On June 14, 2018, the SEC’s Division of Corporation Finance Director, William Hinman, gave a speech titled “Digital Asset Transactions: When Howey Met Gary (Plastic).”  This speech provides additional insight into the SEC’s view as to whether cryptocurrencies and initial coin offerings (“ICOs”) are securities.  Here is a summary:

In his speech, Hinman explains that ICOs typically involve passive investors who purchase tokens in hopes that a promoter builds a successful network.  He posits that the networks involved are rarely functional, and that the token purchase “looks a lot more like a bet on the success of the enterprise and not a purchase of something used to exchange for goods or services on the network.”  These circumstances, combined with token marketing efforts that “are rarely narrowly targeted to token users,” are indicators that an ICO is a securities transaction.

ICO issuers have recently tried to avoid their tokens being classified as securities by labeling them “utility tokens” and arguing that the tokens are for consumptive use.  Hinman directly addresses this practice, stating that labeling something a “utility token” does not prevent it from being a security. While he conceded that tokens by themselves and tokens purchased for consumption only are likely not securities, he emphasized that the “economic substance of the transaction” determines whether a token sale is a securities transaction.  Specifically, the speech focused on the “investment strategy” used, and states that “virtually any assets” can be securities “provided the investor is reasonably expecting profits from the promoter’s efforts.”

To support the above concept that securities can be broadly defined to include an “investment strategy,”  Hinman explains that, as outlined in Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., the Howey test “is not static and does not strictly inhere to the instrument.”  The non-static interpretation of Howey is critical because it indicates that tokens which start as securities can lose that designation over time as a token’s network becomes “sufficiently decentralized.”  Hinman clarified that a security-token loses its status as a security when it becomes decentralized enough that purchasers “no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts,”  noting that, as a system becomes increasingly decentralized, “material information asymmetries recede” and the “ability to identity an issuer or promoter to make the requisite disclosure [required in securities offerings] becomes difficult, and less meaningful.”  This interpretation rewards systems that prioritize decentralization with a shield from securities laws, but creates ambiguity regarding the requirements for a network to become “sufficiently decentralized.”

In light of the above, Hinman finds that Bitcoin and Ethereum’s native token, Ether, are not securities because they are decentralized enough that the efforts of others are not a “key determining factor” in whether an investment in Bitcoin or Ether is successful.  The speech adds that applying the disclosure regime of the federal securities laws to Bitcoin and Ethereum transactions would “add little value”, and that, “[o]ver time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required.”

On March 23, 2018,  in response to Governor Murphy’s Executive Order 6 which directed the New Jersey Department of Health (“Department”) to review New Jersey’s Medical Marijuana Program (the “Medical Marijuana Program” or “Program”), the Department issued  its report  focusing on how to expand the Program’s scope and patient access to medical marijuana (the “Report”).

The Report focused on the following four principal areas:

  • The rules for siting of dispensaries and cultivation facilities and the number of alternative treatment center (“ATC”);
  • The conditions for physicians participating in the Program and prescribing medical marijuana;
  • The number of medical conditions which qualify for the Program; and
  • The maximum monthly product limit, THC dosage limits and the types of medical marijuana products available for patient use.

Certain aspects of these recommendations may be affected by Department regulatory action, while others will require amendment of the existing New Jersey Compassionate Use Medical Marijuana Act (the “Act”).

In order to service the growing population of patients with conditions treatable by medical marijuana, the Department plans to amend the existing regulations to permit ATCs to dispense medical marijuana at satellite locations and permit more than one cultivation site per ATC, subject to Department approval. The Department also plans to create an endorsement system to allow ATCs to engage in some combination of production (including edibles), cultivation, and dispensing designed to increase the supply and availability of medical marijuana.  As stated in the Report, the goals of these amendments are to increase the supply and access to medical marijuana for qualifying patients. The Report also makes the statutory recommendation to amend the Act to permit the existing six (6) licensed ATCs, which are statutorily required to be non-profits, to operate as for-profit companies.

