Regulations are the operating system of the financial world. Strategy in finance starts with the market needs of the ecosystem parties (whose existence is often based in the regulatory structure), the regulations, and only then, the choice of technology. There is a necessary feedback loop in here, as new technology can make new products possible and change the structure of the ecosystem by changing the roles of firms. We are currently in an exciting era because of the potential blockchain technology has to do exactly that.
The most common statements we see about regulations are complaints, particularly from new entrants to this space. The purpose of this article is to examine how regulations fit into the securities industry.
Financial regulations come into existence because governments deem certain behaviors to be unacceptable. Some cause direct harm to other people, like fraudulent securities practices; some are unacceptable because they have consequences in a larger societal context, like payments to fund terrorists. Governments pass laws against these acts and then turn them over to regulators to see that these laws are carried out.
In the securities business, we have two primary types of regulations. The first type constrains the movement of value, both currencies and securities, to hinder all sorts of crime, including terrorism. Another element of this control is monitoring and reporting to ensure that the government receives tax revenues that are due. For decades, governments have been eliminating bearer instruments to further both of these objectives.
The second type, regulations around securities, seeks to make sure that the offerings are genuine, that sales practices are appropriate, that risks are made public to the marketplace, and that investors’ assets are protected all along the way. All nations with significant securities markets have enacted voluminous legislation in this area.
In order to carry out their mandates in the financial markets, regulators create the requirements for individuals and firms to be registered in order to operate and then supervise their conduct. A company operating any of the processes where there is a risk of violating these financial regulations must expect that they will have to be registered and perform regulatory functions as part of their daily operations.
Note that the regulators mostly supervise, while the actual ongoing regulatory activity is generally performed by the industry. In other words, the cost of regulation is borne by the party that has a profit interest in offering the product or service. This means that the regulatory cost is embedded in the price to all customers of that product. It also means that for-profit firms have the same incentive to find regulatory efficiencies as they do for other costs, benefiting customers in the long run.
As Alvin Roth, who won the Nobel Prize in economics in 2012, wrote in his book Who Gets What – and Why, “When we speak about a free market, we shouldn’t be thinking of a free-for-all, but rather a market with well-designed rules that make it work well.” We will have a lot to say at another time about market design, but in spite of excesses resulting in the need to find and even prosecute firms and individuals, requiring participants to perform the necessary regulatory functions has worked extremely well in the securities markets. The participation, liquidity, and efficiency of transactions are a huge success and a source of competitive advantage for developed nations.
As painful as it may be, the industry should generally embrace this role. Where regulators are part of the direct operations of a regulatory function, the result, from an industry perspective, is less positive. One example is the approval by the SEC of prospectuses. The SEC does not have any market incentive to make the process friendlier or easier to navigate. As a result, they logically see any eventual criticism as a failure on their part that they have to avoid, thus drawing out the process and making it more expensive for issuers. A market-based process would recognize that perfection is impossible and balance the important role of encouraging the growth of the market while putting a focus on those issues that really have a significant impact on investors.
We are regularly amused at statements that crypto market regulations are finally becoming clear. While it is true that governments took some time to issue statements on cryptocurrencies and other tokens, it has never been unclear to knowledgeable securities market players where the regulations would end up. The only questions were when and exactly how the existing regulations would be applied.
I was once told by a securities attorney that every regulation exists because somebody lost money. None of us likes the prospect of telling a client “No,” and it’s way more fun to just get on with the business that got us interested in the first place. However, faults and all (and you should hear our private conversations), the $170 trillion of compliant capital in OECD countries continues to grow because of the web of regulation that creates confidence in the liquid global market where we all participate.
To sum this up, the purpose of securities regulation is to protect investors and create an environment where markets can flourish. We, as industry leaders, are active participants and we have the opportunity to proactively include regulatory operations in our new ventures. If we choose not to, then the technology will either be discarded as too unsafe and expensive to operate, or outside parties will impose them, most likely in less elegant ways than we would have done ourselves. Blockchain technology and more specifically distributed ledgers can have significant advantages for the securities industry. We see the potential for exciting developments like changing the relationships between issuer and investor and enabling new products, as well as more basic opportunities to create market efficiencies, increase transparency, and lower risk. In order to reach the lofty heights though, it’s of equal importance for all of us to work to make sure that we simultaneously achieve the aims of our regulatory framework
Propine Accepted into MAS FinTech Sandbox
It was recently announced that Propine has been accepted into the Monetary Authority of Singapore’s FinTech Sandbox.
