Former SEC Lawyer: What You’re Missing About Securities, Ripple/XRP, & Prometheum l Overpriced JPEGs #188

Carly Reilly  0:05  
Hello everyone G MGM welcome back to another episode of overpriced JPEGs. I am so excited for today's episode, more excited than even usual, I would say because this is a conversation I've wanted to have for a really long time, which is diving deeper into the guts of us securities laws, which hopefully sounds as fun to you as it sounds to me. And I did something like this last year where I did a roundtable of lawyers of intellectual property lawyers to really break down IP law copyright trademark CC zero, which was something being talked about a lot at the time. And I personally found it super valuable. And it was also one of my better received episodes, I got a lot of really positive feedback from people on it. So I'm hoping folks will really enjoy this as well. And I wanted to make sure we were anchoring this conversation in some recent real world events, so that this didn't just feel like a law school class that nobody wanted to take. And we weren't just speaking in theoretical. So we really dive into the judge's decision in the ripple case. And we talk a bit about promethium, which has been on crypto Twitter a bit lately for primarily controversial reasons. And while there's plenty of conversation and breakdowns that you can find of the ripple verdict, I felt like this conversation both dug a little deeper and went some places that I personally still had a lot of question marks around even after having listened to a number of other podcasts or, or takes about the ripple verdict. So I hope you'll learn something broader about security laws about what's happening in today's landscape than you maybe have elsewhere. And finally, this is likely going to be a part one of what looks like it might be a two part series. In this episode, I sit down with Karen new Bell who is a partner at Goodwin and Proctor, she leads up their blockchain division. She was also an attorney at the SEC for six years. So she is incredibly well placed to talk about everything we get into today from her legal perspective on the blockchain and on cryptocurrencies to also how we should understand the SEC movements today. Of course, she does not represent the SEC and anything she doesn't work there for a number of years. She also of course, is not providing any concrete legal advice here. But her perspective is super, super valuable. So with that, I hope you enjoy today's conversation and we are going to get to it right after this word from our amazing sponsors who make the show possible. Y'all know the phrase, not your keys, not your crypto. Well in a world where too many people have had to learn that the hard way. overpriced. JPEGs is proud to partner with ledger, the world leader in critical digital assets security. Ledger's nano s plus and nano s hardware wallets paired with the ledger Live app Ledger's own software for setting up your nanodevice and managing your crypto assets is the easiest way to start your crypto journey while maintaining full control of your digital assets. You can use all your favorite DAP with ledger live accessing 15 Plus web three apps including one inch Paris swap lotto and Ziri on so you can not only manage but also grow your portfolio and ledger live is available on mobile and desktop. Securing digital assets shouldn't be complicated. Ledger is as easy as it gets. Uncompromising security effortless connectivity full transparency ledger is your one stop shop to trade and track crypto, grow your assets and manage NF T's secure your future with ledger visit shop.ledger.com today or check out the link in the show notes. I am so excited to announce that this year overpriced JPEGs has partnered with open see the world's leading NFT marketplace built for everyone creators, collectors noobs and experts alike. I'm an open sea user because they have the best selection of NF T's and a truly inclusive view of the ecosystem supporting eight chains and eight global languages. I trust the systems they put in place to keep the space safe like copy protection, malicious URL detection and removal, robust verification and more. It's why they are the place to buy, sell and create an FTS That's right, you know open sea you use open sea but did you know that open sea now has drops new exclusive projects launch every week from top projects and creators and you can check them out now using the link in the show notes. They also recently introduced self serve drops, which is in beta and allows creators to launch their projects right on open seat. This drops products gives creators access to tools like rich storytelling drop pages, multi chain support and drop mechanic customization. The full launch for self surf drops is coming this spring. So check out the upcoming drops on open sea right now using the link in the show notes and own what moves you you'll also be supporting the show in the process. Karen you Bell Welcome back to overprice JPEGs.

Unknown Speaker  4:45  
Great to be back great to see you again.

Carly Reilly  4:47  
I know you have some disclaimers up top we usually have are not not financial advice. Disclaimer. I think you have a not legal advice disclaimer that you want to give here. That's right.

Karen Ubell  4:55  
I am a lawyer but this is not legal advice. You're not my clients You need legal advice, you should consult a lawyer. Anything I say here, obviously, are my own personal views and not the views of my partners at Goodwin, or any of my clients.

Carly Reilly  5:10  
She's a lawyer, but she's not your lawyer. So get your lawyer. Excellent. I said this in my intro, but what we're trying to do here, I think is tease out and better understand the nuances, the complexities of existing us securities laws, by anchoring in what's going on with Promethium. And what's going on with this ripple case. And now, we actually just had a judge counter what George Soros had said in the ripple case, which I think we'll get to at some point here, so there's a lot going on, but let's really anchor this conversation in those things to make it a little bit less head spinning for folks. So where I'd love to start is just level setting on the ripple case. So my laypersons articulation of what the takeaways were there is that Judge Torres said that when ripple, issued these tokens to sophisticated investors, essentially early investors, that was a security issuance, and they violated securities laws by not registering that, but when they issued tokens to the general public via whatever it was a marketplace, what she calls, I think, programmatic sales. That was not an illegal securities issuances. And they were not securities in that context. Is that fair? Is that did I get that right?

Karen Ubell  6:23  
Yeah, that was the gist of the ruling. But getting into the details of it, I think is what's really important to think about what the right takeaways are from this ruling. And I think that the really important part to me of this case was that Jeff Torres said, XRP, the token is not in and of itself as a security is not in and of itself a security. We have heard that before from other judges. But we have heard Gary Gensler in the SEC, beating a very different drum, they're trying to create a concept of a crypto asset security, which is the the token itself embodies the investment contract. And she importantly, incorrectly in my view, rejects that idea. The token is code, the token is a currency, the token is an orange, right like that. I'll come back to that idea. Think about this. If if, if we're an orange, how would we think about this? And so then what you do is you go through and you have to say, look at the manner of sale? How was this offered? And in reviewing those facts, all the totality and facts of circumstances? Is there an investment contract in those cases, do the or the four prongs of the Howey Test met such that transaction and all the facts surrounding it constitute an investment contract? And so what she said is that in certain instances, the facts support Yes, the Howey factors were there. This is an investment contract, therefore, it's a securities transaction. And in other cases, those facts did not support all four factors of the Howey Test. And so it wasn't an investment contract. So therefore, it wasn't a security and is not regulated by the SEC. And so that's, I think, the most important element of this decision. Unfortunately, we've seen it already called into question. And so we'll see how long it continues to stand. But I really do think that this is the important part here is that oranges, when you sell them in the grocery store are not securities, oranges, when you sell them on the street corner are not securities, orange seeds are not securities. But if you sell orange groves and orange seeds with a promise to grow the trees water, the trees of harvest that weren't just sell the oranges and then just return the profits to the people that you had those contracts with, then that's an investment contract. And I think that was really important.