The current regulations require that a physician interested in providing care to patients who qualify for medicinal marijuana to first register with the Department, creating a limited number of doctors who can prescribe and treat qualifying patients. The Report indicates that the Department plans to eliminate the physician registry in Spring of 2018 to ensure that any and all New Jersey doctors meeting the good standing  requirements set forth in N.J.A.C. 8:64-2.5 may prescribe medicinal marijuana for patients meeting Program requirements.

Prior to March 22, 2018, the conditions that qualified for treatment by medicinal marijuana under the  Act  were limited to (i) seizer disorders, intractable skeletal muscular spasticity or glaucoma (provided that  such conditions were resistant to conventional medical therapy), (ii) HIV, acquired immune deficiency syndrome or cancer (provided that  sever or chronic pain, nausea, vomiting, cachexia or wasting syndrome resulted from such condition or treatment thereof), (iii) amyotrophic lateral sclerosis, multiple sclerosis, terminal cancer, muscular dystrophy or inflammatory bowel disease, (iv) a terminal illness (provided that a physician determined a prognosis of less than 12 months of life), or (v) other medical conditions approved by the Department by way regulation. As outlined in the Report, a final agency decision was made to effectuate the addition of the following categories to conditions qualifying for treatment by medical marijuana: chronic pain related to musculoskeletal disorders, migraines, anxiety, chronic pain of visceral origin, and Tourette’s syndrome. The Report also recommends an amendment to the Act permitting medical marijuana to be used as a first-line treatment rather than a last resort for the illnesses described in section (i) above.

Under the current Program, physicians are limited to prescribing two ounces of medicinal marijuana to patients within a 30 day time period. According to the Department’s findings set forth in the Report, physicians should have discretion to authorize more than the Program’s current two ounce limit. As a result, the Department is recommending that the statutory limit be increased to four ounces, which aligns more with our neighboring states such as New York, Pennsylvania and Delaware. The Act presently restricts use of edible marijuana products to qualifying patients who are minors. As stated in the Report, the ingestion of medical marijuana is healthier than smoking, the Report, therefore, also recommends amending the Act to permit the manufacture of edible and topical products and their use by patients.  The Report also provides that the Department will eliminate the regulatory dosage limit of 10% THC limit to allow for more effective treatment of the debilitating medical conditions covered under the Program.

The Report and recommended expansions to New Jersey’s Program  set forth above evidence both the Governor’s and the Department’s goal of growing all aspects of the Program related to the production of and access to medicinal marijuana.

The first two weeks in March 2018 have seen a number of developments with respect to the regulation of cryptocurrencies in the United States.

Regulation of Online Cryptocurrency Trading Platforms

On March 7, 2018, the Securities and Exchange Commission (“SEC”) issued a release addressing the regulation of online trading platforms (or exchanges) on which investors have bought and sold digital assets, including coins or tokens sold in initial coin offerings (“ICOs”).  Consistent with prior SEC articulated positions, the SEC stated that many of these tokens sold in an ICO meet the definition of a “security” and accordingly these trading platforms on which ICO tokens trade should register with the SEC as a national securities exchange or alternative trading system unless exempt from registration.  In its release, the SEC expressed its concern that many of these trading platforms may appear to investors as SEC-regulated exchanges, but are not and do not meet the regulatory and listing standards of a registered exchange. In light of this, in its release, the SEC listed a series of questions that investors should ask before trading assets on an online trading platform.  These include, but are not limited to, asking if:  (i) is the platform registered as a national securities exchange or an ATS with the SEC?; (ii) is there information in FINRA’s BrokerCheck ® about any individuals or firms operating the platform?; (iii) how does the platform select digital assets for trading?; (iv) what are the trading protocols?; (v) how are prices set on the platform?; (vi) how does the platform safeguard users’ trading and personal identifying information?; (vii) what are the platform’s protections against cybersecurity threats, such as hacking or intrusions?; and (viii) does the platform hold users’ assets?  If so, how are these assets safeguarded?  For a complete list of these questions and a copy of this SEC release see SEC Release.

