Video Length: 1:14:49
David Ding: Okay, kia ora koutou, welcome everyone to this learning series event. Today I've got with me James Cochrane and Andrew Comer, they're from Lane Neave. Lane Neave is a very well known kind of full gamut law firm specializing in business and personal law, but their specialty is making really complex stuff simple.
So welcome guys, if you want to do some introductions and we'll kick things off.
James Cochrane: Thanks, thanks David. Hi everyone, I'm James. I'm one of the dispute resolution and Web3 digital assets partners, based in our Auckland office. Andy?
Andrew Comer: Hi guys. I'm a a corporate partner here in the Auckland office alongside James, also a a Web3 partner as well and have followed James down the, the Web3 blockchain rabbit hole.
And here we are today. So looking forward to some sharing some insights with you guys.
James Cochrane: Yeah I'm on the executive council for BlockchainNZ. We I'm also part of the legal working group for BlockchainNZ as a, a firm, our Web3 digital assets team services a whole range of digital assets clients from private clients through to, to businesses and I guess we advise on both contentious and non contentious advisory type work.
We've done a number of or acted for, for a number of clients and given advice and in relation to a number of different types of crypto business including NFTs and I've done a number of presentations to various organizations on NFTs as well. So hopefully we will make the complex simple for you today.
And, but bear with us it's the first time using Circle, and we're having some technical difficulties getting our, our slides working. So hopefully you can see us moving through our slides. If it all turns pear shaped, we'll, we're happy to send you a copy of the slides if you want to get in touch with David.
David Ding: Nice one, James. I'll just go into the format briefly. So they're going to go through the presentation and feel free to put any questions you have in the chat as we go. And at the end we'll have a Q & A and I'll have a few questions for you guys as well. So when you're ready.
Andrew Comer: So this just gives you a bit of a high level overview of what we're going to be discussing today and what the legal landscape looks like. So hopefully you'll come away with a bit of an appreciation that there are actually a lot of legal issues to consider. In terms of practical guidance, we're going to set out for you what the law requires of you at a fairly high level.
It should be able to give you a bit of a roadmap for you to think about when you're doing a web3 project.
James Cochrane: I guess we should note that while we're going to cover a number of different acts today, we're not going to be covering, and we can't cover just in the given the time involved, all the acts that could apply.
We we're New Zealand lawyers, we also can't give advice on any other type of law, any foreign law, any other type of professional advice, like accounting advice, financial advice, so we're limited in terms of what we can talk about. And in any case we're not giving any specific legal advice today.
If you have an NFT project or another digital assets project, you'll need to seek specific advice to be able to rely on that.
This is for educational purposes to cover off. I guess as Andy said, give you a roadmap as to the sort of things that we need to give consideration to when we're advising you. And also the sort of things that the regulators will want when and if you come into contact with them.
Andrew Comer: Yeah, so here's a quick overview of the topics that we are going to be covering today. We don't need to read them out. The first half, as you can see, is the focus is on compliance and the second half is looking at legal issues more broadly.
Andrew Comer: So this, this flowchart gives you a high level overview of the typical approach that we take when a web3 project comes across our desks. Gives you a bit of an insight as to how we service our clients and how we operate.
James Cochrane: Yeah, I guess I, as a... A litigator, that's been my bread and butter for most of my career, I guess I look at things with a lens as to I guess how, how a regulator might look at a project and Andy is being more on the advisory side as thinking about, well, how do we shape the documents and, and, and look at the asset and look at the structuring that's involved.
To best at achieving the outcome that you want.
Andrew Comer: Yeah. And, and sitting above it all is, the key issue around risk, that's what we're trained to do, is to identify and mitigate risk as far as we can. And so just quickly looking at that the flowchart, so once the onboarding process is done, that's when our real work tends to kick off.
But, it's incumbent on... You guys to come to us with a a clear idea as, as to what it is you hope to achieve. And you need to be clear on the key commercial elements of your project. And you need to communicate your pressure points to us around timing cost and any key areas of, of concern. And so once we've we've, we've given you advice you know, you'll go away, consider what we've told you you'll consider the next steps, you obviously have some questions, and then that's an opportunity to bottom out any issues.
And it's typically at that stage that we, we start to look at putting structures in place that will best protect you for your Web3 project. And if, if we think there are any regulatory issues that are coming into play you know, we'll, we'll definitely look to, to get in touch with the regulators at that stage.
James Cochrane: Yeah I guess one thing that may, that will certainly assist us may make your fees with us more palatable for you is if you give us a really good breakdown of what the project is and how it works. From sort of start to finish you know, the things we'll be looking for and sort of in particular around maybe exchange, you know, is, is this going to be just really what is in effect a, a sale of a good you know, just a, a mint for, well, a sale of the NFT.
Or is or is there more complexity involved? You know, things like is there any sort of burn mechanism? Is there a physical asset involved? Is there some sort of treasury, are you looking at a DAO, that sort of thing? Those are the, gonna be the sort of key considerations in terms of the regulations.
Andrew Comer: So now we'll move on to the compliance legislation. And the key one being the Financial Markets Conduct Act, or the FMCA. So this is New Zealand's key piece of securities law. It replaced the old Securities Act about 10 years ago. And it came in as a bit of a response to the the tidal wave of finance company collapses.
And its primary driver is to ensure that retail investors have all the adequate information they need in order to be able to invest in a product. It also puts the asset on offerors as well to ensure that they're giving enough information to those investors.
James Cochrane: So to give you a bit more context. Generally, if someone is making an offer to the public that is is going to be well, could be dealt with by our Financial Markets Conduct Act most of you will probably be familiar with the action that the SEC and Gary Gensler are taking against various crypto projects around the world.
