Crypto Regulation–Elusive Clarity

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CONTEXT: When Crypto first emerged it was unclear how, if at all, it was regulated. The SEC took the position that many token offerings were securities and that the issuances needed to be registered with the SEC; since they were not, they likely were illegal and in any event disclosure was so weak that fraud was a huge risk.  The exact status of token issuances remained unclear, however.  The current Federal administration clearly is pro-Crypto, the President himself issued coins (which have greatly fallen in value although the issuers made a huge profit), and the SEC (now Republican-controlled) undertook to define the SEC position in a more Crytpo-friendly manner.

REGULATION OF CRYPTO IS BIFURCATED: There are two major families of Crypto.  “Digital Commodities” such as Bitcoin and Ether are regulated by the Commodity Futures Trading Commission.  These coins or tokens do not contemplate using the funds raised for any particular project, construction or result, they are just themselves a commodity.  “Digital Securities” arise when they are offered on the understanding that the proceeds will be used to build or create something; they are offered as part of an investment contract and are regulated by the Securities and Exchange Commission.  The analogy is to a corporation selling shares of stock to finance its business. The below discussion relates to digital securities wherein the proceeds will be used for creation of something (a “Project”).

CURRENT SEC PROPOSAL: On August 18 the SEC issued a proposed rule favorable to the deregulation of those Crypto offerings which contemplate a Project.  This proposal is now in a 60-day public comment period.  It joins a prior pending law, the Clarity Act, to be taken up by Congress next month, which will regulate not the issuance and trading of such Crypto but rather the brokers and dealers trading in such Crypto.

In brief summary, the SEC proposal concedes the status of Crypto offerings which contemplate a Project as in fact constituting an offering of a security pursuant to an investment contract, but then  exempts from any registration requirements the following offerings based on size (assuming there is a disclosure document describing the deal): any issuance during a four-year period not exceeding $5M; and, any issuance up to $75M in a twelve month period (this larger exemption provides for ongoing reporting requirements).  The proposed law also pre-empts all contrary State law.  The SEC frames the proposed legislation as part of a desire to encourage innovation and to bring Crypto innovation on-shore to the United States.

IMMEDIATE REACTIONS: Initial reaction by attorneys involved in Crypto regulatory practice is clear: States are going to object strongly and push back as many have already legislated to protect retail investors. Once promoters have fulfilled all their promises as to how the funds raised for Crypto (they have completed their Project as promised),  the proposed law exempts the promoters from any claims of liability for future performance or claim of noncompliance on issuance, contrary to much State law.

Further, the SEC has not provided clarity as to where secondary trading may occur. It is unclear whether Crypto exchanges like Coinbase could list the offerings since these platforms are not registered to list securities (the SEC proposal treats this Crypto as a security, it just exempts certain  issuances from registration). Passing the Clarity Act (referenced above) is needed to round out an understanding of how to trade issued Crypto; the Act’s passage may not be so easy when Congress reconvenes in a couple of weeks, as Democrats are still negotiating parts of the bill, are considering a limitation on the ability of government officials to profit from Crypto, and of course the approaching mid-terms will muddle the Congress for political reasons.

Stay tuned, but one thing seems clear: during the Republican control of Congress, the SEC may have its way, but if the Senate flips be ready for some interesting times.

Is Delaware Still the Place to Incorporate?

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Elon Musk wanted $56 Billion and at first it seemed that Delaware said “no.”  Meanwhile other states have moved aggressively to attract incorporations on the private and public levels.  Although Musk moved his company to Texas, the main competitor for the incorporation business has been Nevada.

This summer the Harvard Law School Forum on Corporate Governance issue a paper (not written by Harvard) suggesting for a variety of reasons that Delaware ought to be the jurisdiction of choice for incorporating, particularly if you plan to go public; but that even at the LLC level (LLCs never can go public) Delaware ought to be the jurisdiction of choice.  Separately, my firm’s corporate law office in Delaware just today held a meeting describing how Delaware has altered its case law to permit disputes involving Delaware entities to use more freely the nonjudicial routes to resolve internal corporate disputes (greater use of arbitration, greater flexibility to provide for alternate tribunals and methodology pursuant to Charter and By-Law regimens).

The most significant response from Delaware was a statutory amendment to codify the favorable “business judgment rule” as a safe harbor for corporate transaction involing conflicted directors and control stockholders if reasonable procedural steps are taken.  If internal votes of disinterested parties approve a transaction, the Courts no longer will apply a standard that nonetheless will hold management to a separate review for “entire fairness.”

For LLCs, Delaware does permit specific provisions delegating decisional power to control directors or equity holders, setting internal governance standards.  And these kinds of considerations are as applicable to start-ups as they are to established businesses, so the general tradition of forming start-ups in Delaware, in part to attract capital, remains a viable decision.