Money Transmitter Rules Apply to Initial Coin Offerings

In a letter published March 6, 2018 by the Financial Crimes Enforcement Network (“FinCEN”), which had previously been sent on February 13, 2018 to Senator Ron Wyden of the Senate Committee on Finance, FinCEN reiterated that in combatting the financing of terrorism (“CFT”) and illicit financing of criminal activity, the Bank Secrecy Act (“BSA”) and anti-money laundering (“AML”) laws and regulations applied to virtual currency exchanges and administrators that are based in the United States or that do business in whole or substantial part in the United States. These would include “a developer that sells convertible virtual currency, including in the form of … ICO coins or tokens, in exchange for another type of value that substitutes for currency….” FinCEN indicated that these exchanges and administrators would be considered a money transmitter who would have to be register with FinCEN as a money service business (“MSB”) with an established written AML compliance program designed to mitigate money laundering risks. These AML/CFT compliance programs would include filing of BSA suspicious activity and currency reports, maintaining records for certain transactions over some monetary threshold and obtaining customer identification information. The letter also clarified that in the case of an ICO that is structured as a sale of a security or derivative, the participants in the ICO could be subject to regulation by the SEC or the Commodity Futures and Trading Commission (“CFTC”).  In such cases, the SEC or CFTC AML/CFT requirements would apply.  Companies and exchanges involved in ICOs should consult legal counsel to clarify and satisfy their respective AML/CFT obligations.

U.S. District Court  Rules that the CFTC has Authority to Regulate Cryptocurrencies Not Involving Derivatives

In a Memorandum and Decision of the United States District Court for the Eastern District of New York, issued on March 8, 2018, Judge Jack Weinstein issued a ruling as to the authority of the CFTC to prosecute a fraud case that it had brought against Patrick Kerry McDonnell, the operator of a cryptocurrency business.  Defendant McDonnell was alleged to have “operated a deceptive and fraudulent virtual currency scheme” whereby his company solicited investments from investors to assist them in purchasing and trading Bitcoin and Litecoin, but instead misappropriated their funds.  In his ruling, Judge Weinstein, after discussing the definition of a commodity under the Commodity Exchange Act (“CEA”) and relying, in part, on a 2015 CFTC administrative ruling that cryptocurrencies were commodities, held that “virtual currencies can be regulated by CFTC as a commodity,” and that, in the absence of federal rules, the CEA permitted the CFTC in a fraud case to exercise its jurisdiction over cryptocurrencies that did not directly involve the sale of futures or derivative contracts.

Judge Weinstein ruled that the CFTC could proceed prosecuting the case against the defendant and granted a preliminary injunction barring the defendant from further engagement in cryptocurrency investments as the case continues. For a copy of the case, see CFTC v. McDonnell.

Not too long ago, technology was considered a “vertical” market filled with companies that met the needs of the “technology” industry (think Microsoft, Dell, Cisco, Intel, and IBM).  However, technological products and services have evolved to the point of serving a “horizontal” market, having become an important aspect of many different types of businesses across a wide variety of industries and sectors (think fintech, healthtech, cleantech, autotech, edtech, etc.) and, by extension, M&A transactions.

For example, deals in the media industry increasingly are focused on the digital media aspects, particularly given the decline in demand for print media.  Likewise, parties to acquisitions in the financial services industry often pay close attention to the protection of proprietary investment strategies, data protection, trade names, and customized software.  Even manufacturers and other traditionally “non-tech” companies are leaning on technology more and more in order to streamline their business processes, manage and analyze data better, and to protect themselves from cyber-attacks.

This trend towards a “horizontal” market only looks to accelerate as technology becomes more and more embedded in businesses of all stripes, as presaged by the $13.7 billion purchase of Whole Foods by Amazon.com Inc. this year.  Similarly, private equity interest in tech and tech-enabled businesses has grown in recent years, particularly for more “stable” businesses such as software companies that generate recurring revenue or that serve other businesses.

Given the growing proportion of M&A deals that are considered to be “tech” deals (even where non-technology companies are involved), middle market businesses of all kinds that are evaluating the possibility of a sale or, conversely, looking for potential targets to acquire cannot afford to overlook the importance of technology as a key asset.

