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
Binance IEOs Outperform Competing IEO Projects – Thought Leaders
Over the past 12-month IEOs (Initial Exchange Offerings) have replaced ICOs (Initial Coin Offerings) as the fund-raising method of choice for blockchain companies. There are undeniable advantages to IEOs compared to ICOs.
One of the biggest advantages is there’s a reduced risk of investment funds being siphoned from a hacked website. One example of this happening to an ICO is the Etherparty hack whereby hackers discreetly modified the Ethereum address displayed on the ICO website to reroute incoming investments to a Hacker’s Ethereum address.
The barrier to entry to launch an IEO is also significantly higher than an ICO, which is beneficial to investors. Trusted exchanges will (in theory) only list reputable projects after they perform extensive due diligence. Compare this to ICOs, many of which copy and paste existing whitepapers, create fake founder LinkedIn profiles, and then advertise to unsuspecting investors using Google Adwords.
In this sense, IEOs are a much better alternative to ICOs. Investors have a much easier time both accessing the fundraising opportunity as well as funding the investment. This is provided in a safe (but unregulated) environment as provided by the exchange. Different exchanges offer differing parameters for listing an IEO. For instance, we noticed much higher quality IEO listings with market leading exchange Binance, and Kucoin, versus some of the smaller exchanges such as LAToken and Yobit.
While IEOs provide financial benefits to both the host exchange and startups, the same cannot be stated for the financial benefits that are offered to investors. From crunching the numbers IEOs have to date performed poorly.
In researching this article we reviewed IEOs from all major exchanges. Over 50% of the IEOs on smaller exchanges were not listed on CoinMarketCap.
Nonetheless, there were some surprises. While the majority of IEOs performed poorly and provided negative returns on the majority of exchanges, Binance was the odd exchange which actually had a higher number of tokens outperform the market. This was especially true for IEOs launched in 2019.
Below we track the launch date of several IEOs on the Binance exchange, the amount raised, as well as the IEO sale price of each token and the current market value of each token. The reason we do not use market map is that this number is very misleading for investors, as the total market cap includes the entire value of a token project, versus the IEO tokens which were initially sold to investors.
These numbers are based on publicly available data and may not be 100% accurate.
|Company:||IEO Date:||Raise:||Initial Token USD:||Current Token USD:|
|Celer Network||March 2019||4M||0.0067||0.005940|
|Perlin||August 2019||6.7M||0.07743 USD||0.060321|
Unfortunately, other exchanges did not fare so well. Some exchanges performed so poorly with the IEOs that they offered, that we could not find the market value of the tokens listed anywhere.
In conclusion, what is currently more important than the actual project being listed, is where the project is listed. We anticipate that once regulated security tokens increase in popularity, that IEOs may be an enticing option to list these security tokens on regulated exchanges. This would be similar to how stock exchanges currently operate.
Disclaimer: While I have previously held BRD & BTT tokens, in September 2019, I did not hold any of the IEO tokens as profiled in this article.
5 Major Takeaways from SEC’s New Investor Protection Rule – Thought Leaders
It seems that the controversies surrounding SEC’s newly adopted Regulation Best Interest rule (Reg BI), would continue to take center stage, even though it goes into effect next summer. The regulation is the culmination of a decade-long process that started in 2010, immediately after the great recession. The Dodd-Frank Act passed that same year authorized the SEC under section 913 to enact a fiduciary standard and best of interest rule to govern broker-dealers and investment advisors when engaging with private investors.
In the aftermath of the introduction of Reg BI, stakeholders, state regulators, investment advisers and broker-dealers have weighed in on various factors that could undermine or aid its effectiveness.
5 Key Takeaways
- Brokers Dealers required to adhere to new “best interest” standard
- Sets up U.S. Department of Labor (DOL) to synchronize rule-making (later this year)
- Big win for broker dealers → even bigger for financial services
- The New Common Reporting Standards (CRS) Says Broker = Advisor → confusion between broker vs fiduciary advisor
- Reverse focus on protecting brokerage role than consumer = more confusion
However, before we highlight these takeaways, let’s first take a look at the substance of the fiduciary standard clarification rule.
The Takeaways from SEC’s Regulation Best Interest Rule
SEC intends to subject broker-dealers, who currently are only required to meet suitability standards, under fiduciary standards.
On one hand, fiduciary standards presently govern the relationship between financial advisors and their clients. And it expects the former to only offer services that are in the best interest of the latter. On the other hand, suitability standards require brokers to ascertain that the investment they recommend suits their clients.
