The Howey Test: Would Your Crypto Offering Pass or Fail?

Before you launch your next crypto token, you should see if you can pass the test.

It is not the smell test with investment bankers.

The Howey test will help you understand if your crypto is one of many digital securities which would present more legal responsibilities, such as disclosure and registration requirements.

The U.S. Securities and Exchange Commission (SEC) v. W.J. Howey Co. was a 1946 Supreme Court decision about citrus grove buyers in Florida. The Howey Company sold citrus groves to investors who leased the land back to Howey. The company’s employees managed the groves and sold the fruit on behalf of the investors. Both the company and the investors profited from the venture.

The investors only needed to supply capital to the arrangement, while others took care of all the other details. An investment contract is what you get when your transaction passes the Howey test.

Of course, this concept impacts things beyond citrus fruit. It is also applicable to the cryptocurrency market. In fact, there are four factors to consider which separate a security from a commodity:

  • An investment
  • A common enterprise
  • A profit expectation
  • Generated from the work of third-parties

In the U.S., the SEC has deemed bitcoin not to be a security. The issuer, an anonymous Satoshi Nakamoto, released all 21 million tokens at once as part of a contract. None of the tokens went to him or a company treasury. When the tokens were released, they had no value, and when they gained value, Nakamoto did not receive any benefit.

In effect, he removed any possible connection between “common enterprise” from the other factors, which disqualifies the venture as a security under the Howey test.

SEC Chair Gary Gensler said, “at the core, these (altcoin) tokens are securities because there’s a group in the middle and the public is anticipating profits based on that group,” during an interview with New York Magazine.

However, Rostin Behnam, the chairman of the Commodity Futures Trading Commission (CFTC), said Bitcoin is not the only commodity. He called another crypto coin—Ethereum—a commodity during a hearing before the Senate Agriculture Committee. In fact, Ethereum has been listed on CFTC exchanges for some time.

An interagency council comprised of state and federal banking officials, as well as commodity, securities and consumer protection groups, agreed in a report that there is not a comprehensive regulatory framework for digital assets. Hence, the reason for differing stances within the industry.

Right now, asset classification dictates how digital assets are regulated. If it is a payment, then it falls under the purview of Money Services Business and the Office of the Comptroller of the Currency. Likewise, CFTC oversees commodities, and the SEC has jurisdiction over securities.

Recently, the SEC has filed a complaint against Binance and Coinbase, alleging that they are selling unregistered securities. The complaint mentioned several coins that could be viewed as securities: Polygon, Cardano and Solana. Soon after the announcement, Robinhood—another crypto exchange—delisted the three mentioned coins.

Binance.US has decided to become a crypto-only exchange, ending US dollar deposits and withdrawals. The SEC wants a federal judge to freeze the exchange’s assets, including $2.2 billion in crypto and $377 million held in dollars.

Either the Coinbase case or the Binance case could make its way to the U.S. Supreme Court, which could in effect create the path for industry regulation with its ruling. As part of a possible outcome, the High Court could also rewrite the Howey test or revise it in relation to digital assets.

At the 2023 Global Exchange and Fintech Conference, Gensler said congressional action is not needed because the laws are already on the books. “Not liking the law, not liking the rules is different than not hearing it or not getting it,” he said. However, this view fails to recognize that the current regulatory framework is not black and white for investors and institutional players.

Under federal securities laws, a company must register with the SEC before offering or selling securities. As part of the registration process, an issuer must disclose financial statements that have been audited by a public accounting firm. These documents provide important information that helps investors make informed decisions about their investments.

As the digital financial assets space grows, more large corporations can be found with crypto on their balance sheets. A 2022 Deloitte Global Corporate Treasury Survey found that 40% of interviewed finance executives said they have already implemented blockchain or they are considering it.

In the short term, issuers will need to work with a law firm with expertise in crypto and digital currencies to navigate the impact of the courtroom rulings and the subsequent new era of regulation on their business.

Make sure your company will be able to pass the test in the evolving legal landscape.

(Joseph M. Pastore III is chairman of Pastore, a law firm that helps corporate and financial services clients find creative solutions to complex legal challenges. He can be reached at 203.658.8455 or

7 Ways to Align Executive Pay with Dodd-Frank

Connecting executive compensation with financial performance took a while to implement—and it wasn’t easy.

Toward the end of last year, the U.S. Securities and Exchange Commission voted 3-2 to accept the “clawback” rules, which are intended to discourage senior leadership from making risky corporate decisions for short-term gain, resulting in restated financial statements.

In short, the SEC called out two types of triggering events involving material and non-material changes to financial statements. And the last part, referred to as “Little Rs,” is why the SEC vote was not unanimous.

Two SEC Commissioners, Hester Peirce and Mark Uyeda, voted no because the new rule included non-material changes.

SEC Chair Gary Gensler, however, supported the rule, citing the fact that corporate restatements have increased to nearly 75% from 35% in recent years. “If the financials are inaccurate, why should executives be getting paid incentive comp on financials that were inaccurate,” he said in an interview with Thomson Reuters.

Here are seven insights to ensure your executive compensation is aligned with the Dodd-Frank Act:


Require Shareholder Advisory Vote

Public companies are required to hold a non-binding advisory vote for their shareholders on the topic of executive compensation at least once every three years.

Although the frequency vote gives shareholders four options, including “abstain,” making the vote an annual tradition is the best practice.

