The CBD’s of Trademarks

By: Jon Avidor and Joshua Weisenfeld

Recent cannabis legalization in 11 states has pushed congress to more formally address the issue of federal regulation and decriminalization. On December 20, 2018, Congress continued this process and moved forward with partial decriminalization of certain types of cannabis and its derivatives by signing the Agriculture Improvement Act of 2018 (“2018 Farm Bill”) into law. The 2018 Farm Bill reclassified cannabis plants, products, and derivatives containing no more than 0.3% THC as “hemp”, and subsequently removed hemp from the list of controlled substances. Passing this bill alleviated some difficulty when protecting cannabis, CBD, and hemp brands. Often when protecting a brand, companies will register their brand as a federal trademark, which was previously unavailable for hemp and CBD products. However, with the removal of hemp from the controlled substance schedule, the United States Patent and Trademark Office (“USPTO”) could no longer deny trademark registrations on hemp products based on their conflict with federal law, therefore legalizing the registration of hemp trademarks. 

There are various ways to protect trademarks, using both state and federal law. Typically, a company will first attempt to register its mark through the USPTO as a federal trademark, as a federal trademark is enforceable throughout the United States. However, if a federal trademark is unavailable, a company may seek to register their mark within their state of operation, incorporation, or use. A state trademark, however, is only enforceable against infringers within the state of the trademark’s registration; substantially limiting the mark’s protection. 

State registrations have historically been the only option for trademark protection in the hemp and cannabis industries because state trademark offices rely on state law rather than federal law. Subsequently, states that have legalized cannabis tend to have more comprehensive trademark laws that allow for registration of cannabis trademarks.

In practice, the federal trademark registration process requires an applicant to identify the trademark’s use within interstate or international commerce. This is because federal registration is only available for goods or services that are in interstate or international commerce. Meaning if someone were to apply for a federal cannabis trademark, they would have to sign a sworn oath that they are using the mark for goods in interstate commerce, essentially confessing to a violation of federal law. Moreover, the USPTO refuses to register a trademark for any goods or services that violate federal law. So even if someone was willing to admit to the interstate sale of cannabis, the USPTO would refuse to register the mark because cannabis itself violates federal law. Some applicants have attempted to circumvent this rule by showing legal uses of the mark in interstate commerce, but the USPTO has consistently rejected these claims. 

This rigid system, as it relates to hemp, recently changed as a result of the 2018 Farm Bill. The reclassification of certain cannabis plants as legal hemp opened the door for hemp companies to apply for federal trademark registrations, since industrial hemp cultivation, manufacture, and distribution are no longer in violation of federal law. This also means that legal hemp can be placed in interstate commerce, so hemp companies can sign sworn oaths stating that their products, which bear the mark, will be legally sold through interstate commerce. More importantly, this admission would no longer be a confession of a federal crime. 

In May, the USPTO confirmed this approach when it updated its examination guidelines for legal hemp. The examination guidelines offer federal trademark examiners an in-depth review of the USPTO’s practice prior to the 2018 Farm Bill, along with current approval provisions for registering a cannabis trademark in compliance with federal law. The new guidelines no longer permit trademark examiners to reject cannabis trademark applications based on a violation of federal law and lack of lawful use in interstate commerce. The new guidelines will allow for hemp companies to register trademarks on hemp plants, products, and derivatives in the same manner as any other legal mark. USPTO has started to see an influx of CBD-related trademark applications. However, while it typically takes three months for a trademark application to be reviewed by the USPTO, CBD-related trademark applications may take up to a year to be reviewed.

The USPTO doubled down on their previous restrictions for registering cannabis trademarks for products containing more than 0.3% THC, as the 2018 Farm Bill did not change the legality of this variety of cannabis. Meaning cannabis companies will still be forced to register their cannabis trademarks with the state, while hemp companies may begin to avail themselves of the benefits of federal trademark protection.