Carly Reilly  8:40  
And you're referring to that was like the seminal case that he launched the Howey Test. Correct? Okay. So that's the basic principle. And then it was the way she applied it was making this distinction between institutional investors and these programmatic sales walk us through the different categories she identified.

Karen Ubell  8:56  
Yeah. And so that's the idea here, right, is you're taking each type of sale and each manner of sale and evaluating the Howey Test factors to see whether or not there was an expectation of profit from the efforts of others with following an investment of money in a common enterprise. And so what she did say is that institutional sales that ripple engaged in getting sold to large institutional investors that gave them slide decks, they gave them updates on the growth of the ecosystem, a lot of direct marketing specifically to them and a lot of engagement with those institutional investors. They invested money went into the company, the company then ripple use that to further grow and develop the XRP ecosystem and in the ripple community. So in those cases, what she said is there was clearly an investment of money. There was an expectation of profits because they thought they would be able to resell these and they were told they can resell them, and that they were expecting the company ripple to pull those funds to further develop the ecosystem and increase demand and adapt optional, etc, etc. So in those cases, she said how we factors are met, this was an investment contract. And therefore, it's a securities transaction that needed needed to either be registered or exempt. In the programmatic sales, she again, started a new, here are the new facts. This is a different set of facts and circumstances, the company ripple was selling through an exchange, through transactions were in her view, if you were a retail investor coming onto an exchange and a bid bid, ask typical blind sale, you don't know who's on the other side of that it could be anybody who previously had ripple XRP that they had purchased from the company or it could be ripple in this case. And so her view was that there was an investment of money, but nobody knew that it was actually going to the company. So that first prong was maybe not necessarily satisfied, because while the money was going in, you weren't giving it to them in the expectation that they would be using it to further develop the network of the ecosystem and create value because you didn't even know that they were receiving the money. And then she also said that the eight years of communications and interview different in her view, obviously differentiating investor decks and investor meetings and roadshows, interviews and, and tweets and things like that by the company's CEO, and things like that were viewed differently, not targeted marketing and advertising to those retail investors. And so they would not necessarily know that someone out there had promised or was putting in those efforts. And so those Howard problems were not met. There was another one in there too, though, where they were using XRP to compensate employees or to provide bounties to people that were finding problems in the XRP system or for partners and partnerships. And in that case, she actually started the very beginning, again, is that actually there was no investment of money first from the Howey Test was even met. We don't have an investment contract.

Carly Reilly  12:03  
Yeah, so that makes sense. But what I've been hearing is the pushback to that is then why are stocks we trade on the stock exchange still securities? Because I'm not buying that from meta I didn't buy a share of meta from meta the last time I bought meta stock. How does How do you reconcile those two things?

Karen Ubell  12:19  
Yeah, I think the really important thing to remember and this is, you know, only a securities law walk this deep, but common stock, equity securities notes, things like that those are enumerated Securities Investment contract is also an enumerated security. So in the Securities Act, in section two, a one that says these are these things are securities and we all know equity, common stock is an equity security, there's no question that when you sell or offer or buy common stock, that is a transaction in a security, it is regulated by the federal securities laws. investment contract. On the other hand, we don't know what that is. And it's not an investment contract unless you have satisfied the Howey Test factors. And so the point here is that every transaction in common stock will always be a security, not every transaction in tokens will be an investment contract, and therefore be a security you have to look at those how we factor prongs to establish that there are met, and therefore it was a securities transaction. And therefore compliance with securities laws needs to needs to occur.

Carly Reilly  13:32  
This investment contract piece is huge. And we we last time you were on this show, we talked about it a little bit, because there's this question around like distinguishing between between the investment contract, which in a lot of these cases was like a Saft or a warrant, and we'll get into that, and then like there's these tokens kind of get issued pursuant to those things. And so there's the separation between the token and then the thing that may have been the initial investment contract. And if people's heads are spinning, I promise we'll walk through that more clearly than I just did here. But I'm just saying that to say let's put a pin in that for a minute, because I want to press on this issue. I guess it feels like strange logic, where could you use judge Taurus as logic in her ruling, to file a lawsuit against I don't know who to say that? You know, based on this, it's no longer true that secondary sales of this common stock equity are actually securities?

Karen Ubell  14:28  
No, because every transaction in common stock is transaction and an equity security.

Carly Reilly  14:35  
And here's my question, if you if you reapply the Howey Test, to a share of meta right now, to me, by the logic that Judge Torres puts forth, it would not pass that it wouldn't be a security according to the Howey Test,

Karen Ubell  14:49  
but so they're in the Securities Act. There's a list of items that are securities, equity securities are a security right and you don't have to apply the Howey Test to the offer and sale because we know every transaction and common stock is a transaction and an equity security, which is named in the list in the statute of these are the things that the SEC has the authority to regulate. And the challenge here is that an investment contract is also enumerated. But we don't know. Nobody really knew. Okay, what is an investment contract? The Howey Test in this room court said, Here's what is an investment contract. And you have to take these factors into account to determine whether it's an investment contract, check the box, I've checked all the four Howey Test factors. Now I'm an investment contract. Now I'm regulated as a security Oh, yeah. Okay. No, there's no manner of sale considerations when you're selling common stock, right? Because, okay, it doesn't have those four factor tests. Now, notes is another example, where sometimes a note like your mortgage is not a security when it's repack, but when but other notes like debt, or Debt Capital Markets, right, those are securities, and there is a different test established by case law. And whether a no or that is or is not a security. That's what I'm saying here is that common stock doesn't get to go through the Howey Test fact. Okay.

