Regulation 101 | Michele Korver

Transcript

[Music] thank you hello everybody I know the first person you want to talk to in the morning isn't a regulatory attorney right [Laughter] all right so the news of late has been unavoidable the government has been expressing its might in the web 3 space just one example is the ongoing tussle between coinbase and the SEC there are others we'll talk about some of them but regulations are needed to address important and legitimate policy objectives such as preventing illicit Finance ensuring Fair markets and

protecting consumers so educating yourself about the regulatory landscape is a necessity for you to be successful entrepreneurs first let me introduce myself I'm Michelle and before I had the Good Fortune of working with web3 Founders at a16z I spent a couple of decades at the federal government first as a financial crimes investigator then as a prosecutor and a policy advisor for the Department of Justice and then my last stop was at the department of the treasury leading digital asset matters at the financial crimes enforcement Network otherwise known as fencing which I'm going to talk about today during this talk I can promise you that

I'm going to repeat two things over and over again one is that before proceeding in various contexts you should consult an attorney or an expert advisor and the second thing I'm going to tell you over again is that you should consult an attorney or an expert advisor one important caveat to that although I am an attorney I am not employed by a16z in illegal capacity so none of what I'm going to say in this presentation is legal advice so there's many agencies within the government we're not going to cover them all and none of them in great depth but I hope to offer you some familiarity

with the major players and the rules of the road in web 3 and that as you're building that you're considering the regulatory implications of your choices and that if a regulator comes knocking that you are well informed and prepared understanding the regulatory environment is going to help you to Build a Better Business okay let's get started with the fundamentals so regulation is simply rules made by a government or another Authority in order to control the way something is done or the way people behave but what's the difference between regulation and policy well if you think about the regulation being the rules that are on the books

right now that you have to follow and policy is the process for getting the rules laws and the business environment that you want in the future and this afternoon Colin or head of government Affairs is going to talk about legislative policy but first let's talk about the Here and Now so who in government regulates crypto and web 3. the answer many agencies and it depends and sometimes there are multiple agencies that will have jurisdiction over the business activity that you're engaged in let's try to make sense of this alphabet soup of agency shall we so we're going to take a deeper dive

into the market regulators and the treasury offices in just a bit but I want to briefly mention two categories of agencies the banking agencies and the Department of Justice and law enforcement the primary Federal Banking agencies consist of the Federal Reserve board and system the office of the control Comptroller of the currency known as the OCC colloquially and also the Federal Deposit Insurance Corporation the FDIC you might be wondering I'm not offering banking services or seeking to uh to get a bank Charter why do I need to know about these agencies well you should care because these agencies are in positions

where statements of them made by them and positions that they may take can greatly affect your web 3 business how first your ability to get a bank account and to maintain a bank account for running your day-to-day operations everyone needs banking services to make payroll and to pay for a myriad of your expenses and recently these agencies have attributed um much risk in the financial system to cryptocurrency and related crypto businesses so this can affect banking relationships and these are agencies that you want to keep your eye on um second where and how you could

custody your crypto could be affected by decisions of these agencies and last banking agencies are likely to be leading the charge relating to regulations and supervision of stable coins which we all know are a kind of a very important uh they play an important role in the crypto ecosystem a player in the space to be aware of and this is my old alma mater is the Department of Justice and their companion law enforcement agencies their primary job is to investigate and prosecute violations of criminal law and some regulatory infractions can also be charged criminally and that would be handled by the Department of Justice

and that can happen primarily with violations of the bank secrecy act and sanctions which I'm going to talk about later in addition if you decide to sue some Regulatory Agencies because you're you think you're being treated unfairly under the law the Department of Justice has a Civil Division called Federal programs that would be defending the agency being sued in court now although today's talk is focused on U.S regulation you need to be cognizant that non-us countries also have their own regulations pertaining to this industry and some of those rules are similar to the US's and

some of them are going to be different just know that legal or physical presence of a business is not the sole determining Factor as to whether the laws apply to you so if you're providing products or services to residents of a country then you may likely be subject to regulatory law and this is vice versa you could be completely set up physically and legally set up outside of the U.S but if you are serving U.S citizens or residents then you would also fall under the jurisdiction of the U.S Regulatory Agencies now as we turn to the agencies who are taxed with regulating the market and

investment activities and also with addressing National Security concerns there's one commonality in one way or another they all regulate Financial activity and financial activity is a fundamental aspect of any business including the building Computing and operating of web 3 products and services let's talk about the Department of Treasury relevant to this discussion is an independent Bureau called the financial crimes enforcement Network or fincen and the office within treasury called the office of foreign assets control otherwise known as ofac both of these report to the under

