Author: Kelly McElroy

3 Ways Crypto Prepares for Looming Regulation

Posted on by Kelly McElroy

Uncle Sam is taking “internet money” seriously.

As a result, elected officials are spending more time talking about crypto.

Do you know what that means? Regulation will follow the buzz.

In an interview with Yahoo!, U.S. Rep. Jim Himes (D-Conn.) characterized the current crypto climate as a showdown with Securities Exchange Commission Chairman Gary Gensler: “We’re sort of in a vapor lock around this issue of the registration of entities, exchanges, etcetera with Gary Gensler at the SEC saying, ‘I don’t need more statute. I’ve got all the law I need. What I need is for people to comply.’ And, of course, many people are saying, ‘Well, we don’t agree with that, and we are not going to comply’. So that suggests we are going to need to figure out whether additional statute is necessary, and Gary Gensler is wrong or whether Gary Gensler just needs to do a lot more enforcement to get people to see his point of view, that they should be registering under existing law.”

To make things more interesting, former SEC Chair Jay Clayton disagrees with Gensler’s stance, asking the agency to provide guidance on the custody of tokenized assets. In an op-ed piece, Clayton said the SEC should take the next step and present guidelines for crypto assets.

In the meantime, Gensler has embraced regulation through enforcement. He firmly believes the existing security laws on the books are fine for crypto.

So, what’s the play?

Here are three moves that will help small/midsize crypto companies prepare for looming regulation:

Register With The SEC

There remains a cavalier mindset about crypto. And that needs to change.

Crypto is not like going outside and throwing the frisbee, even though there is social media chatter about “going to the moon.” It is not fun and games; Crypto is an actual financial asset that has value. The notion that crypto is a novel, foreign idea wrapped in technology needs to give way to reality.

To protect your company, now is the time to register with the SEC. Long-awaited regulation for cryptocurrency is on the horizon. It is better to prepare now to fit into the current scheme than sit on the sidelines.

Do not wait for the government’s final verdict. Err on the side of caution. It is better to fill out more paperwork and “over-comply” than wait one year later to have the Securities Exchange Commission come knocking. When the agency files a complaint against your company, your reputation could take a hit—along with a hefty legal bill.

Eliminate ‘Dirty’ Money

Part of crypto’s allure is its anonymity, which could make it a prime vehicle for fraudulent activity that includes funding for terrorism. The government will soon introduce regulations that strongly encourage crypto companies to have anti-money laundering programs in place.

No matter how small your company is, you will need to have a designated compliance officer on the payroll. This person can perform other duties, but they must have the title. They also must maintain written policies and procedures. The anti-money laundering plan should be well thought out and detailed, not a two-page report. Ideally, your compliance officer would have the proper credentials, such as the ALMA designation, and appropriate experience. Each organization involved in a chain of transactions involving “dirty money” is accountable.

Sens. Elizabeth Warren (D-Mass.) and Roger Marshall (R-Kan.) have introduced The Digital Asset Anti-Money Laundering Act of 2022, which extends the Bank Secrecy Act. The objective is to subject crypto companies to the same rules as banks and broker-dealers. The bill would address a gap with digital wallets and prohibit financial institutions from transacting with forms of technology that enhances anonymity. Last summer, the currency-mixer Tornado Cash was sanctioned by the U.S. Department of Treasury, alleging money laundering activity with North Korea.

Add A Layer of Governance

Governance is a big part of compliance.

Board members can play a pivotal role. You will need seasoned professionals in many areas, ranging from marketing to technology. Make sure you have board members with deep experience in finance, compliance and internal controls.

Know Your Customer (“KYC”) is a process that identifies your customers and their activities. From a corporate level, do you have the entity’s EIN, articles of incorporation and financial statements? For individual investors, should you recommend a volatile asset to an investor in her 90s? What’s the rest of the story? What are the procedures to address these situations?

Back in 2019, the Commodities Futures Trading Commission, Financial Crimes Enforcement Network and SEC classified crypto exchanges as money service businesses (MSBs), which means they must follow the Bank Secrecy Act of 1970, as well as the anti-money laundering and KYC rules.