You might be familiar with the case against ripple labs and the action being taken against Coinbase and Binance. And also, I think, Richard Hart has sort of the latest one and the allegation generally is that there has been a offer of, of securities without a disclosure statement.
So in New Zealand, if you have, if you are making an offer of financial products, generally that needs to be a accompanied by a product disclosure statement. Also called a PDS. The, if, the consequences if you make an offer of financial products that isn't compliant are pretty serious, so you've got potential criminal liability, so the so, if, if it's a company that makes the offer, it can be the company that can be liable, it can also be the director, can also be personally liable. Maximum Penalties, 10 years in prison, one million dollar fine, for an individual, or five million for a company.
So the liability consequence is incredibly serious.
Andrew Comer: There's also civil liability as well isn't there, so You can be pinged for three times the amount of any gains that you may have earned from your project. So, it's there's some pretty serious implications of getting it wrong.
James Cochrane: Yeah, so the I guess also the FMA, which is the Financial Markets Authority also has other powers which could affect a project, right?
So they could include stop orders, which prohibit further action. In respect of the, I guess the NFT Mint. They may make, may make direction orders or they could issue infringement notices. So this could essentially stop a NFT project sort of in its tracks.
What, what that might mean is, you know, for example, if the project had been launched and, you know, if you had it on a marketplace. Probably in New Zealand a marketplace like Glorious, for example then Glorious would be probably inclined to take it down and I guess that could affect the value of the project.
Andrew Comer: So if we're presented with an NFT project which we think could have FMCA implications, we'll typically try and run an analysis under the FMCA to see whether or not your project comes within any of the four categories of financial product. So you can see them on the screen now and we can quickly canter through them.
The upshot is if, if you're offering a financial product, you are an issuer under the FMCA. James has just talked about the implications of that. We'll canvass that a little bit later on. Equity securities, they're the most commonly understood form of security. Critically, there's no right to repayment. If you're, if you've been issued an equity security as opposed to a debt security, which sets it apart, there is a right to repayment.
Examples are corporate bonds, convertible notes, government bonds, etc. Derivatives yeah we've talked about them on the screen there. Futures contracts, options. These are contractual arrangements where you have to give some form of consideration to a third party at some point in the future, and that consideration is driven off something else.
For example... an underlying asset. An index or a commodity. And we've had to run this analysis on an NFT project that we've both been involved in whereby a, a token was issued and that was stapled to a real world asset, and we had to run an, an analysis to determine whether or not that fits within that that category of financial product.
The, the fourth one there is managed investment products. So this is you know, what you probably commonly understand to be things like KiwiSaver and property syndicates. It's an interest in a, in a managed investment scheme whereby the purpose is to pull funds so you can derive interests in the scheme.
You're not allowed to have any day to day say in the operating, sorry, operation of the scheme. And the interests or the financial benefits are usually produced by the activities or efforts of someone else. And then, and then finally, the designation powers is, you know, one that is wholly important.
And by this, the, the FMA has the power to actually designate a specific security as being a financial product. And so what they'll do is they'll look at the substance of what's being offered rather than how it's been described or the form. And, and so they can say, right, that is a financial product that does come under the FMCA.
Yeah, so that's so that is quite critical.
James Cochrane: So the definition of security under the Act means an arrangement or a facility that has or is intended to have the effect of a person making an investment or managing a financial risk. So it's very broad in terms of like the Ripple Labs case. The sort of key issue there is whether the whether the parties that were buying the XRP were making their parties to an investment contract.
So the, the wording is I guess, similar to, The test that they use in, in the US called the Howey Test. So I guess the con the consequences of this is that if if the FMA was to consider that the pro the project was a security, they do have this power. I mean, there's a lot of steps that they have to go through in order to designate something, a security.
But it's a risk, I guess, to be aware of in any case.
Andrew Comer: And what it stresses, again, is the importance of getting legal advice early on in your project.
So we've probably talked to a number of points on this, this slide. The, the length of the PDS is often determined by the nature of the financial product that's being offered. There are a number of obligations that come with offering a financial product other than disclosure. So there are certain fair dealing, governance, operations based obligations that are put on you.
Should also mention that there are a number of exceptions and exclusions under the FMCA which would excuse you from having to prepare a product disclosure statement and there are a whole raft of them in the Act. Most common ones include if you're offering to wholesale investors, so experienced investors, investors with certain thresholds of assets or revenues, if you're offering to close business associates etc.
James Cochrane: Yeah, I think it's a It's safe to assume, if you are doing a mint of NFTs, that there is a reasonable risk that you could be offering the NFTs to New Zealand retail public.
Andrew Comer: And the trigger point is, if you are offering to only one retail investor out of the pool of investors, the FMCA will apply.
James Cochrane: So I guess what we're doing when we go through the project, when we get the facts from you we, doing an analysis, does it fall within one of these categories of financial product?
There's in our experience, you know, reasonable arguments why a lot of NFTs don't fall within the definition, you know, the, the, the classic four categories of financial product. But you should be aware that we have to do this analysis so that when you, or we go to the FMA, if that's what you elect to do, we need to be able to explain how it all works and why for example, it, it might fall into one of the categories for why it doesn't, why it isn't a financial product, and so you're not subject to the requirements of the act.
So financial service providers.
Andrew Comer: So we've got legislation in New Zealand that captures providers of financial services and there are certain obligations that apply to them. So if you're providing a financial service in New Zealand, you have to be registered on the financial service provider's register. Offering a financial service or financial service itself is defined pretty broadly in the law. It captures anything from someone operating a money or value transfer service, if you're offering a financial product or if you're offering a financial market, product market, sorry.
It also captures virtual assets service providers as well. So those people that are offering a virtual asset exchange, people that are providing storage for virtual assets, or anyone who's brokering virtual asset transactions. And the other point is, if you are found to be a financial service provider, you also have to join a dispute resolution team.
