Inside the SEC's first registered blockchain assets

Recently, Gibraltar-based INX Limited officially became the first fintech company to publicly offer blockchain assets registered under the Securities Act. Its lead U.S. counsel, Mark Selinger of McDermott Will & Emery in New York, does not advertise himself as a cryptocurrency expert, but found himself on the frontier of the industry. His job was to apply 75 years of regulations to a brand-new token and blockchain platform.

After three years of back-and-forth with the U.S. Securities and Exchange Commission, Selinger says the final product could advance the practice of regulating digital assets. BenefitsPRO’s sister site, The Recorder, sat down and talked to Selinger. (Answers have been edited for length and clarity.)

Why did INX preemptively work with U.S. regulators to register?

I was approached by the client in late fall of 2017, when the ICO [initial coin offering] boom was still very much booming. Many of these offerings, which at the time were definitively not registered, were raising a lot of money. People were taking various positions trying to support the notion that these were different types of products that somehow didn’t fall within registration. 

My client just took a very different view. I remember we had lunch together in Tel Aviv, Israel, and he said, “Hey look, a bunch of these guys are going to get in trouble. Most of them are going to be gone. I want to do this the right way, because at the end of the day in order for institutional investors and other more typical investors to get really involved in this space, this is going to need to evolve into a registered, regulated product.” 

And that was really where we started from. It was a definite decision at that time, and frankly it was prescient. It was really only around then that the SEC put out one of its first analyses on one of the more egregious ICOs and laid out the concerns. What he was basically saying was this was only going to get worse in the sense of the SEC focusing more on this and taking a more hard line, and he was right. 

So then three years ago you started working with the SEC to get this ball rolling?

We had a call with the SEC staff around December 2017. They said nothing is happening anytime fast, in terms of new regulations to deal with tokens. Their recommendation was if you want to pursue a regulated path, essentially do it the regular way. They said they recognize there are things that are somewhat square-peg-round-hole, but that we’d work together on it. So we took that approach.

What were some of the things that came up that don’t fit in the regular securities registration process, and how did you deal with those issues?

We were also dealing with a nontraditional jurisdiction, because we were in Gibraltar. Under Gibraltar law, the Gibraltar counsel did not view the tokens as an equity security. So in our initial filing, we took the approach that these were not equity securities. And ultimately, the SEC came back and said, “Nah, it’s an equity security. And we’re going to need you to treat it as an equity security for purposes of the filing.” 

So we ended up having to deal with Gibraltar law taking one approach, our accountants from Ernst & Young looking at this and saying it’s something of a hybrid instrument, and then the SEC saying it was an equity security. Given our mandate from the SEC, we had to go down that path and find comparable hybrid-type securities or nontraditional equity securities that we could say, “Alright, we’re gonna treat it like this.” 

And then, it became a bit of a back-and-forth with them, in a productive way. The initial response from the SEC came back in April, and it was extensive, because we weren’t just dealing with their typical accounting examiner, nonaccounting examiner and supervisor. We had eight or more people looking at every filing. So, we had a whole host of comments.

Also, the language was just developing. People were throwing around terminologies that became the words people use, but, when you kind of dug a little deeper, you realize that no one really agreed on what the words really meant. So, we had to get away from buzzwords and define terms. When you say utility token, what do you mean? And does that actually mean anything? And to complicate things our token is really a hybrid of both a traditional security, where there’s a share of the profits, but at the same time—when the INX trading platform is up and running—the token can be utilized on the platform as part of trading activities.

So our disclosure document was almost like a consensus-type of document, where you just have a lot of people interested in making sure that what we were describing was not only accurate but clear. And we were talking about an evolving technology. I would say I’m not a blockchain expert, I’m a securities lawyer. But, in some ways, having people who didn’t necessarily come from that world was helpful, because you’d ask a lot of questions.

Is this the most extensively you’ve worked with a regulatory body?

When we started, we didn’t think it would be a two-and-a-half-year process to get to be declared effective. We knew it was going to be not your typical process, but I wouldn’t have anticipated two and a half years. At the end of the day, it unfortunately kind of made sense. I think there was a lot of thoughtfulness on their side and a lot of input from various parts of the commission that certainly contributed to the back-and-forth and the fact that we had to submit the number of amendments that we did. But at the same time, we were also educating ourselves, because I’m not just talking about myself, I’m talking about the whole team, including the client. Understanding what the regulators cared about was really informative and important. And it definitely helped us even in structuring the features and functions of the token, because you get incentivized when you have someone coming at this from the mindset of protecting investors and ensuring proper disclosure.

What kind of response have you heard of the digital asset and cryptocurrency community?

I think that the community is getting their heads around it. It’s a different animal than they dealt with in the past. My sense is that it’s being received seriously.

Besides time and costs, what were some of the drawbacks you saw going through this process?

Literally, just that. Time and cost are the big ones. It took a very patient client to stay with this. Other than that, I would say it really was a learning process for all of us, the lawyers, the accountants, the technology people—everybody. I would say we got a lot out of the process, but I wouldn’t expect that the next one of these was going to be the lengthy process that we went through. Because they can learn from what we did, and then also, the staff knows more of what it’s looking for. So what we were seeing in comment letter four will probably show up in comment letter one now. 

What were the biggest advantages of registering this offering?

Well, look, you don’t get an SEC seal of approval, obviously. But by going through the process, people understand that this has been looked at rigorously. And that was certainly not the case with the ICOs that preceded it, not to say that those weren’t done by serious groups or that thought wasn’t put into it. 

We had the advantage of being very closely reviewed and commented on and obviously they weren’t going to declare us effective until they were satisfied that the disclosure met the statutory requirements. So, I think going through that process benefits the investor community, and it also creates a precedent for offerings to follow. Once you’ve sort of established what the appropriate level and type of disclosure is presumably that’s gonna be the standard for others. And, you know, that’s got to be good for the whole ecosystem.