Carly Reilly  16:15  
All right. This is really helpful. And I don't know if everybody just picked up on this, but I just had my aha moment. So what you're saying is there is a law, a statute, a law, whatever it is that oversees and regulates securities writ large, it lists out and I think this is where he used the word enumerate earlier. And my brain started spinning around thinking that you were talking about like, we were numbering the stocks, but that's not what I don't think. Now, in hindsight, I don't think that's what you meant. What you're saying is there's a statute, there's this law, that enumerates, what constitutes a security? And that's a list of five or six things, whatever the number is, in that list, is stocks, just what you're gonna find on a stock exchange equity securities? Which No, there's no additional tests, you apply if you are an equity security. We're done.

Karen Ubell  16:59  
Take it back. I'm looking at the statute right now. Note, stock, treasury stock, security based swap, evidence of indebtedness, certificate of participation, and profit sharing things like that. And then,

Carly Reilly  17:12  
okay, so there's a whole list. And within that list is investment contract. Yes. And so let me ask, and then, now, if we drill down further with an investment contract, that's where then how we become is applied? Yes. How he's not just applied broadly to everything in that securities list. It's specifically something that is meant to apply to an investment contract, which is one thing that's a security within there, and then how do you determine if an investment contract? Okay, it's all coming together. So let me ask you this. And I don't want to take us too far down this rabbit hole, but like, how did we determine that digital assets fell in that investment contract category and not

Karen Ubell  17:52  
worry, that was essentially a world in which people are investing a lot of money into digital assets. And so we had to figure out who might be the regulator here and back in the initial stages of this, it seemed that it was likely the SEC would emerge as the regulator. And so you had to decide whether or not hey, is this a security? What is the appropriate test to determine whether or not it's a security? And as you'll see what, just because, for example, oranges, beavers, whiskey barrels, all of these things can be the subject of investment contracts that historically have then been called securities. That was, I think, at the very beginning of this, we all in the legal community thought, okay, that's how that's the hook through which the SEC would try and come and regulate this because it's not, while stock is specifically listed. In section two, a one of the 33 Act, there actually is even case law that says what is stuck, what are the hallmarks of stock, right, and an equity security and there is case law that has evolved around that. I think there's not a lot of question usually, because usually have a certificate that at the top, it says stock, but there are instances in which it has been litigated as to whether something that had voting rights and pay dividends and things like that. So that's why, again, as we're designing tokens, we're taking those factors into account, whether it can be viewed as stock, or whether it can be viewed as a note and whether it can be viewed as an investment contract.

Carly Reilly  19:23  
In some ways, what I hear you saying is, it's almost like the SEC is the one who said this is an investment contract cuz they looked at the things that were under their purview, and they're like, We really probably can't call this stock. We can't call it this. We can't call it that. Investment contracts are under our purview. We're gonna say it's an investment contract.

Karen Ubell  19:36  
I think that's right. I think also just again, at the when there were there, this goes to some of the comments that have been made about back in the day that we were all trying to evade securities laws. No, we actually, as lawyers in the space, we're trying to say, Okay, if it has these features, then it would be considered a security. So what how do these things work? And how is it different Then an investment, typical investment contract, which in our view, they always have been they are there. There's guidance out there that things that have utility things that are used commerce, all of these factors that undermine the investment contract analysis. That's what we viewed as being important and prevalent. But we anticipated that this was the hook that the SEC would try to use to bring it under its jurisdiction.

Carly Reilly  20:26  
So let's continue to poke a little bit at this ruling, because that is helpful. I feel like a lot has been clarified for me and my own brain about this and what we just talked about, but I'm still a little nervous, there is something that still feels a little bit strange, because the sophisticated investors got decks and actually read stuff. It's a security but because because the idiots who just trade this stuff, like shit coins, didn't read any of that it's not a security that feels like a tenuous kind of a logic on which to build this off of, frankly, if she had said there's utility to this, and that that differentiates that would have made me feel better. But I don't think we really saw that in her ruling. Speak to your feeling on that. And maybe it's a good moment for you to bring in and just explain to us briefly what this other judge who is now basically directly refuted judge towards his ruling has said,

Karen Ubell  21:16  
Yeah, I think that's that's right. I think it's a unusual result to find yourself in a position that the poor retail investors are not entitled to are just too stupid

Carly Reilly  21:30  
to have this be a security because we just don't know what we're buying wherever

Karen Ubell  21:35  
investors should get that. Now that being said, I think that in looking even at this newest ruling with Terra Luna from Judge Rakoff it Ray cop, I think, was who it was, because I think what that Judge expressed is that with the Terra Luna process, there was so much targeted heavy marketing in the facts that he assumed into the motion to dismiss order that targeting 20% returns. And really a lot of really targeted efforts to bring retail investors into the ecosystem might be a little bit different. You could argue that was maybe how it was differentiated between just Torez. When you're providing something that's very clearly showing and demonstrating a potential return. When your target whoever you're targeting that kind of information to then that is enough to establish that expectation of profits. I think that may be something that we could differentiate between, because the marketing efforts were just so heavy with Terra Luna on Here's your 20% return for putting your Luna into us t and things like that.

Carly Reilly  22:50  
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Speaker 3  25:14  
So I think Aaron is wrong about this. i He's right that certain projects have filed form two E's in connection with financings. But if you look at those Form DS, all of them were filed for actually convertible instruments such as like a Saft or a warrant, which are distinguishable from any token that can be issued pursuant to them. And security. That is not an instrument not a security, that instrument of security. Right, Rodrigo? Well, let me let me finish. Yes, the Saft is a security. But the tokens themselves were designed with the explicit intent that they are not security. So I don't think it's right to take the position that just because a project filed the form d for a financing, that then a token that is subsequently issued is itself a security and that was issued pursuant to an exemption.

