Transcript:
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Mark Eckerle:
Hello, listeners, welcome to this episode of Cryptonomix. Before we jump into today’s discussion, please keep in mind this recording is for general education and is not intended to constitute investment advice. Any opinions expressed are those of the participants and do not necessarily represent those of Withum.
Mark Eckerle:
Hello everyone, and welcome back to another episode of Cryptonomix, brought to you by Withum. I’m your host, Mark Eckerle, and today I welcome to the show Eric Wiener and Will Brennan, both of whom are partners at Lowenstein Sandler, and lead the firm’s digital asset practice. Today’s episode will be breaking down the SEC’s lawsuit against Ripple and the order that was issued last month. But first I wanna kick it over to both of you guys. Eric, why don’t you start, give us a little background on yourself, Lowenstein Crypto Practice and a few of the exciting things that you guys are working on.
Eric Weiner:
Sure. Thanks so much, Mark. I appreciate the opportunity to join you today. As you said, my name’s Eric Wiener. I’m co-chair of Lowenstein Crypto. I’m also a Partner in our tech group, which is our Emerging Companies and Venture Capital Practice. Our crypto practice is very broad. My role in it is essentially representing startup companies who have some sort of a relationship to the blockchain or NFTs or tokens and representing venture capital funds that invest in those businesses. I’ll allow Will to speak about what he does, but we, you know, in addition to what Will and I do, you know, we, our crypto practice also includes helping out companies with NFTs and commercial contracts and contracts relating to the chain and regulatory issues. So we like to try to touch the sort of the crypto world on all angles.
Will Brennan:
Yeah. And so for me, I’m partner Sandler, so I, you know, I work with Eric in Crypto group and also I sit within our FinTech Practice. So there’s a lot of overlap just in terms of clients products where I think the types of things that, that we’re working on sort of across both of those, right, from the FinTech perspective as well as, you know, specifically crypto, but most of our clients are venture backed financial technology companies, right. Pre-Seed all the way through to growth. And so typically in our group, in the FinTech side, right, helping them figure out from a regulatory perspective, right, that may include digital asset securities considerations, trading platforms. We represent a lot of sort of OTC trading desks as well, right? Kind of trying to fit them from a regulatory perspective into the right, the right bucket, which, you know, is, can be somewhat challenging on the crypto side. And again, a lot of those clients sort of sit, right, different parts of the firm are touching those clients, right? Eric may be working with them from his perspective. We have commercial contracts side of everything. And also, you know, for the projects that end up sort of, you know, sort of in the cross from a regulatory perspective, we have a robust litigation group as well that, that has walked a lot of clients through investigations enforcement like that
Eric Weiner:
In a nutshell, it’s an interesting time to be involved.
Mark Eckerle:
The space isn’t slowing down or waiting for regulation at all. And I mean, we see it on the accounting advisory and tax side, and I can only imagine how much you guys are seeing it
from the regulatory front because clients are building all types of products, all types of token issuers. It’s everyone that’s popping up nowadays is unique in and of itself in some way or some shape. So it’s, it’s definitely interesting and keeps us all on our toes, that’s for sure.
Eric Weiner:
It does. And it’s funny, you know and clients talk to each other and we get questions, well, I spoke to this fund or that fund, they no longer wanna do a token warrant in light of
Ripple or this, that or the other thing. And you know, it’s interesting to, it’s a very interesting practice to be a part of the both frustrating and interesting because the regulatory landscape is so unclear and even in light of Ripple, it’s you know, there’s some clarity there, but there’s really not all that much clarity there.
Mark Eckerle:
That’s a perfect segue into the Ripple case. So I wanna, before we dive into where we’re today, I wanna jump back to the beginning of the original lawsuit. SEC filed against Ripple when it happened, why it happened, kind of what’s their, what was their original motive? So Eric or, or Will, I’m not sure who wants to take the lead on this, but take us back to the beginning, just the original concept of the lawsuit and why it occurred.
Eric Weiner:
Well, I think we’re all familiar with, uh, Mr. Gensler and the sec, right? And, and seems somewhat on a crusade to make clear that any of these types of tokens are securities that need to be regulated by his organization. And look, ripple was sold in, in many different ways as outlined in the case. Uh, or in the, in the, in the recent, uh, judgment, a lot of money had changed hands and the SEC wasn’t involved in regulating it. And I think that’s where it started. I mean, that much money we’re in the world now where there’s been a lot of famous sort of explosions of fraud and the like, and I think the SEC wants to make sure that their hands are on it. And I think they have a very strong view that these tokens are securities in most cases, I believe they’ve said it on, you know, only Bitcoin should be excluded. Although I think that’s not true. But that’s how it started, right? A lot of money changed hands both through into Ripple itself and into the founders of Ripple.