Comprehensive Drug Abuse Prevention and Control Act & Cannabis

By: Rob Griffitts and Kathryn Jones

The free-spirited attitude of the 1960s counterculture, in part, fueled the crackdown of illicit substances by the following decade’s legislature. The Nixon Administration officially began its “War on Drugs” with the passing of the Comprehensive Drug Abuse Prevention and Control Act of 1970.  While the act was seen by many as a means to stop the flourishing anti-establishment youth culture by outlawing marijuana, this legislation governs much more.  The focus of the act is much broader than regulating marijuana and in fact sought to deal with drug use from a medical perspective, rather than a law enforcement one.  With Titles II and III being added over the following years including the oft-debated Controlled Substances Act (“CSA”) and countless government-sponsored anti-drug campaigns, the Comprehensive Drug Abuse Prevention and Control Act changed America’s attitudes toward not only illicit substances but also legally manufactured drugs.  With cannabis’ legal status within the CSA currently hanging in the balance, it is helpful to understand how this law came to be enacted.

During the 1960s it became clear to the country that drugs, both illicit and legal, were being abused.  With the establishment of the Presidential Commission on Narcotic and Drug Abuse in 1963, work began on an all-encompassing way to tackle drug abuse and consolidate over 50 pieces of drug-related legislation.  The Federal Comprehensive Drug Abuse Prevention and Control Act of 1970 was born with the goal in mind to come at the country’s drug problem from all sides.  Title I focused on rehabilitation, Title II deals with the scheduling and distribution of domestic illicit substances and Title III addresses the import and export of these substances.  The most divisive of the three titles is Title II. 

Title II of the Federal Comprehensive Drug Abuse Prevention and Control Act of 1970, more commonly referred to as the CSA, became effective on May 1, 1971. The purpose of the CSA is to regulate and facilitate the manufacture, distribution, and use of controlled substances for legitimate purposes, and to prevent these substances from being diverted for illegal purposes.  The CSA places various plants, drugs, and chemicals into one of five schedules based on the substance’s medical use, potential for abuse, and safety or dependence liability.  These Schedules mimic those created by the Single Convention on Narcotic Drugs (Single Convention), an international treaty created shortly before the CSA. The CSA also provides a mechanism for substances to be controlled (added to or transferred between schedules) or decontrolled (removed from control).  Importantly, the CSA is the guiding document giving authority to the Drug Enforcement Administration (“DEA”).

In 1973, President Nixon sought to create the DEA in order to combat drug abuse both at home and abroad.  Like with the CSA, the goal was to consolidate the work that was previously being done by several competing agencies, making the DEA the ultimate “superagency” to enforce drug laws. Every pharmacist, manufacturer and drug company must first register with the DEA in order to legally produce and distribute drugs.  The creation of the DEA brought back the law enforcement element of the “War on Drugs”.  The focus once again shifted from a medical approach to a criminal justice one. The mission statement of the DEA even states first that its mission is to “bring to the criminal and civil justice system of the United States… those organizations… involved in the growing, manufacture, or distribution of controlled substances appearing in or destined for illicit traffic in the United States.”  The growing heroin problem in the 1980s saw a greater need for the DEA and eventually, Congress passed the Comprehensive Crime Control Act of 1984 which enhanced penalties for CSA violations, thus making the DEA even more important in drug control.

However, as time moved on and attitudes shifted once again about drug use prevention, certain aspects of the CSA are being scrutinized, particularly the scheduling of cannabis in Schedule I.  Currently, the Trump Administration is in the process of notice and comment on a proposed change that would re-schedule marijuana from the schedule containing drugs with the highest probability of misuse to a schedule in which cannabis could be researched, regulated and ultimately put in consumer products.  It is clear that from the creation of the CSA in the early 1970s that it is a document which is often amended to deal with the issues surrounding drug use. One of the most glaring issues today is the competing federal and state legal statuses of cannabis. In order to do its job effectively as the guiding legislation of drug production and distribution, the CSA may have to change again.