In essence, the rule looks to extend the fiduciary rule on broker-dealers who are increasingly taking up the roles of financial advisors, when their primary duty is to sell an investment product for a stipulated commission. Under the suitability standard, it is legal for a broker to recommend an investment product that avails him a good commission, so long the product is suitable to the customer.
While this is a given, it also presents a conflict of interest. It’s possible that there are cheaper investment products with similar features to the one the broker recommends, but with a less attractive commission. This conflict of interest is what the Reg BI looks to eliminate, as it requires brokers to place the client’s interest above theirs.
To do this, the rule would enforce brokers to explicitly disclose important information such as incentives and commissions that could influence their recommendations. More so, it would, to an extent, ban industry practices, like incentives in the form of vacations, that could spur brokers to betray the interests of their clients.
Knowing fully well that brokers could find a way around this requirement by disclosing conflict of interests with technical terms or in a voluminous document, the SEC also introduced another requirement that could counter such practices. The requirement states that brokers must outline conflict of interests and their compensation structure in plain English and in a concise manner on a document called form CRS.
Also, brokers would document the history of legal or disciplinary actions taken against the firm offering the investment product or its financial professionals. Another vital feature of the rule is Care Obligation. This requirement entails that financial advisors to make sure that they diligently and carefully ensure that their recommendations are in the best interest of their clients.
The last requirement is the Conflict of interest obligation. It requires the management and mitigation of commissions that could represent a financial conflict of interest.
Dissecting the Implications of The Regulation Best Interest Rule
As expected, critics left and right have dissected SEC’s Reg BI, and the prominent argument that many have brought up is the fogginess of the rule. For one, some critics have condemned SEC’s reluctance to clearly define what it means by “Best interest”, the actions that would suggest that an investment advisor is not compliant, and how to mitigate financial conflict of interest.
Chances are that broker-dealers would look to find a way around this rule, at least until SEC starts enforcing disciplinary actions against non-compliant investment advisors. Besides, Reg BI does not seem to have enforcement muscle. It is unlikely that non-compliance would lead to class action lawsuits and litigations.
Furthermore, there is an outcry that SEC’s rule has done nothing to clarify to investors the roles of Investment advisors and broker-dealers. Note that a majority of brokers-dealers are registered with the SEC. Technically, this means that they could assume the roles of Registered Investment Advisors (RIA), and yet, they are not fiduciaries.
More concerning is the fact that the Form CRS requirement would do little to change the status quo. This notion stems from the fact that studies showed that consumers found it difficult to understand the contents of CRS forms.
While responding to many of the criticisms leveled against Reg BI, SEC’s chairman, Jay Clayton stated that “differing views were expressed regarding whether the standard should be more principles-based or more prescriptive — and in particular, whether to provide a detailed, specific, situation-by-situation definition of ‘best interest’ in the rule text.”
As such, after careful consideration, the agency concluded that the principle-based approach adopted for the rule “is a common and effective approach to addressing issues of duty under law, particularly where the facts and circumstances of individual relationships can vary widely and change over time, including as a result of innovation,”
Judging from the details of Reg BI discussed above, there is no doubt that the rule has elements of the fiduciary rule that the Obama administration proposed through the Department of labor. The difference is that the latter was looking to classify all investment professionals as fiduciaries. In other words, a client could decide to sue his investment advisor or broker once he notices any discrepancies that would suggest that his interests were not best served by the actions of his investment manager.
Recall that this rule hit a roadblock under the present administration, as the securities industry challenged its viability in court. And while DOL has also indicated that it is pushing for a new fiduciary rule, there is no guarantee that its future proposal would have the same grit as the previous one. This assertion is probable, considering the likelihood that Eugene Scalia, the attorney that led the case against DOL’s previous fiduciary rule, would emerge as the new Labor Secretary.
Also, it is important to note that the Certified Financial Planner Board of Standards plans on enforcing an ethics code that would entail that its 84,000 members adhere to fiduciary standards, irrespective of the regulatory frameworks that govern them. Interestingly enough, this code’s implementation date coincides with that of Reg BI’s.
More importantly, some states are contemplating on taking matters into their own hands by imposing separate fiduciary rules that would correct the apparent flaws of Reg BI. For instance, New Jersey’s security bureau has released a rule proposal that explicitly classifies brokers- dealers as fiduciaries. Other states that have taken a similar path are Nevada and Massachusetts.
In response to this development, SEC’s chairman, Jay Clayton, stated that “I and many others believe a patchwork approach to the regulation of the vast market for retail investment advice will increase costs, limit choice for retail investors and make oversight and enforcement more difficult. I am hopeful that our regulatory colleagues will continue to work with us to minimize inconsistencies and maximize the effectiveness of our collective efforts.”