At the end of May, Russell 3000 companies have only failed 1.5% on Say on Pay, according to Harvard Law School Forum on Corporate Governance. The current failure rate is 130 basis points lower than last year. In addition, the percentage of Russell 3000 companies receiving more than 90% support (i.e., 78% vs. 75%) is also higher than last year.

Investors are now able to vote on the compensation of the top executives in a public company, which includes the CEO, CFO and at least another three highly paid executives.


Bolster Independence for Compensation Committee

The compensation committee balances investor expectations along with a company’s financials to form employee retention strategies. In recent years, however, the role has evolved. Two-thirds of surveyed companies have expanded the role of their committee by expanding the charter or the name as well as the charter, according to the Center On Executive Compensation.

Institutional investors are driving change with more focus on the environment, talent and diversity and inclusion. New topics like human capital metrics, safety and wellbeing, culture and employee engagement are now falling under the compensation committee’s purview.

Strengthening independence requirements for committee members is more important than ever.


Added Disclosure on Conflicts for Consultants

Compensation consultants can serve as an invaluable resource for up-to-date pay rates, ongoing compensation trends and incentives to foster employee performance.

The Dodd-Frank Act requires more disclosure about the portion of compensation consultants and any potential conflicts. Stock exchanges must have listing standards that create greater independence for all compensation committee members, including consultants.

For example, exchanges must consider the source of all compensation to the director and whether the director is affiliated with the issuer via a subsidiary or affiliate.


Oversight of CEO/Rank Employee Ratio

The Dodd-Frank Act requires public companies to disclose the CEO pay ratio, which compares a CEO’s compensation to pay for median employees.

In 2021, CEOs were paid 399 times as much as a typical worker—a 1,460% increase since 1978. The shift in executive compensation to stock-related investments, which represents roughly 80% of the gains over the decades, is cited as one of the driving forces by the Economic Policy Institute.

Even though the SEC strongly encourages companies to follow generally accepted accounting principles (GAAP) metrics to ensure integrity, companies are only required to provide the CEO pay ratio without context or a long discussion, which can be found, however, in the compensation and analysis parts of a proxy statement.


Disclose Pay Versus Performance

Last summer, the SEC adopted amendments to require companies to disclose information that links executive compensation and financial performance.

For the five more recent fiscal years, the amendments require companies to provide a table of executive compensation and financial performance measures, including total shareholder return, as well as the total shareholder return of companies in the registrant’s peer group, its net income and a financial performance metric of the company’s own selection. Companies are also required to provide a list of three to seven financial performance measures that they deem important for connecting executive compensation and company performance.


Mandate Recovery Policies for Restatements

The SEC requires companies to implement policies to recover awarded, incentive-based compensation resulting from an accounting restatement from past and existing executive officers, no matter the level of involvement. As a result, stock exchanges must have listing standards that require companies to adopt a written “clawback” policy, which they will disclose as an exhibit in Form 10-K and on the cover of annual reports.

All types and sizes of restatements can trigger a clawback, including ones that materially impact the financial statements in the current year and ones that don’t from prior fiscal periods.

Companies must recover the compensation that is erroneously awarded and received by an executive in the three years preceding the date of the restatement.


Disclose Hedging

A company must disclose the ability of employees, officers and directors who can use equity securities granted as compensation to hedge. The company must comply by disclosing the practices in full or providing an accurate summary. If the company doesn’t have any hedging policies, then it must disclose that hedging is permitted.

Companies should review their current hedging policies with an attorney and consider updating or streamlining the document. Does your current policy cover the correct category of employees or enough detail about transactions?

Review these items carefully with an attorney to make sure pay is aligned with the Dodd-Frank Act.

(Joseph M. Pastore III is chairman of Pastore, a law firm that helps corporate and financial services clients find creative solutions to complex legal challenges. He can be reached at 203.658.8455 or


6 Ways to End Partnership Disputes

Business partnerships are not always meant to last.

And that includes the successful ones.

Countless reports pin the fail rate at around 70% in the first year. A lack of a detailed partnership agreement upfront usually plays a role. Some partners want to work on the business, while others may want to work in the business. For a couple of months, that arrangement may work. But once it’s clear the other partners are working 25 hours a week, and you’re grinding more than 60 hours, things will change.

Communications may become strained or end.

Regarding the “successful” business partnerships, life tends to get in the way, and some partners may want to retire at some point.

Like any business transaction, always begin at the end. Before you spend so much energy on the entry point, invest the time in your exit strategy.

The odds make it clear that your business partnership will end in some type of dispute.

But what are your options?

Here are six possibilities to consider:

Business Attorney Insight: Mediation

Discussing the disputed matter(s) with your partner should yield results, but it may take a trained mediator to get the job done. Mediators help open the lines of communication and characterize each stance in less provocative ways.

Bringing each partner back to the overall mission—the good of the company—should help create a path forward since it’s the reason each partner signed on in the first place. Focusing on the project as opposed to personalities will increase your odds of resolution.

Business Attorney Insight: Buy Out

You should have included a buyout provision in your partnership agreement. However, if that is not the case, then leverage your buy-sell agreement, which generally is included in partnership agreements.

A buyout agreement should be drawn up by your attorney and given to the exiting partner. You should also work with a financial advisor who can help put dollar amounts on assets. Please do not use a boilerplate template that you found online. Every partnership, not to mention the situation, is unique, and this type of transaction typically involves too much value to leave to a form letter.