The Implications Behind New York’s Decriminalization of Marijuana

By: Steve Masur and Armando E. Martinez

On June 19, 2019, the New York State Legislature in Albany rejected a cannabis legalization bill, which had enjoyed wide-ranging popular support, leaving many to wonder why. New York is the second state in the tri-state area to reject the legalization of marijuana in the last few months, as New Jersey, its neighbor, narrowly rejected a legalization bill in March. When asked to comment on the results, lawmakers stated that the opposition in legalizing marijuana in New York mainly stemmed from uncertainty as to how to allocate tax revenue. The New York State Legislature, however, made advances towards legalization by passing a marijuana decriminalization bill.

Under New York’s marijuana decriminalization bill, possession of up two ounces of marijuana will now carry a fine between $50 and $200, with the specter of jail time significantly reduced. Further, the bill will establish a process to expunge the marijuana-related convictions for those who have been previously convicted of possession. In effect, the bill will not only limit the amount of marijuana-related convictions we see in the future, but it will also provide 600,000 ex-convicts with a thinner criminal record. This means that ex-convicts who were previously precluded from entering the workforce will now be able to enter it, which could drive economic and entrepreneurial growth in New York.

The legal distinction between decriminalization and legalization is thin, but it merits scrutiny. Decriminalization means that a fine is attached to the possession of marijuana in small amounts, yet jail time is not. Depending on the state, further, possession of a larger amount of marijuana, as well as sales or trafficking of the drug, could result in harsher sentences, such as jail time. By contrast, fines and jail time are completely eliminated under legalization, which may also allow sales. Decriminalization is a step towards legalization, and although this was the last legislative session for the first half of 2019, it most certainly will not be the last time lawmakers revisit this topic in Albany. This is because the economic, social, and political implications of legalizing marijuana could likely have a marked impact on the American macroeconomy.

In 2018, the legal cannabis industry generated approximately $10 billion in revenue. Cannabis-related financial services have surged due to many firms taking advantage of the legalized markets to create and scale cannabis supply chain operations. If cannabis were legalized in New York, jobs would be created on both wholesale and retail front, which would effectively allow the state to enjoy a higher tax revenue. The push for legalization probably failed due to questions about how to allocate this revenue.

When Illinois Gov. J.B. Pritzker signed Illinois’ legalization bill, he stated that legalization would provide opportunities to those in communities who have been direly in need of a second chance. By decriminalizing marijuana in New York, the legislature is close to fully afford the same benefit to its constituents, as this bill is focused on creating on opportunities, not limiting them.  However, decriminalization is still only a half measure. In addition to broadening the tax base, full legalization would provide New York with a new industry and a new basis for entrepreneurial growth, which could make it a leader in terms of growth, especially upstate, where it is needed most.

A2IM Indie Week CLE

By: Steve Masur

On June 17th, 2019, for the 10th anniversary of A2IM Indie Week. Steve Masur moderated and produced a Continuing Learning Education (CLE) series of panels at New York Law School. A2IM Indie Week is a four-day international conference and networking event aimed at maximizing the global impact of Independent music. Indie Week includes keynotes, panels, receptions, exclusive networking sessions, and much more.

How Can Blockchain Technology Help the Music Business?

Moderator

Steven Masur

Speakers

 

Negotiating a Sync Licensing Deal: How Much is Your Music Worth?

Moderator

Lauren Mack, Intellectual Property Attorney, Masur Griffitts + LLP

Speakers

 

The Music Modernization Act: What You Need to Know

Moderator

Jennifer Newman Sharpe, General Counsel & Head of Business Affairs, ONErpm

Speakers

 

A big thank you to the incredible panelists and all of those who joined us!

Decriminalization in New York: A Half-Baked Measure?

By: Rob Griffitts and Jordan M. Steele

Passed in the twilight hours of New York’s last legislative session, months of negotiations produced a reform that will further decriminalize possession of marijuana. Advocates celebrate the bill for providing vital relief to individuals through expungement of prior misdemeanor convictions for marijuana possession. However, both proponents and critics remain dissatisfied with the compromise. Critics of the bill rail against it for softening the State’s position on possession, while many of those in favor of ratification remain disappointed with its scope. Despite being “decriminalized”, marijuana remains prohibited in the state of New York. This distinction is critical for the burgeoning cannabis industry; distribution will remain a criminal activity, and as a result, there remain substantive health concerns when the product is produced in the absence of oversight.