Mark Eckerle:
It’s funny you say that because there’s actually I think a video that surfaced of Gary Gensler in like 2019 stating a couple different digital assets that are not securities, but now it’s who knows what’s what today, right? The SEC could have a different purview tomorrow. Okay, so fast forward to July, 2023, right? This lawsuit’s been going on for almost three years now, four years, a few short weeks ago, what did Judge Torres issue as part her order? Let’s break down the ruling, the outcome and what about the key takeaways. What led us to where we are today?
Eric Weiner:
To start, I’ll start with what I think this decision is making clear with respect to what is the security and then I’ll let will talk about the programmatic sales piece of it. I’m sure some of your listeners are aware of the Howey case, which establishes a test for, you know, what’s the security, whether we’re talking about tokens or orange groves or any sort of investment contract. And I think in this case, the Judge Torres sort of made clear that look very similar to cases that have preceded the Ripple case. If you have something that is being sold for money in a common enterprise and the individuals or entities that are acquiring that something are expecting a profit off of the work of third parties that are selling it, it’s security and it doesn’t really matter what the underlying thing is.
Eric Weiner:
So like, I think they use examples in other cases, you know, if, if if the underlying thing is a pig, a pig in and of itself is not a security, but if there’s a scheme or some investment contract that sells the pig, it very well could be a security if the other prongs of the Howey test are met, which is a common enterprise pursuant to which, you know, there’s an expectation of profit by virtue of the work of the those that are selling them. And I think that’s where we are. I think that’s where we are after Ripple. And I think a lot of Ripple, at least in this institutional sales prong where they sold XRP to these institutional purchasers, I think that just reinforces that in those situations we have a security. What I was gonna say was, one thing that I think is really important about this particular prong of this decision is when Ripple and its founders were talking about XRP, they were disseminating information about it over a wide scope.
Eric Weiner:
They were talking about it, they were talking about it on social media, they were on YouTube, they were giving out reports and all this stuff. And it wasn’t just to some limited group of people, they were promoting this to the world and then they sold the actual X P pursuant to these investment contracts. So I think taking all those things together, it was sort of a totality of the circumstances test. You look at all those things under Howey and if you’re gonna sell anything token or otherwise in this way, it’s gonna be a security.
Will Brennan:
So from my perspective, looking at it, it’s like, you know, there’s obviously a lot of back and right history of the case, right? It’s three years, there’s been a bunch of different motions, right? We had various documents released on the SEC side right about a month before the decision came down. To me the takeaway is kind of, I think what a lot of people in the, the industry have been saying, right? XRP itself, right, is not a security, right? It’s all about the wrapper, right? In the context, like similar, similar to Eric’s point, right? You may have an orange or some, some sort of item. Like that item in and of itself is not a security. Like that’s sort directly contradicts, right? The, the position that the sec I think has been, you know, either overtly or sort of implicitly suggesting over the last couple years, particularly since right, Gensler has, has sort of led the charge, right?
Will Brennan:
And so then it all becomes, right, you’re sort of in a, what I view as a more traditional framework, right? You’re looking at a token or an asset, you know, have to think about does this look right? Is this being offered in a way that kind of looks like a capital raise, right? Where you’re reaching out to, to people, they’re giving you money, right? And obviously the, the clear hope is that you’re using that money to build out your business, build out the network, right? And, and people are sort of expecting a return. But when you kind of compare that to like what’s identified in the, the decision is sort of programmatic sales. Those sales are really sort of the, from a number of transactions perspective, right? The huge majority, right? And that’s what I think people, most people care about, right? You have all these tokens listed on exchanges.