Business Attorney Insight: Sell

Like many of the other options, selling can be relatively easy or difficult.

If your partnership agreement addresses what happens when partners sell their interests, this matter should be over quickly. Some agreements provide the existing partners with first dibs on the exiting partner’s equity.

However, if the partners are only given the right of first refusal, then this adventure could take time if it’s shopped around. And then, the question becomes about how the daily operations of your company will be impacted with a potentially disgruntled partner looming around the office and representing the company with A-list clients.

Business Attorney Insight: Freeze-Out

A freeze-out merger happens with a majority stakeholder in a company with another company that they own and control. Then, the majority shareholder submits a tender offer to the original company to force out the minority shareholders. If it’s successful, all the assets from the original company may be moved over to the newly created company.

The courts prefer a merger to another case, so they tend to rule in favor of these mergers, especially if the majority stakeholder makes a strong connection to a corporate purpose backed by sound business judgment.

This is another reason you have an attorney on your team.

Business Attorney Insight: Dissolution

Refer to your partnership agreement for this one. Most agreements include how the assets will be divided and distributed when the relationship is dissolved.

If your partnership agreement doesn’t include this provision, then you may be subject to the Uniform Partnership Act of 1997, which was proposed by the National Conference of Commissioners on Uniform State Laws to govern business partnerships in the United States. To date, 37 states, including Connecticut, have ratified the agreement (check with your lawyer for details).

Dissolution may end a partnership, but not the operations of a company, which shifts its activities to closing accounts, as well as selling and disposing of assets. This part could take many months, depending on the size and complexity of your company.

Business Attorney Insight: Litigation

Business partnerships include more than one agreement.

There’s one for the partnership and another for operations. There are agreements for employment and non-compete terms. Typically, there are also non-disclosure agreements to protect company investments.

If any of these contracts are breached, then that could trigger litigation for resolution.

Examples could include misuse of company assets, failure to disclose potential conflicts of interests and sharing copyrights or trade secrets.

One day, your business partnership will end. Consult with your business attorney for a favorable outcome to your hard work.

(Joseph M. Pastore III is chairman of Pastore, a law firm that helps corporate and financial services clients find creative solutions to complex legal challenges. He can be reached at (203) 658-8455 or

5 Reasons Why Your Non-Compete Agreement Doesn’t Work

The Federal Trade Commission is considering making non-compete agreements a federal issue by banning them.

According to research, one in five employees have a non-compete, which is about 30 million Americans. The FTC claims a ban would lead to better job opportunities and increase wages by $300 billion a year.

Companies would have to find another strategy to protect investments. But it could take years for a final outcome, accounting for passage and pending court challenges.

Right now, however, employers have a bigger concern: Are their existing non-compete agreements enforceable?

The answer presents a real issue for too many companies—and they don’t even know it.

Here are five common reasons why non-compete agreements fail:


Attorney Alert: No Consideration

This is one of the most common problems with enforceable non-compete agreements.

When you onboard a new employee, employers should make the signing of a non-compete agreement part of the process. To create a valid agreement, you must offer the new employee “consideration,” which means an exchange of value. Because you ask new employees to sign on day one, you can write into the agreement that the job and future compensation are consideration for the signature.

If you need an existing employee to sign a non-compete agreement, you will have to put more effort into it. Maybe it is a new title, more money and/or different responsibilities at the company. The “consideration” doesn’t have to be large, but it needs to be real and distinguishable.

Otherwise, you may have an unenforceable non-compete agreement that you assumed was valid.


Attorney Alert: Too Long in Duration

The objective of non-compete agreements is to protect the company, not to punish your employees. Asking for a non-compete for the rest of someone’s life is a non-starter.

Courts have ruled favorably, however, on shorter terms. Generally speaking, six months is practically a certainty. Yet, more than two years could get tricky. If it involves an acquisition, you may be able to get three years.

In any case, you should consult with your lawyer because these matters, especially the ones involving longer terms, tend to be decided on specifics. So, make a small investment to spend time with your trusted counsel—you will thank yourself later.


Attorney Alert: Reliance on a Template

Don’t fall for convenience and use a template for your non-compete agreement. And that goes for older, outdated forms your company has used since its inception.

Every industry is different. Every company is different. Types of proprietary information and confidential relationships vary quite a bit.

What if your company crosses state lines? What if your company has employees who work in different states? When it comes to law regarding non-compete agreements, each state makes the call.

Your leadership team should protect its interest by consulting with an attorney to ensure nothing is lost in the future.


Attorney Alert: No Assignment Provision

When acquiring a company, too many companies forget to obtain non-compete agreements from key personnel at the other company. This oversight can be costly.

One reason for the miscue, in part, is the assumption that the acquired company had included an assignment provision in their non-compete agreements. An assignment clause allows one party to transfer negotiated rights to another party—without re-opening negotiations.

Assignment provisions (i.e., Company A or assignee) can make things easier. Without them, you will have to ask the incoming employees to sign another non-compete agreement, which could prompt talks regarding more consideration.

Some states may prohibit or limit assignment clauses, so review them with your attorney.


Attorney Alert: Not Compliant With State Law

In addition to being a case-by-case matter, non-compete agreements hang on a state-by-state basis.