Carly Reilly  26:04  
So hopefully that was clear to some folks. This is again, this is centered on a very specific set of projects. But this idea that the investment contract was the Saft or the warrant, and that these tokens are something separate. Karen, you brought this up the last time you were here. I didn't understand it last time. I think I have a better understanding of it now, but maybe break this down a little bit for folks and explain what's happening here.

Karen Ubell  26:27  
So as somebody who helped write the original stash white paper, this is near and dear to my heart staffs were, again, I was at the SEC before I came into private practice. When the Winklevoss about the Bitcoin ETF. We literally went into a room, we looked at Bitcoin and we applied the Howey Test to it right, so back to your question of how do we know that the SEC would probably play the Howey Test? Because I was in the room when we applied the Howey Test to Bitcoin, right? So we knew that would be the hook that through the lens through which they were looking at this. And really, when you look at the Saft white paper, it was essentially saying, yeah, when you have a pre functional token, and this was in response to a lot of the ICOs that were happening, where you kind of have a white paper and a smile, and nothing else, and $30 million, about 10 minutes later, we were saying, how do we get this, this industry really into a little bit more of a compliant place. And so we said, Alright, in those instances, if you apply the Howey Test, the token still has to be developed, the network has to be developed. Those are efforts of others, where you've got the investment of money that from the expectation of profits to the efforts of others. So that looked like a security. So at that point in time, if you sold a token, there would be an implicit investment contract there because there was some more to do. So let's paper that let's have a piece of paper in the form of a Saft that says, Okay, here's the investment contract tokens are not the investment contract tokens or tokens, they are code or even at that point in time, they didn't even exist. When I sold when people sold saps, you have an investment contract that says here to you, all you accredited investors, I'm selling these to you pursuant to an exemption. And when I in this is a forward contracts actually a convertible instrument, it's actually a forward contract, it said, you're paying for the right to receive in the future tokens when we are ready to launch them where there are no further efforts of others required.

Carly Reilly  28:22  
I want to interject because I think I just want to make a key point there where you're basically saying at that point, because you're at such an early stage, there's all this quote unquote, effort of others, that's still going to have to happen, right to launch a token essentially. And so that's why you're at this moment, where there is something that is an investment, you need something that is an investment contract, because there's so a lot of efforts of others, but you're saying down the line, once you issue the token, now it's much more out of your hands. Now there's not that same question of efforts of others or efforts of you the initial issuer, and that thing shouldn't be an investment contract. But we need some way to identify that in this founding moment. There's something that isn't investment contracts, let's have a physical instrument that is that investment contract and that's the SAF I don't know if I just made that any clearer to anybody else but I understand it

Karen Ubell  29:06  
but that's exactly right. So we said alright, let's pay for this as something was paper it as a Saft the Saft was a forward contract it's a contract for you're paying now for delivery or something in the future. Paying now for delivery of that token in the future at a time when it is no longer or should no longer be deemed and viewed to be a security

Carly Reilly  29:25  
sold it to you at the SEC this was like an essay

Karen Ubell  29:28  
in private practice. Oh, this is okay. But so then so basically that was the idea and so that you took the time you took the funds, and you use them to build out the functionality build out the ecosystem, all of those things such that when you delivered the tokens pursuant to the Saft they should no longer be deemed an investment contract or a scheme because it was no longer either they had utility and functionalities that there was no expectation of profits people were buying them to use them or there was no efforts of others and like in decentralized world right where there is no longer anybody actually single or entity or person who is responsible for the success or failure of that token in that project? So that was the idea. So I think when going back to what Aaron and Rodrigo were debating is there was a form D filed for the Saft or a warrant or some other instrument. And that was the security or the representative investment contract. It did not make the tokens securities, as Aaron is trying to suggest, if he were trying to create a secondary market in SAFS, he could do that, because that is what the exempt security was. That was covered by the form d. And but I think again, this just goes and I know that for you, Sam has been in a lot of talks with the SEC, but I think it goes to that concept that the SEC is trying to set forth, which is that the token itself embodies the investment contract, which is what just Torres rejected. What I think we all if you put it in the context of oranges don't embody an investment contract. They're a piece of fruit, right? Same idea.

Carly Reilly  31:04  
There's three different things I want to say you're you're you're bringing up so much. That's really interesting. And the first thing I just want to really hammer home because I found Aaron, so unbelievably condescending throughout this whole interview is like judge Torres, despite Aaron's insistence and this is not an investment contract, isn't that an investment contract, as we just heard him saying judge Schwartz has rejected that idea, then get into this orange grove piece, because I think this is where it starts to crystallize for me a little bit better, which is, you made that analogy. And again, this was like the case that birth Towie, which is oranges are commodities, right? Like oranges themselves, clearly, nobody's going to argue that those are securities. However, if you sell an investment contract and a plot of land that yields oranges, and then you sell the oranges, and make a profit, and give that profit back to somebody who made that initial investment, okay, that investment contract now clearly is a security and it's centered around oranges, but the oranges themselves are not the securities, which, so here's, I think the better analogy here, and this is where I wanna get your take. If I sold this investment contract, if I sold an investment contract and a plot of land where I was planting orange groves, and then I gave a bunch of those oranges, to the person who invested in my orange grove plot. Your point is, those oranges still aren't in the security. Yeah. And that's exactly what we're talking about here. Even if that person then went and sold the oranges off and made some money off those oranges.