The New York Reform 

While marijuana possession has been decriminalized in New York for decades, this reform expands upon existing law and provides a means for individuals to have their prior criminal records expunged. The prior law, passed in 1977, decriminalized possession of marijuana for amounts up to 25 grams (approximately one ounce). The new bill does several things, including raising the limit for possession. First, the penalty for possession of less than one ounce will be lowered from $100 to $50 and this amount will not increase because of prior criminal history. Second, the bill provides that possession of one to two ounces, previously a Class B misdemeanor, will become a violation, punishable by a fine of $200. More than two ounces will still be considered a crime, not a violation. Third, smoking marijuana in public will now be considered a violation. It had previously been considered a misdemeanor, a loophole which legalization advocates claimed was used to target racial minorities.

The Effect of the New Bill on Individuals

On the individual level, the bill is a major step forward. Early estimates show that nearly 600,000 New Yorkers could benefit from the expungement of past marijuana convictions. The bill’s sponsor, Senator Jamaal Bailey, has stated that prior convictions for marijuana possession had adversely affected his constituents in the Bronx. Those convictions were “limiting [New Yorkers’] access to housing, access to education, [and] affecting their ability to obtain employment.” In a radio interview on WAMC, Governor Cuomo commented that “it makes the situation much better especially for the black and brown community that has paid such a high price.” Politicians are hopeful that this bill will reduce the disparate impact of the war on drugs on minority communities.

Persisting Prohibition of the Cannabis Industry

Despite the relief the bill offers to individuals, decriminalization is not legalization, and many harms accompanying the prohibition of marijuana still persist. The prohibition continues to fuel an illicit underground distribution network, estimated to be worth $40 billion or more in the U.S. Profits from marijuana distribution in New York continue to go untaxed, and as a result, the state is foregoing a valuable source of revenue. The new bill also misses the opportunity to regulate the industry in order to ensure consumer safety. A regulated market could ensure that marijuana products are free of contamination, labeled for potency, provide adequate warnings to address health concerns and be contained in child-proof packaging. There also still persists the fear of the unequal application of the laws towards minority groups traditionally targeted for drug-related offenses. If history repeats itself, New York could ultimately see certain marijuana arrests increase, which was the result after the first bill decriminalizing marijuana was enacted in 1977. While the bill leaves these issues unaddressed, those in the cannabis industry remain hopeful that this reform provides a step in the right direction on the road to legalization.

Blockchain and Insolvency: How Blockchain Can Make Matters Easier for Creditors, Debtors, and Bankruptcy Courts

By: Rob Griffitts

Digital currencies on a blockchain ledger provide enormous flexibility when conducting commercial transactions. In the capital markets, lenders and borrowers can structure credit transactions at arms-length since the lending amount need not be examined by a financial institution.

On the other hand, if a prospective borrower obtains a loan and files for bankruptcy, a creditor might face trouble in recovering the principal on the loan he or she issued to the debtor. Debtors may attempt to circumvent repayment of loan principals by exploiting the current loopholes in the U.S. Bankruptcy Code pertaining to blockchain-based digital assets. These loopholes have put bankruptcy courts, U.S. Trustees, and estates in a precarious position, as these courts have struggled to compartmentalize digital assets, credit, and blockchain-based currency into a legal framework. This uncertainty, however, allows lawyers to provide bankruptcy courts, prospective lenders and borrowers, and perhaps Congress with a schematic for ascertaining repayment and streamlining bankruptcy proceedings.

The issue with blockchain-based resources in bankruptcy proceedings begins with how to identify these resources; the SEC and the CFTC have provided a starting point as they have, respectively, defined these resources as either monies or commodities. The problem amplifies, however, when a bankruptcy court incorrectly defines the resource at issue, which could effectively prevent the trustee or creditor from recuperating the full value of the resource. 

