Former SEC Senior Counsel Discusses the Digital Assets Space (Part One of Two)

HFLR.com

March 7, 2019 SEC ENFORCEMENT MATTERS Former SEC Senior Counsel Discusses the Digital Assets Space (Part One of Two)

By Robin L. Barton, Hedge Fund Law Report

Philip Moustakis, most recently a Senior in assets based on blockchain or distributed Counsel at the SEC, has joined Seward & ledger technology, including cryptocurrencies, Kissel as counsel. He will work closely with utility coins and tokens. The Hedge Fund several practice areas in New York and Law Report recently interviewed Moustakis Washington, D.C., including the government in connection with his move to Seward & enforcement and internal investigations; SõĴĴÕĆʣñõĴţİĴļ²İļõËĆÕõčĔŁİļŖĔʴĭ²İļĴÕİõÕĴ investment management; and blockchain and summarizes his thoughts on his experience cryptocurrency groups. in the government, as well as the regulatory approach to digital assets and blockchain. For more than a decade, Moustakis was Senior The second article will explore enforcement Counsel in the SEC’s Division of Enforcement, trends in general and in the digital asset space in which role he investigated and prosecuted ĴĭÕËõţË²ĆĆŘʞ²ĆĔčëŖõļñŖñõĴļĆÕÊĆĔŖÕİĴʣ complex matters involving violations of the federal securities laws. He also served a For additional insight from other Seward & lengthy tenure in the Asset Management Unit Kissel attorneys, see “ With the Filing Deadline and was a founding member of the Cyber Looming for Many Advisers, Seward & Kissel Unit, where he focused on cryptocurrencies Attorneys Provide a Roadmap to Amended and initial coin offerings (ICOs). In addition, Form ADV ʽʰ\²İʣʅʞɿɽɾʅʱʨ²čÑĔŁİļŖĔʴĭ²İļ Moustakis was a founding member of the series “HFLR and Seward & Kissel Webinar Distributed Ledger Technology Working &ŗĭĆĔİÕĴİÕčÑĴEÑÕčļõţÕÑõčõÑÕVÕļļÕİ Group, which was formed to coordinate the Study”: Part One (Nov. 16, 2017); and Part Two response to the emerging technology across (Nov. 30, 2017). ļñÕ&ʿĴÑõŕõĴõĔčĴ²čÑĔêţËÕĴʣ|İõĔİļĔñõĴļõČÕ at the SEC, he served as an Assistant Attorney Governmental Experience General in the Investor Protection Bureau of ļñÕ]ÕŖ§ĔİăļļĔİčÕŘ;ÕčÕİ²ĆʿĴcêţËÕʣ HFLR: You spent years working in legal roles in both the state and federal governments. At Seward & Kissel, Moustakis will advise What made you decide to leave government companies and individuals on SEC service and go into private practice in general enforcement matters, internal investigations ²čÑļĔÕŖ²İÑ˯SõĴĴÕĆĴĭÕËõţË²ĆĆŘʤ and other regulatory and criminal matters, as well as on issues arising from investments Moustakis: I worked for the government for

