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Cryptocurrency Crackdown: What You Need to Know about Enhanced IRS/Government Scrutiny of Cryptocurrency Transactions May 16, 2018 Speakers Basil Godellas Lawrence Hill Rachel Ingwer Partner and Co-Chair, Disruptive Partner and Chair,


  1. Cryptocurrency Crackdown: What You Need to Know about Enhanced IRS/Government Scrutiny of Cryptocurrency Transactions May 16, 2018

  2. Speakers Basil Godellas Lawrence Hill Rachel Ingwer Partner and Co-Chair, Disruptive Partner and Chair, Federal Partner, Tax Technologies Task Force Tax Controversy Practice ringwer@winston.com bgodellas@winston.com lhill@winston.com +1 (212) 294-4760 +1 (312) 558-7237 +1 (212) 294-4766 Beth Kramer Michael Loesch Richard Nessler Partner, Corporate Partner and Co-Chair, Disruptive Of Counsel, Tax bkramer@winston.com Technologies Task Force rnessler@winston.com +1 (212) 294-6646 mloesch@winston.com +1 (202) 282-5638 +1 (202) 282-5638 2

  3. SEC and CFTC Regulations

  4. The Regulators – SEC and CFTC • What is the current regulatory landscape for cryptocurrency and digital token offerings (“ICOs”) in the U.S.? • The SEC has asserted jurisdiction over most if not all digital tokens and ICOs (presumably except Bitcoin (BTC)) • and is reviewing “virtual currencies”? • CFTC has asserted jurisdiction over Bitcoin (BTC) • and is reviewing other “virtual currencies” 4

  5. Cryptocurrency and token offerings (“ICOs”) in the U.S. – not much is settled between the SEC and CFTC . . . . • Apart from BTC, both the SEC and the CFTC have stated that many other virtual currencies and ICOs have characteristics of a virtual currency and/or a security. • May 14 th – WSJ reports the CFTC is pushing the SEC to make up its mind on Ethereum or ETH. 5

  6. Definitions? • “Virtual currency” a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, but does not have legal tender status in any jurisdiction.” • Generally consistent across the CFTC, SEC and the IRS. • “Crypto currency” a type of virtual currency that uses various cryptography to provide additional functionality, including additional security, verification of transactions and in many cases anonymity. • “Digital Token” something that represents a digital asset, whether a crypto currency or a block-chain based smart contract. • “Utility Token” a Digital Token that is not a security subject to the SEC’s jurisdiction or a virtual currency subject to the CFTC’s jurisdiction (e.g. “a token that represents an interest in a book-of-the-month club” – SEC Chairman Clayton December 11, 2017). 6

  7. The Securities Exchange Commission (SEC) • The SEC has asserted jurisdiction over most Initial Coin Offerings (and virtual currencies?). • The DAO Report – July 2017 (discussed below). • SEC Chairman Jay Clayton – Statement on Cryptocurrencies and Initial Coin Offerings December 11, 2017. • “...the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities.” • “merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security”… • “while there are cryptocurrencies that do not appear to be securities, simply calling something a “currency” or a currency-based product does not mean that it is not a security.” 7

  8. How did we get here with the SEC? • Early Cases/Enforcement Proceedings – Most are Ponzi Schemes and Unregistered Offerings of Shares (not ICOs) for Bitcoin (BTC). • Bitcoin was launched in 2009. • SEC vs. T. Shavers and Bitcoin Savings and Trust (July 23, 2013). SEC files a complaint alleging that defendant offered investments in return for bitcoin, promised outsized returns and was essentially operating a Ponzi scheme . • SEC Investor Alert : Bitcoin and Other Virtual Currency-Related Investments (May 7, 2014). • In the Matter of BTC Trading Corp. and Ethan Burnside (December 8, 2014). The SEC orders respondent to cease and desist operating LTC-Global Virtual Stock Exchange and BTC Virtual Stock Exchange as unregistered, securities exchanges and brokers dealers. Other violations of securities laws are asserted. • In the matter of Erik T. Voorhees (June 3, 2014). The SEC orders respondent to cease and desist from offering shares of FeedZeBirds and SatoshiDICE in exchange for BTC without registering the shares or relying on an exemption from registration. 8