Under 11 U.S.C.A. § 550(a) (the U.S. Bankruptcy Code), a trustee may recover the property transferred or if the court so orders, the value of such property. When the item transferred is currency, the trustee would be entitled to only the historical value at the time of the transfer; when property is transferred, however, the trustee would be entitled to receive the value of the property at the transfer date or the time of recovery, whichever is greater. The uncertainty in both the identification and valuation of these assets directly impacts how much—or how little—one might recover. For example, a Chapter 11 debtor whose primary asset is bitcoin may have sufficient assets to satisfy creditors in full one day, but the debtor may be insolvent the next.

Inevitably, this uncertainty creates some trepidation for prospective borrowers; blockchain, bankruptcy, and securities lawyers, however, should seize this opportunity to structure loan term sheets and credit arrangements for digital assets with two objectives in mind: 1) to put debtors on notice if debtors attempt to circumvent repayment by exploiting the loopholes in the U.S. Bankruptcy Code; and 2) to streamline potential in-court and out-of-court bankruptcy proceedings. Structuring these arrangements to address blockchain-related gaps in the law, such as asset valuation, identification, and ownership, are just several ways in which practitioners can help both creditors and debtors transact with reassurance and efficiency. The question, then, is how?

First, if the debt contract or credit arrangement between the creditor and debtor involves a digital asset, the contract must have a rigid classification of whether the asset will be qualified as a “currency,” “security” or a “commodity.” This classification, moreover, should include the valuation and timing mechanics of U.S.C.A. § 550(a) to place a floor and limit on the amount at issue. If a dispute based on this contract or arrangement were to make it to court, the lawyers for the parties at interest have eliminated tasking the court with this responsibility, as a distorted classification or valuation of the resource at issue may leave a party with either an insufficient recovery or a potential windfall.

Second, during due diligence, the lawyers for both parties must emphasize access to a blockchain ledger for the parties at interest so they can: 1) validate transactions and ownership of assets simply by accessing the blockchain ledger; 2) track any manipulation or transfer of these assets; 3) create a qualifying bid schematic for any potential asset sales; and 4) structure an outline for claims administration prioritizing lenders in the order, and amount, which they lent. This structure would allow trustees and fiduciaries to track assets more efficiently than fiat money, as digital assets on a blockchain ledger are incorruptible. This structure would also be more cost efficient than it would be for tracing fiat money, as gaining access to bank documents in the event of a bankruptcy proceeding may significantly delay the process.

Lastly, to avoid the fear of fraud, Bankruptcy Rule 2004, Section 341 allows for a meeting of creditors and examinations where a trustee will examine a debtor’s assets, liabilities, and bank records—a meeting of this nature should be implemented into the debt contract and subject any potential fraudulent debtor to consequences, either civil or criminal, if a debtor materially omits a fact in the representations and warranties phase that is later uncovered in a bankruptcy proceeding. While debtors may be apprehensive to agree to this provision at first, it substantially deters the possibility of a debtor circumventing repayment based on fraudulent representations.

Although courts have yet to peg a uniform definition to blockchain-based digital assets, that does not mean that financing arrangements involving these assets must stall. In fact, practitioners should use this gap to their advantage since it creates an opportunity to provide creditors, debtors, bankruptcy courts, trustees, and fiduciaries with reassurance through a flexible, digital-asset based credit and lending agenda.

***

We would like to thank Armando E. Martinez for his contribution to this article.

Blockchain Automotive

Can Blockchain be the Driving Force for Autonomous Vehicles?

By: Jon Avidor

A key issue in today’s automotive industry is that many processes and data storage are manual and paper-based, leading to inaccuracies, disputes, and high transaction costs. Out of 1,314 automotive executives surveyed across 10 countries, 62% of these executives reported that blockchain would be a “disruptive force” in the automotive industry within three years. Equipment manufacturers and suppliers are looking to create privacy safeguards and change how they store information. The need for blockchain technology stems from the change in the once linear structure of the automotive industry, which was simply between suppliers, manufacturers, and dealers. Through globalization, regulation and technological advancements, the automotive industry has expanded so significantly that industry executives believe it calls for a shared ledger to centralize all of its intertwined processes.