Karen Ubell  32:26  
Yeah, it becomes a difference. It's a hard analogy, because oranges are always worse, because I guess they're on the tree, and then they're in a bushel. But it because there is I think there is clear evidence that both from the SEC and judges, this idea that a token can be offered and sold in a way that is a security investment contract signing the transaction and later in a transaction. That is not that even with Judge Torres. She said with the institutional investors that even when they resell those tokens, she did not think that those would be viewed as investment contracts at that point in time, because of the nature of how they were being sold and resold. So it's hard, it's a little bit difficult with oranges, because they're literally physically something that we can hold in our hand and eat but but I think that's the idea, right? Is that when you if the contract was just to deliver oranges, that's actually a forward purchase contract, right? Not a securities transaction. You're saying, I'm going to pay now for these oranges that you're going to produce, and you're going to deliver me all of the oranges that this orange grove produces. And then I'm going to sell those oranges because those oranges so that is a forward purchase contract that's

Carly Reilly  33:36  
still really healthy. Yeah, that that's helpful, because it's not the expectation of profit means money in this case, right? The profit can't be in the form of oranges. It feels putting a pin in this I think I understand with what you just said. Here's where it feels like it gets dicey to me. And we're maybe I'm playing devil's advocate. So you describe this moment when there's the creation of the Saft because you're saying okay, the Saft is the investment contract. But down the line, these tokens are completed entities so to speak. We're past this point of efforts of others. So the token now no longer passes the Howey Test, it is not a security, except that of course plenty of these tokens go to market. And there's still plenty of effort being put in by the original issuer or others, to build up the network to make the token worth more. So it's not really like the efforts of others does truly end once the token is live in the world. How do you address that problem? And does that make this Dornier?

Karen Ubell  34:38  
Truly what we grapple with, as we try to figure out how to launch tokens and distribute tokens, but I think that what you're talking about is truly the concept of decentralization. If you're seeing others and it's not one, it's not in Bill Hinman's speech when he was head of the Division of Corporation Finance. His comment was, is there a single person or entity upon which the success or failure of the enterprise depends. And so even with what the example that you gave, the idea here is that there are many. And I think an analogy that we often use is there's two different ways to decentralize. One of them is to launch and take your hands off the wheel. And another could be not to take your hands off the wheel. But there are now so many hands on the wheel that nobody's really driving, right? Because if there are a number of different integrations, a number of different contributors, there's the validators, all of the different pieces of that puzzle. You're at a point now where this looks like a functioning kind of commodities market. And in many ways, they're all these different things that are contributing to the value. It's not the issuer of the token, the sponsor of the token, the people that wrote the original software code, it's a number of different people. And that's not what the Howey Test contemplates the Howey Test contemplates I give money to you, you exert your efforts, I receive profit from those efforts. And when you is a decentralized group of individuals, that's no longer in my view, that no longer satisfies that plug in that we test.

Carly Reilly  36:11  
Now, what's interesting is the way it's phrased, is others, right? It doesn't specify the initial the other has to be the initial issuer. Right? So is it just That's how it's always been? Mostly, primarily speaking, interpreted that others in that case really shouldn't be that initial issuer? Because it's not fair. If I think I heard Jake Czerwinski give this example. Dogecoin can't be a security. So just because Elon Musk of his own accord one day decided to tweet about it, you cannot pass the Howey Test because of that, but it is a little dicey. Because others again, because it's written just as others, I think

Karen Ubell  36:40  
it would be, I think it would be difficult, yes, there are others that could be contributing to the long term value of a token or token protocol, or whatever that might be. But the securities laws is a regime that governs offer and sale, right? The s 33 Act applies to the offer and sale of a security. And if somebody is tweeting about it, and they're not selling it, I think it'd be very difficult to say that this that Elon Musk is causing the price of Dogecoin to go up. But he's not the issuer of it, and how can we hold him liable in that carnival?

Carly Reilly  37:21  
Anybody say it doesn't? Basically, how can we say it doesn't that it, I never know, if it doesn't pass the Howey Test or it does have passed? It doesn't have the Howey Test? Therefore, it's a security Yes, right. Or it doesn't fail,

Karen Ubell  37:34  
you want you This is actually a ongoing debate, you want to you want to pass you do not want to satisfy all of the prongs of the Howey Test. So whether that's a pass or a fail, I it's frozen. Oh, keep going if you it's an ongoing debate in the in the legal community, whether winning is passing or failing. But basically, you do not want to satisfy all the prongs. So I suppose you've failed the Howey Test. If you don't satisfy all the progress and failing us, we're not an investment contract. Oh, boy, this

Carly Reilly  38:07  
is a Hi, this is the content.

Karen Ubell  38:08  
We're talking about over drinks. Okay. This is something

Carly Reilly  38:12  
that's haunted me as I've thought, frankly, I spent a lot of time thinking about all this as I've tried to understand it. Because you're that decentralization piece feels really key to not satisfying the prongs of the Howey Test and therefore not being a security. And if I look at something like Aetherium, it is a no brainer to me that this fails the Howey Test. First of all, the original issuer of a theory of ether was a for profit company that has subsequently been dissolved, or whatever the phrase would be. And it is now to the extent that you could say this overseen by the Etherion foundation is very evident to me that if the Etherion Foundation, collapsed, ether would continue to exist. Now I do think metallic is important. If I got hit by a car tomorrow, I think it would affect the price of ether, but it would not go to zero. Whereas if meta if the original for profit company that issued the stock disappeared, the stock goes to zero because the stock is one to one correlated. Again, let's forget the nuance to meta profits and meta prices. And that's obviously not the case with ether and the Etherion foundation. So I think when you're talking about the decentralization question, no doubt ether to me, not a security. But then look at something like FTT. Or again, I don't know enough, frankly, about the nuances of XRP. to ripple to know If ripple disappeared tomorrow, would XRP have value do we think? And this is where I think it's a little tricky, because to me with most of these tokens if they're going well, they're decentralizing more and more over time. But what is that moment in time when they officially decouple from the issuer? I don't know what actually T is worth right now, but I'm sure it's nothing right. Nobody's buying ft t because FTX is gone. So you can't argue the FTT was a decentralized token. Really, what was the First of all, there's propping that up other than FTX.