Secretary of terrorism and financial intelligence or TFI which not surprisingly focuses their um focuses them on National Security and reducing or eliminating illicit activity in the financial system is the administrator of the bank secrecy act or the BSA and it supervises financial institutions and it also supervises money transmission so this is where a lot of crypto businesses May intersect with the Department of Treasury and fincen's BSA uh basically it's a legislative framework or a series of laws that was

created in the 1960s or rather 70s and it requires U.S financial institutions to assist both government agencies and law enforcement in detecting money laundering and other illicit activities so how do you know if you're engaged in money transmission and you must comply with the bank secrecy Act so first Vincent has put out guidance actually all the way back to 2013 that said that exchangers issuers and administrators of convertible virtual currencies are money transmitters users are not um second money transmission is very

broadly defined so generally it's the transmission of funds or value that substitutes this currency which is going to capture a lot of cryptocurrency tokens Etc from one person or location to another person or location by any means so you see how really broad that is for coverage whether a token is a convertible virtual currency is a facts and circumstances determination I will tell you though most are and unless they operate exclusively in a centralized enclosed system kind of like Airline points where there's not a secondary market for them to

um to be bought and sold and trade it around they're likely going to be considered a convertible virtual currency or value that substitutes for currency is fincen defines it sometimes the the way a code or a tech operates is going to make the determination as to whether or not the business is engaged in money transmission a complex and difficult determination so here's the first time I say IT consulting an attorney or an expert advisor is often going to be the key to determining what your obligations are also you see on the top of the slide I I've cited the USA Patriot Patriot Act

after 9 11 Congress passed this act to punish terrorist acts in the United States and also to deter this type of activity around the world and also to enhance law enforcement tools for this type of collection there are additional authorities that now supplement the bank secrecy act that mostly fall in ofax jurisdiction but but some Fallen fincess the other thing that the Patriot Act did that's that's a good thing is that it enabled public and private sharing of information so if you're engaged in some type of financial activity or you see suspicious activity it authorizes law enforcement and the Department of Treasury to be sharing information with

public private sector entities and and vice versa in order to accomplish these goals now under the bank secrecy act you know what are your what are the requirements what do you have to do um and this is related to again the anti-money laundering laws financial institutions including the non-bank money transmitters well they must register with fincen establish and maintain an effective risk-based anti-money laundering program establish effective customer due diligence um or a that this comes in the form of a customer identification program all of you may be familiar with this um when you talk about the term kyc know

your customer know your customer or kyc is part of having to have this customer identification program um you have to screen against ofac and other government lists we're going to talk about that in a second you have to establish an effective way of monitoring for suspicious activity and file suspicious activity reports and there are also other record-keeping and Reporting requirements that I won't get into today in certain circumstances fincen also has the authority to designate entities as primary money laundering concerns and when they do that this effectively Cuts The Entity off from the financial system and it means that you can't touch them

either um the other thing that could affect businesses broader is their Authority um this is under special measures um and that is um GTOs they're called Geographic targeting orders um some examples of them that you may have heard about is where real estate in certain areas those transactions have additional reporting requirements directly to Treasury we've also seen it in Insurance related to other illicit cyber activity um so it's it's important to know that there are other authorities separate from the big secrecy act that even if you're not covered by them because you're not a

money transmitter treasury could produce an order and say Hey you know you're required to report this information in addition certain types of businesses regulated by the SEC and the cftc they may have some AML BSA AML requirements so just because you're not a financial institution or a money transmitter doesn't mean that you may not also have to have uh be collecting kyc or have some type of AML program requirements finally let's not forget about the states right Most states regulate money transmission and they may require you to get a money transmission license before you can do