While the automotive industry has not yet implemented blockchain technology, research and development of certain technologies are starting to take place. The University of Nevada, Reno’s Intelligent Mobility Initiative is working with the Nevada Center for Applied Research and Filament to develop blockchain internet of things (“IoT”) technology to create greater safety for autonomous vehicles, which market is expected to increase exponentially between 2019 and 2026.  IoT applications maintain a ledger of how devices interact. Testing is scheduled to begin soon, where Filament’s Blocklet Technology will be integrated into an autonomous vehicle, and the surrounding infrastructure will be placed with sensory functions. The sensory technology includes light detection and ranging (“LIDAR”) and dedicated short-range communications (“DSRC”). The testing phase aims to confirm this technology’s use in accurately documenting events and enabling data exchange through blockchain transactions.

This isn’t Filament’s only involvement in revolutionizing the automotive industry. The remanufactured automotive parts industry estimated by a U.S. International Trade Administration’s Industry Assessment to be approximately a $100 billion global industry. However, the business logistics of these operations make this subset of the automotive industry incredibly complicated and expensive. Filament’s Blocklet Technology is also helping manufacturers create new remanufacturing opportunities through reduced costs and increased efficiency. This technology aids in payment processing and implements smart contracts. The U.S. Department of Transportation (“DOT”) estimated that certain safety applications using vehicle-to-infrastructure (“V2X”) and vehicle-to-vehicle (“V2V”) communications could alleviate or eradicate up to 80% of non-impaired crashes. Since as early as 2014 the DOT has been exploring the use of V2X and V2V technology to allow vehicles to communicate with infrastructure and each other to prevent car accidents. The technology in cars today includes sensors that have a limited range and a delay in relaying data. V2V technology is a step-up because it shares information in real time. However, V2X uses blockchain technology to enable these communications.

Companies are taking note of the use of blockchain-based sensory functions in automated vehicles and are moving forward in filing patents. In April, IBM received a patent for a blockchain application that will manage data and interactions for autonomous vehicles. This V2X technology will intake sensory data from the vehicle and surrounding infrastructure and store the data into a private blockchain system. General Motors filed a similar patent in December. General Motors, BMW, Ford, Honda, and Renault are only a few members of the Mobility Open Blockchain Initiative (“MOBI”) – a non-profit organization created to support the creation and implementation of blockchain technology in the mobility industry.

Car manufacturers aren’t only utilizing blockchain for autonomous driving data and safety. Hyundai is developing a program that allows drivers to connect their Hyundai electric vehicles with their smartphones to customize certain vehicle functions. The application will allow drivers to adjust performance features of the vehicle from their phone. Blockchain technology and its variety of uses in the automotive industry is well on its way to becoming a reality.

***

We would like to thank Rachel Behar for her contribution to this article.

graphic for the 10th annual montauk music festival

Please Join Us at the Montauk Music Festival

By: Steve Masur

Steve Masur spoke at the Montauk Music Festival on May 17th, 2019.

The Montauk Music Festival (MMF) is a volunteer-run, grassroots live music event designed to celebrate, support, and promote the thriving Montauk music scene while showcasing and stimulating the burgeoning artistic, commercial and pedestrian activity in Montauk.  The festival would not be possible without the generous support by businesses and individuals, who, like the festival organizers, are dedicated to nurturing this vital component of the area’s culture.  MMF is a Montauk Sun Production.

MMF is a four-day musical celebration featuring talented up-and-coming independent artists, set against the backdrop of one of the most idyllic beach communities on the east coast – Montauk, NY. Except for the Opening Party on Thursday night at the Westlake Fish House, it is a FREE event. Over 400 artists boasting a wide variety of musical styles (from alternative, rock, folk, pop, Americana, reggae, blues, jazz, bluegrass, to flamenco, hip-hop, country, and more), will be performing for free in the spirit of sharing original music -through showcases -with audiences and fellow musicians.