While your staff manages the day-to-day operations, your board members can still be part of the mix. Give them oversight of key committees, such as risk and compliance, to provide another layer of review, which would protect the firm.

(Tyler Rutherford is an associate attorney at Pastore with expertise in regulatory compliance, contract law and corporate law. He represents a wide range of clients, including crypto and blockchain companies.)

Pastore represents founder of only Private Mountain Ski Club on the East Coast in Federal Court Settlement

Posted on by Kelly McElroy

Pastore LLC represented the founder of the only Private Mountain Ski Club on the East Coast in connection with a dispute in Federal Court.  The Club, which is the East Coast version of the Yellowstone Club, is located in southern Vermont.    The dispute centered around UCC Article 9 and the complex assignment of interests in a LLC under Connecticut law.   The founder had an economic interest in a Limited Liability Company, which had an economic interest in a $11M 6 pack bubble chair, and the founder assigned that interest to a GRAT Trust.   As part of the settlement, the GRAT Trust will receive a distribution from the Limited Liability Company.   Monies will also flow to a former club employee and real estate developers.

 

 

M&A Success: 4 Ways Companies Sidestep Regulatory, Emotional Challenges

Posted on by Kelly McElroy

On paper, mergers and acquisitions look thrilling.

Diversification. Expansion. Cost savings and larger margins—in less time with fewer dollars.

The promise of M&A can be intoxicating. But here’s a sobering thought: 70% to 90% of mergers fail, according to the Harvard Business Review.

For enterprise companies, regulatory hurdles can knock down the pending merger. Reuters reports that the U.S. Justice Department and Federal Trade Commission have attempted to stop more than 20 mergers since January 2021.

For small to mid-size firms, lack of preparation and purpose may kill the deal.

In theory, it’s a common belief that integration will decide which acquisitions move forward. But in practice, people are behind the numbers and processes.

Regardless of size, here are four ways to dramatically increase your chances at M&A success:

 

  1. Begin at The End

Clarity is a great place to start.

Why are you pursuing a merger? This answer should serve as the North Star because it will impact everything that follows in the process. While proper planning will be important, anticipation will be mission critical.

To advance the deal, think about the company’s building blocks in terms of resources and processes. Those two elements yield value and profit. Developing a clear understanding of these variables will allow you to promote and defend the deal—or arrive at better terms.

How would the pending merger impact the marketplace? How would the acquisition improve your company’s performance? Asking the tough, specific questions internally about what the end result will look like will help you anticipate opportunities to address. In M&A deals, being strategic means beginning at the end because it will ensure that every step along the way is tied to the desired outcome.

 

  1. Eliminate Emotion

 

Your exit strategy should be mapped out during the prep stage. This scenario represents the bare-minimum that you will accept in a negotiated agreement. Otherwise, you will walk.

This simple tactic removes emotion from the deal. Typically, negotiations that drag on tend to motivate players to hang on to finalize the deal for the wrong reasons, which may not be a logical fit with your original plan.

As part of a more logical approach, you should develop a list of specific commitments that you could offer to regulators, or the other party. These commitments should be specific, measurable, attainable and have a realistic time frame. Creating this list in advance will allow you to run the numbers and determine which items you can concede in the most cost-effective manner.

Game Theory is a normal part of negotiations, which is a dance that revolves around give and take. Make sure you understand the value of each move before you take it.

 

  1. Build Trust

 

Trust is a special kind of currency leveraged during M&A negotiations. So, spend it wisely.

Open communications will go a long way toward building a relationship with the other side. From the very beginning, you will need to provide prompt, purposeful and intelligent responses. Delaying a request could stir skepticism and trigger an unfavorable outcome. It’s not uncommon for parties to walk away at the onset if they have a bad “feeling,” which is often created from poor communications.

Anticipating inquiries is also imperative. As part of your preparation, you will need to envision the possible questions and pain points in advance so you can quickly provide an advantageous solution.

To continue building trust—it’s a process—you will need timely financial statements, including monthly, quarterly and annual statements, to show them that your financial house is in order. The worst thing that can happen is that they see something that surprises them.