Karen Ubell  40:02  
Yeah, without commenting on a specific tokens, like when are we decentralized is the million dollar question, so to speak, that is a big part of what's going on with the review of the infrastructure bill, because the market infrastructure bill is currently under review. The idea being there, they're trying to say, when you are decentralized enough, you move from the securities regime to the commodity commodities. But that's very hard to determine. And that's truly that's, and this goes to the the challenge of it all. And even going back to the the decision of Judge Torres, it's a facts and circumstances based test. And the facts and circumstances that I think are important, may not be the same ones that a judge thinks is important, or the SEC thinks they're important. And so that's why, while this is certainly a win for the industry to have this ruling, and there's a lot in here, and not least of which is just the SEC lost, and they had a pretty strong track record. And it also just shows that it's not as clear as anyone thinks it is. Or as the Chair counselor would, would say that it is if we have two judges in the same district in the same week coming up, or I guess, the same month coming up with different different answers and different conclusions. But I think it goes to this idea that it is a facts and circumstances based test, which lends itself to 2020 hindsight and which lends itself to is are the facts, the same with a theory them as they are with a different token? Or how do we assess that if there's no metallic for that for that project? Or that it's really that is the million dollar question that we're all grappling with. And that will, I think, continue to be difficult when you have judge made law and regulation by enforcement that just says, The Howey Test is the test. We don't need anything else. And I think that until we have something else that helps give that more clarity, we're going to be doing exactly what you're doing, which is wondering, why this and not this.

Carly Reilly  42:02  
Is there a set of rules that we could set up out front? That could really set precedent and make this all really clear? Or inevitably, is there going to be X number of years of grinding through this in the court system? And maybe I'll phrase it this way. You referenced earlier this piece of legislation? I forget the name of it, is it the one from the Senate, or the one on the house of the house? So this is one analysis. The other? This is the market infrastructure. Okay, so this is this bill in the House that as you just said, but just to make it clear for people is basically saying that out the very initially, tokens will be regulated under the SEC, but that they will as they work towards decentralization, and once they hit a point of sufficient decentralization, then they'll pass over and they'll be regulated like commodities, because at that point, they're no longer securities. Do you like that? Bill? I'd love to get your opinion. Do you think that's would that provide the clarity that we need? Yeah, I

Karen Ubell  42:59  
think that is the right framework, so long as we can get some principles in place on what is decentralization and what is the off ramp?

Carly Reilly  43:07  
Think that security to commodity framework? Right, roughly? Yeah. Because again, I

Karen Ubell  43:11  
think the examples that we've seen of the projects that have tried to take advantage, it tried to go through the SEC process, I think they've just gotten stuck in it. And I think they're still stuck in it with no exit ramp. And so I think that's what's going to be really important is making sure there is an exit ramp. But I do think I think legislation is, is important. And I think that is going to be the best way through this. We could take years and years to try and figure this out through the judicial system. But I think that what we're seeing is that it when you have facts and circumstances based test new technology, different facts and circumstances with every single thing, I think it's going to take a long time for us to find clear path and clear rules. Because we have had cases in the past, there's been kik and telegram and others, but you look at those and even with XRP, and ripple, the fact that they're alleging many, in many cases are many years old. And it's not how tokens are distributed in the modern era, and under the tokens that are launching now. And so even that has some limited value for guiding people today on what they can and can't do when you're basing it off of how it was done in 2015 or 2017. That's just not what people are doing necessarily in 2023 and 2017 18, defi wasn't even around yet. Nf T's weren't around yet, things like that. And so it doesn't, it's not necessarily that helpful in applying that to the facts today. So I think that legislation is going to be a really important factor. Also important for kind of keeping up I think, in the US a competitive landscape, because if you continue to have this level of uncertainty, while others are seeing the opportunity, other jurisdictions are seeing the opportunity to say what if we had a real principles based system, people are seeking those jurisdictions out already and And if you give it too much time here, I think people are already growing very frustrated with that. It's also limiting, there are certain projects and certain founders that are simply not willing to come in, they're not willing to take on that risk, they're not willing to take on that reputational risk. And that's really unfortunate for everybody.

Carly Reilly  45:19  
What would be the ramifications? How would it work? If these if tokens moving forward, were initially securities and then would move to commodities? It's something where we maybe wouldn't see so much secondary activity, or we wouldn't see like trading on them in those early stages. But once they're commodities, they could or is it just that like, then you would need something like a promethium, that could legally trade securities, in some form, like they would have to register and go through that whole process in the beginning, and we'd have some sort of like Securities Exchange they'd be traded on until ultimately, they can move over to other exchanges.

Karen Ubell  45:53  
I haven't looked at the markup and things like that. So I don't really, I don't actually know, I'm not clear actually on how they intend to trade in that

Carly Reilly  46:02  
transition area. Okay, so let's forget about it. So one thing I'm a little bit hung up on, is this orange grove investment contract analogy we've been using. And because they're the investors in the Orange Grove are expecting profit because they're expecting the orange grove planter to go off and sell oranges and give them money back. These early investors in these projects who are expecting tokens down the line, are they also getting equity in the companies like where do they expect their return to come from when they sign that Saft or that warrant or whatever?

Karen Ubell  46:42  
So SAFS you're just getting tokens? So Saft is a simple agreement for future tokens? It is simply that it is a forward purchase agreement that says I'm giving you this money now. And your

Carly Reilly  46:54  
forward purchase agreement. Okay. That's what you mentioned earlier. And that matters. Yes,

Karen Ubell  46:57  
yes. So you're giving them money now for delivery of tokens when they launched the protocol and launched the project.

Carly Reilly  47:06  
So was the forward purchase agreement is a four purchase agreement, it is an investment contract, but it's a specific kind of investment contract?

Karen Ubell  47:12  
Yes, it's a contract. And so anything the underlying facts of what's happening in in in the contract the contractual level, or what makes something an investment contract and

Carly Reilly  47:24  
taking a step back? In some ways, what I think everyone agrees on, except for the really bad actors is that we want to keep retailers safe. And there's obviously been a lot of problems with the existing system. With retailers getting burned. I certainly think that FTX should have had a bunch of disclosures or there should have been more visibility into that whatever point to whatever you want to point you at now. They were of course, not even in the US or law wouldn't apply anyway. But But point being like, this disclosure thing, Gary talks about a lot as being like at the core of all of this, which in the abstract sounds really logical? What I would love to understand a little bit better from you are under existing securities frameworks, like what are the disclosures that are required? That may or may not really be applicable to crypto?