Will Brennan:
The court said, look, when it’s this sort of blind bid ask structure where I’m going onto an exchange, XRP is available to buy, I buy it. I I’m buying it from, I don’t have this relationship with, right? You know, the quotes issuer or the creator of that token, right? I’m not, you know, I may be buying it because I hope it goes up in value, but that’s not right. It looks very different than like the institutional example that they give right in, in the decision that, that Eric was talking about, right? Because that kind of looks and feels like a traditional capital raise, right? In some instances, right? Whereas the programmatic sales buying and selling in a blind bid ask fashion is, is very different. And so to me that’s the, that sort of getting some clarity at least as to like structure and approach, right? The underlying assets, not security, but now we have to look at like the surrounding facts and features, right? The totality of the circumstances, right? Which is the typically the
Eric Weiner:
Which is interesting because if you think about in a footnote in the decision when they were talking about the programmatic sales, they had mentioned secondary sales and one thing that remains open now is under this decision is a secondary sale. One that is gonna be governed by the section five of the Securities Act. And it’s a, it, it’s, it’s maybe, and it, and the, the court in this case didn’t, didn’t answer the question. What they did say is it’s maybe, but it’ll probably be another totality of the circumstances test under Howey to make a determination of whether or not a secondary sale is gonna be governed by those specific securities laws. But that gives some gray, you know, I can imagine seeing some secondary sales being consummated in light of Ripple that are not gonna be registered.
Mark Eckerle:
Do you foresee that section five p some of that gray area being any part of the appeal process from the SEC as part of this ruling? Could they bring that up as kind of some foundation to build upon or no?
Eric Weiner:
Oh, I think they’re gonna appeal
Mark Eckerle:
Oh, I think they’re gonna appeal
Eric Weiner:
As to what they’re gonna argue. I just dunno, I mean, I think there was like hundreds of facts in dispute in connection with the summary judgment motions. So I, I’m certain that they’re gonna try to pick this apart. Hard to know. I dunno if Will has a a different view. It’s hard for me to know where they’re gonna stand. But I, I think the, I think the decision made, it was very well written with respect to the programmatic piece. Seems a little in, in all cases, but the programmatic argument one where it’s a blind bit ask and you don’t know who’s profiting from it or not seems to, seems to be a clear and a reasonably clear to me exception to the how we test.
Will Brennan:
I mean, I think my, my sense is they’re gonna write every single fact in detail, right? It’s gonna be something they’re gonna push on. You do get to this point where it becomes just from a practical perspective, kind of hard in some ways, right? Because you take a step back, most of the recent activity from the SEC has been right, focusing on intermediaries, right? And, right. So you have Coinbase probably the most, you know, prominent example, right? Where being charged with, right, effectively acting as an unregistered broker dealer because those, some number of the tokens are unregistered securities. But you’re in this sort of bizarre situation where the actual issuers haven’t been charged, right? Ripple is a little bit different, right? It’s again, sort of precedes some of the more recent activity, but I think it becomes hard, right? Because once you start focusing on secondary transactions, like the consequences of an unregistered security sale and trying to follow the chain, right? For like rescission rights and all that kind of stuff, especially in a crypto context, right? How do you even like begin to, you know, transactions. Yeah. So it just becomes a bit, you know, I think they’re gonna pick and choose, but I think it’s pretty broad, broad scale in terms of like fighting.
Mark Eckerle:
Now many, I would say in the community observers, if you’ll view this as a victory, do you guys see that this rulings a victory because digital asset community for other companies? Or is it a, is is there a potential takeaway from the SEC here that they have some foundation to stand on and something to build upon that formal guidance came out. What, what is your takeaway, positive or negative from this ruling?
Eric Weiner:
I mean, it’s funny, I think in the first 48 hours after this decision came down, it was almost like a ticker tape parade in downtown Manhattan. And I think that that’s tempered. I think there’s just still a lot of uncertainty about that initial step. You know, how are we really gonna structure these things? Because not every sale is a programmatic sale or a distribution to an employee or something like that. The SEC is gonna fight this, like will said, tooth and nail. I think we need to take a wait and see approach. Certainly, I think this is a positive for the crypto community and uh, you know, I think a small step, but a step in the, in the right direction of getting some clarity. But unfortunately we’re not, there’s no finality here. You know, the, the appeals are gonna go to the second circuit and we’re gonna see what ultimately happens.
