is how it self-graded on their first “Strategic Goal”:

Strategic Goal 1: The Commission believes that its rules and regulations should be drafted to enable market participants to clearly understand their obligations under the federal securities laws and to conduct their activities in compliance with law. The Commission aims to promulgate rules that are clearly written, easily understood, and tailored toward specific ends.

Strategic Goal 1. Of 10 performance targets, the agency met or exceeded nine and did not meet one. The SEC devotes a large share of resources responding to no-action letters and interpretive and other requests from regulated entities, public companies, and other outside parties. The agency is committed to speeding the response to such requests.

Providing clear guidance in a timely manner is certainly praiseworthy and hitting 9 of 10 metrics seems great. But dig a little and the picture becomes less rosy.

For instance, in the Trading and Markets (TM) division: “The target is based on a fixed deadline for responses to written requests for no-action letters, exemptive applications, and written interpretive requests (collectively, “requests”). Some requests are extremely complex and require extensive consideration and consultation both within and outside TM.” (Emphasis added).

What’s the deadline? They don’t say. How long is it taking for complex issues, like crypto? Again, they don’t say. On a brighter note, they’ll return phone calls or emails within two weeks.

One place SEC Machinists admittedly fail is the Enforcement Division. Being under SEC investigation according to one securities lawyer is like “being in hell without dying.” Given the stress and expense, the SEC’s goal is to bring enforcement actions within two years of opening an investigation. They only met that goal 53% of the time. And the Machine isn’t shy about what happens if you challenge them: “In addition to victories in the cases the agency brings to trial, the SEC’s litigation efforts also help the SEC obtain strong settlements in other cases by providing a credible trial threat and making it clear that the SEC will go deep into litigation and to trial, if necessary, in order to obtain appropriate relief.” Translation: our budget is unlimited, yours isn’t, don’t f*ck with us.

Compare the SEC’s rosy view with those that engage SEC guidance and advise clients. It is less sanguine. Crowdfund Insider recently published two articles about guidance on crypto issues. Some chose to remain anonymous as to not upset the Machine.  

Is the SEC hitting “Strategic Goal 1”? not according to “insiders”: “As for the new SEC Fintech portal where you can submit your questions to public officials. We have heard that responses are slow to come – if they ever come at all – so don’t hold your breath on receiving any feedback. A bit of a policy black hole… that’s too bad.”

Linda Lerner

To her credit, securities lawyer Linda Lerner put her name on her words:  

But while there are many crypto asset platforms heading down this path, these platforms must first become a registered broker-dealer. As one may expect, this process can take some time. But in Lerner’s opinion, the feds are dragging their feet for far too long, overly concerned about getting it wrong.

Lerner, who is knee deep in the process, says the SEC is “standing there like a roadblock because they are afraid something will blow up in their faces.”

“By not allowing the intermediaries to get registered they are stifling innovation and preventing issuers from raising capital, they are standing in the way …” states Lerner. “They are so afraid something might go wrong.”

Lerner says they punish everyone who does not pursue a compliant process but the enigma is there is no clearly defined compliant option. Communication between divisions within the SEC may be a problem as well. Lerner is concerned there has been a disconnect, at times, between some of the larger segments of the securities regulator. The Commission has been slow to create an effective management and information process for crypto asset innovation. Trading and Markets must coordinate with CorpFin and, meanwhile, Enforcement is investigating dozens or hundreds of allegations of crypto fraud. As a federal bureaucracy, the SEC can be very siloed at times.

Standing athwart the Machine like a 21st century Bill Buckley yelling “Stop!” is Commissioner Hester Peirce aka CryptoMom. Peirce recently spoke at the Digital Chamber of Commerce’s Blockchain conference. Despite her Machinist background she has the entrepreneur’s government-skeptic eye. Unfortunately, her ability to affect any real change is limited by her single vote and voice.

CryptoMom talking crypto

As she discussed the various issues the crypto-sphere has asked for three years e.g. When will we get token guidance? What’s the path forward for security tokens? Why hasn’t the Commission approved any Reg A+ token sales? Can we do utility tokens? Are you concerned entrepreneurs will leave the US? Peirce repeatedly suggested companies advise her so she can follow up, educate her on vexing issues, and provide policy solutions she can promote.

While it’s nice a rouge Machinist will promote entrepreneurial concerns, her limited influence was obvious in her answers. Peirce can only do so much. She needs help from the courts or Congress. (Kik, flush with money, and seemingly ready for a fight could help.)

This leaves the US to slowly lose influence as technologists, entrepreneurs, and innovators won’t wait over two years for an Ivy League-trained lawyer to green light a project or bankrupt it.

In the meantime, France, (FRANCE!) will soon allow ICOs without a formal approval process.

