Pastore Calculates RAUM of over $1 Billion for Registered Investment Advisor

This past month, Pastore LLC assisted a registered investment advisor (RIA) with the filing of its Form ADV.  In connection therewith the firm assisted the RIA in its calculation of regulated assets under management (RAUM), which totaled over $1 billion. The Securities and Exchange Commission (SEC) uses RAUM as its  measurement of assets for registration purposes. However, RAUM has  sometimes been misunderstood as representing total assets under management (AUM) for a company, and based on the firm’s experience the SEC itself has sometimes confused RAUM with AUM.  RAUM does not include every type of asset that an RIA may manage, and in particular may not include certain real estate investments or investments in portfolio companies controlled by the fund.  When assessing the financial condition of an RIA and its funds, it is important to distinguish between the assets counted under RAUM and the assets counted under AUM.  An RIA that appears to manage a small volume of assets based on its RAUM may in fact manage a much larger volume of assets based on total AUM.

Tokenized Assets: What are They and how are They Regulated?

As the decentralized world of blockchain continues to grow, tokenized assets have caught the eye of investors and regulators alike. Tokenized assets may be fungible or non-fungible. Fungible tokenized assets are interchangeable and indistinguishable such as Bitcoin and other cryptocurrencies (“Crypto”). Non-fungible tokens (“NFTs”) are unique tokens that are non-divisible and cannot be replaced because each token has a unique value.[1] Tokenized assets result from taking a tangible asset (such as real estate, paintings, and precious metals) or an intangible asset (such as a digital picture or a YouTube video) and converting the asset ownership into a digital token on a blockchain.[2] This process is known as tokenization.[3] By taking a real-world asset and making a digital representation, it creates a broader investor base, geographic reach, and a reduction in transaction times.[4] Moreover, placing the digital token on a blockchain ensures no single authority can erase your ownership in the tokenized asset.[5]

While tokenized assets can allow for a broader base of investors, like the Crypto market, the NFT market lacks clear regulations from the regulatory agencies such as the U.S. Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”).[6] Moreover, state regulatory bodies have yet to issue guidance on the tokenized asset market.[7]

The current legal framework was not designed to regulate and guide the creation and trade of digital assets.[8] Moreover, the question of what category an NFT falls into depends on the particular asset that was tokenized.[9] For example, the CFTC has stated that renewable energy credits and emission allowances are commodities as defined by the Commodity Exchange Act.[10] However, the SEC has stated that depending on the facts and circumstances of a given NFT, it might be considered an investment contract under the Howey test, which would cause the NFT to be regulated under the Securities Act of 1933 and Securities Exchange Act of 1934.[11] The legal uncertainty within the NFT market led SEC Commissioner Hester Peirce to recently state that guidelines would help provide the public with an understanding of how the SEC is approaching these issues.[12] The lack of a clear regulatory framework has made investors susceptible to fraud, and it allows for bad actors to avoid domestic and international anti-money laundering laws.[13]

Additionally, there is no standardized set of rights that accompanies an NFT since the seller determines what rights follow the NFT.[14] Therefore, sellers and buyers alike should understand the limitations that a transfer, assignment, or license may have on the NFT.

While tokenized assets allow for quick cross-border investment and increased liquidity of real-world assets, investors are left without a clear regulatory framework and, at times, not knowing what rights follow the purchase of an NFT. As the decentralized world of blockchain continues to grow, it is imperative that investors and businesses use common sense, sound legal advice, and diligence to navigate this market. Given the lack of legal certainty, attorney legal opinions on these assets will likely immunize any reasonable use.

[1] Tokenization: Opening Illiquid Assets to Investors, BNY Mellon (June 2019), https://www.bnymellon.com/us/en/insights/all-insights/tokenization-opening-illiquid-assets-to-investors.html.

[2]Id.

[3]Id.

[4]Id.