So there's a way in which disgruntled investors have the ability to claim against you.
James Cochrane: I guess one of the key points is you'll need to register as a financial service provider if you an anti money laundering reporting entity under our anti money laundering legislation for providing financial services and the test there is reasonably broad and most VASPs will be caught under the definition of financial institution under the AML CFT Act 2009.
Andrew Comer: So, just a couple of points to be made here regarding jurisdiction. If you're extending the offer or allowing participants in New Zealand only, you're limiting the scope of... Regulation to New Zealand law. So this, this sort of allows you to plan and budget accordingly to ensure that you're complying with New Zealand laws.
It also means you're only having to deal with one regulator. If conversely, your your allowing participation outside New Zealand, You're basically, opening up Pandora's box. For example, most countries, have similar securities laws to New Zealand. And so if you're offering beyond our borders, this means you're going to have to comply with the securities laws in those jurisdictions as well. And some of those laws might in practice actually be you know, more strict than, than what we've got in New Zealand. So that's why we strongly recommend Web3 project creators to, to seriously consider the scope of participants from a jurisdictional perspective.
Ah, finally on that list there are certain countries around the world that have been blacklisted by the Financial Action Task Force. That's the Global Anti Money Laundering Watchdog. And if you're blacklisted that means that some your AML laws aren't up to a certain level Which creates risk for anyone dealing with with entities within those countries. The blacklist of countries at the moment are North Korea, Iran, and Myanmar.
And so if you're offering if you're creating a project, consider excluding them from the offer. You also probably want to have a think about other countries that. Yeah, you know, may have human rights abuses, there may be corruption, unfriendly governments, or there might be war sympathizers, and so we typically would recommend that our clients exclude those countries as well from, from the project.
James Cochrane: I guess one, there's a couple of ways... You can attempt to control this. And I, I guess that's through your website terms and conditions, your, you know via Ts and Cs associated with, for example, your telegram or your discord. And also I guess if you are going to mint through a third party exchange typically third party exchanges will have some sort of know your client AML, CFT requirements because they will exchanges are typically VASPs.
So they will hopefully have done some screening for those excluded nations.
Andrew Comer: Fair Dealing,
James Cochrane: Yep, so Fair Dealing is caught under the financial markets conduct act, but also under our fair trading act and this is essentially a consumer protection law, which is designed to protect market participants from misleading deceptive statements. For example, I guess if you are making statements or having the developers making statements in the for example, the the discord chat.
Try to ensure that those are aren't misleading. You know, they're not overblown about what you are promising to deliver.
Andrew Comer: Can be supported by facts.
James Cochrane: There was a case, we've done an article about it which you can find online if you want to have a read about, Kim Kardashian, she essentially got reprimanded in the US for making statements on her Instagram.
So just bear in mind if you are engaging third parties to help you promote the project that you want to ensure as much as you can through your agreements with them that they will I guess not go outside of the their your instructions to them as to what they can and can't say.
Andrew Comer: And, and so just to round it out, be really careful when you're promoting the project on, you know, in your roadmap. Your white paper on your website or on your your social media channels just around the the messaging that you're putting on there.
James Cochrane: Next topic is AML CFT.
As we've said here the, the AML CFT legislation will apply to reporting entities.
Andrew Comer: Yeah, so those are businesses that provide a specific type of financial service under the anti money laundering laws in New Zealand. If... If you are found to be a reporting entity under those laws, there are a number of obligations, and some of them include you have to have an AML officer appointed within the organisation to ensure compliance with the AML CFT Act. You have to report on certain activities that may have occurred and you also have to maintain an AML compliance program as well.
James Cochrane: So there's a, there's a lot going on compliance wise. We've advised a handful of projects in relation to risk and compliance plans. There's some great guidance from the Department of Internal Affairs for VASPs. I'm sure we can... We may have done a link somewhere, but that is well worth having a read because as I mentioned before VASPs will be caught by the AML CFT Act as financial institutions.
And so when you have a look at the VASP guidance. There's different types of VASPs which can be caught. And, and one of those which can be caught is an initial coin offering provider. And so a a an NFT Mint, as you'll appreciate is, is similar to launching a, or doing a coin offering for a a, a cryptocurrency. As opposed to an NFT.
So, these involve transferring money or value arguably, arguably on behalf of a customer or issuing or managing a means of payments and potentially called as money or currency changing. So those are the, those are the things to watch out for with the AML CFT Act.
So, There's a lot of compliance going on you can outsource or you can't outsource your obligations entirely, but you can engage third parties to assist you with your AML obligations parties like Chainalysis and Kroll provide these sort of services to help you identify who you are dealing with and As sort of mentioned before, the if you're using a whitelisting process, particularly if you're going through a third party exchange then that can assist you with compliance as well.
Andrew Comer: So that's the the compliance section done. Now we'll look a bit more broadly. So first up, privacy. If in the course of your project you're collecting personal information, you need to be mindful of your obligations under the New Zealand Privacy Act. So personal information is defined as any information that allows you to identify an individual, and if you're collecting information around that, there are certain requirements that relate to collection, storage, use, and disclosure.
You'll also need to appoint a privacy officer, much like an AML officer. This person ensures that you're complying with the obligations under the privacy act.
James Cochrane: Yeah I guess, sorry to jump around a bit but probably sort of mentioned the FMA guidance on cryptocurrencies is useful to refer to as well when you're considering financial markets conduct, and AML and financial service providers. And there's also the pre registration service for the FMA and that's a service where you can consult with the FMA about the project and as mentioned before, you can, I guess, get some guidance as to whether the FMA believes that there might be a financial product or financial service in terms of your project.
