An irreverent Wall Street Blog
[In]Securities GUEST BLOG: Not the One You Need by Aegis Frumento Esq
September 12, 2019
Not the One You Need
Sometimes
a plot is so transparent that you can't help but know what is going to happen
next. As many of you know, there've been several attempts over the past two
years to have the SEC approve an exchange-traded fund that holds bitcoin. There
are at the moment two applications pending before the SEC, one by the Bitwise
Bitcoin ETF Trust, and another by the VanEck SolidX
Bitcoin Trust. The SEC has promised a decision on both of those in
mid-October.
Spoiler alert: Both will be
denied.
No, I've not been getting messages
from the future. It's just that few days ago SEC Chairman Jay Clayton said on
CNBC that there was still "a lot of work" to be done before the SEC would
approve ETF's that held bitcoin. He raised the usual issues. "How do we know that
we can have custody and have a hold of these crypto assets? That's a key
question," he said. "An even harder question given that they trade on largely
unregulated exchanges, is how can we be sure that those prices aren't subject
to significant manipulation?" https://cryptoslate.com/sec-bitcoin-etfs-vaneck-solidx-btc-disinterest/.
Well, you can never "know" or "be sure" of either. But
we're certainly not going to "know" or "be sure of" next month more than we do now,
and there's nothing that the applicants can do about it. The custody issue was
dramatically illustrated by the collapse of the Canadian coin exchange QuadrigaCX
when its founder died with the passwords needed to access most of the
cryptocurrency deposits. http://www.brokeandbroker.com/4438/aegis-frumento-quadrigacx/. The
risk of manipulation was illustrated by The Attacker of The DAO, and even by
Bitwise's somewhat self-immolating "proof" that 81% of all coin exchanges might
be fraudulent. See http://www.brokeandbroker.com/4412/aegis-frumento-dao/ and http://www.brokeandbroker.com/4497/aegis-frumento-bitwise/. None of those concerns
have anything at all to do with the ability of Bitwise or Van Eck to manage an
ETF. They are problems inherent in the infrastructures of cryptocurrencies, and
since they haven't been solved and certainly won't be in the next few weeks,
it's fairly easy to predict that the SEC won't be approving any ETF
applications anytime soon.
Van Eck can read
the tea leaves as well as the rest of us, which best explains its recent
announcement that it would rebrand its crypto fund as a Rule 144A security. https://www.wsj.com/articles/van-eck-solidx-to-offer-limited-version-of-bitcoin-exchange-traded-fund-11567503003?
Rule 144A was the first experiment in creating a trading market for private
securities. I know that sounds like an oxymoron. Doesn't a market in private
securities make them sort of public? Only sort of. Private securities are
simply instruments that have not been registered with the SEC. Rule 144A
securities are sold under one of the exemptions from registration contained in
the Securities Act of 1933 that define when an offering is not "public."
Generally, those being offered a chance to invest in an unregistered security
have to be sophisticated, wealthy, and few -- those 1%ers who the SEC feels can
fend for themselves.
So the idea of a
market in a private security is not so far-fetched. The 1%ers are few in relation to the rest of
us, but they still number in the hundreds of thousands or few millions. There
are more than enough of them to sustain a true market. Today, outfits like
SharesPost and SecondMarket do a thriving business hosting private markets in
late-stage private companies for the benefit of accredited investors waiting
for the IPO that will make it all worthwhile.
Rule 144A was somewhat unique because it created the concept of the
Qualified Institutional Buyer, or QIB. A QIB is an institutional investor (not
a person) with over $100 million in investment assets. The concept behind Rule
144A was that, even more so than rich persons (who despite their wealth (or
because of it) might not be so bright ), QIBs really could be left of their own
devices. Rule 144A created an unregistered security that QIBs could trade
amongst themselves. The SEC expected a private market would arise in 144A
securities restricted to a very exclusive club, the QIB Club. If you are a member
of the QIB Club, you can trade 144A securities with other QIBs to your heart's
content, and the SEC generally leaves you alone. You would expect banks and
insurance companies and hedge funds to be QIBs, but there are surprises.
Prepaid college tuition plans are in the QIB Club too. https://www.sec.gov/divisions/corpfin/cf-noaction/2016/cspn-011216-501a.htm
It's not entirely clear how well the Rule 144A experiment
has gone. For a time NASDAQ had sponsored sort of a market for the QIB Club called
the Portal. The Portal Market had been in existence in the early 2000s. NASDAQ had
plans to make it into a quasi-established trading institution known as the
Portal Alliance, to be governed by a group of senior QIB Clubbers. The events
of 2007 put an end to all that. NASDAQ abandoned its Portal rules for equities
in 2008. https://www.sec.gov/rules/sro/nasdaq/2008/34-58638.pdf. Portal for debt securities
lasted just another year. https://www.sec.gov/rules/sro/nasdaq/2009/34-60991.pdf.
Since then, broker-dealers maintain or buy lists of known QIBs so they can verify
membership in the QIB Club before allowing a 144A trade. That's not to say that
144A securities don't sometimes end up in the hands of someone who's not a QIB,
but that's relatively rare.
Meanwhile, Van
Eck is trying to pass off its rebranded bitcoin fund as an ETF for the QIB
Club. That's even more of an oxymoron than a market in private securities. The
point of an ETF is to make complex investments available to the public. By making its bitcoin trust available only to the QIB
Club, Van Eck is essentially conceding that bitcoin ETF's ain't happenin', which,
of course, is what the SEC has been saying all along.
All this still raises the question, Why would anyone invest in a
fund that only holds bitcoin anyway? As if to provide a scratch-off answer, in
the week since Van Eck announced its bitcoin 144A fund, it has raised $41,000,
the value of just 4 bitcoins. https://cointelegraph.com/news/vanecks-new-bitcoin-trust-assets-total-just-41k-in-first-week. Not resounding show of support.
In one of the great understatements, crypto maven Alex Kruger tweeted, "This trust is just a
bad launch of a product for which there's not much demand." https://twitter.com/krugermacro/status/1171228055806849026.
Small
wonder. No one has yet explained why bitcoin should ever be owned in a fund,
especially if, as with Bitwise and Van Eck, that's all the fund owns. It is easier
and cheaper to buy and hold bitcoin through a coin exchange. After all, that's
what the bitcoin funds would do. Then you'd avoid having to read the fund's
PPM, fill out its subscription agreement, pay its fees and expenses and put up
with all the other hassles that come with owning a fund. Creating a fund to
hold a single asset that is more liquid in its native form than the fund would
be seems ludicrous. Whoever invested $40,000 in Van Eck's fund could more
easily have just bought 4 bitcoins directly on any coin exchange. The creation
of a bitcoin ETF, fund, or what have you is a tale told by an idiot, the sound
and fury of securitizing everything, whether it makes sense or not.
Perhaps the public would more gullibility buy into a
bitcoin ETF. But the QIB Club is not so dumb. When it comes to buying into a
bitcoin fund, the QIB Club is clearly singing, it ain't us, babe.
ABOUT THE AUTHOR
Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice
380 Lexington Avenue
New York, NY 10168
212-792-8979
Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters. Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.
Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.
He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.
NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of BrokeAndBroker.com Blog.