[5] What is asset tokenization?, Hedera, https://hedera.com/learning/what-is-asset-tokenization#:~:text=Asset%20tokenization%20is%20the%20process,either%20digital%20or%20physical%20assets.&text=Asset%20tokenization%20could%20convert%20ownership,0.0002%25)%20of%20the%20property (last visited Feb. 3, 2022).

[6] William de Sierra-Pambley, Tokenization: Opportunity and Regulation, Finding a Balance, Sheppard Mullin (Oct. 18, 2021), https://www.jdsupra.com/legalnews/tokenization-opportunity-and-regulation-5158893/.

[7]Id.

[8]NFTs: Key U.S. Legal Considerations for an Emerging Asset Class, Jones Day (April 2021), https://www.jonesday.com/en/insights/2021/04/nfts-key-us-legal-considerations-for-an-emerging-asset-class.

[9]Id.

[10]Id.

[11]Id.

[12] Sarah Wynn, SEC’s Peirce says agency guidance on nonfungible tokens needed, Roll Call (Jan. 25, 2022), https://rollcall.com/2022/01/25/secs-peirce-says-agency-guidance-on-nonfungible-tokens-needed/.

[13]NFTs: Key U.S. Legal Considerations for an Emerging Asset Class, supra note 11.

[14]Id.

Pastore Brings Claims to Thwart Violations of Securities Laws by Broker-Dealers

Pastore LLC has brought claims to thwart violations of securities laws by broker-dealers to funnel money away from a rightful beneficiary to a wrongdoer. The scheme, as alleged in the federal complaint, conducted by the broker-dealers led to violations of their supervisory responsibilities under the Securities Exchange Act of 1934 (the “Exchange Act”) and the Investment Advisers Act of 1940 (the “Advisers Act”) as well as multiple FINRA rules. Moreover, FINRA and the SEC have previously fined these broker-dealers for conducting similar schemes. A recent article regarding this matter can be found here.

Second Circuit Affirms Jury Verdict Win for Pastore’s Hedge Fund Clients

The Second Circuit Affirms Jury Verdict Win for Pastore’s Hedge Fund Clients in Multimillion-dollar Securities Fraud Case Brought by Billionaire Family Office

On November 15, 2021, the Second Circuit affirmed a jury verdict obtained by Pastore in a federal securities fraud case. This concluded a contentious, multi-year litigation, defeating claims of fraudulent inducement and securities fraud brought against two hedge fund executives by a billionaire family office special purpose investment vehicle. The billionaire family office, the heirs to and founders of a well-known apparel store, had invested in the fund’s General Partner limited liability company.

In 2018, The United States District Court for the District of Connecticut granted a summary judgment in favor of the defendants. The summary judgment was subsequently appealed up to the United States Court of Appeals for the Second Circuit, before being remanded back to, and concluding with, a jury trial in the United States District Court for the District of Connecticut. Pastore LLC was hired for the trial. After two weeks of evidence and 7 hours of jury deliberation, Pastore LLC was able to secure a favorable jury verdict for the clients. The jury had found in favor of the defense on a federal securities claim.

Then, the billionaire family office appealed the jury verdict to the Second Circuit and argued that it was entitled to a new trial because, it alleged, the district court’s abuse of discretion had a prejudicial impact on the jury’s verdict. Among other alleged errors, the billionaire family office alleged that evidence concerning a billion-dollar company investment agreement with one of the world’s largest private equity funds should be excluded. The Second Circuit stated, “the district court instructed the jury ‘the entity that holds an interest in a security suffers an economic loss if the investment experiences a decline in value.’ App’x 559. In other words, the district court instructed the jury that it should find that…suffered an economic loss if it determined that…owned the investment interest in…, regardless of the source of investment funds, and that this investment declined in value.”