Establishing open communications, built on transparency and honesty, is invaluable. In part, that means timely responses and organized financials.

 

  1. Stack the Deck

 

Take it from someone who played in the NFL, the teams with the best players tend to win.

In the M&A game, assemble a winning team of experts to increase your chances for success. A tax advisor and business consultant should be on the list and at least one consultant should be familiar with valuing companies in the target industry.

You will also need internal stakeholders, such as your chief finance officer and controller, to be part of your team. These employees, along with the chief operating officer, will be responsible for telling and supporting the story.

And your attorney will bring it all together and keep it moving along.

Collectively, your team will be accountable for building good faith and goodwill throughout the process. They will amplify the positive and address the challenging items directly to bolster the relationships that get the deal done.

Amid the columns of numbers strewn across spreadsheets, you will always find people.

To close your next M&A deal, start there to seal success.

 

(Paul Fenaroli is an Associate Attorney at Pastore. His practice focuses primarily on corporate law, contract law, employment law and regulatory compliance involving M&A activities.)

 

Pastore Alum Susan Bysiewicz Sworn in for Second Term as Connecticut LT. Governor

Posted on by Kelly McElroy

Susan Bysiewicz, the former Secretary of State for the state of Connecticut, was a partner with Pastore (then Pastore & Dailey) for several years, running the firm’s office in Glastonbury, CT. She left to run for Governor, and has been elected now to her second term as Lt. Governor. While at the Firm, Ms. Bysiewicz worked on corporate, banking and election law matters. A graduate of Yale University and Duke Law School, Ms. Bysiewicz serves with Connecticut Governor Ned Lamont.

Pastore Overcomes Summary Judgment Motion in Multi-Million Dollar Greenwich Hedge Fund Dispute

Posted on by Kelly McElroy

Earlier this month, Pastore successfully defended former hedge fund manager’s claims of unfair trade practices against investment vehicles established by heirs to a multi-billion dollar national retail company. Hon. Sheila Ozalis, presiding over the Stamford, CT Complex Litigation Docket, held that genuine issues of material fact exist as to whether defendants’ conduct was unfair and/or deceptive in a manner violating the Connecticut Unfair Trade Practices Statute.  Accordingly, plaintiff’s claims, which related to the unfair attempt to deflect an investment commitment from one of world’s largest hedge funds to a potentially competing fund, will proceed to trial.

FTX’s Bankruptcy Shines Light on Selling Trade Claims

Posted on by Kelly McElroy

In the wake of FTX’s downfall and bankruptcy filing, more crypto companies are expected to file for bankruptcy.[1] With a tumultuous year in the crypto world, creditors have been left with billions of dollars worth of claims. Unfortunately, bankruptcy proceedings can take years to resolve, thus leaving a creditor in a state of limbo and waiting to learn what portion of its claim will be paid out. As a result of this uncertainty, creditors may wish to consider selling their claims.[2] By selling a claim, a creditor can receive an upfront payment for the claim instead of monitoring the debtor’s bankruptcy case for years. Reconciling and distributing claims in the bankruptcy process is notoriously slow, particularly for very large debtors such as FTX.

Unlike stocks, bankruptcy claims are not sold or traded on the New York Stock Exchange. Instead, creditors must sell their claims through individually negotiated assignment agreements.[3] While there are no standardized forms for claim assignments, creditors tend to use assignment agreements that contain universally accepted terms in addition to negotiating the details, such as whether the buyer can force the creditor to repurchase the claim. Conveniently, creditors do not need to disclose the purchase price or other details of the assignment in the bankruptcy process.

While the prospect of quickly monetizing a claim may be enticing to a creditor, a creditor should consult an attorney to ensure that risks, such as the purchase price being returned to the buyer if the claim’s validity is questioned, are considered and mitigated. We are confident a market for FTX bankruptcy claims will emerge over the next 60 days.