For more information and tickets for the festival, please use this link.

Is Ethereum a Security?

By: Steve Masur

SEC Chairman Jay Clayton recently confirmed in a letter that Ethereum and similar cryptocurrencies are not securities. This letter was in response to Representative Ted Budd’s letter asking the SEC to clarify the criteria used in determining whether a digital token offered or sold is an investment contract and thus is an offer or sale of a security. Ever since SEC Director William Hinman’s June 2018 speech, where he announced Ethereum and other similar cryptocurrencies are not securities, the crypto community has been wondering whether these remarks, in fact, reflect the beliefs and policies of the SEC – despite his disclaimer that his statements reflect his own opinions only. Generally, his speech concerns when a digital asset is offered as an investment contract and is thus a security.

There were several key takeaways from Director Hinman’s speech:
1. A token itself is not a security, but the transactions pursuant to which a token is distributed may be a securities transaction.
2. The Bitcoin and Ethereum networks are currently decentralized enough that the disclosure rules in federal securities laws would add little value. Further, other networks could become decentralized enough such that the tokens that are on these networks do not need to be regulated as securities.
3. Drawing on the well-known Howey Test, the form of a transaction is less important than the economic reality of it. The sale of tokens may qualify as a securities transaction where the tokens are sold in efforts to fund an enterprise, and where the token purchasers rely on the efforts of a third party to see a profit.
4. Lists of relevant factors in assessing whether a third party is driving the expectation of a return on a digital asset, and in determining when the sale of tokens may be a securities transaction.
5. The way that securities laws are applied to token distributions may impact the securities treatment of the token or sale in secondary transactions.

Chairman Clayton reiterated that whether a digital asset is an investment contract, and thus a security, depends on the application of the Howey Test and its progeny, including the Forman Test. While he didn’t specifically mention the consumption/consumer use test from Forman – finding that when a purchaser is motivated by a desire to use or consume the item purchased – it is assumed that this test applies. Chairman Clayton agreed with Director Hinman that the analysis of whether a digital asset is offered or sold as a security can change over time – that a digital asset may be initially offered or sold as a security, but that this designation as a security can change if the digital asset is offered or sold in a way that no longer meets the definition of an investment contract. He further agreed with Director Hinman that a digital asset transaction may no longer qualify as an investment contract if a purchaser no longer reasonably expects a third party to generate a return.

Chairman Clayton said that networks such as Ethereum and similar coins are sufficiently decentralized such that they are not investment contracts, and thus not securities. Although he didn’t specifically say it in his letter, he has mentioned in the past that Bitcoin is not a security. It is clear that a coin, alone, is not a security. It’s about the method in which the coin is offered or sold that makes it a security. If a coin is sold to fund an enterprise and the purchasers of the coin are relying on the efforts of a third party to make a profit, the coin is likely to be deemed a security. While this increased clarity is helpful in providing some general rules of thumb to consider in determining whether a digital asset could be considered a security by the SEC, it has also left open many questions that would need to be answered for this to achieve the level of real guidance.

What is the meaning of sufficiently decentralized, and at what point does a network become sufficiently decentralized? Networks will want to know more from the SEC on what this looks like, so they know what to expect. What does the SEC consider to be a similar coin, and what factors do they use to determine this? This is still an open question, and it may be wise to wait and see what coins the SEC deems to be similar to Ethereum, before assuming that a coin is not a security. The main takeaway from the letter is that the SEC is going to move slowly and carefully in providing guidance.  So for the time being, it is safest to presume a new digital asset might be considered to be a security in the US unless you are confident you can prove otherwise if tested in a court of law.

If you have further questions about a digital asset you plan to create, we can help you develop a good legal strategy for how to remain compliant when releasing it, both in the US and abroad.

***

We would like to thank Rachel Behar for her contribution to this article.

