Use Non-Blockchain Precedents as a Guide To Self-Regulation Say Perkins Coie's Crypto Lawyers

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David Berlind: I'm David Berlind with Blockchain Journal. Welcome to the Blockchain Journal podcast. Today's April 12th, 2023. I'm coming to you from New York City where right now one of the largest NFT conferences is taking place, NFT New York City. And I just walked out of a standing-room-only session that was presented by a bunch of lawyers on stage talking about regulatory uncertainty, toeing the line when it comes to the law, not running afoul of regulators, and all the various enforcement agencies out there. Standing with me are two of the presenters, both attorneys with Perkins Coie, they are Valerie Dahiya and Jamie Schafer. You're partners at the firm, and you're based in Washington, D.C. is that right? Thanks for joining me on the show.

Valerie Dahiya: Thanks for having us.

Jamie Schafer: Thanks for having us.

Berlind: So, of all the sessions I've been to, that one had an amazing number of people just packed in. I took a picture. We're all sitting around the walls. Obviously, a lot of people are concerned with this. Blockchain Journal targets in the enterprises, CIOs, IT directors, chief financial officers, CEOs. The general counsel's office, I think their job is always to say, "No" to anything like this. And when you think about all of the different blockers to blockchain adoption, regulatory uncertainty is at the top of the list for a lot of enterprises. So you both spoke very eloquently about many of the concerns there. I'll start with you, Jamie. How does an enterprise who's trying to think about this new technology, what it means to them, not getting disrupted, moving forward with some project, but at the same time not running afoul of all of the regulatory uncertainty that's going on out there?

Schafer: Yeah, absolutely. Well, I think there is a lot of regulatory uncertainty and there's a lot of newness in the industry, but there are kind of standard and understood compliance expectations from our regulators that come from corollary industries. One of the points we made during the panel is in the NFT space, you have what is somewhat a benefit in that all of these products are backed by some underlying transaction that is tied to something that we've been dealing with forever, some financial regulation. One good example in the NFT industry is just the art and antiquities market. This is a market, and from my perspective, anti-money laundering and economic sanctions are kind of my focus. This is a market that has had a grand history of dealing with and addressing anti-money laundering and economic sanctions issues. So when you're thinking about what are the risks I face and how do I design compliance infrastructure that is going to appropriately address those risks, I would say the place to start is, what is the corollary industry? What is the underlying transaction here that this technology is addressing and what can I learn from that space?

Berlind: Yeah.

Dahiya: I would just add to what Jamie is saying is that the technology is a tool, and so what are you doing with that tool? What you're doing with it and how you're using it is going to determine what regulations might apply. So you have to just distill it down to, okay, yes, it's an NFT. Yes, it's a blockchain. But what exactly are you attempting to do? How are you using it? What is your actual ultimate goal there? And once you figure that out, then you can pretty much say, "Is what I'm doing regulated? And if so, by what regime?

Berlind: Right. So you're saying going back to the precedence that have already been regulated and what's the closest thing that's to what you're doing with NFTs, and then using that as sort of the basis of your self-regulation?

Dahiya: So for instance, if you're using NFTs to fundraise, we know that fundraising in the US is highly regulated. Right? And so if you know the way that you're using something, it's just a novel use case of a technology. But at the end of the day, what you're doing is fundraising. You should probably be looking to the Securities Act 1933 and determining, "Am I going to register or rely on an exemption from registration?"

Berlind: One of the things we've heard from regulators over the past couple of years when they advise businesses and enterprises what to do is they say, "Come in and talk to us. We have a lot to say about this, so come in, sit down with us." Of course, my response to that is how open is your calendar? Because there's a lot of companies that would do something like that. But I spoke to Summer Mersinger who is with the CFTC. She said, "Come in and talk to us." And so, one of the issues is that even after you talk to a regulator and maybe they say something to you, the field is shifting. What they say six months ago — changes now. How does an enterprise deal with all of that uncertainty? Because if they make a move and then they go and do something and will wake up one morning and they'll be on the wrong side of the law, their brand will be in on the CNN headlines. It's a very troublesome area for anybody who's trying to make a move.

Dahiya: I think it's a really complex issue because you are dealing with people who are unwittingly crossing over into one of the most highly regulated spaces. And when that happens... So you go into the CFTC, you go into the SEC, the industry is used to doing that. The securities industry, the commodities [industry], they're used to having direct connectivity with those regulators. So yes, there is an open door.

Berlind: And you would know this, right? Because you were...

Dahiya: Former SEC. So that's where I think that understanding what is the point of having that conversation. Are you going in because you have already thought [it] through, identified the legal issues, you have come up with viable solutions to address the regulatory concerns, and you're just socializing it with the regulator for them to opine on? Are you going because you are seeking some type of no-action position or some type of relief? You really need to know what is the point of the conversation. Because what you can't do is go in and expect them to be your lawyers.

They're not your lawyers, they're the regulators, and they know their role. They know how to play it really well, and I think that new entrants into the space, they don't necessarily appreciate where those lines are. So, it can be confusing trying to say, "Okay, well, we went to the regulator, we had a conversation." They didn't really say... they didn't say, "yes" or "no", they didn't tell us, "Proceed." And so we went out and we did what we were planning to do, and now we're receiving a request for information or a Wells Notice. But we talked to you and the regulator is like, "Yeah, you told us you were going to do something that was non-compliant. We pretty much intimated it or told you it was non-compliant and you did it anyway, and so now you're going to deal with enforcement." And so I think that that's what we're seeing honestly play out is that there's just a disconnect between... The industries are kind of clashing and not appreciating, "Okay, what is the purpose of this? What might be the downstream consequences of doing this?"