This move sees Propine join iSTOX as a participant within the sandbox. While the iSTOX is working towards serving capital markets, Propine will be testing their custodial capabilities within the program.
Over time, Propine indicates that their goal is to develop a comprehensive suite of services, tailor built for the digital securities sector. The following are a few the capabilities expected to be offered through the platform.
- Asset Servicing
- Trade Settlement
A ‘FinTech Sandbox’ typically refers to a structured program, built to allow for the testing of new technologies and approaches towards the industry. The purpose of such programs is to allow for innovation to flourish, while ensuring that the public retains high levels of protection at all times.
Tuhina Singh, the Chief Executive Officer and Co-founder of Propine, commented on acceptance into MAS’s Fintech Sandbox:
“We are extremely glad that we are going to be a part of the Fintech sandbox. Singapore is one of the most progressive economies in terms of support and in providing a platform for innovative solutions such as ours to experiment, build and thrive. The regulatory sandbox is a great step for us as we move into a more organized and regulated world for blockchain. A supportive initiative like this will propel the country’s rich history of innovation to much greater heights along with growing companies such as ours”
Founded in 2018, Propine is a Singaporean company, which operates within the digital securities sector. Building off of a specialty in custody services, Propine is actively developing a comprehensive suite of services surrounding digital securities.
CEO, Tuhina Singh, currently oversees company operations.
The Monetary Authority of Singapore is a regulatory body which wears multiple hats. Their roles include acting as, not only the nation’s central bank, but as the financial sectors regulator.
These roles mean that the MAS is responsible for, not only the economic growth of Singapore, but for ensuring the protection of investors through compliance measures enforced within banking, insurance, capital markets, and more.
In Other News
Over the past two years, Singapore has managed to establish themselves as a leader within digital securities. They have managed to do so through the use of programs such as the FinTech Sandbox described here today. The following articles are examples of forward thinking steps involving Singapore and the MAS.
Blockstation Joins the IIROC
The tokenization platform, Blockstation announced on Oct 31, that it will accept a leadership role in the Investment Industry Regulatory Organization of Canada – IIROC. The news showcases a push for more regulations in the Canadian security token sector, as well as, stronger positioning of Blockstation in the market.
The IIROC is a Canadian self-regulatory body created to help further development in the security token sector. The group’s primary focuses include broker-dealers, trading, and the institution of Universal Market Integrity Rules (UMIR).
The IIROC includes a huge variety of professionals from various parts of the industry. As such, the group provides a rare opportunity for regulators to collaborate with leading financial, legal, and technological institutions across Canada.
Currently, the group includes regulators, crypto firms, law firms, and three of the largest banks in the country. Specifically, the Crypto-Asset Working Group members are:
- Stephen Allcock (Questrade Financial Group)
- Pam Draper (Bitvo)
- Robin Ford (Robin Ford Consulting)
- Andrew Grovestine (Canadian Securities Exchange)
- François Lavallée (National Bank Financial)
- Julie Mansi (Borden Ladner Gervais LLP)
- Felix Mazer (Coinsquare)
- Linda Montgomery (Coinchange Financial/Blockstation)
- Brian Mosoff (Ether Capital Corp.)
- Souvik Mukherjee (Scotia Wealth Management)
- Laurence Rose (Omega Securities Inc./ 4C Clearing Corporation)
- Duncan Rule (CIBC)
- Phil Sham (Aquanow)
- Sean Shore (Canadian Compliance & Regulatory Law)
- Paul Stapleton (Fidelity Clearing Canada)
- Dino Verbrugge (DV Trading LLC)
- Joseph Weinberg (Paycase Financial)
- Robert Whitaker (Blockchain Intelligence Group)
- Lara Wojahn (Dominion Bitcoin Mining Company Ltd.)
One of the main goals of IIROC is to develop a regulatory framework that supports a robust, thriving digital asset marketplace to further drive innovation in the space. Additionally, the body seeks to integrate more consumer and investor protections in the market.