Karen Ubell  48:17  
Yeah, then this is I think, the real challenge. And the issue here is that if you think about a typical company about to do an IPO, their disclosures, our description, their business, sure that makes sense. We can discover business risk factors, okay, risk factors, that's easy. But then they go into their financial statements, does that really matter to a purchaser of crypto, what the financial statements of the entity are executive compensation, the list goes on and on. A lot of these things are already publicly available to a lot of for people to access via blockchain. Material contracts is also a weird disclosure in that there are no material contracts necessarily in the crypto space. Also, there's this concept of current disclosures of here's an important event that happened that we want to disclose to the market so the market can absorb that information. But when you have a decentralized network, there could be 100 different people that are doing things that might be material. So whose obligation is it to report on material information? And particularly, as an issuer, the issuer, so to speak? Do you even know what and when those things are happening? I think the point is, I don't know that the current form S one, which is what you see when you get to when you get the the public offering. IPO registration statement is necessarily the information that's material and important to somebody who's buying into a crypto ecosystem, or somebody is more importantly, the users, right? If you're a validator or something like that, what do you really need to know if this is the platform that you want to build upon and start accumulating

Carly Reilly  49:57  
the right ones? Yeah, I'm interested in it. is on a couple of levels. One, I'm just I'm interested in helping people understand what, what is being what is meant when we talk about disclosures. And you talked about the things that are required that may not fit or make sense for a crypto company. And I want to drill down on one of those in a minute. But that's to say nothing of the things that aren't included, that would actually probably do a better job of protecting retailers, whether it is token omics, or whether it is like there's any number of things that we actually would maybe want to add to a disclosure form on crypto to better protect retailers, I want to drill down on the revenue piece that you just mentioned, because financials you mentioned that when a traditional IPO, let's say a company obviously asked to disclose their financials. And that's one, that's probably the most important thing that any investor is going to look at when debating buying a stock is what are the financial this company look like? There's plenty of other factors, right? Because, again, back to that thing I mentioned earlier, which is when you're buying a stock, in simplest terms, it is very correlated to the profit there. I think what's interesting, because I've thought about this now, when I think about crypto and I gave the FTX example earlier, clearly, there's an extent to which depending on how centralized or decentralized the coin is, you do want to know, is this company about to go bankrupt? There's like a very binary level to which you want to understand the financials. But again, I don't first of all, to your point, probably revenue to the Ethereum foundation is mostly going to be found on the blockchain. It's already covered anyway. But again, I don't, my I don't buy Aetherium in any way, because of how much money the Etherion foundation is bringing in, I don't buy ether because of how much money the Etherion Foundation has been is bringing in, it's really important for people to understand because even for people outside, I think, especially people outside of the crypto ecosystem. I think you might be like, of course, you're gonna care about the financial standing of ripple. But no, again, XRP is trading on so many factors. And this is what Judge Torres did understand general crypto market sentiment is going to drive these prices, there's a lot that's going to drive these prices. But it's completely independent from ripples, financials, which is just not true, when in the case of any of these stocks, but I'm curious because now understanding this framework better of within the construct of securities, is that all do all securities, so notes, investment contracts, stocks, all the things that list we went through at the top of this episode, too, all of them have the same disclosure requirements.

Karen Ubell  52:15  
If they are doing their offering and seeking listing on a public exchange on a registered exchange, if you're doing an IPO, then yes, they all have the same form is one disclosure requirements. Other times maybe if you're not doing a direct listings, for example, you're still doing a resale offering, it is all the same disclosure. Also, there's a world in which you could say some people become just public companies, or finally 10, Ks and 10 Q's and things like that. There's a different regime for reggae, it's a little bit more reduced. But if you are doing this offering on a public basis, then yes, you have to provide essentially the same disclosures with one caveat, which I think is really important is that the SEC has actually recognized in the past, a certain type of transaction and type of security benefits from a different type of regulatory regime. And that's reggae beat. That's asset backed securities. So they actually looked at those asset backed securities. And they said, is there an entirely different set of disclosures that we think are important for purchasers of this, we are creating a new regulation Reg, A, B, and then new forms, pursuant to which asset backed security issuers will make disclosures on that basis, because it was very different kind of material information that the investors would want. So there is history of creating a more tailored regime, rather than just fitting a square peg in a round hole.

Carly Reilly  53:46  
I think there's a lot more we could dive into and want to dive into maybe even a little bit around promethium, or certainly around Promethium. Because around exchanges, and there's almost gets us into the Coinbase and binance side of things, which is this idea that they're illegal securities platforms, and they're doing illegal security offerings. I don't think we have time for all of that today, which is where I think we may do a part two of this that really goes into the exchange side of these laws and the what are the implications once you've established security and non security? What are the implications there in terms of how were we as retailers come into all of this, but maybe to close? This part one of all this? I have a couple questions. One you're probably going to demure against or whatever but is do feel like you have advice or you have for not actual formal legal advice, but just like what is your perspective on how a company interested in issuing a token now should go about it based on what we have from the judge Torres ruling the judge breakoff motion to dismiss whatever that was? Where do you feel like folks should land?

Karen Ubell  54:51  
Gosh, that's a hard one to be on the spot. I think generally. What I think maybe the unfortunate takeaway is that not a lot has changed, we're still in a world where one judge can look at a set of facts and circumstances and find it to be an investment contract. And even with the same asset, find different forms of offer and sale to be, and to not to be investment contracts and transactions. And I think and then you can have a few weeks later, another judge come to a different conclusion. And so I think that we are still in this world of divining, and reading tea leaves, we get bits and pieces from these these decisions where we can try and draw analogies where we can. And I think it is very positive. Right, it is positive to see where Judge Torres came out. Because I think, ultimately, these are the the right results. And I think also there was a lot in there about secondary market trading, which, you know, is really the important piece for Kryptos is being able to have trusted and liquid and high volume trading markets for people to access these tokens across the world and whatnot. So I think that it's just hard for me to say necessarily, but with the rain, you

Carly Reilly  56:07  
don't really have an answer still. Yeah, I think Do you think do you think it holds up against an appeal? Judge doors is rolling?

Unknown Speaker  56:15  
Okay, I don't know that I like to make predictions.

Carly Reilly  56:19  
I'm a little nervous.