Berlind: Well, to your point that the regulators are not your lawyers, so they're not there to give you legal advice. I'm assuming, Jamie, that you guys are the ones who provide that legal advice. And probably the best way to have that conversation with a regulator is to go in there with one of the two of you and sit down and make sure that once the conversation's over, you go back out and say, "Okay, here's what we heard. Here's what we're going to do."

Schafer: Yeah, no, absolutely. I mean, having competent counsel and experienced counsel is really important anytime you're dealing with a regulator. I think one of the mistakes, though, that companies make as Val is suggesting is if you go in seeking advice from a regulator, you have to be prepared to listen to it. Because once you've got notice that the regulator's position is X, then the downstream consequences of not following that advice are much more significant. I will say also, when you're thinking about engaging with regulators, different regulators should be approached in different ways. So when you're talking about the SEC, there is potentially a lot more uncertainty around how SEC rules apply to different use cases of NFTs. When you're talking about something like anti-money laundering or US economic sanctions, there's kind of a mythology around the notion we're not regulated because we're not subject to the Bank Secrecy Act — yet — although that may be coming. But that's not true.

Anyone within US jurisdiction is subject to our anti-money laundering laws and is subject to our economic sanctions restrictions. And so the notion of moving forward and asking forgiveness later, it's really difficult to support that from a risk perspective. And we engage, I mean literally on a daily basis with OFAC and with FinCEN to talk through — sometimes even on an anonymous basis — but to talk through, "Okay, we've got this new technology, what is your position on how we should address the risks here?" And those are very valuable conversations because what you don't want to be is in a situation where you're asking forgiveness later. They're not very patient with that.

Berlind: Sure. Now, one of the things that we heard inside is that a lot of companies that are starting with their Blockchain projects, they don't even think about any of the existing laws, let alone the ones that aren't even on the books yet. They just go forward and maybe like 75% of what they have to do is just about stuff that's already existing, sweepstakes laws, things like that.

Dahiya: That is very true, and that was kind of my point with I think that the industry is very much this creative, innovative, this is so exciting, we're moving at the speed of light, and we know that regulation moves at the speed of a sloth. So the rules are there. How they may be applied and interpreted, yes, there's some lack of clarity there, but I think that we've seen enough enforcement actions. I'm not sure that it's as unclear as people say.

I think that where there could stand to be more clarity is, "What does compliance look like?" With these novel technologies that allow you to dis-intermediate and do things that normally we would require multiple different intermediaries to play very specific roles, now because of this technology, you can kind of just cut through that. Not understanding that having those various tasks performed by different entities creates checks and balances.

Berlind: Yeah. So that's really a great point. I see the discussion in Washington D.C. as largely about whether a token is a security or a commodity, and that conversation seems to have been taking place for a very long time, moving at a very glacial pace, as you say, no progress. Whereas I feel like there are certain things where they could just move very quickly. For example, if you're running an exchange, you can't run a stablecoin. There's [a] separation of church and state, so you have these checks and balances. You're running an exchange, you can't even run a chain. These things should be separate. The New York Stock Exchange and NASDAQ, they're not brokers. There's a reason for that. So, any idea why we just don't go after that low-hanging fruit and take care of that first, and then maybe come after these more complicated questions of security versus commodity later?

Dahiya: Because I think that asset characterization determines what Regulatory regime you're in. So you have to start with the asset and under what jurisdiction does it fall? So if it's not a security, generally speaking, the SEC doesn't have jurisdiction, although I'm not sure, that that line has become more blurred. And so that's why I think that you have to start with the product itself. What is this asset? What is the appropriate characterization? And then, that will tell you, from a regulatory perspective, what framework will apply or what frameworks? It could be multiple different frameworks that you're dealing with, depending on the use case.

Berlind: We heard in this session that NFTs are kind of special because they get used as all kinds of different things. So maybe different rules apply depending on how you're using the technology and the NFT, right? Whereas a fungible token, maybe things are a little more clean-cut, right? NFTs can get used as sort of a loyalty thing. It could be used as just a digital twin to a sneaker. They're selling sneakers down the hall with NFTs. How do you carve up the NFT space in a way that you can maybe come up with a legal framework for the people who are doing that?

Schafer: Yeah, I mean, it's tough, but I think, again, one of the places to start is thinking about the underlying transaction and purpose and drawing the corollaries to what already exists in the world and the regulatory expectations that are already out there. I do think, and this is one of kind of our mantras in the compliance space, I do think thinking about all these different ways that an NFT can be used, it makes the necessity of a risk assessment at the beginning of any project even more important, because you just can't look at the NFT space and say like, "Okay, here are the risks." It depends on your product entirely. It depends on your product, the geographies you're going to be open to, the type of customer you're going to be open to. And so, building that foundation on risk assessment and figuring out really what are the risks based on what I want to do? That is critical to building your product in a compliant way.

Berlind: All right. Well, Valerie and Jamie from Perkins Coie, you're down in Washington D.C. Great advice there. I guess also the idea is you better find somebody, a lawyer, an attorney who knows this space. There's probably very few of them relatively speaking to all the attorneys out there to help guide you through not only your own deliberations, your business deliberations, but also conversations with regulators, lawmakers, or whoever you're talking to. Thank you very much for joining us on the Blockchain Journal Podcast.

Schafer: Thanks for having us.

Dahiya: It was a pleasure. Thank you.