Eric Weiner:
But I think seeing, uh, uh, to Will’s point, seeing a judge made clear that like, just because your XRP doesn’t mean you’re a security. I mean, here there is a very clear statement to that effect. There has to be more than that. So that’s a good thing, I think good in the right direct, but it’s not over. And I would be, you know, cautious to start structuring tons of different wrappers around tokens based on, on this decision alone. So I think it’s, you know, we’re, we’re seeing activity, I’m seeing the same type of activity in the venture market with respect to, you know, crypto based startups that I was right before it. And interestingly, seeing some fear with respect to some of the tokens that we’ve been commonly using in the marketplace for venture rounds. So, you know, if a fund is buying equity of a company and then potentially getting rights to a token, you know, there’s, there’s a bunch of flavors of that, one of them being a token warrant. Some people are now afraid to get a token warrant, even though in our case, it’s a very limited offering to highly sophisticated and accredited investors. You know, it’s not something that’s being broadcast over YouTube to 5 million people. So the initial issuance is probably fine, but actually seeing some fear, which has surprised me in light of the decision.
Will Brennan:
I was gonna say, I just to chime in, I think definitely a hundred percent positive, I think a cautious approach makes sense. At the same time, I, I wouldn’t be surprised. I think if you see certain, like more aggressive market players, right? Kind of using this as a blueprint, right? Because in some ways, right, if end goal is programmatic sales, right? You somewhat have right, fitting within the confines of sort of what presented in the order. Obviously it’s subject to appeal, but I think, you know, there, there’s a risk spectrum there and you know, we definitely see people all across that spectrum. So I wouldn’t be surprised if you see some people trying to kind of create a framework, right? Effectively just sort of transposing the facts here, right? And taking, taking the route that they see is at least, there’s at least some light at the end of the tunnel as opposed to prior, right before the order, all everything from the was it’s all security. You have to come in and come in and register. Of course, when you go in and register, you’re not gonna get approved, right? So you’re sort of stuck in this like dead zone. So I think some people will sort of jump at, you know, that, that limited opportunity.
Mark Eckerle:
On a little of a separate note, kind of, Eric, the point you were making, are you guys seeing, I guess outside of 2017 to 2019, since then, I guess since this Ripple lawsuit kind of went into effect in 2020, have you seen a slowdown on token issuers and like the ICO process as a whole? I know it’s been changed and everyone puts their own, like you said, type of wrapper on it, what the look and feel is, but have you seen a little bit of a slowdown there or are people still chugging full steam ahead with different makeup of what that looks like?
Eric Weiner:
I can tell you what I’m seeing, and I’d be curious to, to hear Will’s thoughts on that. About 18 months ago or 20 months ago when crypto companies were sort of coming outta the woodwork like wildfire. We were seeing more companies than we even knew what to do with just tons of companies. And you were seeing these very outsized equity valuations on those companies because the thesis from the investors was, I wanna get a pro rata right? Or some access to the ultimate token that they’re gonna issue. I care about the equity, but I care about it a lot less than the token. So we were seeing hyper upsize valuations companies that are four months old, six months old, eight months old with nine figure valuations on the equity side. Now that has really changed. We’re not seeing that, at least in my practice, I’m not seeing that equity valuations are much, much, much lower even when there are tokens related to the deal.
Eric Weiner:
And what I’m hearing in the marketplace from clients that I deal with though some of disagree with me, and that’s very healthy and fine, is that there’s the belief in the technology and the blockchain and, and what it’ll ultimately become is there. And that there’s really incredibly bright and dynamic people in the space are gonna do great things with it, but people are actually believing in the equity value now and, and maybe investing more about the equity value in these companies than necessarily the token. They’re protecting themselves by getting some right to the token in the future if it’s ever minted. But it’s okay if it’s not in a lot of these situations. That’s my experience right now.
Will Brennan:
So from the FinTech group perspective, you know, a lot of this tends to sort of come in waves. Like to Eric’s point, you go back and look at the calendar, 2019, 2020, a lot of token projects, right? You have 2021, right? There was a lot of NFT type projects, which have now really at least gone down from the sort of the hysteria, right? That there was at a point in time. I think a lot of the things we’re seeing now is sort of more of like a surgical approach, right? Especially on the financial services side by trying to figure out what is actually sort of solving a problem where a token makes sense, right? And where there’s at least some amount of clarity and enough to kind of get up off the ground and sort of experiment from a, from a project perspective, right?
Will Brennan:
We’ve seen a lot of interest in like projects dealing with sort of like tokenized treasuries, right? And sort of other sort of real world assets. Those have sort of always existed, but I think as funding has sort of become harder to come by, right? The cream in some ways is sort of rising to the top and I think we’re seeing a lot of really interesting teams, you know, with good experience, right? Both from the tech side as well as like traditional financial services, which I think at this point you sort of need, right? Given just the significant regulatory scrutiny.