Blockstation Joins the Team
Blockstation received an invitation to participate in the IIROC after the group recognized the firm as an industry leader in the region. Importantly, Blockstation has experience working with regulators in other jurisdictions to develop its platform.
Today, Blockstation operates a fully compliant tokenization platform. The services provided by the firm include an end-to-end solution for listing, tokenizing, trading, custodianship, clearing and settlement, and lifecycle management of tokenized assets. Specifically, the firm’s Marketing Advisor Linda Montgomery will lend her experience to the IIROC.
Blockstation Makes Headlines
Notably, Blockstation made headlines this week after the announcement that the firm will host a compliant digital securities ecosystem via the Jamaica Stock Exchange (JSE). This limited pilot will test the trading of Bitcoin (BTC) and Ethereum (ETH) according to an April 3, press release.
Jamaica Stock Exchange
The JSE first announced its crypto aspirations back in August. At that time, the JSE signed a master agreement with Blockstation. For its part, Blockstation would develop the tools for the trading of digital assets and security tokens on the JSE.
Blockstation Making Waves
Blockstation is a true pioneer in the Canadian crypto space. Now the firm seeks to help develop the fledgling STO sector into a major FinTech market. You can expect to hear more from these exciting developers as their JSE project continues. For now, Canada looks to be ready to take the next steps in blockchain adoption.
Veritaseum Hit with $8 Million in SEC Fines
In another example of the SEC turning up the heat on firms, the regulatory body hit Veritaseum and its CEO with hefty fines. Veritaseum had been embroiled in an SEC trial since earlier in the year. The SEC alleged the firm illegally sold securities to investors. Now the company must pay $8 million in fines and judgments as part of its retribution.
As previously reported, Veritaseum LLC, its CEO Reggie Middleton, and a sister firm, registered in NY, Veritaseum Inc. faced serious scrutiny from the SEC for its 2017 – 2018 ICO. During the unregistered coin offering, the firm secured $14.8 million in funding from investors.
By mid-2018, the SEC received numerous complaints of fraudulent activity on the part of Mr. Middleton. For example, the SEC report alleged Middleton downplayed the risks involved in the investment. Additionally, he misrepresented the tokens his company offered.
Tokens are not Coupons
On multiple occasions, he referred to the tokens as securities or software. The report states that at least on one occasion, he told investors the tokens were similar to gift cards.
On top of the troubling miss information campaign, Veritaseum had other shady incidents occur during its now controversial ICO. According to Middleton, the company was the victim of a hacker that stole $8 million from funds raised. Of course, these funds were never recovered. Consequently, the incident added to the black cloud accumulating over the Veritaseum camp.
In August of this year, the SEC responded to investor complaints. The regulatory body sent Middleton a cease-and-desist. As part of the complaint, Middleton’s ability to host an ICO or operate his firms was put on freeze.
SEC Enters Talks
The SEC entered official settlement talks with Veritaseum on OCT 9. This decision followed a postponement of the original trial date until Nov. 14, 2019, by the New York Eastern District Court.
According to reports, Veritaseum must now pay $8.4 million in disgorgement fines. Of these fines, $7,891,600.00 goes to defendant liabilities. Additionally, the company is liable for a civil penalty of up to $1 million and a prejudgment interest amount of $582,535.
Veritaseum Hit Hard
The news hit Veritaseum’s market value hard. Since the start of the trial, Veritaseum lost around 35% of its value. The token fell from around $25 per coin to $15, before rebounding slightly to $18.71.
SEC on the War Path
The SEC has been on a mission to crack down on ICOs from the 2017 crypto craze. Regulators already hit Sia with a $225,000 for its 2017 ICO in which the firm raised $120,000. EOS is another example of the SEC crackdown. The company must pay $24 million for its $4.1 billion 2017 ICO. While both firms faced charges for illegally selling securities, neither had such significant misrepresentation claims put against them as Veritaseum.
Veritaseum is Unique
In this manner, Veritaseum is significant. The firm is still operating but Middleton is no longer able to conduct blockchain crowdfunding ventures. It’s hard to say exactly what the long term effects of the settlement will be. For now, the crypto community must watch and wait patiently to see the results.