The people at the SEC have good motives, they do their jobs according to the expectations and conventions of the Machine. But they are fiddling away the future of the US economy as the crypto world whirls past them.

By Jossey PLLC

What will life be like after Google?

Will blockchain kill Big Data? Will upstart companies untangle the internet from our Silicon Valley overlords? Will the future web center on security and privacy or free and surveilled?

Will Google soon stop “assisting” us?

Author George Gilder tackles these questions in Life After Google. He believes a new cyber world is almost upon us. In it, tech giants don’t record and sell our every public thought. This world surpasses the determinism of ‘do no evil’ and unleashes the creativity and surprise of the induvial mind.

While Gilder doesn’t present a unified theory for this coming paradigm shift on a practical level, he does offer compelling theoretical prognostications as to why Google’s model will stop working. Gilder’s future is individualistic and empowering. Whether that world is really upon us is debatable.

Gilder traces Google’s story back to an obscure 1930 German academic conference where the finest minds gathered to present a theory of the universe. Is the world finite? Can it be explained with mathematical precision? Most said yes, but one young upstart proved them wrong. Kurt Godel showed “Every logical system necessarily depends on propositions that cannot be proved within the system.” We are not reducible to calculable things, uncertainty always exists. This theory and attending debate goes through Isaac Newton and Alan Turing and lands at Stanford University’s computer labs where Sergey Brin and Larry Page created a company that would dominate the web like no other.

Google became a juggernaut counterintuitively—reducing consumer costs to zero. In return we give Google something more valuable than money: our time and attention, where we are, what we do, who we communicate with, how we spend our time. Google captures this and peddles it to companies that sell us things algorithms say we want.

“Above all,” Gilder states, “you pay in time. Time is what money measures and represents—what remains scarce when all else becomes abundant in the ‘zero marginal cost’ economy. Money signals the real scarcities of the world concealed in the false infinities of free . . . It’s the free world, and it is reaching past your wallet, spurning your earned money, to seize your time—which is actually your life.”

Gilder claims Google along with Facebook, Amazon, and Apple operate under the old, finite deterministic view that ignores surprise and human conscious in favor of essentially exhausted aggregated knowledge. “The neo-Marxism of today’s Silicon Valley titans repeats the error of the old Marxists in its belief that today’s technological achievement—not steam and electricity, but silicon microchips, artificial intelligence, machine learning, cloud computing, algorithmic biology, and robotics—is the definitive human achievement. The algorithmic eschaton renders obsolete not only human labor but the human mind as well.” “The conclusion” according to Gilder, “is that the last significant human beings are the inventors of super-intelligent AI.”

It is this deterministic world view that will eventually provide Google’s downfall. “Big Data” can only capture so much, build so many “cloud” farms, assign so many new email addresses, until the laws of physics and computer science catch up. At that point the usefulness and returns dissipate. Gilder believes that paradigm shift has already begun. He explains:

Cleaving all information is the great divide between creativity and determinism, between information entropy of surprise and thermodynamic entropy of predictable decline, between stories that capture a particular truth and statistics that reveal a sterile generality, between cryptographic hashes that preserve information and mathematical blends that dissolve it, between the butterfly effect and the laws of averages, between genetics and the law of large numbers, between singularities and big data—in a word, the impassible gulf between consciousness and machines.  

Gilder sees the coming change through the limitations of physical laws like the speed of light and the laws of computer science that limit how much data can be captured and used given the now-known conduits and substrates. But there is another reason Google’s dominance may soon end and that is the revolutionary technology of blockchain.

Blockchains are distributed ledgers that record transactions using some unit like Bitcoin that cannot be censored or duplicated. The power of blockchain, at least in theory, is that it distributes control over network nodes instead trusted third parties like governments or Google.

Google is hierarchal but life after Google will heterarchical. Google is top-down. Life after Google will be bottom-up. Google rules by the insecurity of all the lower layers in the stack. A porous stack enables the money and power to be sucked up to the top. In life after Google, a secure ground state in the individual human being, registered and timestamped in a digital ledger, will prevent this suction of hierarchal power.

Blockchain will allow individuals to control and distribute personal data on their own terms. In a blockchain world they will get tokens for their time and attention—for the information in their brains that machines cannot cipher. “The crude imperatives of ‘free’ will give way to the calibrated voluntary exchanges of free markets and micropayments.”   

Gilder profiles companies and protocols using blockchain or other innovations like advances in virtual reality to dilute Google’s power and lead us into a decentralized world. These companies and established protocols include Bitcoin, Ethereum, Brave, Bitmain, Blockstack, NEO, Cardano, EOS, and IOTA.

The competition between Bitcoin and Ethereum joined to lesser degree by XRP, EOS, Zcash and Monero will someday facilitate global transactions where individuals and security triumph over Big Data.