However, regardless of the loopholes of Reg BI, and the controversies that spurred responses from state regulators, I believe that the SEC’s proposal is a step in the right direction in order to protect investors.
For investors, it is a matter of asking the right questions:
- Who pays your broker’s commission?
- How much he gets paid for encouraging you to buy an investment product.
- Are you a fiduciary?
- How does a broker apply investor protection rules?
The information provided here is personal opinion and provides only a subjective opinion of the rules and regulatory guidance provided by the SEC. It should not be read as legal or compliance advice. Consult with your compliance professional for further details.
Top 5 Equity Crowdfunding Websites – Opinion
Crowdfunding has been around since 2008 with the launch of indiegogo, followed by Kickstarter which launched in 2009.
The early crowdfunding websites offered users free perks, and goods in exchange for funding their business venture. Most of these start-ups fizzled out after a few months but some of these were widely successful. One of the most notable success stories is the virtual reality headset Oculus which raised over $2.4 million on Kickstarter in a campaign that also caught the attention of Mark Zuckerberg. Shortly thereafter Oculus was acquired by Facebook for $3B. This was a monumental acquisition for a start-up with a great vision and zero profits.
Unfortunately, while the Facebook acquisition of Oculus was life changing for the Oculus team, the early backers of the project on Kickstarter received nothing, as no equity was offered for their initial backing of this project.
In 2012 the JOBS Act passed which opened the doors to crowdfunding websites offering early investors equity. Now investors from all over the world have the opportunity to support start-ups who are too small to access traditional venture funding.
These equity crowdfunding websites serve an important purpose as they are directly responsible for nurturing entrepreneurs while offering investment opportunities to investors who are not based in Silicon Valley.
Below are in my opinion the top 5 equity crowdfunding websites. As a disclaimer, I’m an equity owner in 3 of the companies listed below (WeFunder, Microventures, StartEngine).
#1 – SeedInvest
SeedInvest differentiates themselves by focusing on only having handpicked start-ups in upcoming industries. If you want to invest in the future of tech this is one of your best options. The industries that are often featured include:
- Augmented Reality
- 3d Printing
- Artificial Intelligence
- Space Technologies
They’ve helped over 150 companies raise capital, and the team is great at filtering out most companies that apply, to offer investors a curated list of world class companies to invest in.
#2 – Microventures
This website is different than the rest of this list as they offer two different focuses and they target accredited investors only.
The main focus is on Late Stage companies. Some of the late stage companies which have been featured include:
- Honest Company
This offers the easiest possible route to investing in phenomenal late stage companies which are often only a few years away from going IPO. The minimum investment is often in the $5000 to $50000 range, with the minimum depending on the interest level and the company.
They also offer investment opportunities in Early Stage companies with minimum investments in the $3000 to $5000 range. These companies are often in Fintech, robotics, 3-D printing, etc. The quality of these Early-Stage companies is high and is also handpicked.
#3 – WeFunder
They were responsible for helping to write the JOBS Act, and are one of the oldest companies in the crowdfunding space. There’s been some huge success stories on this website.
In April 2013 Zenefits raised at a $9M valuation, and only 2 years later in May 2015 they raised an additional $500M and were valued at $4.5B. This means if you had invested $10000, you would have received a cool return of $500,000 in a 2 year period.
WeFunder came out of the Y Combinator accelerator program, which is the most famous and successful accelerator program in the world. Some success stories from here include AirBNB, DropBox, Stripe, coinbase, etc.
The reason this is important is that Y Combinator companies support each other in what is a giant ecosystem. Many of the start-ups on WeFunder are Y Combinator graduates (such as Zenefits).
#4 – Fundable
One of the oldest platforms on this list, Fundable launched on May 22, 2012. Since then they have been offering access to a notable list of companies in every industry that you can conceive of. I’ve seen everything from solar power fields to revolutionary 3D printed prosthetics.
Fundable is a crowdfunding website which offers an extensive live of companies to choose from.
#5 – StartEngine
Over 90M has been raised by 265+ companies. They even recently successfully raised a$10M STO for themselves.
While this is a great platform they are not as selective as the rest of the equity crowdfunding websites on this list, so you do have to be more careful and perform extreme due diligence in who you invest in. That being said there are some gems to be found. Hackernoon recently successfully completed a $1.07M raise. I do find that they have too many companies listed, which makes perusing the list a bit exhausting.
These are the top 5 crowdfunding websites which I believe offer investors the best access to investment opportunities. You should always perform proper due diligence, and understand that Early Stage investing is high risk, and that you are more likely than not to lose access to all of your capital. You should also expect that it takes 7 to 10 years to earn a return on any of these investments.
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