Brian Korn has been a regular suspect on the Fintech trail for years. From the early days of online lending and securities crowdfunding, to the more recent rise of digital assets, Korn has provided counsel to emerging firms seeking to benefit from the Fintech revolution. A partner at Manatt in the New York office, Korn leads the Fintech practice where he also provides legal advice on compliance, including crypto, as well as capital markets issues like M&As, funds, and IPOs.
This past week Crowdfund Insider caught up with Korn to hear his perspective on the digital asset sector – an area of profound transformation. Our discussion is below.
You are working quite a bit in the digital asset sector. Recently you shared that the majority of funds are heading towards tokenization. Can you quantify this a bit more? What is fueling this transformation?
Brian Korn: There’s been a trend recently where funds that are investing in the cryptocurrency space are issuing interest in the form of tokens and not partnership units or traditional elements of equity. I don’t mean to say that all funds are moving towards tokenization, but we’ve certainly seen an interest in tokens from fund investors in much greater ways than we have in the past.
And what about digital securities like shares of stock? Why is this taking so long to come to fruition? Is it the cart before the horse? No Demand?
Brian Korn: Most digital ledgers are simply electronic transfer agents that also print to the blockchain. The blockchain is not really additive to the process and is done as a demonstration of transparency (if you know where and how to look for it). I think we will get to a point where some of the DeFi developers will move towards electronic trading of mainstream listed stocks, and we will see benefits from technological advances such as instant clearing and trade reporting.
What about infrastructure? Where do exchanges sit in this equation? We know there are ATSs providing these services.
Brian Korn: The New York Stock Exchange the NASDAQ have been slow to adapt to the digital and tokenized worlds. There are broker-dealers who have ATS designations who are running “Dex“ exchanges (decentralized exchanges) which look and feel a lot like trading of listed securities. Some decentralized exchanges are not brokers and I think there is some risk there by providers who don’t prepare for the regulators to catch up. It would be a mistake to take the relative inactivity of the past year as a sign of regulatory acquiescence. Regulators have comparatively unlimited time and budget to police their policies and rules if the public is being harmed.
What are your thoughts on the regulatory environment regarding digital assets? Do we need Congress to act? What about digital securities? What about digital assets that have utility?
Brian Korn: I think it would be extremely helpful for Congress or a leading agency such as the SEC to give some legal clarity to the status of coins, tokens, and other Blockchain items of value.
The current environment has been based on enforcement cases and statements made by the former SEC chairman and various commissioners at conferences and other appearances. The current state of affairs is that Bitcoin and pure cryptocurrencies are generally not considered securities, but that tokens that relate and derive their value from a common enterprise likely are securities unless there’s a demonstrable and overwhelming use case apart from investment returns, such as usefulness in a game.
It’s very difficult for us to recommend that a company chart a path that is based on a regulatory finding in the future that a token had sufficient use case to avoid classification as a security. That is why the Blockchain legal bar has essentially taken the view that all token transactions should be treated as securities because you otherwise will be placing a real bet on the outcome of that question.
Now as securities, they must be offered pursuant to a registration statement filed with the SEC or an exemption such as the private placement exemption or the offshore offering exemption.
We’re seeing a huge proliferation of offshore transactions which carry the advantage of not being limited to accredited investors and do not generally have a lock-up period. This structure is not bulletproof, however, and I would wager that some careless operators will get snagged in the nets of a future case.
And NFTs? Thoughts on this market?
Brian Korn: The entities have the advantage of being solidly anchored in the legitimate art world, which has never been regulated by investment agencies. Of course, there are investments that are not securities, and we believe that derivations of artwork and other graphic depictions that are one of a kind or limited sets would not be securities. I think the NFC market has great potential and promise, and there are other legal pitfalls for NFT operators and providers of NFT works, such as misappropriation of copyright, alteration of the underlying work, and ultimate loss of control.
SEC Chairman Gary Gensler has voiced his concern regarding sufficient investor protection within the crypto markets? Any thoughts on what the SEC may do?
Brian Korn: It’s really anybody’s guess.
Chairman Gensler is a very smart person who knows a lot about the Blockchain space, having taught a course on Blockchain at MIT. That being said, the SEC is more like an aircraft carrier than a speedboat.
I believe there will be some ad hoc committees and other commissions that can be formed on a relatively quick basis to help deal with the situation, although frankly, the SEC tends to react to crises or congressional outrage, neither of which is really present at sufficient levels in my opinion to provoke very aggressive behavior by the commission.
As one of my partners told me recently, there are enough cases of outright fraud that are still being reviewed and prosecuted to keep them busy for a while. When investor outrage or a crisis boils up to a critical mass, we will see action.
It is important to remember that the SEC is not in the business of regulating which investments should be made or whether an investment is good or bad, only that the rules are followed and that sufficient disclosure is provided to investors. This could be tested in the future, however.
Recently, you participated on a panel at the CfPA event regarding investment crowdfunding. You have been involved in this sector for a very long time. What is needed to scale online capital formation? What about institutional money? Retail available funds?
Brian Korn: I believe we’re right on the cusp of significant institutional participation in the online investment space.
Institutional capital management requires a risk aversion and that generally means they stay with the large household names. As more of the large names and investment banks move in a digital direction, I believe their clients will come with them. I do not believe that you will get a large teachers’ pension fund to invest in illiquid alternative funds proliferated by start-up companies. I think generally speaking the online age has come about in the world and in 10 years will look much different than it does today, both in terms of how capital is formed and how exchanges execute orders and trades.