Commercial Mortgage-Backed Securities, COVID-19, and the New Potential Systematic Risk

A commercial mortgage-backed security (“CMBS”) is a group of bonds comprised of commercial real estate loans commonly contained in trusts which are then sold to investors.[1] As of 2020, the largest loan contributors to the CMBS market include large banks, such as Citibank, Goldman Sachs, Morgan Stanley, Deutsche Bank, JPMorgan Chase, Wells Fargo, and Bank of America.[2] The commercial property loans securitized by CMBS are generally compromised of commercial properties such as apartment buildings, hotels, factories, office buildings and parks, or shopping malls.[3] These bundles of bonds are also referred to as tranches.[4] CMBS loans are ranked – those with the highest rating have the lowest risk, and those with the lowest rating have the highest risk.[5] Lower risked bonds are known as senior issue, and higher risk bonds are known as junior issue.[6] After the bonds are sold, the bank receives the money from the sale.[7] The bank then lends these proceeds to a subsequent borrower to collect additional fees.[8]

Investing in CMBS poses a lower risk to borrowers than a residential mortgage-backed security (“RMBS”) loan because commercial mortgages typically have a fixed term.[9]  CMBS loans are also compromised of fewer loans than RMBS loans.[10] Many investors seek out this loan because they are interested in obtaining property for an extended period of time and CBMS loans provide lower interest rates.[11] Other incentives of CMBS loans include a higher leverage financing, and CMBS loans are nonrecourse loans, and thus have a wider range of accessibility, because investors with lower credit are more readily able to obtain these loans. [12]

Although there are numerous advantages of CMBS loans, there are several disadvantages tied to a CMBS loan investment. First, these loans have prepayment penalties, which penalize a borrower for paying back a loan outside of the fixed term, even in the circumstance where the borrower pays the loan back earlier than the predetermined date.[13] Second, CMBS loans go through a defeasance profess before prepayment, which can be a painstaking process involving the borrower consulting with a financial advisor in order to set up alternative securities to replace any collateral and interest that the lender no longer is obligated to.[14] Lastly, the terms of CMBS loans are more difficult to negotiate, and a borrower has little or no say in the terms of the loans.[15]

The CMBS market has been greatly impacted by the COVID-19 pandemic. A shift towards working from home has created a failure of roughly $5.5 billion commercial mortgage loans since the summer of 2020.[16] The delinquency rate of CMBS loans in June 2020 was reported to be 10.32%. [17] The delinquency rate continued to increase during October of 2020, during the second wave of the pandemic.[18] The trends of CMBS loans due to the financial crisis that the pandemic has caused are almost identical to the trends of CMBS loans during the 2012 financial crisis, which poses an alarming issue when considering the impact the 2012 crisis had on the CMBS market.[19] The rise of delinquency rates is directly correlated to the effects that COVID-19 has had on commercial real estate: apartment owners, retail owners, restaurants, and hotels are bringing in substantially less income, and are left unable to pay mortgage and other commercial property-related debts.[20]

The last financial crisis in 2012 led to grave delinquencies in the CMBS market, which may signal that the CMBS market will undergo similar disruption in the future, indicative of a similar systemic risk.[21] However, much has been learned from former financial crises and the risks they pose on all types of mortgage backed-security loans, to avoid unnecessary risk in the CMBS market. Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act after the 2007-2008 financial crisis, which affects CMBS by “including risk-retention requirements for asset-backed security sponsors, increased disclosure requirements, the Volcker Rule and enhanced capitalization requirements for banks.”[22]

These protective measures are an attempt to make the CMBS market a safer space for investors by decreasing the systematic risk that the CMBS market decline may have on the overall economy.[23] An unforeseen consequence has been an increase in the price of entry into the CMBS market which affects retail investors, and aspects such as the Volcker Rule, which decreases market liquidity and restricts proprietary trading by preventing a bank from holding inventories of secondary market securities and disallowing a banks from investing in real estate.[24]

While the effects from the COVID-19 pandemic may affect the CMBS market and make these loans less accessible to borrowers, overall, the Dodd-Frank reforms have likely mitigated a majority of the risk to the CMBS market directly tied to COVID-19 and will provide a lasting benefit by decreasing this systematic risk impacting the overall economy.

[1] Owen Haney, The Virus, Risk, and Commercial Mortgage-Backed Securities: Examining Dodd-Frank’s Impact in the Midst of a Pandemic, 26 Fordham J. Corp. & Fin. L. 391, 394 (2021)

[2]Id.