almost 15 years and performed public service HFLR: What kind of matters did you work on êĔİ²ÊĔŁļɾʅĔêČŘţİĴļɿɽŘÕ²İĴĔŁļĔêĆ²Ŗ ŖñõĆÕ²ļļñÕ&ʿĴ&čêĔİËÕČÕčļ"õŕõĴõĔčʤ school. In terms of the SEC, I felt like I had a great run, wore a number of hats and had the Moustakis: When you join the Enforcement opportunity to handle many interesting cases, Division, you start out as a generalist. You walk but it was time to move on. I had squeezed all in the door and are handed a Ponzi scheme, an the juice out of that orange. offering fraud or something similar. Once you demonstrate your abilities on those kinds of At Seward & Kissel, I will work primarily cases, you are given the opportunity to handle with the government enforcement and more complex, sophisticated or sensitive internal investigations group; the investment Č²ļļÕİĴ²čÑļĔāĔõčĴĭÕËõ²ĆļŘŁčõļĴʣñÕţİĴļ management group; and the blockchain and such unit I joined was the Asset Management cryptocurrency group. What attracted me Unit and later the Cyber Unit. to Seward & Kissel is that they already have a deep bench of excellent lawyers working [See “ Ĕʴ"õİÕËļĔİĔê&&čêĔİËÕČÕčļ"õŕõĴõĔč in these groups, from whom I could learn a Champions New Retail Strategy Task Force and great deal. Conversely, with my extensive SEC Cyber Unit” (Nov. 16, 2017).] experience, I felt that I could bring a valuable čÕŖÑõČÕčĴõĔčļĔļñÕţİČʿĴÕŗõĴļõčëĭİ²ËļõËÕ I spent the bulk of my time at Enforcement in in these areas. the Asset Management Unit, where I gained broad experience prosecuting matters against HFLR: Before you joined the SEC, you worked investment advisers to private funds and êĔİļñÕ]ÕŖ§ĔİăļļĔİčÕŘ;ÕčÕİ²ĆʿĴcêţËÕʣ mutual fund complexes. For example, I served Please describe the work you did there. ²ĴËĔʴĆÕ²ÑĔč²čõčŕÕĴļõë²ļõĔčĔê²ĭİõŕ²ļÕêŁčÑ adviser, which led to enforcement actions Moustakis: I was in the Investor Protection against the adviser, a couple of portfolio Bureau of the New York Attorney General’s Č²č²ëÕİĴ²čÑļñÕËñõÕêţč²čËõ²ĆĔêţËÕİ ĔêţËÕʞŖñÕİÕĔŁİāĔÊŖ²ĴļĔõčŕÕĴļõë²ļÕ²čÑ for insider trading, a mismarking scheme prosecute violations of the Martin Act and and supervisory failures. [See “ Charges of other investor and consumer protection laws. Fraudulent Valuation, Insider Trading and For example, I was a member of the team that Failure to Supervise Employees Cost Manager reached what many consider to be a landmark and CFO More Than $10 Million in SEC settlement with AIG that, combined with the Settlement ” (Jun. 14, 2018).] SEC’s parallel action, required the company to pay more than $1.6 billion in restitution and I also worked on matters involving market penalties. Other investigations I worked on manipulation; valuation issues; insider focused on the İÕĴõÑÕčļõ²ĆČĔİļë²ëÕʴÊ²ËăÕÑ trading; cherry picking; front running ; securities market , insider trading and the ŁčÑõĴËĆĔĴÕÑËĔčŤõËļĴĔêõčļÕİÕĴļ; supervisory reinsurance industry. Shortly after the change and compliance failures ; as well as matters of administration in New York, I moved over to ļñ²ļļĔŁËñÕÑĔčÊİĔăÕİʴÑÕ²ĆÕİĴʞõčĴŁİ²čËÕ the SEC. ËĔČĭ²čõÕĴ²čÑÕŗĭÕİļčÕļŖĔİăţİČĴʣ

ʮÕÕĔŁİļŖĔʴĭ²İļĴÕİõÕĴʼAĔŖ²čAÕÑëÕ:ŁčÑ Managers Avoid Insider Trading Violations

When Using Expert Networks?”: Part One Digital Assets and Blockchain (Feb. 10, 2011); and Part Two (Apr. 1, 2011).] HFLR: You were a member of the Cyber HFLR: What is the impact of your state and Unit and the Distributed Ledger Technology federal government experience on your Working Group. How would you describe the ËŁİİÕčļĭİ²ËļõËÕ²ļÕŖ²İÑ˯SõĴĴÕĆʤ SEC’s approach to regulating the digital asset Ĵĭ²ËÕʤ Moustakis: First and foremost, I would say an SEC enforcement matter can be a complex, Moustakis: I can speak to the Enforcement even byzantine, process. It can take any Division’s approach to digital assets. In my number of turns and involve any number of the view, from the outset, Enforcement took a &ʿĴÑõŕõĴõĔčĴ²čÑĔêţËÕĴʣñÕĆõčÕêİĔČţİĴļ very thoughtful and deliberative approach to contact with the exam or enforcement staff cryptocurrencies. The early cryptocurrency to the formal order through an investigation cases out of the SEC made the very simple to litigation or resolution is rarely – if ever – a point that the securities laws apply regardless straight one. of whether an offering or investment scheme involved bitcoin or another cryptocurrency. There are many opportunities along the Faced with a very new and emerging way for advocacy. Someone with prior SEC technology, the Enforcement Division was experience is better equipped to create, able to demonstrate at a basic level how the recognize and act on those opportunities. securities laws apply. For more than a decade, I served as lead counsel on enforcement matters and have For example, the ţİĴļÕčêĔİËÕČÕčļ²ËļõĔč been through this process many, many times. in the space charged a man named Trendon Having that experience and perspective can be Shavers and his company Bitcoin Savings enormously valuable to my clients. I learned a and Trust with defrauding investors. This lot at the SEC and now have a full toolbox with was a plain vanilla Ponzi scheme – except which to advocate for Seward & Kissel’s clients. Shavers solicited the investments and paid the purported returns entirely in bitcoin, so there My experience in the New York Attorney were no U.S. dollars involved. The SEC did not ;ÕčÕİ²ĆʿĴĔêţËÕĴñĔŁĆÑÊÕčÕţļĔŁİËĆõÕčļĴõč take the position in that case that bitcoin itself a similar manner: subject matter expertise, was a security; it was the investment scheme knowledge of process and experience. that formed the basis of the charge. But the Moreover, clients will often have exposure point was made: just because a fraudster found on both the federal and state levels, and I can a new way to monetize an investment scheme apply a rare combination of experience to does not mean the securities laws do not helping those clients. apply.