For example, these agreements are not enforceable in Oklahoma and California. Nine other states prohibit non-competes for employees who earn more than a set amount. Iowa and Kentucky only prohibit the agreements for health care workers.

In Connecticut, “reasonable” non-compete agreements are enforceable. But that means several details will have to be reviewed to determine validity: Is it too long or too restrictive? Is it fair? Does it prevent the employee from making a living?

Your lawyer will guide you down the right path.


(Joseph M. Pastore III is Chairman of Pastore, a law firm that helps corporate and financial services clients find creative solutions to complex legal challenges. He can be reached at (203) 658-8455 or




5 Reasons Why Business Partnerships Fail

William Proctor and James Gamble figured out how to do it in 1837.

Ben Cohen and Jerry Greenfield found out that success could be sweet in 1978.

Larry Page and Sergey Brin started their own brand of digital domination in 1998 before most knew what they were talking about.

Today’s stock market is filled with prosperous corporations that began with a business partnership. Although those who succeed tend to grab the headlines, all the rest fade away.

According to BLS data, 45% of new businesses fail during the first five years and 65% fail during the first ten years.

Hiring an attorney at the onset of a business partnership can dramatically increase your chances of a favorable outcome. Lawyers can help partners decide the best corporate structure and draft documents that will add clarity and resolve disputes to keep the organization moving forward.

Unfortunately, business partnerships that don’t work with a lawyer as their first step bear more uncertainty.

Here are the five most common legal claims that cause business partnerships to fail:

Attorney Alert #1: Breach of Partnership/Operating Agreement

Don’t enter into a business partnership without a written agreement that clarifies many important variables, such as your responsibilities, compensation and exit.

In fact, negotiating the partnership agreement should be part of your process to determine if this company is the best fit for you. The time spent on this dialogue will be invaluable.

For example, how are profits distributed? What happens when one partner doesn’t want to take the distribution in that year? Will you have the right of refusal when your partners bring forward a prospective partner? How will each partner exit without harming the interest of the company?

A thoughtful partnership agreement will go a long way to building stronger relationships—and mitigate one of the most common causes of failure for business partnerships.

Attorney Alert #2: Breach of Fiduciary Duty

Fiduciary duties are included in business partnerships.

The interests of the partnership, for instance, should be held paramount compared to your own self-interests. This is referred to as the Duty of Care. You should also avoid self-dealing situations where you benefit at the expense of your partners—also known as the Duty of Loyalty.

Failing to account for company funds, sharing trade secrets or acts that benefit a competitor are also examples of a breach of fiduciary duty.

In an attempt to mitigate this potential cause for business partnership failure, partners could be required to review their fiduciary duties in writing and sign their names periodically to keep these responsibilities top of mind.

Attorney Alert #3: Failure to Delineate Authority

When partners enter a business venture, it is often assumed that each partner will work an equal amount. And that’s why issues happen.

Andrews Campbell, who published “Collaboration Is Misunderstood and Overused” in the Harvard Business Review, writes that success depends on three circumstances:  1) partners need to be truly committed to working with each other, 2) partners have high respect for each other’s expertise, and 3) each partner has the skill to bargain with each other over cost and benefits.

The last circumstance could be the sole reason to hire an attorney to draft documents to increase the odds that the collaboration will be a success. For instance, each partner should clearly understand their responsibilities as part of operations and the leadership team. Blurred lines will lead to disagreements and a waste of time of redundancies.

A semblance of hierarchy needs to be established so the company can move forward. Delineated authority would ensure that all mission-critical areas are covered by the partners.

Attorney Alert #4: Gross Negligence

Partners are responsible for providing a certain standard of care. When that doesn’t happen and harm is caused, a matter of gross negligence can cause irreparable damage and end the partnership.

Mismanaging partnership funds, failing to abide by contracts and hiring unqualified, key personnel could trigger a claim of gross negligence.

A court would apply the business judgment rule, which is a standard that examines if the action in question was done in good faith with the care of a “reasonably prudent person” and with the understanding the partner is acting in the best interests of the company.

If gross negligence can be proven, unfortunately, it would knock down that level of protection.

Attorney Alert #5: Partnership Abandonment

When a partner decides to leave, it could trigger dissolution almost immediately, depending on the partnership agreement.

However, if the departing partner has not acted in the best interest of the partnership, it could be grounds for a lawsuit.

It may make sense to review the partnership agreement before resentment and business losses kick in. Often, a buy-out option is stated in well-drafted agreements and incorporation papers to lay the groundwork for a soft landing for all parties.

(Joseph M. Pastore III is chairman of Pastore, a law firm that helps corporate and financial services clients find creative solutions to complex legal challenges. He can be reached at (203) 658-8455 or


S.D.N.Y. Issues Ruling Regarding Cryptocurrency Regulation – The Ripple Effect

The U.S. District Court for the Southern District of New York recently issued a significant ruling regarding cryptocurrency regulation. In 2020, the U.S. Securities and Exchange Commission (the “SEC”) sued Ripple and two executives concerning Ripple’s XRP token and the sale thereof. The SEC alleged the XRP token was an unregistered security; thus, their sales of the XRP token amounted to illegal sales of securities. In response, Ripple argued that XRP was not a security. Judge Torres ruled that Ripple’s sales of XRP to institutional investors constituted an illegal sale of securities. However, the token was not considered a security when it was sold on digital asset exchanges to the general public. The distinction, according to the judge, depended on whether the buyers knew that their money could fund Ripple’s operations and result in the generation of potential profits. Certain elements of the case are still undecided, such as whether the two executives aided and abetted the illegal sales and can therefore be held responsible. However, there is already discussion emerging on this ruling, which may impact the SEC’s ongoing case against Coinbase, and within 24 hours following the ruling, XRP’s price increased by nearly 100%.