business with residents of that state there are law firms that specialize in obtaining those mtls as we call them and note that if you want to do crypto business in New York then expect that you're going to spend some money because the nyd DFS the New York Department of Financial Services requires you to obtain a bit license from them and not only is this a rigorous licensing application process but they also supervise licensees vigorously um again an attorney well-versed in money transmission law and regulation can help you navigate what may seem like a pretty complex area so now we're going to talk about the

office of foreign assets control um oh fact this is a really important office within the Department of Treasury and the reason why is their their broad coverage so let me talk about what they do they administer and force um economic and trade sanctions um based on U.S foreign policy and National Security goals and it's usually targeted against foreign countries um and regimes terrorists International narcotics traffickers etc those people that are engaged in activities related to the proliferation of weapons of mass destruction you may have seen recent sanctions that have been put out against North Korea some of the Cyber criminal activities that have

been engaged by state actors from dprk in order to obtain funds since they have been blocked from other economic normal and economic activities their sanctions programs work by using the blocking or freezing of assets and also trade restrictions to accomplish these goals so this is one of The Regulators that you need to really care about regardless of what type of business model you have it doesn't really matter what the business does because their Authority is really Broad it applies to U.S persons um and that's citizens permanent

residents and all persons and entities within the United States all U.S Incorporated Incorporated entities and their foreign branches so I don't have to go on and on you you see where I'm going with this pretty much everybody has to it falls under their jurisdiction and this means what at a minimum you should be screening against ofax list of specially designated Nationals and blocked persons this is often referred to as the sdn sometimes people's call it ofax Blacklist um and the information about what's on that list is on their website what will be relevant to you is web 3 Builders are

cryptocurrency addresses there are plenty of them on there they're constantly being added but know that you don't want to get incred in ofax crosshairs and why well because the consequences are very serious first of all civil liability that's where you didn't intend to transact with that North Korean address you had no idea that that happened but in fact it did and therefore you are in violation of sanctions just by the mere fact that it happens regardless of whether you knew about it at the time or intended it's called strict civil liability and it's very very expensive the fines are horrendous and you can

lose your Banking and other business relationships and so doing at the minimum screening of incoming and outgoing addresses and if you're conducting Bank transaction regular Fiat Bank transactions are really important so severe penalties losses of relationships that will allow you to go forward with the business and certainly there also as I mentioned before are criminal penalties now I know that none of you are going to have to worry about that because in order to be guilty or be charged with a Criminal penalty you would have to knowingly um be knowingly transacting with a sanctioned entity look seeking to help

these countries or entities or persons that are engaged that are on the list um and so um a lot of times people talk about going to jail with sanctions and that's going to be a rare rare circumstances most of the people who get in trouble with ofac is because they were negligent or lazy about not setting up screening and watching what was coming in to their house and what was going out so you don't always have to pay an expensive attorney to get information that's that's the good thing and not all attorneys are expensive many useful resources are published by these Regulatory Agencies and are available free on their websites I encourage you to read and even consider subscribing to

some of these guidance advisories and alerts that are periodically published just two examples I want to recommend particularly if you may be involved in financial activity or money transmission or think you are Bill building towards that end is the 2019 guidance that fincen published it has a lot of good information about different types of Technologies and business models and what might qualify as many transmission or not um and then second um the Cyber infrastructure and Security Agency sometimes referred to as sisa and the FBI frequently published joint alerts about cyber um security incidents ransomware Etc

they contain really good descriptions of these incidents including methods of identified threat actors and they usually include technical details about the code and suggested mitigation member measures so given that you're all conducting web 3 and online activities I highly recommend those resources so now let's turn to the Securities and commodities laws and the the two primary agencies although there are some smaller peripheral agencies that that dip their toe in this we're talking about the Securities and Exchange Commission and the Commodities features trading Commission so generally digital assets can be created that resemble Securities or commodities

as well as rights to Goods services and IP this flexibility sometimes results in uncertainty over which regulator has jurisdiction given the differences in how the agencies operate it can be important to get good advice on how any token you may want to deploy may be viewed um the commodity Futures are regulated by the cftc as I mentioned Securities by the SEC and commodities spot markets not really directed directly regulated by either but the cftc has jurisdiction over fraud in the spot Market so as I'm sure you've heard why all the markets have generally viewed only