[1] MacKenzie Sigalos and Rohan Goswami, Crypto firm BlockFi files for bankruptcy as FTX fallout spreads, CNBC (Nov. 28, 2022), https://www.cnbc.com/2022/11/28/blockfi-files-for-bankruptcy-as-ftx-fallout-spreads.html.

[2] Bruce S. Nathan and Scott Cargill, A Primer on Selling Bankruptcy Trade Claims, Business Credit (Feb. 2021), https://www.lowenstein.com/media/6418/nathanpluscargill-a-primer-on-selling-bankruptcy-trade-claims-business-credit-22021.pdf.

[3] Bankruptcy Claims Trading: What is it? How do I maximize my returns?, Nossaman (Mar. 25, 2010), https://www.nossaman.com/newsroom-insights-bankruptcy-claims-trading-what-how-do-i.

Pastore Negotiates Top Executive’s Separation from Publically Traded Boston Based Bio Tech Company

Posted on by Kelly McElroy

Pastore LLC successfully negotiated the separation of C-suite executive from a publically traded Boston based bio-tech company. Key issues involved the vesting of stock options and related plan documents, adherence to Rule 144 in the disposition of stock and the scope of non-competition agreements under Delaware law.

How the SEC’s New Marketing Rule Affects Investment Advisors’ Advertising Awards and Third-Party Ratings

Posted on by Kelly McElroy

On December 22, 2020, the Securities and Exchange Commission (“SEC”) announced new rules regarding advertising and marketing for investment advisors.[1] The SEC passed the new rules to synthesize and modernize their “Advertising Rule” and “Cash Solicitation Rule” into a new, singular rule designed to regulate investment advisers’ marketing communications.[2] This new rule, 206(4)-1, also known as the “Marketing Rule,” applies to all advertisements. The SEC provided a new definition of what an advertisement is under the Marketing Rule.[3] The revised definition of advertisement has two parts:

First, the definition includes any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser’s investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors. The first prong of the definition excludes most one-on-one communications and contains certain other exclusions.

Second, the definition generally includes any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes, and reduced advisory fees).[4]

Following the definition, which now includes endorsements or testimonials that promote awards won by the investment advisor, the SEC lists prohibitions.[5] The Marketing Rule prohibits advertisements, “including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced.”[6] SEC-registered investment advisors (“RIAs”) must follow the standards set by the Marketing Rule and transition their advertisement of awards won and their performance results. The SEC provided an 18-month transitional period for SEC-registered investment advisors to conform to the new Marketing Rule.[7] The 18-month window closed on November 4, 2022, and the SEC now requires full adherence to the rules.[8]

RIAs seeking to promote third-party ratings, rankings, awards, and performance results through advertisements and social media are directly impacted by this new rule. The SEC dedicated an entire section to third-party ratings in its issuing release, so it is essential for RIAs to be in compliance. The SEC states Rule 206(4)-1(c) will “prohibit an investment adviser from including a third-party rating in an advertisement unless certain conditions are met.”[9] Because of the SEC’s consideration of third-party ratings and awards as advertisements, the advertisement must follow general prohibitions.[10]

The Marketing Rule prohibits making untrue statements of material fact. If the third-party rating entity is credible and the advisor does not use the rating inappropriately, then the prohibitions can be avoided.[11] If the RIC plans to advertise one kind of service when the rating is for another kind of service, the Marketing Rule prohibitions apply.[12]

Additionally, a third-party rating agency providing the rating or award must generate ratings as part of their normal course of business.[13] The RIA also must fulfill two requirements to show the third-party rating or award is presented equally. First, they must show due diligence. The RIA must “have a reasonable basis that any questionnaire or survey used in the preparation of the third-party rating is structured to make it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result.”[14] To comply with the due diligence requirements, RIAs can look at the rating methodology and show the rating is not one-sided or seek representations from the third-party rating agency regarding general aspects of how the survey or questionnaire is designed, structured, and administered. Alternatively, a third party rating provider may publicly disclose similar information about its survey or questionnaire methodology.