To read more:

4 Legal Insights: How to Fund a Crypto Startup

The most recent cryptocurrency winter has ended, and the next bullish cycle has begun.

But not everything has been forgotten.

The government may attempt to regulate this burgeoning industry through the courts, as more tokens, exchanges and venture capital firms fail to pass muster. The short list of collapses in 2022—BlockFi, Three Arrows Capital, Celsius Network, TerraUSD/Luna and FTX—has sent chills through the most thrill-seeking investors.

As a member of the Connecticut Crypto Forum, which Pastore LLC has sponsored since last May, I have watched cryptocurrency startups succeed, while others have struggled.

On the surface, funding seems to be a big obstacle. However, garnering the needed financial support for a cryptocurrency startup is more of a series of actions than a single event—especially during these challenging times.

So, are you looking to fund a cryptocurrency startup? Let’s start with a summation: Don’t go out too early.

Now, here are four more insights to improve your chances for success:

Business Law Insight: Leverage A Big Problem

The problem with having a solution is that you first need a problem.

So, start there.

Bitcoin serves as an alternative payment system free of government control where people can send money over the internet. Ethereum created a place in a new financial ecosystem as a platform for programmatic contracts and applications. Besides being digital assets, they both have something else in common: The entire world is their market.

When developing a solution for a problem, you must think big and make sure it’s scalable. The target market must be worth 10s of millions in revenue per year. If it generates $250,000 annually, you will go nowhere.

The cryptocurrency idea may solve a problem for title insurance in real estate. It’s a two trillion-dollar industry. Maybe it solves a record-keeping issue in health care. That’s another enormous potential market.

Because people buy the story before they buy the stuff, articulating the problem and the solution in a succinct, meaningful way will monetize your effort.

Business Law Insight: Produce A+ Documents

Producing top-notch documents should put you on the short list with potential investors. Your lawyer will write this one with help from the company’s leadership team.

A private placement memorandum (PPM) is not necessarily required depending on the nature of the offering, but it’s essential. Unlike a business plan that serves as a marketing document, the PPM is straight to the point. It is a legal document that informs investors of securities for sale. Several key aspects are addressed in the document, such as a description of the securities, risk factors, biographies on the management team, financial statements and, perhaps, important contracts.

This document will go a long way towards attracting a network of cryptocurrency investors. You definitely don’t go out to the marketplace in general because it is not amenable to crypto-type investments and general solicitation may run afoul of the securities exemption you are relying on. You will need a group of savvy investors who understand and have experience with digital assets—not a scattershot approach in the marketplace.

Business Law Insight: Build A Credible Team

In the beginning, investors don’t buy ideas. They purchase a team.

Ideas are only worth something if they can be executed. So, choose wisely.

Build a team of professionals who understand the cryptocurrency space and who can leverage relationships within the industry. This type of network, albeit small at inception, will provide instant credibility for your startup.

Next, create a strong compliance program with legitimate personnel. Start with a chief financial officer or controller with cryptocurrency experience, as well as anti-money laundering expertise. Leverage established credentials, such as ALMA, CPA, CFA, to guide the selection process.

To create more oversight, select qualified board members with experience in finance and controls, as well as regulation to name a few areas. Make them part of governance by empowering them to manage the compliance committee and audit committee. If you are raising money domestically, they will ensure you don’t stray into offshore associations that could taint the enterprise.

Business Law Insight: Convince A Bank

You need an investment bank on your side. In fact, you can’t raise real money without one. You are beyond friends and family now.

Keep in mind that an investment bank with a well-regarded broker dealer business unit will conduct due diligence on your startup. To pass the test, your financial house needs to be in order.

Let’s begin with the basics, such as bylaws and resolutions. There is the certificate of incorporation or the certificate of formation if it’s a limited liability corporation. Don’t forget the operating agreement, including business-partner assignments, a business plan and a financial forecast.

The next phase includes your financials. To be more specific, timely financial statements are required because anything less begs for more questions and suspicion. Accountants need to be part of this mix—and an attorney with cryptocurrency experience to bring everything together.

(Christopher Kelly is an attorney at Pastore who has practiced corporate, transactional, fund employment and banking law for more than 30 years at sophisticated levels. He has worked on complex transactions aggregating in value of more than $10 billion, involving private stock and debt offerings, mergers and acquisitions and assets deals.)


Stock Options: What Corporate Execs Should Know About Amended Rule 10b5(1)

Corporate executives and other “insiders” are forbidden from trading on material, non-public information.

When it comes to stock options, every public filing and formal announcement from a publicly traded firm comes with a blackout period for “insiders.” So, how can executives realize their earned gains without the threat of insider trading?

The U.S. Securities and Exchange Commission (“SEC”) defines illegal insider trading as: “The buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, non-public information about the security.

In an effort to provide guidance, the SEC enacted Rule 10b5-1 in 2000 to create a defense against insider trading if the following criteria are followed:

  • Enter into a Rule 10b5-1 plan in good faith.
  • Adopt a trading plan that is not within a blackout period.
  • Specify the timing, price and amount of your transactions.