[3]Carol M. Kopp, Commercial Mortgage-Backed Securities (CMBS), Investopedia, (October 25, 2020), https://www.investopedia.com/terms/c/cmbs.asp

[4]Thomas Kenny, What are Commercial Mortgage-Backed Securities?, The Balance, (October 7, 2021), https://www.thebalance.com/what-are-commercial-mortgage-backed-securities-cmbs-416910

[5]Id.

[6]Id.

[7]Id.

[8]Id.

[9]Carol M. Kopp, Commercial Mortgage-Backed Securities (CMBS), Investopedia, (October 25, 2020), https://www.investopedia.com/terms/c/cmbs.asp

[10]Maegan E. O’Rourke, The New Normal: How the Dodd-Frank Risk Retention Rules Affect the Future of CMBS, 51 Suffolk Univ. L. Rev. 77, 81-82 (2018).

[11]Understanding CMBS and CLO Markets, Signet Investments, “https://signetinvestments.com/understanding-cmbs-and-clo-markets/” https://signetinvestments.com/understanding-cmbs-and-clo-markets/ (Last visited November 6 2021)

[12]Commercial Mortgage-Backed Securities (CMBS): A guide, Quicken Loans (January 27, 2021), https://www.quickenloans.com/learn/cmbs

[13]Id.

[14]Id.

[15]Id.

[16]Dorothy Neufield, Commercial Mortgage Delinquencies Near Record Levels, Visual Capitalist (July 16, 2020), https://www.visualcapitalist.com/mortgage-delinquencies/

[17]U.S. CMBS Delinquencies Resume Increase in October, Fitch Ratings (November 6, 2020), “https://www.fitchratings.com/research/structured-finance/us-cmbs-delinquencies-resume-increase-in-october-06-11-2020” https://www.fitchratings.com/research/structured-finance/us-cmbs-delinquencies-resume-increase-in-october-06-11-2020

[18]Id.

[19]Owen Haney, The Virus, Risk, and Commercial Mortgage-Backed Securities: Examining Dodd-Frank’s Impact in the Midst of a Pandemic, 26 Fordham J. Corp. & Fin. L. 391, 394 (2021)

[20] Peter J. Irwin et al., CMBS Loan Workouts During COVID-19: A Borrower’s Perspective, Debevoise & Plimpton (May 14, 2020), https://www.debevoise.com/-/media/files/insights/publications/2020/05/20200514-cmbs-loan-workouts-during-covid-19.pdf https://www.debevoise.com/-/media/files/insights/publications/2020/05/20200514-cmbs-loan-workouts-during-covid-19.pdf

[21]Steven L. Schwarcz, Systematic Regulation of Systematic Risk, 2019 Wis. L. Rev. 1, 1 (2019).

[22]Owen Haney, The Virus, Risk, And Commercial Mortgage-Backed Securities: Examining Dodd-Frank’s Impact in the Midst of a Pandemic, 26 Fordham J. Corp. & Fin. L. 391, 401 (2021)

[23]Craig Furfine, The Impact of Risk Retention Regulation on the Underwriting of Securitized Mortgages, 58 J. FIN. SERVS. RSCH. 91, 93 (2020).

[24]Volcker Rule, The Real Estate Round Table https://www.rer.org/policy-issues/capital-credit/volcker-rule https://www.rer.org/policy-issues/capital-credit/volcker-rule (Last visited November 6, 2021)

Federal Jury Rules Four Cryptocurrency products are not Securities

A recent decision in the United States District Court for the District of Connecticut appears to be the first of its kind in the nation. In the case Audet et al v. Garza et al, a federal jury recently weighed in on whether cryptocurrency products were considered securities.[1] The jury held that four digital-asset products linked to cryptocurrency were not securities.[2]