While Gilder describes some promising companies as hopeful counterweights to the Googleplex, he fails to present a practical unified theory as to how all this will work. The book leaves open to his mandate for uncertainty and surprise how we will get there for those of us two degrees removed from the cypherpunk and tech geek scene.

George Gilder

On an everyday level, what will the new the new web look like? How will we control our data and distribute it on our terms and not Google’s? Gilder only gives hints, promoting for instance Brendan Eich’s new browser Brave, but fails provide a path as to how it will overtake Chrome, Firefox, and Edge. Dapps the supposed tools of the decentralized future aren’t mentioned at all.

What assurance do we have that the companies Gilder profiles won’t also capture and monetize our public thoughts? Some companies Gilder mentions are offering free services. What is government’s role in our decentralized future? These questions go mostly unanswered.

Yet we can help shape the future Gilder predicts and many want. Google’s power and Facebook’s scandals have seeped into public consciousness. Starting to resonate is just how much we are giving away for what we get “free.” If Gilder’s vision ensues it will take more than laws of physics, it will require citizens demanding or at least supporting those determined to create our decentralized future.

Finally, it is refreshing to see someone thinking about these issues on the economic right. Gilder is thankfully acquainted with the Austrian School of Economics. The individualism of Gilder’s predicted future will be distorted by present economic paradigms that range from socialism to crony capitalism.  

So much writing about technology and by technologists comes steeped in do-gooder platitudes of the Google code and Burning Man creed Gilder also cites. This language masks the underlying motives and economic realities of those pronouncing it and essentially lubricates the lies of those telling us they “do no evil.”

Another example is Gilder’s decrees about the academy. Gilder rightly sees through the credentialism that not only defines the Googleplex but stifles innovation. He champions (perhaps too much) incubators for entrepreneurs like those seeded by Peter Theil that promote young college-eschewing visionaries. Gilder sees this emphasis on paper credentials and its dogmatic approach to social issues as debilitating and even anachronistic.

Credentials are the way the old academic order perpetuates itself and its hierarchies. At vast expense, the universities channel students into echoing corridors or an increasingly reactionary educational establishment that imagines that socialist nostrums, identity politics, chemophobia, sterile hedonism, druidical sun-henges, totemic windmills, and great walls of batteries are progressive.

. . .

Ivy institutions are pursuing the fancies of a declining intellectual and business elite, full of chemophobic nags and luddite lame-ducks quacking away on their miasmatic pools of old money as the world whirls past them.  

Overall this book is well worth reading if one can get past the ‘insiderism’ of Silicon Valley speak and the emphasis on theory beyond practical use and the promotion of particular companies some of which, odds are, will falter or turn “evil” themselves.

Nevertheless, Gilder presents a hopeful and compelling vision without Big Data and with a realistic view of how we pay for what we get “free.” It may take more effort from the masses than he realizes but his future is (hopefully) attainable.

By Jossey PLLC

SEC goes for Kik will it get knifed?

In 2017, Canadian-based social-media company Kik sold Kin, a token usable within and outside its native ecosystem. Late last year the SEC kiboshed the kibitzing and now the lawyers have drawn their swords.

A Kik or a knife?

This case could be fervently important to the unsettled token regulatory environment. The SEC has been flummoxed from the start, making discordant declarations with little firm guidance. Congress tried to step in, but with the nonstop Trump show Republicans and Democrats can’t agree what color the sky is. That leaves the courts. Kik has hired white-shoe fencers in DC and Palo Alto and neither side seems up for compromise.

Kik and its foundation isn’t giving back the $100 million from its token sales and the SEC’s enforcement division would have to backtrack on its two-year policy to let Kik slide. There are important questions that at this point only courts could decide. And those answers could profoundly affect America’s future tokenized economy.

In its “Wells Submission,” a document kindly asking the SEC to go away. Kik presents itself as a victim of circumstance; diligently following the rules as they were, consulting qualified counsel and tax experts, and not selling Kin where issues could arise. It argues subsequent decentralized Kin use makes it cryptocurrency like Ether and Bitcoin and shields it from the SEC’s watchful eyes.

This argument has some obvious flaws. A YouTube video shows Kik’s CEO talking the language of securities, not currencies when discussing Kin with potential investors. Second, Kik initially sold Kin only to accredited investors via a Form D with the SEC, which is what security-selling companies do (or in this case warrants for future securities).

It then sold nearly $50M more Kin to the public in what it deemed a Token Distribution Event (TDE). But here it chose not to distribute through a qualified exemption, either Reg CF or Reg A+. Thus it’s hard to square Kik taking the precaution to sell the first $50M under Reg D, which admits it’s a security and then sell the second $50M to the public in an open sale. Finally, Canadian authorities warned them they were selling securities so they didn’t sell there, nor to New Yorkers, or the Chinese. But they did sell in every other U.S. jurisdiction.