In December 2022, the SEC enacted additional requirements for the 10b5-1 plans.

“Over the past two decades, though, we’ve heard from courts, commenters and members of Congress that insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information,” said SEC Chair Gary Gensler. “I believe today’s amendments will help fill those potential gaps.”

The new requirements alter the steps that corporate executives and “insiders” must take to fall under the 10b5-1 safe harbor, such as:

  • As part of the 10b5-1 plan, executives must certify that they are not aware of any material non-public information about the issuer or its securities and that the plan is adopted in good faith.
  • The good faith requirements must be extended beyond adoption through the entire duration of the plan.
  • Directors and officers may not trade during the later of 90 days after plan adoption or modification or two business days after filing a Form 10-Q or Form 10-K. Insiders who are not directors or officers may trade after a 30-day period following adoption or modification.
  • The 10b5-1 defense is no longer applicable if the “insider” has more than one 10b5-1 plan for the same time period.
  • Issuers must make new disclosures in their reports, including names and titles of “insiders,” dates of plan adoption or termination and number of shares that are planned to be bought or sold.

Accordingly, corporate executives and “insiders” must be familiar with the above changes to the 10b5-1 plans.

How Stock Options Overtook Cash

Two decades ago, corporate executives were compensated mainly with cash and bonuses, while stock options were footnotes. But the drive to link pay and performance has increased over the years, putting equity at the forefront. According to a 2021 Associated Press study, a little more than a quarter of compensation for the typical CEO at an S&P 500 company came from salary or bonuses. At the top, cash makes up 5% of total compensation.

The shift to stock options carries more responsibility for corporate executives. Insider trading, for example, can cost up to 20 years in prison. Back in 2020, the SEC employed 1,300 staff members in its Enforcement Division and budgeted more than half a billion dollars to investigate and prosecute illegal insider trading cases.

An attorney with expertise in complex financial instruments like stock options can help you regain peace of mind about your compensation package.

(Joseph M. Pastore III is chairman of Pastore, a law firm that helps corporate and financial services clients find creative solutions to complex legal challenges. He can be reached at 203-658-8455 or

How to Use Specific Allocation Cost Basis to Manage Capital Gains Taxes on Cryptocurrency Gains

The cryptocurrency reporting rules have changed but compliance requirements have not been made any clearer. The recent changes in the tax reporting requirements have left crypto platforms, brokers, and traders with minimal guidance and exposed buyers and sellers to a potential tax trap.

This note illustrates a process by which taxpayers who engage in virtual currency transactions can properly report their taxable gains or losses, even in the absence of revised guidance from the IRS. This process, properly deployed, will save many taxpayers who sell cryptocurrency during the tax year substantial amounts of money in federal taxes.

Section 80603 of the Infrastructure Investment and Jobs Act, P.L. 117-58 (signed into law November 15, 2021) amends both Section 6045 and 6045A of the Internal Revenue Code to accomplish three significant changes in the tax law related to returns of brokers regarding digital assets:

  • Brings digital assets under the broker reporting requirements by:
    • Adding to the definition of “broker” for purposes of information reporting “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Code §6045(c)(1)(D)(effective for returns required to be filed and statements required to be furnished after December 31, 2023) and
    • At §6045(g)(3)(B)(iv), adding digital assets to the scope of covered securities for purposes of Code §6045(g)(2)(a). This addition has the effect of requiring the newly-expanded population of persons treated as brokers under the tax law to report the capital gains and losses of persons disposing of digital assets on Form 1099-B. Reg. §1.6045-1(d)(2)
  • Defines a digital asset as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology” and includes an exception deferring to other and further definitions as may be promulgated by the Treasury. §6045(g)(4)

Cryptocurrency exchanges, such as Binance, Coinbase Exchange, Kraken, KuCoin, and OKX are now explicitly required to provide information reporting on Form 1099-B. However, the IRS has recognized that the existing reporting regulations do not contemplate virtual currency and so, in Announcement 2023-2 (December 23, 2022), the Service relieved brokers from the new reporting requirements pending issuance of final regulations under the new law. Taxpayers, however, remain responsible for reporting the proceeds of the virtual currency dispositions.

Taxpayers must report the nature and magnitude of their gains and losses on dispositions of digital assets whether or not any exchange or platform reports their transactions. This leaves responsibility for accurate recordkeeping squarely, and exclusively, on the taxpayer disposing of the assets. Indeed, decentralized finance exchanges such as Idex and dYdX, which do not collect Know Your Customer information (See, 31 CFR 1023.220), and self-custody traders, which do not provide information reporting, have no present role in tax reporting.

On whatever form — 1099-B, 1099-K, or no reporting form at all  —  a taxpayer receives regarding information reported to the IRS about the proceeds from the disposition of digital assets, that information must be translated into its tax effects via Form 8949, then to Schedule D, and, ultimately, to Form 1040. This reporting array provides to the IRS information describing the assets, the dates of acquisition and disposition, basis calculation, and the resulting gain or loss from each asset disposition. It also serves to characterize the resulting gain or loss as ordinary or capital and, if capital, as either long or short term. See, Code §1222; Reg. §§1.6045-1(d)(2)(i) and (ii).  Capital gains, calculated using the netting rules of §1222(11), are, generally, taxed at more favorable rates than ordinary income. Code §§1(h)(1) and (j)(5).