Meme me a Meme

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There is an ill-used category for posts to this site called “I’ve been thinking.”  First, I normally post as to substantive matters and have even stopped posting about the aggravating Red Sox.  Second, as has been suggested by some readers, if I presume to believe that I am thinking then I am truly out of my depth.  BUT I feel compelled to provide the below petulant post about the word “meme.”

What the hell is a meme?  Seems it covers every thing and idea that circulates. How did that happen?  I know language evolves, but I am a traditionalist and believe it should evolve rarely, slowly and, if  you will, from the top down.  Serious people, scientists, ought to add much-needed words in the pursuit of progressive society.  But all of sudden, everyone is calling everything a meme.  We even have the President producing a meme coin, and there is a putative marketplace for meme tokens as an asset class.

As I like to lie to myself by saying that I am a modern writer who is part of the modern genre, I retreated to seek counsel from my newly-trusted adviser GPT: “What is a meme,” I asked.  Today, it is an idea, a behavior, a phrase, an image, or a style that spreads socially by imitation.  As I guessed: it is everything that is popular.  Seems to me that, as such, we do not need the word at all, we can just talk about any subject currently if it is generally known,  not bother to establish a new category.          For example, if you are talking about the Red Sox you describe them as such and do not think “I am talking about a meme called the Red Sox.”

In fact, and many seem to have known this well before I today consulted GPT, the word did come from the scientific vector, a1975 biology text called “The Selfish Gene.”  The author I am sure did not intend to invent a new word for general usage of anything. He was talking genetics, not pop music or a worthless physical token bearing the image of a sitting President.  Why then did society extrapolate this analogy?

It seems clear to me that it is the result of our electronic culture, the ubiquitous presence of electronic mass communication.  Everyone consumes the same thing.  Something new has intrigue, cache, proof of exciting newness.

Do you find use for this word and, if so, is it in dismissive context (eg “not another meme” or as I have asked “what the hell is a meme anyway”)?  Or is it now the way you refer to things of general cultural popularity, regardless of category.  Put another way, is this whining, testy post that you are perhaps still reading itself a meme, applying the word to an entire posted literature bemoaning the existence of a word in normal usage?

Future posts will be of substance and not passing peevishness.  Meme-hatred has now been expunged from my system.  We will return to your regularly scheduled broadcasts…..

State of Private Equity in 2026

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Private equity investments were considered selective last year, with price being an apparent issue mitigating against deal flow.   Perhaps also a lack of sufficient cash-outs constrained available capital. Optimism prevailed at the start of 2026, although to me there did not seem to be any objective indicator.  And indeed through the 26th of June, it was reported that over 3,600 PE deals totaled over $735 billion.

But according to several leading PE attorneys, as reported in the Law360 information service, a sense of caution prevailed, characterized by one as a “strangeness in the market.”  It seems that different opinions as to enterprise value was a major factor.  The impacts of this factor are these: use of co-investment vehicles, more roll-overs for some seller equity, and an increase in earnouts (see my June 30 post as to earn-out usage).  Buyers are using their leverage in fixing such structuring.

There is also activity by secondary funds creating liquidity for prior investors, so-called “continuation funds.”  Whether such activity will in turn free up capital to drive new investments is unclear to me, however.

While real estate and defense deals seem to be robust (no surprise as to the latter given state of the world), current anticipation seems to be continued calm in the second half of the year.  One reason may have to do with the elections, in my view, a point not noted in the reportage.  Perhaps people are just unsure about a large number of things, and that leads to inertia.

 

 

Tenth Man on Your Board of Directors

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This month’s issue of Directorship (the publication of  National Association of Corporate Directors) discusses the necessity of having a “tenth man” in the board room when discussing complex matters with substantial risk wherein the board promptly has granted approval.

Boards are admonished the have a person with the obligation (after such approval) to challenge the result.  Not to be argumentative, the task is to inquire if the board has asked the right questions in reaching such decision.  Such approach is said to keep the conversation civil and not adversarial, inducing discussion of assumptions, risks not discussed, impact of failure, risk of oversimplification.

Lest one person become seen as an annoyance and not a team player, it is recommended that the chair rotate the role, so it is understood as an analytical tool and not the encouragement of a person who relishes conflict.

Unanswered is the metric for determining that a decision had been reached too quickly without full analysis.  This seems to me a subjective game-time call.  The board chair in this scenario needs quickly to exercise judgment as to speed of decision, question of whether alternatives were considered, and perhaps most importantly whether (since every idea has the risk of failure) a wrong decision would be “too expensive” in terms of P&L or the closing down of alternative approaches.