Wyoming blockchain MG+

Wyoming’s New Frontier for Blockchain and Digital Assets

By: Steve Masur

Wyoming, generally known for its great skiing and cowboy culture, is also quickly becoming an oasis for blockchain technology-based companies. The Wyoming legislature recently passed three blockchain-friendly laws—totaling 13 in the past two legislative sessions—that allow corporations structured under the Wyoming Business Corporations Act (“WBCA”) to facilitate transactions involving digital assets. By defining digital assets as both “virtual currency” and “utility tokens,” Wyoming is now the first state to place blockchain-based assets into their own distinct asset class, seemingly positioning itself as the go-to destination for blockchain-based commercial activity.

Wyoming’s blockchain-friendly ecosystem entices companies to incorporate in its state, such that competition with Delaware is imminent. Although Delaware still offers a tax and corporate-friendly environment for businesses, it has yet to establish a friendly legal framework for companies engineered around digital assets and virtual currencies. Other states have either labeled digital assets and virtual currencies as a “security” or a “commodity.” Since the Securities Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) have defined virtual currencies as “securities” and “virtual commodities”, respectively, businesses that are incorporated under Delaware law or transact with virtual currencies face the specter of answering to these agencies, potentially jeopardizing their operations.

The Wyoming legislature, by contrast, has taken the reins on defining digital assets as “virtual currencies” and “utility tokens”, placing these mediums of exchange into their own unique terminology buckets under Wyoming law. Since these benefits under Wyoming law only apply to businesses incorporated under the WBCA, blockchain-based companies have begun heavily considering Wyoming as their entities’ state of organization. Should Wyoming keep its current pace of enacting blockchain-friendly legislation, we can expect a paradigmatic shift in the number of companies, especially blockchain-based ones, spurning Delaware to incorporate in Wyoming.

Wyoming’s legal classification of digital assets as “virtual currencies” and “utility tokens” provides these assets with the same legal treatment as money under Article 9 of the Uniform Commercial Code (“the UCC”). Under UCC 9-332(a), “[a] transferee of money takes the money free of a security interest unless the transferee acts in collusion with the debtor in violating the rights of the secured party.” Eliminating the security interest requirement allows blockchain-based companies to issue, lend, and borrow virtual currency without the need of a financial intermediary, such as a bank. In the context of issuing blockchain-based tokenized assets, cutting out the middle person may incentivize Wyoming-based companies to conduct more token offerings as a capital raising strategy.

The lack of clarity in defining these tokens at the federal level puts digital currency exchanges, such as Coinbase and Gemini, under vast scrutiny when conducting token-based offerings, since courts have interchangeably classified these currencies as both “securities” and “commodities.” This has impeded courts’ ability to clearly establish the rights of investors in these offerings, as many have received a fraction or nothing of what they were promised in the offering. By treating virtual currency and fiat currency as the same, legally speaking, Wyoming has legitimized token-based offerings bilaterally for issuers and consumers, as Wyoming-based exchanges may now conduct token-based offerings sans a financial intermediary and provide consumers with established rights under these offerings. Eliminating the hassle of dealing with a financial intermediary, while also providing greater security for prospective token offering investors, makes Wyoming an attractive destination for future digital currency exchange startups.

Wyoming’s legislative treatment of digital assets as money under the UCC has exempted owners of blockchain-based digital assets from paying property taxes on these assets. That is, Wyoming will treat these assets like fiat currency, but they will not have the same tax implications of United States currency, as the legislature does not recognize digital mediums of exchange as legal United States fiat currency. This is the icing on the cake for Wyoming-based blockchain companies, as their digital assets can be placed in a Wyoming bank as a store of value, free of any state property tax concerns.

Given Wyoming’s friendly treatment and definition of digital consumer assets, we will likely see a sharp increase in blockchain-related commercial activity in the state. In fact, Wyoming’s flurry of blockchain-friendly legislation indicates that the state is positioning itself to be the virtual currency hub of the United States. Should other states follow suit? If Wyoming’s economy creates a gold rush environment, we could see a legislative arms race among the different states to emulate Wyoming’s virtual currency legislation.

***

We would like to thank Armando E. Martinez for his contribution to this article.