The John Reed Stark and Mark Cuban thread is a must read - part 1


Eagle, CO

Last updated on Jun 14, 2023

Posted on Jun 14, 2023

I've followed Mark Cuban since the early 90's. I wish he'd run for President.

Today's thread with John Reed Stark and Mark Cuban is epic. Mr. Stark accurately lays out the case against crypto.

I think it's vital for crypto advocates and entrepreneurs pay attention to what Mr. Stark is saying. Crypto's problems, which Mr. Stark lays out in excruciating detail, aren't a death knell. They're an opportunity. But only if they're viewed as such.

Here's the first thread that centers around the concept of an investment contract and the Howey Test. I've maintained for the months that crypto fails the Howey Test and is therefore an investment contract.

I've copied and pasted the text here:

Mark, thanks for your respectful and constructive response. You are right, Judge Jackson was likely speaking about crypto-related securities regulation generally. But she was also addressing defense counsel's arguments per their brief about a lack of crypto-regulatory clarity.

I’m with you on the barriers to entry for entrepreneurs, especially relating to onerous, burdensome and unreasonable regulation. It’s way too challenging for the US entrepreneur; bureaucratic red tape is ubiquitous; taxes are absurdly high; and the federal/state government seems to discourage hard work.

However, I am always concerned that easing regulation (e.g. lowering accredited investor requirements or providing larger exemptions for certain types of offerings (e.g. Rule 504 of Regulation D)) can attract a lot of con artists, like penny stock fraud did in the 80s and microcap fraud did in the 90s. (I know "OK Boomer.")

All I'm saying is that it’s a tough balancing act. But I definitely respect the fact that you understand business far better than I ever could.

But I can’t agree that there is a lack of regulatory clarity in the cryptoverse. First off, securities regulation is not meant to be precise but is instead intentionally drafted to be broad and all-encompassing; clarity is not just uncommon, it is deliberately avoided.

Second, though securities regulation is primarily a principles-based legal framework, there already exists extraordinary regulatory transparency and lucidity regarding crypto.

Finally, although the crypto industry constantly grouses for regulatory clarity, whenever any specific regulatory crypto-related rules are promulgated or proposed, the crypto industry cries foul and almost instantly files a flashy legal challenge to its enactment.

I wrote an exhaustive article (admittedly a bit of a snoozer) addressing this "regulatory clarity" issue, which provides an encyclopedia’s worth of support for my conclusions at:

I also can’t agree you that about the crypto tagline lambasting “SEC Regulation by Enforcement.” Litigation and SEC enforcement are actually how securities regulation works. The flexibility of SEC statutory weaponry is an SEC hallmark, enabling SEC enforcement to keep fraud in check. Moreover, vigorous SEC enforcement efforts also pave the way for legitimate technological innovations to flourish, rendering markets more efficient and transparent, thereby allowing investors more opportunities for success.

This is why the statutory definitions of “security” include not only conventional securities, such as “stocks” and “bonds” but also the more general term “investment contract.”

The all-encompassing definition of investment contract was reinforced 76 years ago in the oft-cited Supreme Court case of SEC v. Howey, where the Court held that investment interests in orange groves constituted securities. Since then, courts have applied the Howey Test for decades, to investments in eel farms and ostrich breeding to wholly bogus “prime bank notes.”

Even before the Howey test, in the first several years of US federal securities laws, some entrepreneurs were notified that they had to register their offerings of chinchillas, whiskey warehouse receipts, oyster beds, and live silver foxes as securities offerings.

Take so-called prime bank notes for example, which were financial schemes that began to surface in the 1990s. Con artists shilled Prime bank notes as sound and safe financial instruments purporting to derive their value from secondary European markets for standby letters of credit. Prime bank notes, while appearing sophisticated and a safe investment bet, were actually a complete fiction.

In the seminal prime bank case, SEC v. Lauer, the purveyors of prime bank notes argued that prime bank notes were not securities because they were fictional so the SEC lacked jurisdiction. The 7th Circuit disagreed, noting that the Howey test did not require that the securities existed but rather whether the investment, if true, had the characteristics of an investment contract –– underscoring just how broad the definition of investment contract is.

That securities laws on the books adapt well to technology should come as no surprise – they were drafted with that specific notion in mind. Consider a 1989 case captioned Reves v. Ernst & Young, where Justice Thurgood Marshall stated:

“In defining the scope of the market that it wished to regulate, Congress painted with a broad brush. It recognized the virtually limitless scope of human ingenuity, especially in the creation of ‘countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”

Per Reves and countless other precedent, judges have agreed that Congress never meant to "cabin the scope" of securities regulation but instead, crafted definitions to contemplate not only known securities arrangements at the time, but also any prospective instruments created by those who seek the use of others’ money on the promise of profits.

The bottom line for all crypto-investment iterations? Whether an investment product acts as a stock token, is priced off of the value of securities and operates like derivative, is a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities, they must all comply with US securities laws.

From policing foreign bribery payments (before the FCPA), to municipal securities fraud, to derivatives scams and unlawful insider trading, to fictional prime bank instruments and subprime grifts, to non-existent eel farms and bogus ostrich farms, the SEC has addressed emerging issues via enforcement actions, and without the benefit, or the hindrance, of precise prescriptions.

Instead, whatever the technologies or innovations involved, the SEC has relied on the general proscriptions of the federal securities laws and applied them with practicality and prudence. Merely because no blackletter rule exists does not somehow violate due process or render the SEC’s enforcement efforts into ex post facto punishment. I wrote an exhaustive analysis of this argument as well (also admittedly a bit of a snoozer) at:

As SEC Chair Gary Gensler (who I typically criticize and who I know drives you nuts) explained: “It’s not about whether you set up a legal entity as a nonprofit and funded it with tokens. It’s not whether you rely on open-source software or can use a token within some smart contract. These are not laundromat tokens: Promoters are marketing and the investing public is buying most of these tokens, touting or anticipating profits based on the efforts of others.”

You may abhor the Howey Test and you may want better laws. That's a fair point. But for now, the law is what it is and a lack of regulatory clarity is not a legal defense but a policy memo for Congress.

SEC registration is difficult to say the least but tough financial regulation makes for a safer/more trustworthy marketplace. The crypto verse has just operated in an unregulated space for too long and likes it that way.

But having said the above, you clearly understand the entrepreneur and I can't imagine not agreeing with any regulatory changes that you thought made sense. Notwithstanding Voyager's failure (which I know you regret), your heart is undoubtedly in the right place.

What you are doing for the costs of drugs for example, blows me away. Your battle to help people and to reduce drug prices is selfless and admirable. You should run for President.

Yes, I disagree with you about crypto – but whatever. Agree to disagree. I say this in all sincerity: You would make a great president, I would vote for you in a heartbeat and I would campaign for you all day long.

Part 2 is here.

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