Welcome to the inaugural edition of Hunton Andrews Kurth LLP’s AI and Emerging Technologies Newsletter, a resource focused on multidisciplinary, current topics affecting businesses in the industry. Inside, we cover a bit of what you need to know about AI in the context of contract terms and conditions, US privacy laws, insurance, employer use monitoring and workforce management, and copyright law, as well as the rise in crypto class actions. Please do not hesitate to reach out to the authors or others in our AI and Emerging Technologies practice with questions regarding these topics and new, arising issues in this space.
On October 30, 2023, the G7 leaders announced they had reached agreement on a set of International Guiding Principles on Artificial Intelligence (AI) and a voluntary Code of Conduct for AI developers, pursuant to the Hiroshima AI Process. The Hiroshima AI Process was established at the G7 Summit in May 2023 to promote guardrails for advanced AI systems at a global level.Continue Reading G7 Leaders Agree on Guiding Principles and Code of Conduct on Artificial Intelligence
On October 13, 2023, California Governor Gavin Newsom signed into law AB39, the Digital Financial Assets Law (the Act). The Act provides broad authority to California’s Department of Financial Protection and Innovation (Department) to license, regulate and examine certain businesses transacting in digital financial assets in California.Continue Reading California Enacts Digital Financial Assets Law
On October 16, 2023, the SEC’s Division of Examinations released a reporting detailing its 2024 examination priorities. The document lays out the key risks, topics and priorities that the Division plans to focus on during its upcoming cycle of inspections and examinations of broker-dealers, investment advisers and other regulated securities intermediaries. Among the various areas of focus, once again risks related to crypto assets and blockchain will be an examination priority.Continue Reading SEC Announces Crypto Examination Priorities
On September 18, 2023, the New York Department of Financial Services (“DFS”) announced new proposed guidance for BitLicense holders and certain limited-purpose trust companies (“VC entities”) seeking to list virtual currencies on their platforms. The proposed guidance would replace existing DFS procedures and establish new protocols for listing virtual currencies that are not subject to the DFS greenlist.
The proposed guidance seeks to provide a framework under which VC entities may seek DFS approval to self-certify the listing of new coins. In order to self-certify a coin listing without the prior approval of DFS, a VC entity must create a coin-listing policy in accordance with the proposed guidance that considers four broad categories of issues: governance, risk assessment, ongoing monitoring, and delisting. From a governance perspective, the proposed guidance would require a VC entity to have an independent board of directors or equivalent body that would approve and oversee the overall listing process, with a particular focus on managing actual or potential conflicts of interest.
Additionally, the VC entity would be required to perform a comprehensive risk assessment to ensure that any coin is consistent with DFS regulations, consumer protection, and the safety and soundness of the VC entity. The proposed guidance identifies a variety of potential risks to consider including, without limitation, technical design and technology risk, operational risk, cybersecurity risk, market and liquidity risk, illicit finance risk, legal and reputational risks, and regulatory risk. According to DFS, mitigating conflicts of interest and ensuring customer protection should be at the forefront of risk management. The proposed guidance also calls out several types of coins, such as stablecoins and bridge coins, that cannot be self-certified.
The proposed guidance further provides that a VC entity seeking to self-certify a coin must have policies and procedures in place to monitor the coin to ensure that its continued listing remains consistent with safety and soundness principles, the protection of customers and the general public, and the other requirements of the proposed guidance. As nonexclusive examples of such policies and procedures, the proposed guidance highlights periodic re-evaluation of the coin to assess whether material changes have occurred, documentation and implementation of control measures to manage risk, and an orderly coin-delisting process. DFS must approve the coin delisting process in advance, and the process should ensure that there are sufficient governance features with due regard to the impact delisting may have on consumers, as well as provide for a detailed process that underlies the delisting events. DFS generally expects that a VC entity will provide at least 30 days’ prior written notice to customers of a delisting event and ensure there is adequate customer support, including appropriate documentation, ongoing monitoring of safety and soundness, and due consideration of second-order impacts a delisting decision might have on the VC entity’s operations and counterparty relationships.
Public comments on the proposed guidance are due by October 20, 2023.
On August 28, 2023, the SEC settled enforcement charges against a Los Angeles-based media and entertainment company for conducting an unregistered offering of non-fungible tokens (NFTs). The case represents the SEC’s first foray into the NFT space.Continue Reading SEC Brings First NFT Enforcement Case
As reported in a Hunton Client Alert, the US Department of Justice (DOJ), the US Department of Commerce’s Bureau of Industry and Security (BIS), and the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) recently issued guidance regarding the voluntary self-disclosure by US businesses of violations of US sanctions and export control laws to these agencies (Tri-Seal Compliance Note: Voluntary Self-Disclosure of Potential Violations) (Compliance Note).Continue Reading DOJ, BIS, and OFAC Issue Inter-Agency Guidance on Voluntary Self-Disclosures of Sanctions and Export Control Violations
As we previously reported in our summary of the Ripple case, a federal district court judged determined that under certain circumstances the offering of a digital asset does not create a security. The reasoning in the Ripple case has been criticized by leading to an outcome that places institutional investors ahead of retail investors and employees. In a separate, recently decided case involving digital assets, another federal district judge has declined to follow the ruling in Ripple.Continue Reading Federal Court Declines to Follow Ripple Holding
On July 13, 2023, the Federal District Court for the Southern District of New York issued the hotly anticipated ruling in the SEC’s case against Ripple Labs, Inc. (Ripple). On cross-motions for summary judgment, the court found that only Ripple’s sale of its XRP tokens to institutional buyers pursuant to sales contracts constituted unregistered sales of securities in violation of Section 5 of the Securities Act of 1933. But according to the court, Ripple’s programmatic sales of XRP through crypto exchanges, Ripple using XRP to pay employees and service providers and Ripple executives’ personal sales of XRP through exchanges are not investment contracts and therefore not sales of unregistered securities.