highly decentralized Network tokens like Bitcoin and ether depending on who you talk to as Commodities the current SEC commissioner has asserted that virtually all tokens other than Bitcoins are securities under the Supreme Court's how we test so I know that this is something that you need to think about as you're thinking about how you're going to design and also deploy your tokens both now and in the future and unfortunately the law is still in flex but again Colin's going to talk this afternoon about some legislative activity that's happening in DC on this front a Founder may think that he or she is not covered by the Securities Law if

you're not engaged in say fundraising efforts right um you've already you know you've built your product and it's out there you're not selling tokens in order to fundraise um but remember that the laws can be implicated by the products and the projects and the project except that the project itself is designing and so you need to remain flexible particularly as these laws are changing meaning guidance and rules may change over time and it's important to design with operational flexibility in mind as you're figuring out what you're going to do with your business and even if you've got everything figured out and you've run it by

attorneys and you've run it by Securities experts if you decide to Pivot or expand again this is an area of the regulatory law that you're going to need to revisit with each pivot and change of your business model all right so your favorite thing tax right all I have to say is file and pay your taxes right um the IRS is actually um a fairly friendly um agency in my opinion in this space because they're actually I'm very good listeners as they're trying to develop um how these digital assets should be treated for tax purposes they've done a

lot of interaction with private sector in order to really understand the technology and figure out what is going to work best um so I had a chance to talk to one of our tax experts and she gave me a few tips that I just wanted to run by you to remember that your federal corporate income tax is also due on April 15th but you can extend all the way out to October 15th um when you're filing and deciding where you're going to file state income tax returns um that that's going to be determined by generally the physical presence of where you are but it also could be affected by market Source meaning um the based on the sales in a

particular State now in California that there's a minimal minimum annual tax of 800 dollars and in some states you have to pay sales tax if you've if sales tax is applicable on a monthly basis um so the takeaway for all these as far as filing is there are a lot of different dates and due dates and filing requirements so um again going back to the theme talk to an attorney or tax consultant these things can be complicated when you're running these types of businesses all right so there's also a lot of different reporting requirements depending on again what type of business you're running and also which the location of the customers that you're

serving when thinking about tax costs you don't want to forget that annual registration and business licenses need to be paid or included and are important part of your tax self also know that valuation can vary greatly for different types of stock options if that's something that's going on with your uh with your business looking forward to developing areas that you're going to want to watch is um how IRS is going to treat nfts um and how they're going to treat staking activities those are still things that are being decided and in fact one of the reasons why um I said that IRS is friendly in this regard is that they actually have put out a

request for comment um to the ecosystem and Industry to provide information about what are you doing with your nfts how should they how should they be treated um they want to take in all this information so that they can tax this appropriately and fairly long story short a lot of moving Parts with tax so consult a Tax Advisor or an attorney all right I'm getting some Smiles but you're not like repeating back to me yet [Laughter] all right so what are the circumstances in which you may want or need to communicate or interact with Regulators we're going to turn to two types of interactions reactive and proactive when

you want to go to them proactive and when they come to you reactive and particularly those proactive interactions can be really beneficial opportunities um despite all of the the bad that's the focused of the news with Regulators lately most Regulators particularly the career staff at these agencies they are very eager to learn about the latest technology um they want to do this because they want to hear about the developing business models it helps them to do their jobs better if they're supervising to Industry it helps them to understand what's going on and they want to know what's coming next the emerging Tech

which is what all of you are working on so there are lots of ways to interact with them some agencies have offices for example the SEC has a finhub which used to be visited in the past quite a lot but perhaps doesn't get as much traffic these days um fincen often hosts Innovation hours that are based on topic so if you're working on digital identity for example there could be Innovation hours related to that in different topics some of the Regulatory Agencies have um have some type of regulatory lab there are opportunities to present demos of your of your products for them and interaction and interact with them at

conferences and Tech Sprints that they may host in addition um there are opportunities and if appropriate you should definitely reach out and schedule meetings to talk to them so that you can get clarity as to how you think you fit into the regulatory regime and what the expectations are for supervision but again going back to the repeat you should consult a legal advisor before marching into a regulatory agency and trotting out your wares ultimately however and this is why I turn to this their jobs are to supervise the industries and certain types of activities right and to enforce the rules and non-compliance within their remit and so