They've got the right to request access and change anything that may have been provided by them. And if you are storing personal information overseas you need to communicate that to your investors. And you need to let those investors know that the storage... Repositories overseas might not have the same privacy laws, or they might not follow the same privacy laws that, you know, we follow in New Zealand.
So yeah, investors need to be made aware of that.
James Cochrane: Next topic, IP ownership and licensing?
Andrew Comer: Yep yeah, there are a host of IP issues to consider when you're launching a Web3 project. Key categories of IP are in that first bullet point there. Yeah, it's, it's critical that, you know, you, you're running an internal analysis of a couple of things.
So you want to work out from your perspective, what kind of IP you think you have.
And also in the course of the project, what rights you want to be giving out to participants or investors. Yeah, an example is an NFT project James and I worked on where there was, you know, an option of either Giving ownership rights in the IP to the investor or, you know, simply licensing the right to the investor.
And so ultimately we, we came to the decision that from the creator's perspective to the extent possible, it's best to retain all ownership rights and, and effectively just license the right to use the product under that project.
James Cochrane: Yeah, I mean, there's, there's different approaches. Most of you would have ,you probably noticed that when the owner of the Bored Ape Yacht Club purchased the rights to Crypto Punks they the Bored Ape Yacht Club purchasers had very broad commercial rights, so you would have seen the, the purchasers who purchased them were able to do things, for example, you know wear Bored Ape clothing and things like that, or have their Bored Ape appear in a music video or something like that.
Whereas the, the Punks holders didn't have the same rights but when because lava labs brought the rights for Punks, they granted the Punks holders more broad intellectual property rights and that ultimately pumped the price of, of Punks again because they just had more value for the holders.
I guess another thing to note on intellectual property is around your contracts with with your developers and any other employees involved in the, in the project you want to be quite clear when you're engaging those parties as to who retains ownership of the intellectual property.
If you're not clear about your agreements with the these parties, and we'll cover this. There is risk that I guess your exclusive ownership of that intellectual property might get challenged.
Andrew Comer: So when it comes to structuring for your project, there are a host of options or vehicles at your disposal. The most common ones typically tend to be adopting a company or a limited partnership vehicle. There are also, as that slide shows, other options like charitable trusts or incorporated societies.
Quite often it's a... A tax driven decision that determines the best approach, but it's also about protecting you as far as possible from any claims that might arise. And, we call it ring fencing your liability. So putting you in a protective bubble,
James Cochrane: Yeah, I mean, there's other structures, there's a whole range of different structures.
One of the sort of key issues in the Ripple Labs case is that Ripple Labs adopted a different structure to, for example, Ethereum and even Solana. Ripple labs had the essentially, the company structure, I believe it was whereas Ethereum and Solana both operate via a foundation and the foundation is essentially a non profit.
And I guess that, can using a, a nonprofit as I understand it reduces the risk of the project being viewed as an offer of securities because the, it's the foundation which is essentially trying to grow the the platform as opposed to grow wealth for the owners of the, the, the currency.
Andrew Comer: That's right. Just to that second point on, on the slide, the, this is something that we quite often recommend to our clients is to consider adopting a, a holding entity and, and an operating entity approach. And under that the holding entity whether it be a company or a limited partnership or whatever, that holds all the good stuff or the assets, the cash the IP, et cetera.
You set up a, a sister company called an operating entity, and that's the client facing vehicle that contracts directly with third parties. And so if, well sorry, we have a license arrangement between the two whereby the holding entity allows the operating entity to use all the good stuff. And if if, if the operating entity ever gets into trouble, there's nothing sitting behind it, so nothing for disgruntled investor to claim.
Secondly, disgruntled investor can't have any rights as against the holding company because it never had a contractual arrangement in place with it in the first place. So, that's something, yeah, to consider when you are doing a project.
James Cochrane: There's also, I guess, asset protection in terms of structures that you can adopt to try and while they may not shield you from criminal liability they may protect you from I guess protect your assets provided they're ring fenced and in terms of civil liability, as I mentioned, the use of a family trust to hold an interest. Estate planning having a solution in place, you know, particularly if you are controlling wallets and other assets. And, you know, there are great projects in New Zealand like Everlasting, who is a fantastic estate planning service.
Relationship property agreements, you know, you could create an incredibly valuable project overnight. And if you're, you are in a a relationship that's covered by the Property Relationships Act. If things were to turn south with your partner, they may have a claim against you and the, and the project. So Again, you know, there's lots of different laws here that can apply property relationships act, companies act, limited partnerships act, limited partnerships act, charitable trust act you know, there's this Numerous numerous things to give consideration to.
Yeah. And, and as part of that, you know, we strongly recommend you, you get tax advice as well. And, and just to round it off, that, that family trust approach is, is not a bad one because there could potentially be tax benefits for the beneficiaries of that trust. And also from a liability perspective, your personal creditors can't, you know, attack the trust because because of where the assets are located. So yeah, a bit to consider.
James Cochrane: Tax issues cover this pretty briefly.
Andrew Comer: Get tax advice. Yeah, pretty much.
James Cochrane: Seek specialist advice. And I mean, increasingly there are well we deal with a number of accountants who have, you know, good knowledge in this area. They speak Web3 I guess it's, it's not our, but like we can form a view on certain things, but ultimately we're not qualified to prepare your your tax returns and things like that.
So you'll need specialist advice. And as Andy says, this is also relevant to structuring and of trying to find the best, most tax efficient structure for you. And unfortunately the reality is that sometimes another jurisdiction such as Singapore or Dubai, you know, might even be more appealing to you from a tax perspective.