  9. How did we get here? (Cont’d) • SEC vs, Garza, GAW Miners LLC and ZenCloud (December 1, 2015). SEC alleged that defendants violated the securities laws by offering “hashlets” without registering the hashlets or relying on an exemption from registration, as well as committing securities fraud. • In the Matter of Sand Hill Exchange (June 17, 2015). SEC orders respondents to cease and desist from offering security-backed swaps that were bought and sold using linked to the valuation of startups, based on “smart contracts”. Some users bought products using BTC. The security- based swaps were sold in violation of the Dodd Frank Act and the “smart contracts” did not exist. • SEC Investor Alert : Beware of Fantasy Stock Trading Websites Offering Real Returns June 17, 2015. 9

  10. How did we get here? (Cont’d) • In the Matter of Bitcoin Investment Trust and SecondMarket Inc. (July 11, 2016). SEC orders respondents to cease violating Regulation M. Bitcoin Investment Trust’s only assets were BTC and it sold shares in a private placement in exchange for BTC. BIT, via its affiliate, SecondMarket, a registered broker dealer, began a shareholder redemption program which violated Rules 101 and 102 of Regulation M. • SEC vs. Haddow, Bar Works, 7th Avenue and Bitcoin Store (June 30, 2017). Defendant Haddow allegedly operated an unregistered broker dealer to sell securities in a few companies, one of which was Bitcoin Store, a platform for customers to hold and trade BTC. Among a number of alleged violations of law, the offering materials misrepresented material facts about the companies in violations of the Securities laws. 10

  11. The DAO Report – July 2017 • Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (the “DAO Report”). • The SEC analyzes an ICO for the industry – a warning . . . • In the DAO Report, the token holders exchanged Ether for Virtual DAO Tokens to fund projects in which the investors would share in anticipated earnings. 11

  12. The DAO Report – July 2017 (cont’d) • The SEC analyzed the DAO tokens under the 1946 case, SEC vs. Howey which “generally” has 4 elements: • 1) Is there an investment of money? • Yes, Ether for DAO Tokens • 2) In a common enterprise? • Yes, the DAO organization • 3) With a reasonable expectation of profit? • Yes, token holders expected a return on investment. • 4) Derived from the entrepreneurial or management efforts of others. • DAO curators reviewed proposals, and the token holders had limited voting rights and were relying on management. 12

  13. SEC – Next Steps • The SEC left the door open at that time to analyze each token to determine whether the facts and circumstances (Howey factors) are met. • SEC Investor Bulletin July 25, 2017 – “Depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities.” • September 25, 2017, the SEC launches a new Cyber Unit that focuses on violations involving ICOs. • SEC Investor Alert : Celebrity Endorsements (November 1, 2017). 13

  14. SEC – Next Steps (cont’d) • In the Matter of Munchee Inc. (December 11, 2017) • Munchee creates an iPhone app for people to review restaurants. Munchee alleges that it has conducted a “Howey” analysis and found that MUNs were not securities (i.e. utility tokens). The SEC finds that MUN Tokens offered by Munchee to raise capital to improve the app and recruit users is a security. The SEC also focuses on Munchee’s marketing efforts. • The SEC contacts Munchee, no tokens had been delivered yet and Munchee returns all proceeds. • Late 2017/Early 2018 – Chairman Clayton speaks (see previous slide). • Since then, more enforcement actions and cease and desist orders: SEC v. Arisebank (Jan 25, 2018); SEC vs. Bitfunder (February 21, 2018); Centra Tech, Inc. (April 2, 2018; amended April 20, 2018) and SEC v Longfin Corp (April 6, 2018). 14

  15. Takeaway • In the current regulatory environment, digital tokens most likely will be viewed as securities by the SEC until proven otherwise and ICOs must comply with the securities laws . • Register tokens as securities under the Securities Act (but not certain the SEC will approve given the retail nature of a registered offering). • Rely upon a private placement exemption from registration. 15

  16. Digital exchanges - regulatory and legal challenges • On March 7, 2018, the Division of Enforcement and Trading and Markets of the SEC stated that if a trading platform offers trading of digital assets that are securities (including ICOs which the SEC views as securities) and operates as an exchange, than the platform must register with the SEC as a national securities exchange or be exempt from registration as an “ATS” or Alternative Trading System. • An SEC registered exchange is the equivalent of the NYSE; a self regulatory organization (or SRO) with robust policies and procedures. • An ATS is registered with the SEC as a broker dealer and becomes a member of and SRO. 16

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