Ted talks cryptocurrencies or securities?

Kik stands much firmer when it discusses the SEC’s atrocious lack of guidance, its scattershot way of disseminating direction, and its ‘policy by enforcement’ policy that kills innovation.

Cryptocurrencies (including Bitcoin and Ether) have been gaining adoption for many years. Throughout this period, the Commission did not provide any meaningful, forward-looking guidance about the application of the federal securities laws in this space, nor did it develop a regulatory structure that would make sense for these emerging technologies. As cryptocurrency markets exploded in 2017, the Commission finally spoke on the matter, but even then, the Commission did not give industry participants a clear view of how or when the SEC believed the federal securities laws would apply to sales of cryptocurrencies . . .

Further, law and regulations are supposed to provide clear notice and guidance without necessitating confirmation of compliance by regulatory agencies. In the absence of any clear guidance from the Commission, companies like Kik are under no obligation to present every new idea to the Commission for its blessing. This is their strongest argument. And, there are substantial doubts whether the Staff would have given Kik clear direction, and even if it did, it would take years to receive it as many projects are experiencing.

Even more amazing is a quote Kik provides from an SEC staffer implying uncertainty is a benefit because firm Commission guidance via hypotheticals might encourage subterfuge. (Valerie Szczepanik, Address at the ACT-IAC 2018 Blockchain Forum (April 3, 2018)). This is the attitude of someone who’s never run a business. Most entrepreneurs aren’t trying to avoid regulations they are trying to follow the rules so they don’t get a dreaded knock on the door from Ms. Szczepanik. That knock usually means expensive lawyers, capitulation, or shut down.

At the Commissioner level, only Hester Pierce recognizes the burden the SEC’s insouciance is causing those building the future economy. The Enforcement division with its job security, union protections, and pensions are the last people that should be setting policy for the SEC and by trail the larger economy. As Kik warns, “This ‘regulation by enforcement’ approach has had a dramatic and negative impact on the development of blockchain and cryptocurrency technologies in the United States as innovators have either directed their activities overseas or shelved their projects altogether.”

What’s a security? Don’t ask the boss.

That is why judicial findings even if not in Kik’s best interest would start the path toward some workable rules. Several questions need answering and the SEC seems unwilling (at least so far) and Congress is too distracted to answer. They include:

  • How much token decentralization will make the SEC back off? Corporate Finance Division Director Bill Hinman stated Ethereum isn’t a security because it’s decentralized ‘enough.’ Hinman is an experienced securities lawyer but not Senate-approved. It was welcome news and a contrary opinion would have killed the token economy in the U.S. But where is the line?
  • How much consumptive use of a token as opposed to passive ‘hodl’ factor into what makes it a security or currency. In United Housing Found., Inc. v. Forman, 421 U.S. 837, 852-853 (1975) the Court concluded no expectation of profits exists where purchasers are primarily led to expect an item for use or consumption. And according to Kik, even if infrastructure building ensures a viable ecosystem, that shouldn’t count as efforts to increase investment value. How does investment for profit versus use as a medium exchange affect how the SEC should view tokens and token ecosystems?
  • How is value measured through efforts of management versus market forces? Kin holders don’t own a traditional security in the sense of ownership in Kik. Thus did Kin buyers expect its value to rise through the “common enterprise” of Kik as the seller? Kik avers its only obligation was to deliver Kin to purchasers. Kik states markets not its efforts will drive the value of Kin, “courts have held that where a contract involves a sale of a commodity and expected profits arise primarily from resale on the secondary market, the final prong of Howey is not satisfied. See Noa v. Key Futures, Inc., 638 F.2d 77, 79 (9th Cir. 1980) (no expectation of profits from the efforts of others under Howey because, once the commodity was purchased, the profits of the investor depended on market fluctuations, not the managerial efforts of the defendant).”
  • How much should we rely on Howey? The SEC and courts have relied on the Howey test since 1946. Is this still the best guide in the token economy? Howey embodies a “flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” SEC v. W.J. Howey Co., 328 U.S. 293, 299 (1946). This flexibility may have served a purpose in a different era, the question is should an independent federal agency have this much leeway in deciding the future of the U.S. economy.
  • How much discretion should the SEC have prosecuting nonfraudulent cases? Everybody recognizes the devastating affect an SEC investigation can have on a business. Even if the company wins it can take years and cost millions. No one has yet claimed Kik misled or defrauded them into purchasing Kin. Should the SEC be able to destroy a company unwilling to settle where no actual harm has occurred?
  • These questions need answers and faster than the SEC or Congress is providing them. Courts are not exactly paragons of efficiency, but their decisions provide concrete answers (after appeals). Further, courts have less turf-protecting or political motivations in finding answers. Kik may be case that kikstarts this long-needed process.

By Jossey PLLC