Andrew Comer: So we've sort of touched on this a little bit earlier. It's critical to consider, you know, when you're employing staff, whether you're employing independent contractors, or if you're hiring employees, because there's a legal difference with implications for each. If your em, if you are hiring employees they've got protections under the employment law in New Zealand and they at a high level include the right to you know minimum wage, public holidays, paid leave.
Whereas if you're employing an independent contractor they don't have those, those rights that apply to them. So that's one consideration. And then the second one is the intellectual property point, which James touched on earlier. Under the Copyright Act in New Zealand, if you're an employee and you're creating copyright or IP in the course of the employer's business, that necessarily that sheets home to the employer. Whereas with an independent contractor, that IP sits with the contractor. So that's, that's quite a significant consideration. And so if you're bringing on board contractors, and you want to hold on to that IP, we strongly recommend that you have an agreement in writing which says something along the lines of any IP created by the independent contractor belongs to the, the project creator.
James Cochrane: Yeah, another point worth noting is, you know, if you're engaging a developer from overseas, it pays to have a clause in whatever agreement you have, whether that's an employment contract or an independent contractor agreement, making New Zealand the exclusive jurisdiction to determine any disputes. The last thing you want is that contractor having a go at you from a overseas location that just increases cost for you, it's not familiar you'll have to engage foreign lawyers. You can control the process if you have the right agreements in place.
The other thing is which we've got there is the confidentiality non disclosure agreement always good practice if you've got a project, If you think you've got a good idea, then try and utilize a non disclosure agreement to protect that, because ideas themselves are very hard to protect.
You can protect the expression of it with copyright, or you can protect a name with a trademark, protect a design with a just a design. But when it's just an idea about what the project looks like that is a lot harder to protect. The way that you protect that best is through an NDA with appropriate IP provisions.
There are a host of different platforms where you, you might need T's and C's. For example, for your website for the specific project itself for relationships that you might have in place between you and your customers and your suppliers. T's and C's also apply in the context of employment and or independent contracting arrangements, IP licenses, and also at a more corporate level the relations between you and your founders or, or fellow investors, for example a limited partnership agreement or a, or a shareholders agreement.
And, and, you know, something that we haven't, I don't know if you want to talk to anything else about that, but one thing that we haven't canvassed in the slides just on this investment component here, In terms of raising capital, you're probably aware that there are a number of options to raise money for your project out there.
Callaghan Innovation, they offer grants and R& D in a technical development context. There are crowdfunding options like Snowball Effect where they can offer either a reward or equity based options. So, yeah, crowdfunding operators, they have a regulated platform in which you can raise funds. Also angel investors, which provide early stage funding as well, for example. Enterprise Angels and Flying Kiwi Angels.
James Cochrane: So that's probably us. I guess I can add a few do's and don'ts. Do be clear about the nature of the NFTs that you're offering. That's going to help us and it's going to help the regulators understand the project and determine whether or not they're going to be a financial product or a financial service.
So, do be clear about the way in which the NFTs are being offered to the public. Where are they being offered? Is it just New Zealand or elsewhere? Do be clear about the services that you're providing in relation to the NFTs. Is there a treasury service? Is there not? Is there a burn mechanism? Are you giving you know, additional rights in relation to the company or something like that.
Do consult with a lawyer to ensure that you're complying with all applicable laws, don't offer NFTs that are considered to be financial products or financial services without complying with the relevant regulations. Don't fail to comply with the AML CFT Act, and don't fail to register as an FSP if you're providing financial services.
Go have a look at, before you come to a lawyer, have a a look at the FMA guidance on ICOs and do have a look at the DIA guidance on VASPs. The more prepared you are, the the smoother it should go and also the sharper we can be with our, our pricing because if we're having to go through a lot of back and forth with you to try and work out what, how the project works, if we have to go through a whole ton of documents then everything just takes time and it becomes more expensive.
Andrew Comer: So that effectively is, is all from us. We've reached the end of our formal presentation.
James Cochrane: Okay, so we stop sharing.
David Ding: Nicely done. I actually got a hell of a lot out of that guys, so and I know you can think of a number of founders off the top of my head who will be able to move forward on a couple of things just from this presentation.
So I've got a few questions, but I'll just read out the questions in the chat first. From John Hussey, how often are these fines actually happening? Referring to the fines you were talking about, the FMA fines?
James Cochrane: Well they, I wouldn't know off the top of my head to be honest. You know, they, it's more common in relation to non crypto projects.
I think it's probably fair to say that most of the most of the projects that we have looked at have not touched on the or we've made compelling arguments as to why they're not financial products.
Andrew Comer: Yeah, the regulators are taking an increasingly proactive stance though, like they're removing financial service provider licences, other forms of licences when the strict requirements of the legislation are not being met.
So I think that's probably only going to continue and you know they're getting guidance from what's taking place overseas as well. So it's a it's a pretty dynamic and rapidly evolving area.
James Cochrane: Yeah, I think, I think you can if you were to approach it on the basis that if the FMA learned of your project after the fact, rather than by having some consultation with you beforehand, and they formed the view that you were offering financial products and you had operated in breach of the Act I think there is much higher likelihood of a fine than if you had consulted with, with the regulator in the pre registration process.
David Ding: So being seen to be, you know, you used the phrase taking the regulators on the journey. Yeah. You know, there's actually credence
Andrew Comer: Ask for permission rather than ask for forgiveness.
James Cochrane: Yeah, so that the regulator's not going to rubber stamp it. And you have to be aware that if you are, if the project changes from the time that you consulted with the regulator, you know, then you could could create problems for yourself.
What you have to remember is, you know, you could have a disgruntled investor who reports you, you know, or you could have a competitor who is not happy with whatever you've done, who reports you. So, you might think you're flying below the radar, but you might, you might actually be on the radar.