The second requirement is disclosure.[15] The RIA must disclose, or ensure the third-party rater has disclosed the date the rating was given, the identity of the third-party that created and tabulated the rating, and if compensation has been provided directly or indirectly by the adviser in connection with obtaining or using the third-party rating.[16] When presenting the rating, the RIA must ensure these disclosures are presented with equal prominence as the rating itself.[17] With the additional attention of the due diligence and disclosure requirements of the Marketing Rule, promoting ratings and awards continue to be possible as long as they are credible.[18]

With the SEC’s focus on solicitation activity regarding awards and ratings, it is imperative of RIAs to review and update their policies and procedures for the publication of awards on their websites, communications, and social media. Given the complexity of the Marketing Rule and the scrutiny of advertising practices, investment advisers should be fully engaged in implementing new policies for their advertisements in compliance with the Marketing Rule.

[1] SEC Adopts Modernized Marketing Rule for Investment Advisers, U.S. Securities and Exchange Commission, (Dec. 22, 2020), https://www.sec.gov/news/press-release/2020-334.

[2] Scott L. Beal, Kerry Potter McCormick, Scott Budlong, Travis Ortiz, Paige McHugh, Compliance Date Approaching For New Marketing Rule For Investment Advisers, Vol. XII, The National Law Review, 319 (2022)

[3] Id.

[4] SEC Adopts Modernized Marketing Rule for Investment Advisers, supra note 1.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] 17 CFR Part 275 and 279.

[10] Benjamin Bishop, SEC Marketing Rule: Implications for news releases that promote third-party ratings and rankings, Lowe Group Financial Communications, (Aug. 3, 2022), https://lowecom.com/2022/08/03/sec-marketing-rule-implications-for-news-releases-that-promote-third-party-ratings-and-rankings/.

[11] Id.

[12] Id.

[13] Id.

[14] 17 CFR Part 275 and 279.

[15] Id.

[16] Id.

[17] Id.

[18] Benjamin Bishop, supra note 10.

Opportunity for U.S. Backed Digital Currency

Posted on by Kelly McElroy

Cryptocurrency (“Crypto”) is an easily accessible digital asset used for financial transactions.[1] Crypto has become a source of payment on virtual platforms and utilizes blockchain technology.[2] While digital transactions eliminate the need for intermediaries such as banks, credit card companies, or third-party payment processors, it is an unregulated and volatile field.[3] The recent events with FTX highlight this issue.

The use of Crypto rose globally at an unprecedented rate during the COVID-19 pandemic.[4] Developing countries in particular accounted for 15 of the top 20 economies in 2021 using Crypto.[5] One of the most notable countries attempting to adopt Crypto is El Salvador. In 2021, El Salvador became the first country in the world to recognize Bitcoin as legal tender.[6] As such, El Salvador attempted to turn an impoverished area around the Conchagua volcano into a Bitcoin City.[7] The President of El Salvador, Nayib Bukele, hoped to create a futuristic metropolis from Crypto using the Conchagua volcano as a geothermal plant.[8] Unfortunately, President Bukele invested $100 million of government funds into Bitcoin when prices peaked, which led to a further debt crisis in El Salvador. One of the issues El Salvador and other developing countries have run into with the use of Crypto as legal tender is the volatility of the market. Since 2021, Bitcoin has dropped 61%, and El Salvador is likely to default on its debts in the next few years due to the dramatic drop in value.[9] The price of Crypto is open to fluctuation, fraud, and tax evasion due to the lack of regulation and backing by a central bank or government.[10]

One solution that has been proposed to bring stability to the Crypto market is a Central Bank Digital Currency (“CBDC”), which is a digital token, similar to Crypto, issued by a central bank. In the United States, the digital form of the token would be the equivalent of the U.S. dollar.[11] President Biden and the Federal Reserve are evaluating the creation of a U.S. CBDC and how it would work alongside the existing form of physical currency.[12]

The benefits of a U.S.-issued CBDC include privacy-protected digital currency, improvements to cross-border payments, and support to the U.S. dollar’s international role.[13] A U.S. CBDC would offer access to digital money that is free from credit and liquidity risks, unlike money held in a traditional bank.[14] Currently, Federal Reserve notes are the only central bank money available to the public. The use of a CBDC would provide a cheaper, faster form of transferring money and bring people who do not have bank accounts into the financial market.[15]

