A bold plan to launch a new cryptocurrency by Facebook and partners looks a lot like the plans of another firm the Securities and Exchange Commission is now suing to stop.
Libra is a “global, digitally native, reserve-backed cryptocurrency built on the foundation of blockchain technology,” according to the Switzerland-based not-for-profit membership organization formed to run the initiative, Libra Association. The Libra Association says it will “be raising money in a private placement to help jumpstart the ecosystem and drive adoption.”
Ultimately, Libra aspires to become an alternative payment system for real world goods the way Kik Interactive, a Canadian social-media messaging company that was sued by the SEC on June 4 for raising $100m allegedly without registering the offering, sought to become the go-to currency for digital assets.
Kik used a Form D exempt securities offering to initially raise money in late 2017 from a limited number of wealthy investors. Kik offered investors a future right to purchase its tokens, called Kin. The Kin tokens would become available to those investors when the company had fully developed the ecosystem where the tokens would be used.
Form D securities offerings are exempt from full SEC registration requirements only as long as the offering is limited to “accredited investors” — that is, individuals that have a net worth of over $1m or who have consistently made more than $200,000 per year in income, or companies with $5m or more in assets.
Kik, like Libra, characterises its token Kin as a currency like Bitcoin and Ether, neither of which the SEC regulates as securities. Kik’s mistake, the SEC said in its complaint, was to offer and sell one trillion Kin tokens to more than 10,000 retail investors worldwide after its private placement.
The Libra whitepaper and supporting documents outline the responsibilities and financial requirements for founding members of the Libra Association. An investment of at least $10m in the network via a purchase of Libra Investment Tokens is required to become a “validator node”.
The currency will be governed by the Libra Association Council whose initial members are the founding members and will serve as the network’s initial stakeholders or “validator nodes”.
MarketWatch emailed the Libra Association press team to ask if it had already raised the funds from the founding member investors via private placement. The press team emailed a response that admitted, “The association has not begun raising money from founding members yet. The association will ultimately decide how this will work.”
“The overview of the Libra Association states that it will be raising funds through the sale of investment tokens to accredited investors in a private placement, clearly making those Libra investment tokens securities,” says Margaret Rosenfeld, an attorney who is co-head of the Blockchain practice at K&L Gates.
“The Libra investment tokens will give those founding members the right to a portion of funds from a future reserve as well as ‘incentives in Libra coin’. The Libra Association is clear that it intends for the Libra coin sold to users on its blockchain to be a currency.
However, the intermingling of the Libra coin as incentives for the founding members may be viewed by the SEC as integrating the offerings of the Libra investment tokens and the Libra coin, making the Libra coin a security as well from the SEC’s viewpoint. That means the Libra Association may be heading down the same regulatory problematic path as Kik and Kin,” says Rosenfeld.
The Libra Association members are the only ones able to create or mint and destroy or burn Libra coins. Authorised coin resellers have to purchase those coins from the association with fiat assets such as dollars or euros to fully back the new coins.
Authorised resellers will always be able to sell Libra coins to the reserve at a price equal to the value of the basket, the whitepaper says, so the Libra Reserve is intended to act as a “buyer of last resort” governed and constrained by a Reserve Management Policy.
Kik collected approximately $100m in total in US dollars and digital assets such as Ethereum. More than half of the funds Kik raised, millions the SEC now wants it to give back, came from investors located in the United States. Most token sales have shunned US investors, out of fear of SEC scrutiny given the uncertain regulatory environment.
Libra, like Kik, also has plans to get its tokens into the hands of retail investors after the initial sale to its founding members. “Over time”, the whitepaper says, membership in the Libra Association, which gives the privilege of minting and burning coins and operating validator nodes on the blockchain “will open to any holders of the Libra currency”.
Libra is “more a dream than a plan”, said Stanford University’s Joseph Grundfest, primarily due to the significant regulatory uncertainty. Facebook and its partners might know what functionality they’d would like to achieve, but “they don’t really know how they are going to connect the dots to get from here to there, and how the regulators will respond,” said Grundfest, a senior faculty member with Stanford’s Rock Center for Corporate Governance and a former SEC commissioner, in a Q&A on the Stanford Law School blog.
MarketWatch sought comment from several companies listed as founding members of the Libra Association — Andreessen Horowitz, Uber, Lyft, eBay, Mastercard, Visa, and Paypal — about their investment and what legal form it took. Only the spokeswoman for Andreessen Horowitz responded to the request, writing in two emails, “Unfortunately, we’re not able to share additional details on that front. We’re not able to share any more than what’s in the blog post.”
Facebook chief operating officer Sheryl Sandberg had to admit in an interview with Bloomberg TV the day after the announcement that the company’s planned cryptocurrency coin is a “long way from launch.”
Rosenfeld told MarketWatch that blockchain-based transactional businesses, “must consider and reflect everything we’ve learned and everything regulators globally have been saying since 2016”.
“Using the blockchain to execute transactions for a payments system is an appropriate goal — a great use of the technology. It’s more effective, secure and transparent to use digital-tokens than fiat currency across a global platform. To avoid the issues, Kik is facing with Kin, a company should separate its financing transaction from the business model,” said Rosenfeld.
The Libra Association says in a post on its website that it will “continue engaging with regulators, policymakers, and experts to solicit feedback and ensure that this global financial infrastructure is governed in a way that is reflective of the people it serves”.
Facebook’s Sandberg also told Bloomberg TV on June 19, “We know this is a heavy, heavily regulated space. We need to talk to people, meet with people and that’s what we’re doing and we are then going to launch. Regulators have concerns.”
Rosenfeld told MarketWatch, “We don’t know yet if they are reviewing their model with the SEC and CFTC to resolve these challenges. For example, one option would to be to register the Libra coin as a security with the SEC. Another option would be to not use the Libra coins as incentives for the Founding Members.”
MarketWatch emailed each of the SEC commissioners and a spokesman for the Commodity Futures Trading Commission and asked if the Libra Association had contacted the regulator yet to discuss its plans. There was no response.
Representative Maxine Waters, the Democrat from California who leads the House Financial Services Committee, objected to the press launch of Facebook’s token given the organisation had never consulted with legislators.
In a press release Waters said: “The cryptocurrency market currently lacks a clear regulatory framework to provide strong protections for investors, consumers, and the economy. Regulators should see this as a wake-up call to get serious about the privacy and national security concerns, cybersecurity risks, and trading risks that are posed by cryptocurrencies.”
Waters requested that “given the company’s troubled past”, Facebook agree to a “moratorium on any movement forward on developing a cryptocurrency” until Congress and regulators have the opportunity to examine these issues and take action and agree to come before her committee to answer questions.
She said on Tuesday that Facebook has been invited to testify at a July 17 hearing of the financial services panel but that the company has not yet responded to her call for a pause.
A Senate Banking Committee hearing is scheduled for July 16 hearing to focus on “examining Facebook’s proposed digital currency and data privacy considerations.”
Fed Chairman Jerome Powell said during a press conference on June 19 that Facebook had discussed its plans with the central bank. “It’s something we’re looking at … we would wind up having quite high expectations from a sort of safety and soundness and regulatory standpoint if [Facebook does] decide to go forward with something,” he said.
However, Powell also said the Fed has input into the payments system but does not have primary responsibility for regulating cryptocurrencies.
This article was published by MarketWatch