In the case, a class of customers brought an action against GAW Miners LLC (“GAW Miners”) and ZenMiner LLC (“ZenMiner”) for running a cryptocurrency Ponzi scheme.[3] When GAW Miners and ZenMiner were faced with demands from customers for the physical cryptocurrency mining equipment which they could not meet, GAW Miners and ZenMiner turned to Hashlets, Hashpoints, Paycoin and HashStakers (collectively the “Digital Assets”). [4]  These Digital Assets provided customers with a portion of the computing power without owning the physical hardware.[5] Moreover, the Digital Assets served as virtual wallets for the promissory notes and virtual currency of GAW Miners and ZenMiner.[6] The plaintiffs argued that these Digital Assets were investment contracts and therefore were unregulated securities.[7]

The plaintiffs asked Judge Michael Shea to rule as a matter of law that the Digital Assets were securities under the Howey test. [8] The Supreme Court in Howey stated an investment contract exists when “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” [9] However, in an unusual decision, Judge Shea declined to rule as a matter of law that the Digital Assets were securities.[10] Instead, the judge left the issue of how to classify the Digital Assets for the jury.[11] Despite the SEC previously referring to one of the Digital Assets, Hashlets, as a security in a case against one of the former defendants in this case,[12] the jury ruled that the Digital Assets were not investment contracts, and therefore, they were not securities.[13]

The issue of how to define cryptocurrencies is an ongoing debate, and the federal jury’s ruling in this case does not settle it.

[1] Elise Hansen, Crypto Mining-Linked Products Weren’t Securities, Jury Finds, Law360 (Nov. 2, 2021), https://www.law360.com/articles/1436790/crypto-mining-linked-products-weren-t-securities-jury-finds.

[2] Id.

[3] HHR Wins Groundbreaking Jury Verdict in Crypto Fraud Trial, HHR (Nov. 3, 2021), https://www.hugheshubbard.com/news/hhr-wins-groundbreaking-jury-verdict-in-crypto-fraud-trial.

[4] Id.

[5] Hansen, supra note 1.

[6] Id.

[7] Id.

[8] Alison Frankel, In apparent first, Conn. class action jury finds crypto products are not securities, Reuters (Nov. 3, 2021), https://www.reuters.com/legal/transactional/apparent-first-conn-class-action-jury-finds-crypto-products-are-not-securities-2021-11-03/.

[9] SEC v. W. J. Howey Co., 328 U.S. 293, 298­–99 (1946).

[10] Id.

[11] Id.

[12] HRR, supra note 3.

[13] Hansen, supra note 1.

Recent Landmark Decision in Cryptocurrency Law

A recent decision in the United States District Court for the Southern District of New York has sent shockwaves through the world of cryptocurrency investing.  In re Bibox Group Holdings Ltd. Securities Litigation, the Court ruled that a plaintiff did not have standing to assert class claims on cryptocurrency assets he did not own.  However, it was what the court didn’t rule on that made this a landmark case in the legal field developing around cryptocurrency, as the Court took no issue with the fact that the Plaintiff brought a case alleging securities violations against a cryptocurrency issuer and exchange.

The background on this matter is as follows.  In October 2017, Bibox Group Holdings Ltd. and their affiliates funded the launch of their new crypto exchange by launching a new ERC-20 cryptocurrency called BIX.  In this offering of BIX, Bibox raised approximately $19 million in funding.  Bibox told investors that they could exchange BIX for tokens on their exchange, and Bibox would use a portion of the funds raised in the offering to buy back some of the BIX that was issued.  BIX was one of six ERC-20 tokens on the exchange, with the others being EOS, TRX, OMG, LEND, and ELF.

The Plaintiff, Mr. Alexander Clifford, was one of the initial investors who bought BIX.  Mr. Clifford ended up exchanging his BIX for Bitcoin in December 2018.  Mr. Clifford never purchased or owned any of the other tokens.  On April 3, 2020, Mr. Clifford then filed an action in the Southern District of New York against Bibox and their affiliates.  In his complaint, Mr. Clifford alleged that Bibox had violated federal securities law and state Blue Sky law in connection with the trading activities of the six tokens.  Defendants moved for a motion to dismiss, arguing that Mr. Clifford lacked standing since he was asserting claims based on the five tokens he did not purchase, and that his claims pertaining to the one token he owned were time-barred.