Mark Eckerle:
My last question, that’s a great segue into it where seeing what kind of regulatory clarity is potentially on the horizon, right? I mean, I personally on the accounting side, right? We’re going off FAQs from the IRS, we’re going off like notices or addendums or it’s very few and far between of actual clear cut guidance that we can fall back on. And I feel like it’s very similar on the regulatory side where you’re using these rulings as a mandate or you’re using certain verdicts. And I’m just curious to get your thoughts when we should expect, can expect if ever some type of clarity from the regulatory front? Because I know a lot of companies I work with that they want that direction, they wanna know what the path forward is, they wanna be following all the, the right laws and compliance, but they’re just trying to figure out what that is as it relates to digital assets, right? It’s trying to fit that circle in a square peg and see how digital assets fits into the traditional finance world. So I’m just curious both of your point of views on that.
Eric Weiner:
And you just had your, uh, the ruling on the crypto staking taxation of crypto staking rewards, right? I think this isn’t a really hard question to answer and I, and I wish I had that crystal ball. The one thing I I do genuinely think though is I think the Ripple case puts a little more pressure on the SEC I mean this is a punch in the gut on some levels to them and hopefully that means there will be some increased desire to stop regulating the way that they’re doing it. Now, what that means, how much it accelerates, I don’t know, but this is certainly a positive in that regard. I think there’ll be more clarity sooner than as a result of it.
Will Brennan:
Yeah, I’m not hugely optimistic for broad scale clarity. I feel like people have been sort of asking this question for quite while now, and it’s right, there’ll be something that’ll happen, there’ll be a bill in congress that, that people are sort of hopeful that that people will sort of coalesce around. But I think part of the problem from a US perspective is just like the regulatory structure, right? Unlike most other countries, you have have multiple regulatory agencies. You have the SEC, you have the CFTC, you have states, you have money transmitters, right? All sort of competing, giving guidance that oftentimes conflicts, which just like muddies the waters in such a way that I think a lot of other jurisdictions like don’t base that type of problem, right? They have one financial regulator, everyone’s on the same side, they can sort of take meaningful steps, sort of test the waters and sort of roll things out.
Will Brennan:
Whereas in the US you don’t have that to the same extent. And I think there have been some movements, right? On the SEC sort of FINRA side, there’s been some rulings about, you know, broker dealers that can custody, right? Digital asset securities, it’s like limited guidance, but like nothing’s really happened with that, right? That was a couple years ago. We just heard recently even large institutions like Robinhood, right? Applied, got rejected. And so if that’s any indication, I think it’s gonna be potentially slow going. Again, I think there’s this constant paralysis about the fear of the unknown. We submit a rule, we create some sort of structure and then before you know it, right, there’s like an FTX like event, right? And now instead of that happening in a vacuum, it, it’s happened under this framework, right? That a regulator has put forth right? Then they’re sort of in the crosshairs. I’m hopeful, but it’s, I think it’s gonna be a tough slog to where we get to a place where it’s, where it’s no different than saying you wanna start a typical traditional securities broker dealer where you just go through the process, everyone knows what it’s, I think it, you know, it could be some time before we kind of get to that place.
Mark Eckerle:
That’s what I’ve been saying for a while. I feel like last four or five years, four or five years ago, it was the, the regulatory agencies are taking their time. They wanna make sure they get it right and nothing’s really changed since then at least too much. So it’s, I feel like we’re still in like a holding pattern. So I’m definitely not holding my breath by no means.
Eric Weiner:
And unfortunately, you know, we, it’s not like we have a congress that moves quickly either. And there’s, there’s still antagonism from the SEC for sure. You, let’s see if, if this decision Coinbase is ongoing stuff is gonna move something in the right direction, but moving in the right direction could be molasses either way.
Mark Eckerle:
That wraps up today’s episode. I really appreciate you guys taking the time today, Eric and Will thank you both for joining me. If you wanna learn more, visit lowenstein.com. They have a crypto practice and a landing page there so you can see more insights, sign up for their, uh, newsletters and yeah. Thank you guys for joining me today.
Eric Weiner:
Really appreciate it, mark.
Will Brennan:
Yep. Thank you.
Mark Eckerle:
Thank you.
Mark Eckerle:
All views expressed in this podcast by Mark Eckerle or his guests are solely their opinions and do not reflect the opinion of rhythm. This podcast is for informational purposes only.