Gains on the disposition of capital assets, including covered securities, are calculated by subtracting the cost or other basis of the property from the net amount realized from its disposition. See, Reg. §1.1011-1. This amount is reported by the exchange or broker on Form 1099-B and, in turn, by the taxpayer on Form 8949.

This two-step process includes a mathematical trap for the unwary, which the IRS tacitly acknowledges in its virtual currency FAQs released October 9, 2019 (IR-2019-167). These FAQs largely reflect the two methods of basis allocation provided in the regulations that are available to a taxpayer who sells less than their entire position in a virtual currency account. However, because the regulations (Reg. §§1.6045-1(d)(2)(i) and (ii)) were promulgated prior to the explicit addition of digital assets to the statutory information reporting scheme by Section 80603 of P.L. 117-58, the Service has issued this interim guidance to remind such taxpayers that their basis reporting for digital assets may be accomplished in either of two ways:

  • Identification of the specific units of virtual currency that were sold. Such specific identification must include

(1) the date and time each unit was acquired

(2) the taxpayer’s basis and the fair market value of each unit at the time it was acquired

(3) the date and time each unit was sold, exchanged, or otherwise disposed of, and

(4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit or

  • If the taxpayer does not identify specific units of virtual currency, the units are deemed to have been sold, exchanged, or otherwise disposed of in chronological order beginning with the earliest unit of the virtual currency purchased or acquired; that is, on a first in, first out (FIFO) basis

FAQs 40 and 41.

Recall that Form 1099-B, when used by crypto exchanges and brokers for reporting sales of less than a taxpayer’s entire position, reports in Box 1(e) only the summary figure of cost or other basis, without specifying how that basis is calculated. The regulations and the FAQs prescribe that the FIFO method is the default basis reporting calculation in the absence of information adequate to support allocation of basis to specific units of digital currency.

Form 1099-B is, however, not the end of the taxpayer’s analysis. This is important because Form 8949, generally required to be filed with the return of a taxpayer who has sold capital assets (now, including digital assets) during the tax year, enables the taxpayer to correct the basis reported on Form 1099-B.  Brokers and exchanges will, as a rule, simply report out capital gain on a FIFO basis, potentially leaving inattentive taxpayers with a larger tax bill than they would have with proper figuring.


Here is how capital gains tax exposure can be unnecessarily inflated for a seller of digital assets who does not liquidate his or her entire position during the year.

The comparison may be illustrated with these pricing data from a popular digital currency over a recent period where a hypothetical taxpayer invested in a single unit of the asset each calendar month at its then-prevailing price.

Comparison of Capital Gains Tax on Sale of Virtual Currency Positions Using FIFO and Specific Information Basis Allocation

Comparison of Long Term Capital Gain Tax Using FIFO and Specific Identification Methods of Basis Allocation

A taxpayer who partially liquidates a digital currency position, then, should make strategic use of the Form 8949, whether or not the taxpayer receives an information statement from a broker or exchange. Note that for each transaction type for which Part I, Box (A), (B), or (C), or Part II, Box (D), (E), or (F) is checked, a separate Form 8949 must be filed.

The taxpayer should complete the appropriate part of the form (Part I for Short Term Capital Assets, Part II for Long Term Capital Assets) and enter in column (e) the appropriate basis allocation. If the taxpayer elects to use the Specific Identification method for a partially liquidated position, he or she should be prepared to document the claim with

  • The date and time each unit was acquired;
  • The basis and fair market value of each unit at the time acquired;
  • The date and time each unit was sold, exchanged or otherwise disposed of;
  • The fair market value of each unit when disposed of; and
  • The amount of money or the value of property received for each unit

FAQ 39.

In circumstances where the allocated basis of the liquidated asset varies from the amount stated in Box 1(e) on the Form 1099-B or other information statement, the taxpayer should enter Code B in column (f) and enter the amount by which the stated basis is being adjusted on the Form 8949. The current amount of gain or loss should then be entered in column (h).

The total amounts on Line 2 in Parts I and II of Form 8949 should then be transferred to Schedule D as follows:

  • If Part I, Box A is checked, transfer the amount in Part I, line 2 to line 1b of Schedule D
  • If Part I Box B is checked, transfer the amount in Part I, line 2 to line 2 of Schedule D
  • If Part I, Box C is checked, transfer the amount it Part I, line 2 to line 3 of Schedule D
  • If Part II, Box D is checked, transfer the amount in Part II, line 2 to line 8b of Schedule D
  • If Part II, Box E is checked, transfer the amount in Part II, line 2 to line 9 of Schedule D
  • If Part II, Box F is checked, transfer the amount in Part II, line 2 to line 10 of Schedule D

In conclusion, the responsibility of accurate capital gains reporting for digital asset transfers remains in the hands of the taxpayer. Because of the present gap between the statutory information reporting requirements and the associated regulations and forms, taxpayers must pay particular attention to how they elect and calculate basis in transactions that both were and were not reported to them or, in some circumstances, to the IRS, and whether such transactions affected long term or short-term capital assets. While taxpayers may, in most cases, benefit significantly from the Specific Identification method of basis allocation, they should be cautioned to invoke it only when they can meet the prescribed documentation to support that method. Otherwise, the default FIFO allocation should be used.

This note illustrates general principles only and is not intended as tax or legal advice. The reader is cautioned to discuss his or her specific circumstances with a qualified professional before taking any action.