The court’s analysis focused on the Howey test for investment contracts, measuring each of the four types of XRP transactions at issue against the well-established factors for identifying a security. In a win for Ripple, the court did not waste time analyzing whether the XRP token itself was an investment contract and therefore a security. It stated that XRP “is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract.”
The court repeatedly emphasized the importance of evaluating the “economic reality” of the transaction at issue in order to appropriately apply the Howey standard. In the discussion regarding Ripple’s sales to institutional buyers, the court efficiently moved through its analysis that the first two Howey prongs were satisfied. In assessing whether the institutional buyers were purchasing the XRP for speculative motives, the court instructed that this should be an objective analysis of the promises and offers made to investors, not the specific reason for each individual investor’s decision.
The court points to Ripple’s marketing materials to institutional buyers that tied the success of Ripple overall to the success of XRP and its increase in value. Notably, Ripple’s marketing efforts highlighted that one of the value drivers for XRP is the talent of the Ripple team building the ecosystem around XRP. Combined with problematic public statements by Ripple executives that Ripple was committed to investing its capital in ways that would increase the price of XRP, the court found that the third Howey prong was satisfied.
The court bolstered this finding by analyzing the economic reality of the sales to institutional buyers, which were made pursuant to sales contracts that included lock-up provisions and resale restrictions. The court referenced similar facts from the 2020 ruling in the SEC’s case against Telegram, and concluded that, “[t]hese various provisions in the Institutional Sales contracts support the conclusion that the parties did not view the XRP sale as a sale of a commodity or a currency—they understood the sale of XRP to be an investment in Ripple’s efforts.”
“Of course, some Programmatic Buyers may have purchased XRP with the expectation of profits to be derived from Ripple’s efforts. However, ‘[t]he inquiry is an objective one focusing on the promises and offers made to investors; it is not a search for the precise motivation of each individual participant.’ Telegram, 448 F. Supp. 3d at 371”
In a victory for Ripple, the court held that Ripple’s sales of XRP through exchanges were not unregistered securities offerings. The court’s analysis focused only on the third Howey prong and found that because these sales were blind, bid/ask transactions facilitated through an exchange, the purchasers were ignorant to the fact that Ripple was the counterparty. As a result, there is no way to conclude that the purchasers knew they were contributing money to Ripple with the expectation that the proceeds from their purchase would be used to increase the value of XRP. The court noted that it is possible that some of these programmatic purchasers bought XRP for speculative purposes, but their individual motivation was not relevant. Again citing the Telegram decision, the court emphasized that Ripple could not have made promises or offers to these buyers because it had no idea who they were. The court engaged in a similar analysis in finding in favor of Ripple regarding its executives’ personal sales of XRP through exchanges.
In evaluating the other distributions of XRP by Ripple as payment for employees or service providers, the court concluded that the first Howey prong was not satisfied since there was no money exchanged. These recipients of XRP did not put up any capital that would be reinvested into the business by Ripple.
If it survives a potential appeal by the SEC, this decision can be seen as a win for Ripple and a blow to the SEC’s jurisdictional reach with respect to the regulation of digital assets, at least insofar as secondary market trading is concerned. Shortly after the opinion was released, XRP was reinstated on a variety of crypto exchanges for trading. Market participants should take note, however, that this ruling does not address secondary market sales of all digital assets on exchanges, but rather only held that Ripple’s sales and its executives’ sales of XRP through an exchange were not unregistered securities offerings under the Howey test. Because this case was being evaluated by the court as cross-motions for summary judgment, it only narrowly decided the issues of law in dispute. The court also held that Ripple had fair notice that its sales to institutional buyers could be illegal securities offerings based on advice it received from a law firm, and there were issues of fact that a jury will need to decide in order to determine whether Ripple executives aided and abetted this unregistered offering of XRP to institutional buyers.
Last week, the FTC announced its long-awaited finalization of updated Endorsement Guides. These guidelines come after the FTC initially voted to publish revised guidelines in May 2022. The new Guides were approved by a unanimous vote and make a significant number of updates to the 2009 version.Continue Reading FTC Updates Endorsement Guides: Highlights Online Reviews, Social Media Tags, and Clear Disclosures