David Ding: Okay. So from Mo, he's asking if you're using a third party for KYC and AML, such as Sumsub, do they still need to have a compliance officer? Oh, is it an AML officer actually specifically?
James Cochrane: Well, if, again, if you're if you think you're going to be caught as a financial institution, then the AML CFT Act is going to apply.
You're going to have to meet all the, all the tests. So the fact that you are outsourcing it is only one element in what you have to do. My expectation would be you probably do need to have a risk and compliance person and have a plan in place.
David Ding: If you're a founder, is that okay to nominate yourself?
James Cochrane: You can, yeah. I get, you know, it's, it's one of those things where it, it could be quite a big task. So you have to weigh up the, the benefit versus the hassle on that.
David Ding: So we've got a couple of comments. Interested to get your comments on this. So someone said SEC vs Ripple is trying to draw the line between financial product. In brackets, institutional sale and non security in brackets, usage token, which Judge Tory has ruled in favour of Ripple on programmatic sales and DEX purchases.
So limited the Gessler gambit that every token is a security token. Have you got any awareness of that or any comment?
James Cochrane: Yeah, so I guess the first thing to be aware of is in the U. S. they don't have these sort of four categories of financial product. We, New Zealand's got financial products, we've got the equity securities, debt securities, managed investment schemes, and derivatives.
So, these are sort of quite tight categories, quite defined. You know, there is the designation power, which refers to securities, which does encapsulate that how we test potentially, but the main test for the FMA is whether it's going to fall within one of those four defined categories. So if you are limiting your offer to New Zealand, then you, you can really focus on those four categories.
If you're making it broader, for example, if you're including an offer to parties in the U. S., more likely than not, well, the safest practice would be to go and speak to a U. S. lawyer about whether or not what you're doing could be touching on the Howey test. So, in the Ripple Labs case, I think what you have to remember is the initial coin offering was to institutional investors.
And that was I guess in New Zealand we call them wholesale investors. There aren't the same requirements as there are when you're offering products to retail investors. The, the offer in Ripple Labs to the institutional investors was caught as a security. So it wasn't the, wasn't the tokens that the XRP, in and of itself, it's not on its owner security.
It was just the way that it was offered, which was the security offering. And they hadn't complied with the requirements there in terms of having the appropriate what is essentially in New Zealand our PDS product disclosure statement. Now the programmable sales which is where what happened was the the sales by the by Ripple Labs and the institutional parties to retail was all conducted through exchanges.
There was essentially what was called a blind but ask process. So the purchasers didn't know who they were purchasing from, and the institutional parties didn't know who they were selling to. And because of that, Judge Torres formed a view that it, that particular programmable sale didn't fall within the In the definition of a offer of securities And investment contract. Okay.
So I guess if you strip it back there's still the chance that an offer of Tokens if you're offering the tokens to retail straight out the bat then potentially that could be an offer of securities. Now as far as I'm aware there hasn't been Any case law on whether NFTs fall within this definition of securities, but, you know, there's not too much in terms of difference apart from the fungible, non fungible aspect of them.
David Ding: But your comment earlier about beware of inadvertently making a retail offer. Can you just talk to that? How can people make sure that they don't do that? Are there simple ways to make sure you don't do that?
Andrew Comer: Retail offer?
James Cochrane: So an offer to retail as opposed to an offer to a wholesale? Yeah, I, I guess you'd have to understand who you are offering to.
Yeah. Usually if you're gonna do a, a wholesale offer there's a process to go through with that and you will know the party that you are offering to, and you typically seek comfort that they are qualify as an institutional wholesale investor. Whereas if you are just doing a a mint to anyone, you're not sure who it is, if you just then there's a reasonable chance that it could be a retail offer.
As Andy said, you only need one retail person to create a, an offer to the public. How can you control that? Possibly through the use of minting process through the through an exchange that's done KYC so that they know who's involved.
Andrew Comer: In conjunction with, you know, specific disclaimers and waivers, as well, that canvass that, that you're only offering to certain sections of the community, which is quite often what we see.
James Cochrane: Another potential strategy might be to do a free mint, where there's actually no cost. In terms of the purchase of the asset, right? Obviously you're not gonna raise as much capital, but that, you know, as part of that process, you know, the idea behind our financial markets law is to protect consumers in relation to offers of financial products.
So you know, the idea is protect them from spending money and yeah, putting themselves at risk if they don't fully understand the risks. You know, that's the part of the idea with the product disclosure statement is that the person who's buying the asset knows exactly what they're getting and that's why it's so important that the product disclosure statement be accurate, not misleading in any way.
And Yeah, so if you think about your white paper a little bit like a product disclosure statement, then ensuring that it's not misleading in any way, that it's accurate, always sensible to have a lawyer have a look over it you will hopefully reduce some risk.
Andrew Comer: Yeah. And remember, the trigger is always, if you're offering a financial product.
And so hopefully by that stage, you've engaged lawyers to, to advise you on what you're offering. And, you know, as a secondary step. Touch base with the, the financial markets authority to get their take on it. And, and so hopefully by that stage, you'd hope more often than not that what you are offering is not actually a financial product. And by that, the FMCA stuff just falls away.
David Ding: Okay. And, and so, so do you handhold people through that process with engaging with regulators or do you refer them?
Andrew Comer: No, we've we've, we've had experience with that liaising with and, and corresponding with the FMA. In particular sort of setting out an analysis of what's being offered under the project and, and we provide our views and there's, you know, a bit of back and forth between us and the regulators.
David Ding: Okay. So just a couple more questions here. So, if doing AML/KYC, then by definition you're doing personal data collection. With the multitude of jurisdictions around, this becomes increasing compliance costs. For start up, for a start up from a small nation like NZ, this burden is a serious headache.
Any comment on that one?