there are going to be times when you are going to get a reactive interaction or a reactive contact from a regulatory agency some of those are the oh I need to call an attorney and others are hey they're just looking for information and doing their jobs they're not looking at me so examples of um oh I need to go talk to an attorney are request for information notices of Investigations you may have heard about the wells notice you don't want that that's where they're announcing that they are investigating you and they're giving you

notice so that you can basically talk to them and convince them why you shouldn't be charged um you also could get subpoenas um search warrants seizure warrants particularly if you're custoding Chris crypto um those are things that again I think talking to Insider outside counsel before proceeding or uh is important um but you shouldn't assume that there's a problem um sometimes it's that evidence happened to land um in your lap in your business in some way shape or form and sometimes you may get legal process and this is why talking to council is good and law enforcement might be looking for

something that you don't have that you don't actually have they often have a hard time figuring out the Myriad of businesses and where data may be held or whereas who has control over assets and so it's simply sometimes pointing them over to the next guy all right so as we've discussed crypto and web 3 is a very fluid and develop developing area of Regulation um again I've repeated this later today our head of government Affairs is going to be talking to you about what's happening in Washington but it's really important to monitor these ongoing activities I know that you're busy trying to build your business and hire engineers and write code and all the all

of the really challenging things that you're doing um but in developing your business watching the new legislation the ongoing court cases and the agency rule makings and actions these could affect the rules of the road and how you're going to proceed as you're building in particular I would encourage you to follow the court cases um the reason why is it's a lot more interesting to read kind of the important tidbits that affect what's going on in the regulatory space when you see it with facts set out in something that you understand now one case to watch in my opinion is one that I

um well I actually was going to allude to at the beginning of my talk but I forgot to and just yesterday so it's very timely the Supreme Court announced that they are going to hear a case that could overturn a 40-year precedent that we talk about as a legal concept called Chevron deference and Chevron deference means that um a court is required to defer to a government agency's interpretation of the law so you can be challenging that agency in court but they're always going to get the benefit of the doubt in the eyes of the courts as far as the interpretation of that agency action

and what is this case involved it involves not crypto or web 3. it involves hearing fishermen and Herring fishermen in the Atlantic specifically who say that the national marine fisheries service which falls under the Commerce Department doesn't have the authority to require them to pay the salaries of government monitors that are required to actually be on their boats while they're fishing so the law requires as it stands right now that you have monitors on your fishing boats and not only do you have to make space for them but you also have to pay their salaries this is being

challenged in the court and it's going to go to the Supreme Court it was just um a fir the regulatory agency position was affirmed in the Appellate Court and the Supreme Court yesterday said we'll hear it next next uh term so this is important because it could affect what the standard is when the courts are looking at regulatory action in a very hot space of the law and that's crypto web 3 and particularly the security slots so remember it's better to be reading about and following the cases than living them right okay so I know that was a lot to take in so here's my Ted lasso pep talk to leave

you with um when written and implemented well and fit for purpose regulations are a good thing um they should be promoting a safe and fair playing field for Innovation creativity and economic opportunities for them to thrive compliant businesses are successful businesses because they prevent their use by Bad actors including abusive and authoritarian regimes none of you want to be facilitating that right and because they instill trust in the customers and the creators who use them and the builders who are going to build on top of them so here's the last thing to remember before I close and open for questions

given the increased focus on crypto issues by all of The Regulators but particularly The sec's Barrage of Enforcement cases that we that we've seen out there what is it important for you to do it's important more than ever to consult good legal counsel to inform your token and product design and launch to determine your obligations under the bank secrecy act or the tax laws and to assess your sanctions exposures where appropriate you should be building compliance programs and screening mechanisms that's going to minimize the risk of events that's going to draw regulatory scrutiny to you the good news is that you're not alone in this this is

not just about avoiding fines unwanted penalties um getting shut down or going to jail which this is really about is building a trusted customer experience you've done all of this work you have a lot of work ahead of you and you want it to be a successful safe and compliant place for people to to interact with to go to and for you to be successful in contributing members of um of society as entrepreneurs thank you for your attention and time thank you Michelle [Music]