While not one to argue with the NACD (particularly being advisory to the New England Chapter), I did get a chuckle out of a passing comment in the same article: “Consider a board discussion on adopting agentic artificial intelligence where alignment around a well-reasoned functional recommendation from a director came quickly.”  Seems AI now is welcome in board deliberations?  The idea has facial logic, I suppose.

And finally, why am I offended by the invented worded “agentic”?  I guess progress carries its own nomenclature….

EEOC Formally Eliminates Affirmative Action

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Monday the US Equal Employment Opportunity Commission formally deleted support materials permitting affirmative action in cases where it was deemed appropriate to overcome past or present barriers to equal opportunity in employment.  This action is not unexpected; it is a logical extension of Republican administration policy, premised on the idea that every individual in America should be treated equally and thus without a leg-up on any basis.  The EEOC took this action without public hearing, cancelling a hearing originally scheduled for today.

This action was taken over the dissent of the sole Democratic member of the Commission, who also objected to the cancellation of the meeting.  But the result was clearly coming, based on emerging Supreme Court and lower court case law.

The regulatory basis for the deleted provisions dated from 1979 and 1981; forty-seven years of US policy now has been stricken from the books.  Seems to me two issues are presented.  The first is the stated conclusion: is the Supreme Court in fact correct that the Constitution should be read as establishing a legally neutral playing field in the face of clear historical  bias operating in the marketplace?  The second is this: assuming historically there was bias in the marketplace thus denying equal rights to minority citizens, have facts evolved over the past decades so that today such de facto bias does not exist?  If the second conclusion is correct, then while the EEOC action seems to revoke a clearly useful and correct standard, its deletion is without practical effect.

If you are cynical about the current state of the marketplace, then the action of the EEOC is regrettable.  I am not smart enough to speak definitely as to the facts on the ground.  I wonder who is….

M&A: Trends in earn-outs and reps/warranty insurance

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Interesting trends have popped up relative to the use of earn-outs and insurance against seller misrepresentations in acquisition practice.  (Tip of the hat to the firm of SRS Acquiom which provides shareholder services in such transactions and periodically reports on M&A trends.)

Earn-outs: for the uninitiated, an earn-out defers payment of the purchase price for a company until a future time, and the amount (if any) of such deferral is based on the post-closing economic performance of the acquired company.  As can be seen immediately, this can be dangerous for the seller; an acquirer can be tempted to down-play immediate success when good results means more has to be paid to the seller.  These arrangements are more typical of larger deals but occur about a fifth of the time even at the lower end of reported transactions.

What can be written in a contract to provide realistic protection for the seller if there is an earn-out?  Solutions include agreements by the purchaser: to act in good faith in running the acquired business (a vague standard); to run the business as in the past (not a likely result as the buyer will want to adapt the business to its own management style, or merge it into existing operations); to take no action with the intent to minimize future earnings (hard to prove what is in someone’s intentions); to operate to maximize profits (buyer’s independent business judgment might drive the opposite rational business goal, for example to revamp for long-term profitability or to integrate a business into internal product flow).  In any event, proving any one of these fact patterns is, to say the least, not easy.

Without descending to great detail, in practice the percentage of potential earn-out dollars actually paid is very little.  Possible take-away for many sellers, in my view: avoid pie-in-the-sky possible future windfalls and trade earn-out for as many dollars as you can negotiate up front.

Warranty and representation insurance: these are insurance policies to indemnify a purchaser for damages suffered when a business seller has misrepresented (willfully or not) as to salient facts about the business being sold.  When I started practicing law, admittedly decades ago, this was not common and indeed if I recall correctly not even available in the dim dark past.  Today, such insurance was purchased in 76% of reported acquisitions by venture capital firms and 34% of cases involving strategic buyers.  I suspect this reflects the likelihood that a strategic buyer possesses greater knowledge of the details of a related business being acquired while capital investors are at greater risk by reason of not being in a similar business.   Deal negotiations here revolve around whether insurance is purchased, who pays for it, and whether the seller remains on the hook for any damages arising from incorrect representations for amounts in excess of insurance limits.  Note that in about 80% of all cases the sellers are left on that hook.

These deal realities lead to the practice of a hold-back of purchase price to cover, among other matters, any such  misrepresentations.  Part of the purchase price is placed in escrow, often covers mechanical costs of winding up the transaction, but also is held to cover misrepresentation injury to the buyer.  Sellers often must decide whether they are better off buying insurance or suffering a holdback of funds in an escrow fund.

Each deal of course is different in substance and motivation.  Particularly in strategic deals the final deal model is unpredictable.  With private equity, not so much– when the buyer is not intimately knowledgeable about a given space, the buyer is much harder to deal with.  Be ready to be asked: “Aren’t you sure of your representations?  You are making me nervous about this deal if won’t stand behind the business you are asking me to purchase.”