The dollar is the world’s most widely used currency for payments and investment.[16] A CBDC would expand the U.S. economy by creating a financial market with the global use of a CBDC.[17] Recently, China introduced its own CBDC, which may decrease the demand for the U.S. dollar abroad. The creation of a U.S. CBDC would allow competition on a global scale with China and other countries that have developed a digital currency backed by their central bank.[18]

Despite the benefits to the U.S. consumer and the global financial system, a U.S. CBDC has several issues. Many Americans actively use and prefer cash.[19] Additionally, there are privacy issues with digital currency. A Federal Reserve-backed CBDC system would allow the central bank to see every user transaction.[20] Additionally, banks have questioned the legal authority of the Federal Reserve to issue a digital currency without authorization from Congress.[21]

The White House, the Office of Science and Technology Policy, and the National Science Foundation continue to work on the National Digital Assets Research and Development Agenda.[22] The Executive Branch has placed a high priority on advancing research concerning Crypto and how it could provide financial inclusion and equity to Americans.[23]  While the benefits of a U.S. CBDC are plentiful, there are many moving parts to the initiation of a central bank backed digital currency in the United States. However, even with the lack of regulation and its volatile nature, Crypto is not going away. Crypto provides businesses and consumers with easily transferable, convenient, less expensive means of transferring money.[24] A U.S. backed stable coin may provide such stability. Clearly, the U.S. would not want the European Union or another Western power to issue such a coin and undermine the U.S. leadership in global currencies.

 

[1] Molly Mastantuono, Cryptocurrency 101: A Guide to Digital Dollars (Dec. 17, 2021), https://www.bentley.edu/news/cryptocurrency-101-guide-digital-dollars.

[2] Id.

[3] Id.

[4] UN trade body calls for halting cryptocurrency rise in developing countries, United Nations (Aug. 10, 2022), https://news.un.org/en/story/2022/08/1124362.

[5] Id.

[6] Joe Hernandez, El Salvador Just Became The First Country To Accept Bitcoin As Legal Tender, NPR (Sept. 7, 2021), https://www.npr.org/2021/09/07/1034838909/bitcoin-el-salvador-legal-tender-official-currency-cryptocurrency.

[7] Zeke Faux, El Salvador’s $300 Million Bitcoin ‘Revolution’ Is Failing Miserably (Nov. 4, 2022), https://www.bloomberg.com/news/features/2022-11-04/el-salvador-s-bitcoin-revolution-is-failing-badly.

[8] Id.

[9] Id.

[10] UN trade body calls for halting cryptocurrency rise in developing countries, supra note 4.

[11] Dr. Alondra Nelson, Alexander Macgillivray, Nik Marda, Technical Possibilities for a U.S. Central Bank Digital Currency (Sept. 16, 2022), https://www.whitehouse.gov/ostp/news-updates/2022/09/16/technical-possibilities-for-a-u-s-central-bank-digital-currency/.

[12] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, Board of Governors of the Federal Reserve System (Jan. 2022), https://www.federalreserve.gov/publications/files/money-and-payments-20220120.pdf.

[13] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, supra note 12.

[14] Id.

[15] Andrew Ackerman, What is a Central Bank Digital Currency and Should the U.S. Issue it? (May 26, 2022), https://www.wsj.com/articles/should-the-u-s-issue-a-digital-dollar-which-could-compete-with-crypto-assets-11646921329.

[16] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, supra note 12.

[17] Id.

[18] Boucher, supra note 16.

[19] Andrew Ackerman, Fed Launches Review of Possible Central Bank Digital Currency (Jan. 20, 2022), https://www.wsj.com/articles/fed-launches-review-of-possible-central-bank-digital-currency-11642706158

[20] Id.

[21] Id.

[22] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, supra note 12.

[23] Id.

[24] Shobhit Seth, What is a Central Bank Digital Currency (CBDC)?, Mar. 9, 2022, https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp.