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Why EU blacklisting the Cayman Islands matters for the STO industry – Thought Leaders

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Why EU blacklisting the Cayman Islands matters for the STO industry - Thought Leaders

On February 18th the European Union added the Cayman Islands to its tax haven blacklist. While this has not made the news in the security token industry, it has had major implications. Due to the strict demands of AML & KYC in many jurisdictions, regulators are focusing more resources on beneficial ownership, tax transparency, and enforcement.

For companies raising capital, the blacklisting means you should not take money from a Cayman fund if you’re a European issuer. In the EU, a lot of the investment in security tokens, real estate, and private equity comes from or through Cayman fund structures. Cayman is also where a large portion of American VC funds are domiciled.

The current tax haven blacklist also includes American Samoa, Fiji, Guam, Oman, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands, Vanuatu, and Seychelles.

Any company taking funds from a Cayman domiciled fund, or working with a platform/issuer/bank in that market should be aware that being associated with a blacklisted country could create significant new risk exposure for your project, and possibly yourself. These changes are effective immediately. Until recently, most firms could fly under the radar but the EU is also rolling out a public registry of corporate ownership. This will not only make non-compliance much easier to spot but also increases the ability for regulators in the EU to investigate and enforce.

The regulation could impact people working at (including directors, officers, or significant shareholders) a company that received funding from a Cayman source after the blacklist date. Enforcement severity changes by country but can include criminal charges, company seizure, and known associates may end up on a variety of sanctions and watch lists. Not to mention the reputational damage.

This is a good example of why a good AML program does not only consist of face matching a document and pinging an API to name match a sanctions list – you are opening up your venture, and most likely yourself, to massive liability. Your legal and regulatory obligation is to take a risk based approach. What that looks like can change by country, transaction value, activity history, etc., so AML program needs to be dynamic, robust, and comprehensive enough to catch things like narrative sanctions.

For example: The most popular security token platforms today only use KYC for digital onboarding of natural persons – not corporate entities. However, when you look at the investors in their previous token issuances you can see that most of the funds are coming from corporate accounts, corporation owned wallets, but the on-chain transaction and KYC is done by an individual. These platforms are missing the technical capabilities to spot transactions coming through blacklisted jurisdictions such as Grand Cayman.

iComply recently helped a virtual asset exchange pass the audits needed to offer their users the ability to spend virtual assets, such as Bitcoin and Ethereum, with a Visa card. This process involved independent audits from Visa, their banks, and regulators – each wanted to see the client demonstrate how they would be able to identify these risks and fulfill the requirements of a whole web of regulations.

Now that they have passed the audit, they are first to market with a very compelling offer compared to their competition who still have months of development on their AML systems before their applications will go through. Using iComply to get ahead of the regulations has also put them ahead of their competition.

We can expect the same for the security token market. Token issuers need to pay close attention to their AML compliance – Telegram had to refund over $1B USD over AML, has spent millions in court with the SEC, and the OCC has not even started with them yet…after that, how many of their “not investors” will be ready to jump onto an investor class action lawsuit? We have already seen this with the recent OCC case against MYSB in New York, or with the SEC and AirFox in Boston.

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Matthew Unger is founder and CEO of iComply. After founding a $42M wealth management practice, Matthew exited by age 26 and co-founded a practice management platform for wealth managers which was acquired by Planswell in 2015. Matthew has studied blockchain, AI and Business Strategy at MIT and is a global expert in Security Token Compliance.

Regulation

KYC/AML – Who is Proactive? Who is Under Fire?

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KYC/AML

AML (anti-money laundering) refers to the laws, regulations, and policies that are used by financial-based institutions to monitor and screen customers’ source of funds, and to ensure that the funds are obtained legally; AML acts as a deterrent for criminals wishing to hide and move illegal money.

A subset under the larger AML umbrella is KYC (know-your-client/customer).  KYC is the collection of data by financial institutions to know its customers better and establish a customer profile that details a customer’s risk tolerance, financial position, and financial literacy.  Documents often collected in the KYC process are notarized passports and utility bills, employment status, net worth, source and description of funds, etc.  KYC is used to protect the financial institution and the customer.

While KYC/AML plays an important role in investing, not all financial institutions are equally thorough in the collection of KYC/AML data.  There have been multiple companies in the digital asset industry that have come under fire for lax approaches to the KYC /AML verification process.  By contrast, there are also multiple instances of companies in the digital asset industry that have taken proactive approaches.

Why are KYC and AML practices important?

While it would be nice to live in a world absent of bad actors, this is simply not reality.  KYC/AML plays a role in creating safe and fair financial markets for everyone.  They also provide a means of recourse against those found to be acting in bad faith.

There are drawbacks in trying to foster fair markets though – notably, a loss of privacy.  Yes, honest investors may gain better safety, but they are also forced to give up vital identifying information about themselves.  This is a valid concern; when giving up personal data, you are entrusting that it will be safely guarded by the receiving entity.  Unfortunately, financial institutions are not immune to data breaches as recently made evident by the Canada Revenue Agency which had a breach of more than 48,500 accounts.

Lax Data-Gathering

Despite the noted benefits of KYC/AML, there are many companies that have opted for a half-hearted approach to these practices.  The following are only two recent examples in a pool of many which highlight this.

Binance Sued

One of the largest cryptocurrency exchanges in the world, one would assume that Binance would partake in good KYC/AML practices. This, however, is not the case in the eyes of Japanese exchange, Zaif.  This lesser-known exchange is now suing Binance over its ‘lax’ KYC/AML practices.  The lawsuit stems around a hack of Zaif in 2018, which resulted in roughly $60M of stolen assets being laundered through Binance – an occurrence that Zaif believes would not have occurred if the KYC/AML procedures used were up to par.

ePayments Shut Down by FINRA

In this instance, payment processor, ePayments, went under a FINRA imposed lockdown in early 2020. While the company has remained quite tight-lipped regarding the reasoning for this, it is known that the lockdown stems from a lax approach to KYC/AML.  In recent days, ePayments has provided a small update, indicating that it is commencing a platform restart soon – albeit with the discontinuation of support for cryptocurrencies – after months of overhauling its KYC/AML approach.

Learning by Example

Although there are those that have not placed enough emphasis on KYC/AML, others have watched and learned from these transgressions.  The following are examples of this, showing both service development, and adoption.

BnkToTheFuture Invests in/Adopts Blockpass

This recent announcement is more than just an investment. BnkToTheFuture will be incorporating a tailor built solution by Blockpass, meant to facilitate comprehensive and efficient KYC/AML procedures.

Securitize makes KYC easy

Industry leading, Securitize, recently launched a new service, dubbed ‘Securitize ID’. This service was built to bring new efficiency to KYC/AML procedures.  It essentially allows for an investor to be ‘whitelisted’ after completing KYC/AML processes through Securitize.  Being whitelisted involves assigning a unique investor ID, which is then recognized by co-operating companies – meaning the process does not need to be repeated countless times.

A Growing Industry

If anything can be derived from these various examples, it is that the world of blockchain needs to take KYC/AML seriously.  While there may not have been services to fit these needs at one point in time, this is no longer the case.  Moving forward, expect to see increased adoption of these services tailor-built for KYC/AML, as companies look to avoid the wrath of regulators, and ensure fair markets for clientele.

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Regulation

Nigerian SEC Provides Clarification on Token Offerings and Digital Asset Classification

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nigerian

Investors continue to flock towards assets such as cryptocurrencies and digital securities as, not only a new form of currency but a hedge against global economic uncertainty.  As a result, regulatory bodies around the world have had to adapt or clarify approaches towards these alternative asset classes.  The latest to do so is the Nigerian Securities and Exchange Commission.

Before jumping into what a few of these approaches are, the Nigerian SEC took the time to allay fears of an unnecessarily strict approach.

“Digital assets offerings provide alternative investment opportunities for the investing public; it is therefore essential to ensure that these offerings operate in a manner that is consistent with investor protection, the interest of the public, market integrity and transparency. The general objective of regulation is not to hinder technology or stifle innovation, but to create standards that encourage ethical practices that ultimately make for a fair and efficient market.”

Default Classification

In this recent address to the public, the Nigerian SEC was explicit in its approach towards digital assets, stating,

“The position of the Commission is that virtual crypto assets are securities, unless proven otherwise.”

By taking this stance, it removes the guesswork surrounding the treatment of digital assets.  Essentially, it does not matter if an asset fails to fit the definition of a security.  In order to be deemed something else, this needs to be proven to the Nigerian SEC on a case-by-case basis.  Only then, with the approval of the regulatory body, can an asset be reclassified.

Where the Onus Lies

In addition to establishing its position that all digital assets are to be treated as securities by default, the Nigerian SEC elaborated on where the onus lay for those looking to change the classification of an asset.

“…the burden of proving that the crypto assets proposed to be offered are not securities and therefore not under the jurisdiction of the SEC, is placed on the issuer or sponsor of the said assets.”

Essentially, the Nigerian SEC will not be taking it upon itself to classify every asset.  It is the responsibility of a tokens issuer to prove the most appropriate classification.

All Token Offerings Regulated

While the first two points of clarification maintain a focus on investors, a third was made to provide clarity to companies hosting capital generation events.

These events, which include ICOs, DSOs, and IEOs, are all subject to regulation by the Nigerian SEC.  There are no forms or variations that ‘skirt’ around existing regulations.  As all digital assets are deemed securities by default, this classification spills over into events meant to facilitate their sale/distribution.  It is stated,

“…all Digital Assets Token Offering (DATOs), Initial Coin Offerings (ICOs), Security Token ICOs and other Blockchain-based offers of digital assets within Nigeria or by Nigerian issuers or sponsors or foreign issuers targeting Nigerian investors, shall be subject to the regulation of the Commission”

In the ICO boom of 2017, companies around the world took part in these popular means of raising capital.  While many were scams, there were still many well-intentioned companies that simply were not well informed.  As a result, many hosted ICOs, under the impression that securities laws would not apply when this was simply not the case.

This stance by the Nigerian SEC was made in an effort to avoid this confusion moving forward.  While ICOs may not be as popular as they once were, token offerings still regularly occur in the form of DSOs and IEOs.

SEC Nigeria

The Nigerian SEC in its current form was founded in 1979.  Much like similar regulatory bodies, it is tasked with ensuring fair and transparent capital markets through the creation and enforcement of regulations.

Chairman, Olufemi Lijadu, along with a 9 person board, currently oversees operations.

In Other News

At the beginning of today’s look at the actions of the Nigerian SEC, we alluded to similar occurrences in a variety of nations.  Some of these occurrences involved real change, while others simply clarification.  The following are a few examples of these.

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Regulation

FLiK and CoinSpark Orchestrators Charged by SEC for Fraudulent ICOs

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FLiK CoinSpark

On September 11, the SEC announced charges against FliK and CoinSpark, as well as five individuals associated with the two companies.  The charges stem from two fraudulent ICOs (FliK and CoinSpark) held in 2017.

With 2020 being a disaster in many ways, it is easy to develop a short term memory of past years.  Unfortunately for the bad actors that took part in past fraudulent ICOs, the Securities and Exchange Commission (SEC) remembers.

SEC Charges

The charges surrounding these two ICOs are various.  Not only did the events represent the illegal sale and distribution of securities, but they were rife with other fraudulent activity.

  • Illegal sale and distribution of unregistered securities
  • Misrepresentation
  • Appropriating and misusing investor funds
  • Market manipulation

As a result of these charges, all parties have opted for a settlement with the SEC – each of which consists of restrictions on future market participation, along with fines that range from $25,000 – $75,000 USD.

Naming Names

The aforementioned charges are particularly noteworthy, due to the names attached to these projects.  Of the 5 individuals charged, two are well-known celebrities.

Clifford ‘T.I.’ Harris – T.I. is a rapper/actor that not only promoted, and sold FLiK tokens, but also misrepresented himself as a co-owner of the project.

Ryan Felton – Primarily a film producer, Ryan Felton was the main orchestrator behind both illegal securities offerings. The SEC took the time to comment specifically on his actions, stating, “The federal securities laws provide the same protections to investors in digital asset securities as they do to investors in more traditional forms of securities…as alleged in the SEC’s complaint, Felton victimized investors through material misrepresentations, misappropriation of their funds, and manipulative trading.”

Off the Hook?

If there is one individual that may yet rest easy, and be happy with the conclusion of this saga, it would be Kevin Hart.

When the SEC first began investigating the actions of those affiliated with FLIK, Kevin Hart was among those named.  Fortunately for the superstar actor/comedian, recent developments indicate that there have been difficulties proving his involvement.

For the time being, there was no mention of Kevin Hart in the SEC’s most recent communication.

Securities and Exchange Commission (SEC)

Founded in 1934, the SEC is a United States regulatory body.  Its purpose is to foster fair and transparent markets, through the creation and enforcement of regulations pertaining to assets deemed securities.

Chairman, Jay Clayton, currently oversees operations at the SEC.

In Other News

When looking at some of the other high-profile cases to be settled with the SEC, news of FLiK and CoinSpark seems relatively minor.  Despite this, when looking at the big picture it becomes clear that no ICOs are safe from enforcement actions by the SEC.  These smaller cases discussed today are simply the latest in a long line of similar instances.

By not letting anyone ‘off the hook’, the SEC is sending a clear message moving forward that the blockchain industry needs to remain mindful of existing securities regulations, and that companies will be held accountable for their actions.

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