5 Common Legal Claims: How RIAs Can Protect Themselves

As fiduciaries, Registered Investment Advisors (RIAs) must, at all times, serve the best interest of their clients and cannot place their own interests ahead of the interests of their clients. These obligations generally fall into two broad categories commonly referred to as the duty of care and duty of loyalty.

The Duty of Care requires an investment adviser to provide investment advice in the best interest of its client, based on the client’s objectives. The Duty of Loyalty requires RIAs to eliminate or disclose any possible conflict of interest involving themselves, their advice or their client.

In one way or another, most legal claims against RIAs stem from these two duties that serve as the underpinning of the profession. The Securities and Exchange Commission (SEC) recovered its largest amount of damages in fiscal year 2022 with RIAs and investment companies targeted for the most actions taken.

Clear communications and concise policies can help your firm prevent and mitigate the five most common legal claims against RIAs:

Breach of Fiduciary Duty

This is what happens when RIAs fail to exercise their responsibility to safeguard a client’s best interests. And it can be career-ending. It could come at the cost of a professional license in addition to financial damages.

The easiest way to mitigate any potential exposure is to be transparent. Make sure you disclose any possible conflicts of interest. Be crystal clear with your investment advice. Translate industry jargon into layman’s terms so your clients understand what is being said.

Working with an attorney on a new policy that prohibits self-dealing would be a good start.

Last year, the SEC ordered a dually registered RIA and broker-dealer to repay more than $800,000 to harmed clients for breach of fiduciary duty.

The SEC found the RIA did not adequately disclose conflicts regarding compensation that it received from the client investments, as well as a breach of its duty to provide best execution when it opted for a more expensive class of mutual funds when classes of more favorable value were available. In addition, the RIA failed to implement compliance policies and procedures designed to prevent such violations.


Simply put, negligence means carelessness, while gross negligence means recklessness on a bigger scale of damages.

As a fiduciary, you have responsibilities. In other words, your clients expect you to perform your duties in a manner that doesn’t harm their financial interests.

Last year, a federal court in Massachusetts ruled against an investment advisor who defrauded two advisory clients when he recommended that they invest in a scam investment abroad. The SEC’s complaint alleged that the investment advisor ignored and failed to disclose warnings from two banks in Turkey that the opportunity was probably a scam. The court ordered the advisor to pay more than $500,000 in damages.

RIAs should work with an attorney to draft disclaimers that can help mitigate errors. Each state has differing laws on negligence and award amounts, so make sure your disclaimers comply with your state’s laws to ensure they are enforceable.

Cyber Security Failures

Protecting your clients from cyber security breaches means being proactive.

The SEC continues to add more consumer protections, which will make your research and planning more valuable to your business. In March, for example, the SEC proposed amending Regulation S-P to require “covered institutions”—including RIAs—to provide notice within 30 days to investors affected by certain types of data breaches. The original regulation, which was adopted in 2000, simply required investment professionals to notify their clients about how they use their financial information.

Creating policies and procedures is the best way to start building the framework for a program that will better protect all stakeholders. Written policies and procedures will ensure your IT team is protected because they will know how to safeguard the data, prepare for possible cyber attacks and how to best respond. Because technology connects all of us, the same standard should be used with all your vendors’ IT programs. Do they have similar polices in place? Ultimately, you will be responsible.

Ongoing stress-testing your systems will provide another layer of protection to your firm. Hire a company that will send fake “scam” emails to your employees and turn it into a teachable moment.

Remember when your bosses sent you emails asking you to buy them gift cards on behalf of the company—with the promise of being reimbursed? (They really didn’t.)

Failure to Disclose

Be transparent with your clients about matters that involve your financial relationships with vendors and investments. More specifically, make sure you state the details about how you are compensated when it involves your client recommendations.

In 2020, the SEC sued an investment advisory firm for defrauding its clients by failing to disclose financial conflicts of interest when recommending investments. The agency alleged the advisory firm recommended their client invest $16 million in four private real estate investment funds without disclosing their fund managers received $1 million from the funds, as well as incentives to keep their money invested. For two of the four funds, the undisclosed financial arrangement resulted in reduced returns.

Any client grievance—written or verbal—should be taken seriously, which would reduce the odds of the complaint becoming a docket item. The matter should be taken directly to your in-house compliance officer or attorney if you have outside counsel. Acknowledge receipt of the complaint to your client and provide a timetable for an outcome.

If the investigation has merit, the compliance officer should immediately contact an attorney, who can draft a legally binding agreement for resolution.

Making Up Unsubstantiated Claims

When it comes to attracting new clients, the truth is your friend.

Research your own investment history to ensure that you can substantiate every claim. If a specific fund has yielded 50% annual returns in the past, then that is something you can talk about—but stay away from what is possible in a perfect world.

Last year, the SEC filed a civil action against former investment advisors for alleged participation in a Ponzi scheme that raised more than $110 million from more than 400 advisors. The defendants received undisclosed compensation from the investment fund, which was recommended based on unsubstantiated claims.

When it comes to the five most common legal claims against RIAs, say what you mean and mean what you say. It will go a long way toward protecting your book of business.

(Paul Fenaroli is an Associate Attorney at Pastore admitted in Connecticut and the District of Connecticut. He provides private companies with a full range of business law services covering formations, mergers, acquisitions, corporate governance, securities offerings and litigation)