James Cochrane: I agree. Yeah, and I guess this is where if you can have some support from an outfit like Callaghan, you have supportive investors that will assist in terms of what Blockchain NZ is doing. This this is a big issue, and I personally would like to see something in the in the way of like a regulatory sandbox, which is what they have in overseas jurisdictions where there's essentially like a almost like a regulator handholding process as well.
But I'd also like to see some specific law around in terms of the penalties penalties not necessarily applying until a project gets to a particular threshold. So and these are, you know recommendations which have also been made overseas by Blockchain Australia. And yeah, I guess that's a wait and see as to what how the law develops.
I'm expecting that our politicians are waiting to see what Australia does. We tend to, rather than be a a change maker, we're more in the the lane of being a fast follower. So there's definitely a lot going on in Australia. So I guess watch this space, but I totally appreciate that. Going through all this process with lawyers and accountants and other professional advisors is really expensive. And can be cost prohibitive.
I guess the, the challenge that all of, you know, many nations have is how do we have how do we encourage innovation without creating bottlenecks like this, which encourage people to go overseas to other jurisdictions where it's a bit easier and, and not quite as expensive.
David Ding: Thanks for that. So question from Mark. How long would it take regulators to respond with an answer?
James Cochrane: They're usually pretty quick. Yeah. I guess it depends on the the nature of the project and where the, the project has potential similarities with any with any of those sort of four key financial products.
You know, the sort of the, if there are aspects which look like they could fall into that category, there might be a sort of like a question and answer project. So so I can't, it's a bit vague, but...
Andrew Comer: It also depends on their workload as well. But they're usually pretty communicative and transparent around that, if you front foot things with them.
David Ding: And so I'm pretty keen to get your thoughts on where we're at in New Zealand currently with the challenge with getting bank accounts and and the emergence of Alternative intermediaries for want of a better phrase. Can I just get your thoughts on And maybe a snapshot view from your perspective on that issue.
James Cochrane: Yeah, look it's it's definitely a major issue something that we've talked about at BlockchainNZ and was a hot topic at the Digital Assets Conference I went to in Sydney recently organized by Blockchain APAC. You know, we've had, it yeah, major issue.
I guess the, when you look at projects that have done well in New Zealand, like Easy Crypto, Glorious, they are trying to do things in a compliant manner. Some an outfit like Easy Crypto uses Chainalysis to help it track source of funds and gives it information in terms of any suspicious activity reports that they have to do.
When you have that level of support that, that can give a bank more confidence. Right, so there are I, I think generally the New Zealand banks are, which are, are a bit hesitant in this space, you know, one of the what the Chair of Blockchain NZ, it's Sorel Carr, he's head of Fintech at BNZ, he'd certainly be a good person to talk to.
Yeah, I, look it is a, a major issue, we've I know of at least one of our clients who went through all this process, got compliant well registered as a financial service provider, went through the big process of getting a compliant, compliance plan and things like that, is subject to suit the regulation of the Department of Internal Affairs. But then for whatever reason wasn't able to get a bank account.
And that effectively shut down the project in New Zealand. And so, you know, really unfortunate. I think that not only for the client, because they had invested a lot to try and be compliant. They were compliant, and then they effectively couldn't do their business, but it also robs New Zealand of, of tax revenue.
Robs New Zealand of Jobs. So, hopefully, I'd love to see maybe a more open minded approach from the New Zealand, Aussie banks. I mean, if you look, you've got BlackRock, Fidelity, jP Morgan. They're all lining up. These are some of the world's biggest asset managers and banks, BNY Mellon. They're all lining up overseas and I think what will happen is once there's a bit more clarity in terms of the law, particularly in the US. Things are moving in Europe. They've got markets and crypto assets, which is their specific law in Europe, the UK's looking at, at law. Singapore's got specific law, Hong Kong's making moves.
I think as, as you see these changes and clarification of the law and more institutional parties coming in, there'll be more confidence for the banks. And so hopefully less de-banking or non banking.
David Ding: Makes sense. A question's just come in, would it be possible to register a new bank which is more crypto friendly? And I think it's kind of, it's that de risking process for the banks that's really the, the fulcrum of progress. And I'm definitely going to look.
Is it Chainalysis you said?
James Cochrane: Yeah, there's like, outfits like Chainalysis. I know they... Well they're, they're global but I know that we had we hosted an event for Blockchain NZ with Chainalysis the other day, and I know that Easy Crypto used them because Paul Quickenden was co presenting with us, so Chainalysis is one, Kroll is another one, they're also, they've been out, outfit in Australia and.
Yeah, so that, that, you know utilizing these third party, essentially blockchain forensics companies can can really assist on the legitimacy source of funds, verifications, identifying suspicious wallets and things like that.
David Ding: There's a question here. Why doesn't the New Zealand government force Kiwibank to be more accommodating to New Zealand startups?
So that's quite, quite a complex issue. I know from my perspective. What I can say is that there's a lot of activity around this to imbue trust into the value chain, you know, between intermediaries. And I'd say, you know, progress is slow, but there is stuff happening. And especially Callaghan Innovation, we're trying to accelerate innovation in this space as much as we can.
David Ding: Another comment here. What would it take if, say, under UK NZFTA, to converge to a common set of market accepted practices with co regulation that broadly conforms to Commonwealth of Nations to simplify the compliance burden.
Andrew Comer: Great idea. Yeah.
David Ding: Yeah. Just quickly, to preface that, I think a lot of people don't realise that opinion leaders like yourselves do a lot behind the scenes to influence the ecosystem, so maybe you could speak to some of the stuff you're advocating as well.