The next enforcement action applied the securities laws to an unregistered offering ĔêĴñ²İÕĴõč²ŖÕĆĆʴăčĔŖčÊõļËĔõčÊÕļļõčë game and a second unregistered offering õč²ÊõļËĔõčʴİÕĆ²ļÕÑĴĔËõ²ĆČÕÑõ²Č²İăÕļõčë

venture. Again, the message was simply that to be drawn once the focus is on ICOs is a security is a security. It doesn’t matter that between the token and the capital raise. ICOs the capital raised came in the form of bitcoins. are by and large capital raises, so they meet If you are going to offer and sell a security, the elements of investment contracts. A digital absent an applicable exemption, it must be asset offered in connection with an ICO, registered. however, may change in character over time êİĔČ²ĴÕËŁİõļŘļĔ²čĔčʴĴÕËŁİõļŘʣ Another early enforcement action applied the same logic to two online venues that [Compare “ U.S. District Court Rules That used cryptocurrencies to trade shares in Digital Tokens in Initial Coin Offerings May ËİŘĭļĔËŁİİÕčËŘʴİÕĆ²ļÕÑŕÕčļŁİÕĴʣë²õčʞõê Not Constitute Securities ” (Jan. 24, 2019) with ŘĔŁʿİÕëĔõčëļĔĔĭÕİ²ļÕ²Ĵ²ÊİĔăÕİʴÑÕ²ĆÕİĔİ “Federal District Court in New York Rules That an exchange, you must register as such. ICOs May Be Securities ” (Oct. 4, 2018).]

Then the seminal DAO Report came out in In a June 2018 speech , William Hinman, July 2017, putting the industry on notice that Director of the SEC Division of Corporation digital tokens could be securities under the Finance, alluded to that very point. He said Howey test for an investment contract. Simply that, putting aside the fundraising when ether put, if you have an investment of money – even Ŗ²ĴĆ²ŁčËñÕÑʞõļŖ²ĴĴŁêţËõÕčļĆŘÑÕËÕčļİ²ĆõşÕÑ if that money is bitcoin, ether or some other by the time of his speech that he would not cryptocurrency – in a common enterprise with consider offers or sales of ether to be security the expectation of returns based on the efforts transactions. In the same speech, he urged of a promoter or a third party, you have an the industry not to focus on the digital asset investment contract and thus a security. itself but on the circumstances surrounding its offering or the manner in which it is sold. [See “ SEC Halts Allegedly Fraudulent ICO That |ĔĴļʴ"cʞļñ²ļõĴŖñ²ļļñÕ&ñ²ĴÊÕÕčÑĔõčë Employed a Bogus Regulatory Agency and as evidenced by the matters involving digital False Claims of SEC Approval ” (Nov. 29, 2018); assets that it has pursued. “Unregistered Crypto Fund Hit With Multiple Securities Laws Violations by SEC ” HFLR: Do you see a use for blockchain (Oct. 18, 2018); and “ SEC Cyber Unit Files and distributed ledger technology within Charges Against Allegedly Fraudulent ICO ” the private funds space, such as for a fund (Jan. 11, 2018).] manager’s internal accounting, reporting or ËĔČĭĆõ²čËÕêŁčËļõĔčĴʤ HFLR: How did the SEC’s enforcement ²ĭĭİĔ²ËñËñ²čëÕĭĔĴļʴ"cʤ Moustakis: The short answer is “yes.” Many enthusiasts believe blockchain technology will Moustakis: |ĔĴļʴ"cʞļñÕêĔËŁĴĴñõêļÕÑļĔ replace the client server model of the internet the ICO space. Not that long after the DAO with distributed blockchain applications, Report was issued, Chairman Jay Clayton said meaning the possibilities are limited only in testimony before a Senate committee, in by one’s imagination. Whether it is custody, effect, that he believed that every ICO he had fund administration, clearing or whatever seen was a security. An important distinction ļİ²ÑõļõĔč²ĆĴÕËŁİõļõÕĴʴİÕĆ²ļÕÑêŁčËļõĔčļñ²ļõĴ

being replaced or brought onto a blockchain, that is for the business people to develop. We lawyers are here to help them do so correctly within the framework of the securities laws. [See “ How Blockchain Will Continue to Revolutionize the Private Funds Sector in 2018ʽʰQ²čʣʁʞɿɽɾʅʱʨ²čÑĔŁİļñİÕÕʴĭ²İļ series on blockchain and the private funds industry: “Basics of the Technology and How the Financial Sector Is Currently Employing It ” (Jun. 1, 2017); “Potential Uses by Private Funds and Service Providers ” (Jun. 8, 2017); and “Potential Impediments to Its Eventual Adoption” (Jun. 15, 2017).]