Judge Denise Cote of the Southern District of New York granted the motion to dismiss as to all claims, ruling that Plaintiff lacked standing to assert claims based on the five tokens he had never purchased.  This was for two reasons.  First, the Plaintiff did not suffer any injury from the unpurchased tokens.  Second, the Court precluded standing on the grounds that “such conduct implicates the same set of concerns as the conduct alleged to have caused injury to other members of the putative class[1]” because all the tokens were made by different entities and had distinct characteristics and advertising history, meaning the injuries could not be proven in a similar enough way to allege standing.

The Court also dismissed the remainder of claims Plaintiff asserted on the token he did purchase, BIX.  In doing so, the Court rejected the argument that the one-year statute of limitations began to run when the cryptocurrency Plaintiff discovered the token could qualify as a security.  This is because the SEC had previously issued a publication on April 3, 2019 stating that cryptocurrencies may be qualified as securities under the Howey test in the right circumstances.  Rather, the Court held that the statute of limitations began to run when Plaintiff became aware of his injury, which was his last transaction in April 2018.

The main takeaway here is that the Court did not rule that securities laws did not apply to crypto, but rather took issue with the Plaintiff’s standing.  It makes it clear that cryptocurrency issuers and exchanges could be held liable under securities law for their actions.  In addition, while the Court precluded the “same set of concerns is implicated” argument, it is possible another court could find otherwise.  This is due to the fact that the six tokens were on the same exchange, used the same blockchain and were based on the same technological standard.  In conclusion, the rapidly developing field of law around cryptocurrency is one that continues to require close monitoring because of major developments such as this.

[1] Ret. Bd. of the Policemen’s Annuity & Ben. Fund of the City of Chicago v. Bank of N.Y. Mellon, 775 F.3d 154, 161 (2d Cir. 2014)

Pastore Retained to Advise a Large Registered Investment Advisor in Sale

Pastore was retained to advise a large registered investment advisor in connection with the sale of its business to Victory Capital Holdings, a large national registered investment advisor.  The registered investment advisor, based in Connecticut, invested primarily in microcap securities, providing services primarily to institutional investors and large religious-affiliated clients. The advisor, which was previously owned by Old Mutual Asset Management Trust Investment Funds LLC, spun out in 2009.

Pastore Retained to Advise Multibillion-dollar Registered Investment Advisor in Restructuring

Pastore was retained to advise a multi-billion-dollar registered investment advisor and related private equity funds on the restructuring of the advisor. Pastore advised the advisor and private equity funds in connection with modifications to ownership structure, distribution rights, employment rights, indemnification, and banking issues. Pastore also assisted in substantial revisions to the advisor’s Form ADV, other SEC filings, Compliance Manual, Corporate Governance documents, and Policies and Procedures.

Pastore Obtains a Dismissal of a Large Investment Banking Case in Delaware District Court

Pastore & Dailey won a complex securities and M&A action in the United States District Court for the District of Delaware arising from a derivative rights holder agreement and related investment banking engagement agreements. This is the latest iteration in the saga between the Defendant, Pastore & Dailey’s client, and the Plaintiff, a representative of the shareholders to a company seeking to invalidate investment banking fees owed following a series of complex insurance corporate mergers.

After Pastore & Dailey successfully defended its client in the United States District Court for the District of Nebraska and then successfully defended its client in the appeal before the Eight Circuit that followed the District of Nebraska decision, its Motion to Dismiss was granted in the District of Delaware. In its Memorandum Opinion, the District Court agreed that Plaintiff’s claims were batted by the doctrine of res judicata and that the Plaintiff lacked standing to assert its claims.

Pastore & Dailey attorneys have vast experience arguing and defending matters in various federal courts across the country and are well-situated to handle similar claims involving complex contractual and investment banking issues.