Regulation of Prediction Markets

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To my mind, few things make less sense than the regulatory status of the prediction markets.  A very new phenomenon, prediction contracts first were regulated by various forms of State regulation, toyed with by the SEC and then came under the self-proclaimed jurisdiction of the US Commodity Futures Trading Commission, a jump in logic which I report without comment.  Of course now the States and the Feds are fighting and suing over who’s in charge here.

Let me predict, with admittedly no special information or insight but noting the current appetite for Federal regulation loosely applied in all instances, that the Feds are going to end up as the regulator to be dealt with.  In any event, on June10 the Feds sent to the White House a 250 page proposal for regulation of the prediction market, and also released that proposal to the public.

The proposal itself is very fluid, asserting CFTC control and stating that it “preliminarily believes” that markets hinging on outcomes of professional and collegiate sports events are permissible under federal law, except for contracts that settle on player injury or outcome of officiant’s calls or involve Little League games.  It is suggested that contracts need to demonstrate they are free of manipulation and are resolved based on verifiable criteria; MLB, NBA and PGA all responded that settlement of contracts should reflect league data.  There is express request for regulatory suggestions that preserve for Fintech firms the ability to be creative in enhancing access to these derivatives, and in integrating digital asset technology.

Those who decry the professionalization and commercialization of sports, particularly at the collegiate level, marked by compensation of athletes by Universities and the movement of better athletes among different school programs to prime them for millionaire contracts in the pros, no doubt will decry that added commercialization.  Those who fear manipulation by athletes at all levels for purposes of obtaining returns on bets similarly will be unhappy.  But the combination of public appetite and Federal bias in  favor of “free markets” in every area will doubtless create a permanent betting universe easily accessed by most would-be players.  Add the emergence of prediction markets to the already constant harping of sports betting sites on television, often during televised sporting events, and the free market will brings us a host of optimistic losers.

And note: prediction contracts are not all about sports; you will be able to open a contract on just about anything– for example how many thousands of people will read this post in the next few days…..

 

 

Cannabis Status Revisited

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First, I find that many people do not understand the status of recreational cannabis.  It is Federally within Class 1 and thus is not legally available, according to clear reading of Federal law.  Since it may nonetheless be available under State law and since the Feds do nothing about it, it is a matter of “no blood no foul.”

What IS legal federally? Two things have been made available by reclassification in April from Class 1 to Class 3: FDA-approved drugs; and, products containing  marijuana subject to a state-issued medical license.  (This reclassification covers certain [but not all] extracts and derivatives if within the foregoing categories). There are a few other subsets of cannabis and hemp also remaining outside Class 3; as is always true with respect to my posts, they are general and do not constitute legal advise and cannot be relied upon as such, something particularly important to remember with respect to a technical scientific differentiation as herein.)

What comes next–eg when if at all will recreational cannabis per se become nationally available by reclassification to Class 3?  The DEA announced in April that it would hold expedited hearings starting on the 29th of this month (June) to consider possible reclassification of recreational cannabis; so hold the phone.

Changes in Rating of Banks

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Banks are evaluated by a Federal Council staffed by several other agencies, including the Federal Reserve Bank.  The existing bank rating criteria, in effect in current form for thirty years, considered capital, asset quality, management quality, earnings, liquidity and exposure to market risk.

Proposed new guidance, being suggested by the Federal Council, moves away from this general analysis and focuses not on what may seem abstractly undesirable, but rather  focuses on what in fact creates material financial risks to safety and soundness.  Inter alia, the new framework removes consideration of management depth and succession per se as extraneous and not necessarily bearing on current risk.

Further, the current ratings consider reviews of information technology, consumer compliance and compliance with the Community Reinvestment Act in evaluating management; these evaluations under new guidance will be irrelevant unless they can be related to an actual current material risk to bank soundness.

I now note a theme in the above regulatory approach that may be an undercurrent in the regulatory approach of the current Federal Administration.  My immediately prior post noted that the SEC proposal revising regulation of public company climate disclosure, to eliminate reporting of what might be considered socially undesirable factors if these factors did not in fact create a current risk or weakness in the public company involved, took the same approach as these bank rating criteria: do not need to report things that may seem facially “bad” top some people, but only report what has current material detriment to the entity involved in the instant report.

This trend reflects, I suggest, an effort to remove general social critiques reflecting an intrusive liberal disclosure philosophy from government-mandated disclosure or consideration.  Regulation should not reflect policies which call for disclosure by, or intrusion into the affairs of, private business unless current material problems exist.  While this approach may offend liberal sensibilities, there is some logic to such a close definition of the proper role of government under libertarian principles.