High-level legal concerns often revolve around the target’s ownership or right to use key technological assets, as well as the level of protection and ability to transfer the same.  This includes making sure that all owned intellectual property of the business is properly registered with the USPTO or copyright office in the name of the appropriate entity, and that all renewals and maintenance fees have been paid.  Additionally, acquirers should check that employees and, particularly, key independent contractors of the target have assigned their rights in and to all key intellectual properties to the target.  Inbound licenses that are material to the business, as well as revenue generating outbound licenses, should be reviewed to determine assignability.  It goes without saying that it is critical to ascertain whether the target has any existing or suspected infringement claims, as well as any security interests or encumbrances affecting its key technology assets.

Further, to the extent key technologies are held within a joint venture between the target and a third party, an acquirer should consider whether its business model would allow it to “step into the shoes” of the target vis a vis the joint venture versus the extent to which the acquirer could readily extract the technological assets and/or wind-down the joint venture.

The takeaway here is when engaging in M&A transactions – whether in the middle market or otherwise – ignore technology at your peril.  Those companies (even “non-tech” ones) that can demonstrate a strong command of their technological assets should increase their attractiveness as targets as we move into the future.  Conversely, acquirers that understand their own technology “gaps,” can quickly assess the target’s key technological assets and grasp how such assets will improve the integrated business post-closing will be better positioned to focus their due diligence efforts, minimize indemnification risks, and ultimately achieve the intended synergies.

As New Yorkers enjoy their pumpkin spice lattes, the fact that a Grande (16oz) serving will cost them about 380 calories (including 2% milk and whipped cream, because why not?) is becoming common knowledge.  Calorie information has been conspicuously posted on menus at “covered establishments” in New York City for nearly a decade, but on August 28, 2017, New York City agreed to postpone enforcement of its rule requiring restaurants, convenience stores and other establishments to post calorie counts for prepared food in response to a law suit brought by the food industry and supported by the Federal government.

In 2008, New York City became the first jurisdiction in the United States to require chain restaurants to post calorie information on menus and menu boards.   Shortly thereafter in 2010, the Federal government adopted similar laws by way of the Affordable Care Act.  The Federal government’s implementation of such laws has continually been delayed over the years, but now the Food and Drug Administration (“FDA”) plans to provide additional guidance on menu labeling requirements in May 2018.  New York City did not want to wait for the Federal guidance to begin enforcement of its Rule 81.50, New York City’s nearly identical version of its federal counterpart.

New York City’s most recent version of Rule 81.50 tracks its federal counterpart and applies to “covered establishments”, which means “a food service establishment or similar retail food establishment that is part of a chain with 15 or more locations nationally doing business under the same name and offering for sale substantially the same menu items, or a food service establishment that is not party of such a chain that voluntarily registers with the United States Food and Drug Administration to be subject to the federal requirements for nutrition labeling of standard menu items pursuant to 21 CFR 101.11(d), or successor regulation”.   For any such covered establishment, “[m]enus and menu boards must provide the number of calories contained in each standard item.”

While the FDA plans to provide guidance in May 2018, New York City nonetheless wanted to move forward with its enforcement of Regulation 81.50 beginning on August 21, 2017, but on July 7, 2017, the Food Marketing Institute and the National Restaurant Association teamed with several other food-service industry groups to file suit against the City of New York for what it said was premature enforcement of nutritional disclosure guidelines for food-service establishments. The National Association of Convenience Stores and the New York Association of Convenience Stores also joined in the suit, which was filed in the U.S. District Court for the Southern District of New York.

Court documents claim that that the local New York City rules are not identical to the impending FDA rules because they are effective immediately which would clash with the Federal government’s plan to delay compliance for one more year.  The plaintiffs asked the court to stop New York City from enforcing the regulations on the local level prior to the nation-wide rollout in May 2018 and argued that New York City’s Rule 81.50 was preempted by Federal law. The FDA filed court papers in support of the lawsuit.

New York City has now agreed to honor May 2018 as the start date due to the preemption of Regulation 81.50 by the similar provisions contained in the Affordable Care Act. As such, “covered establishments” will have more time to comply and the FDA will be able to set forth guidance as it planned in May 2018.

As the nation awaits the FDA’s guidance, food establishments in New York City should begin to think about whether or not they are a “covered establishment” and the steps they will need to take in order to avoid eventual enforcement action.