James Cochrane: Yeah, I think so I was at this digital assets conference and there was a whole host of Aussie, predominantly lawyers, but also regulators discussing the various issues around digital assets. And as you'll appreciate, a lot of people who are very new to this space, they're just learning trying to upskill people on this technology can be a real challenge, particularly if they don't have any specific interest in it themselves.
So there is this, everyone is sort of going through an educational process. I guess there is differing views on definitions. Is it a digital asset? Is it a crypto asset? Is it, you know, a virtual asset? So you have all these challenges across different jurisdictions, sort of similar issues, but across different jurisdictions.
So, you know, I, I think working, having some sort of global framework would be ideal. I guess it's just trying to find agreement on that. You know, that's not to say that it can't happen. We've got cross border model law and things on which apply in insolvency for example. So I think it's a watch this space that might take a wee while.
David Ding: And so what about finally, sorry.
James Cochrane: I, I was just gonna add David, I think part of all this move by Mr. Gessler and SEC is in part, and I'm just speculating in part designed to put pressure on US lawmakers to try and form a view on what the law is. to encourage lawmaking as opposed to lawmaking by enforcement and by the courts.
Yeah, so I think there's a recognition that there needs to be law made in the various jurisdictions. And you can see them moving towards that, but different jurisdictions work at different paces.
David Ding: And so, so I think you know, to, to cap this off, I think if we could finish on, because you've done quite a bit of writing and you, you, you're a strong advocate for the sandbox, perhaps you could talk to how you envisage how a sandbox could be viable in New Zealand.
James Cochrane: Yeah, well, I think if if there is a forum where, you know, a party is looking to launch. Where they can go and discuss the project, get guidance from the regulator, get guidance from, you know, perhaps a group of professionals, preferred suppliers, who understand the topic, where the project can be discussed in a free manner without sort of worry that the regulators really just trying to gather information to bring it an enforcement action or something like that, where the goal is supporting innovation then you know, where there's I guess, clear law, lots of guidance from our regulators, as to, you know, we have some guidance from our FMA. We've got some guidance from the IRD, but there's not a huge amount as I mean I haven't looked recently, but my recollection is, is actually no specific regulated guidance around any around non fungible tokens.
So yeah, I guess that's sort of how I envisage that there's sort of like a, like a one stop shop that someone can go for some guidance. And then if there is a regime where essentially there's different categories of liability, depending on how big the project gets. I think that will encourage innovation.
So if you've got a smaller entity that has a, for example, lower market cap in terms of the amount of capital raised then lower or no liability. I think you'll, you'll never escape a scenario where you have no liability because consumer protection is a key goal, but if there's some sort of lenience in terms of breach, then I think that will foster innovation.
You know by the time the projects get bigger, they're better resourced, they can obtain legal advice, they should be compliant.
David Ding: That will inform policy makers and legislators?
James Cochrane: I hope so. Well, because I think in an environment like that the regulator will just be better educated. You know and then I think it's going to have to be an iterative process and nothing is going to be perfect.
And if we are too slow on deciding what our law is, then I guess you have this scenario like we have now where you'd have so many different acts, a lot of potential risk and liability, a lot of compliance and either that reduces the number of projects or moves the projects overseas.
So we can't just sit on our hands. I think we do need to be a fast follower.
David Ding: It makes sense. And one thing I would say is that we have a regular stand up meeting with the regulators, with the key ones, every fortnight. And when we share our frustrations on behalf of founders, they're very quick to say, well, we regulate to around legislation.
So without the legislators on board, there's only so much they can do as well. Yeah. So. So I'm interested in your thoughts on how we can engage legislators or have access to them as well.
James Cochrane: Yeah, so a couple of years ago, the Parliament invited submissions on, in relation to digital assets. I made a submission on that I guess we're still waiting for the outcome of that consultation process.
So great to see consultation but there hasn't been much movement. I believe that Jeremy Muir from Minter Ellison Rudd Watts and Alex Sims from the University of Auckland are assisting Parliament in relation to that and they submitted a report a wee while ago, but again, still waiting to hear the outcome.
You know, we have our RBNZ recently invited submissions on in relation to digital assets and particularly around central bank digital currencies and things like that. So there is a consultation process going on. And you need a process like that in order to help educate the parliamentarians just to remind them that digital assets you know, not everything is a an FTX, not everything is just a pump and dump scheme, you know, okay, yes, the whole space is littered with cowboys and dodgy behavior but I think the more that the parliamentarians can be, educated the more that will help move things along.
Things like Web3NZ, BlockchainNZ, organisations like Easy Crypto putting out resource, public resource that assists people in the space is, You know, critical as I'm a big believer in creating content to, to help. You know, that's why we're doing this webinar. I believe in the asset class, believe in the technology, I think it's superior and it's only a matter of time that I feel obliged to try and help people to navigate this space.
So, what, what can we do unless there's a, you know, apart from calling up your local politician and seeking a meeting, my view is the best way is to engage in any sort of consultation process and just keep producing content to help educate people.
David Ding: Yeah, makes a lot of sense. Well, that's been a great session, guys.
I think we'll wrap it up here. I've put a feedback form link. We appreciate your feedback. We want to make these sessions as useful as possible. And so Andy and James, just interested in your availability for, for, for exploratory discussions with founders.
Andrew Comer: Absolutely.
David Ding: How do you suggest they engage?
Andrew Comer: Yeah, happy to take calls, emails?
James Cochrane: Happy to take a call always, you know, I, I just love talking about this topic. Love learning about new projects people are doing. So more than happy to take a Zoom or a have an in person coffee and have an initial chat.
David Ding: Sounds good. Feel free to contact me, anyone that's listening and watching and I can put you in touch with these guys as well.
Okay, that's it for now. Appreciate your time. Thanks for attending. Cheers, James and Andy. We'll catch you soon.
Andrew Comer: Thanks, David.