Karen Ubell  56:20  
Yeah, I think we're all a little bit nervous. But I think that she's applied the Howey Test, I think what we'll I'm hopeful that what we'll hold up is what we started at the top of the podcast with, which is that the tokens themselves are not embodiments of anything, you have to you have to establish the prongs of the Howey Test in connection with every offer and sale to say that it's an investment contract, and therefore the securities laws apply. And that would be a real win. Now, again, like I said, it puts us in this place where we're still in a facts and circumstances based test. But I think that this concept that is being espoused by the SEC, and others, that the token itself is a class of security that is registered as a crypto asset security, which is certainly not in that list of enumerated securities that I listed off at the be at the beginning of our discussion. That is not that that is a bad result, right? Because it gets to a world in which every single transaction continues to be a securities transaction. And that's just not the right result than not, it's not the right case, for the growth of this technology. And for the operation of this technology, you cannot have a programmatic distribution of a mining reward or a staking reward be viewed as a securities transaction. That's just not feasible, for example,

Carly Reilly  57:43  
and I think the win here, obviously, we don't yet have clarity, and we haven't solved the problem at this point. But the win would you pointed out earlier, is maybe a philosophical one, which is that this has established that existing laws are not clear enough to settle this issue. And that has been I think, the frustrating thing where many of us feel like we're being gas lit by the SEC or Gary Gensler or promethium, who want to act like this is all very clear, very simple. And what are you talking about, of course, we can use existing securities laws existing securities regimes to do this, and y'all are just a bunch of Wild West cowboys that are trying to break the law willfully. Because it's actually very clear. And there's unlike it, when it's especially being said in that tone, like quite literally by some people, you're like, I'm not crazy. This is actually complicated and more nuanced than that. And at a very minimum, if we get nothing else, we have gotten that out of Judge doors, this ruling is okay. Look, we have a judge who was clearly siding with us in such a way that suggests this is not all clear and solved. And and so we we do need new new legislation. The last question I was gonna ask, which is maybe a silly question to even start diving into. But how we're here is just obviously, we're a more NFT focused podcast, and we spent today talking exclusively about fungible tokens. I'm not necessarily optimistic about where all this lands for non fungible tokens were, I think, the kinds of creative things that we sometimes want to be able to do with non fungible tokens, which is Bootstrap and author or bootstrap a musician's career where we then get some level of profit later down the road when they're really popular. As I've learned more about this, I'm like that feels like printing really strongly passes the Howey Test. All the problems are like they're there. That's the orange grove contract. And we haven't even gotten to any of that in court because they've way bigger fish to fry. But would that be your read on that situation as well?

Karen Ubell  59:40  
No, I think I think and as it relates to NF T's I think that there is a lot more to explore and what they can do and how they can be used. But, but yeah, I think you just you still have to keep I think the point here is that the investment contract analysis is the applicable analysis, whether it's an NF TS or no matter what it is, and guess what Whether it's a, an NFT, or a an orange or a whiskey receipt or a chinchilla, things like that they're all these truly they're all kinds of animals that people have turned into investment contracts, essentially. But But yeah, so you still have to apply that framework, I think is, is the overall lesson that I think we knew. And now I've been affirmed.

Carly Reilly  1:00:19  
Here's the last question I have. And I knew I was going to do this and just keep asking you questions, even after I said, it was gonna be my last question. I know, I think last time you came on, as we prep for that, you mentioned Matt Levine. So I think you're a matt Levine reader. I'm definitely a matt Levine reader. And it his his big piece after the ripple verdict came out was really centered on what we'd got to earlier, which was this idea that by Judge Torres logic, stocks that chain buying a stock off the exchange of an asset, whatever stock exchange wouldn't be a security because you're not buying it from meta directly meta is not profiting off of it, whatever. What do you make of that article? Now me understanding that these are two separate in an investment contract and stock are two separate prongs in this list of things that are securities? Do he just miss that? What do you think he was getting out with that piece?

Karen Ubell  1:01:07  
Yeah, do you think this is a common issue? Like even amongst securities lawyers, where you want to think of it as is the transactions are all the same, and it's the thing is all the same, but you have to establish that it is a security in order for then judge Tauruses. concepts to apply. So, I think that maybe it's possible that he did miss that concept, right. Stock is always a securities transaction, we don't assess and evaluate who gets the money and how it's being traded. But I do think maybe what he was also getting at, though, is this idea that just because you're buying it off an exchange, and it's not money isn't going to met a set point that we talked about earlier, which is that doesn't mean that people shouldn't have the protections of the benefit of the disclosures and security protections, but I do think I, maybe I should write him a note.

Carly Reilly  1:02:01  
Now I want to have that on is I love Matt Levine so much. And I think he's such a good writer. And I really value his his take on things in a lot of ways. And now this makes me want to like have mana be like the answer to this, like, how did this I don't know that,

Karen Ubell  1:02:14  
you know, even amongst my own partners. So it was somebody posed that question, but does that How is that possible? That means that LP interest in a fund would originally be sold as a security and later not be sold as a security? And then the answer is no, that is always a security a limited partnership interest in a fund is always a security

Carly Reilly  1:02:31  
numerating in that list, the manner of sale. Yeah, Karen, this was so wonderful. As always, thank you for walking me through all of my ridiculous machinations trying to try to understand all of this. And and we'll have you back again, there's so much we didn't even catch here. But I'm like, we I didn't want to touch new categories, looking at the clock being at the 60 minute mark. So we'll have to bring you back.

Karen Ubell  1:02:53  
Yeah, of course, I'd be happy to do it. It's it's not easy. As we're seeing from the judges and the Southern District of New York. It's it's not totally

Carly Reilly  1:03:01  
and it's not easy to talk about. And I told you this was like the hardest episode I've ever tried planning. Like, I don't even know what's about to happen, because it's too hard to wrap your head around at all and know how to give the right amount of context. And so I really appreciate you you're working through it with me.

Unknown Speaker  1:03:16  
Of course I'm gonna do it

Carly Reilly  1:03:22  
thank you so much for watching this episode of overpriced JPEGs if you liked this conversation if you liked this episode, please go ahead and hit subscribe. It helps me out it helps the show out and it means you will get alerts and updates when we post new content. Thanks again.