Mike Pieciak

NASAA – A “To The Moon” Approach to Regulating Crypto

We’re joined by Mike Pieciak, President of the NASAA. Not to be confused with the space agency, the North American Securities Administrators Association brings together state, provincial, and federal securities regulators in Canada, Mexico, and the United States. This relatively unknown organization helps align the financial regulation policies of over 50 agencies across North America and coordinates enforcement action in cross-border cases. In 2018, the NASAA launched “Operation Cryptosweep” in which over 200 ICOs and cryptocurrency-related investment products were investigated for potential investor fraud.

Topics we discussed in this episode
  • Mike’s background as a lawyer and the Commissioner of the Vermont Department of Financial Regulation
  • What is the NASAA, it’s goals, members and jurisdiction
  • The story of “Operation Cryptosweep” and what came out of that action
  • Mike’s thoughts on the future of blockchain regulation
  • How regulation might apply in the context of transnational projects which are nation state-invariant
  • The United State’s restrictive securities laws in the context of Defi and security tokens
  • Vermont’s attempt to attract blockchain projects, and the “Blockchain-Based LCC”
  • Vermont DFR’s pilot project in Captive Insurance
  • What Mike hopes to achieve during his one-year term as president of the NASAA
Sponsored by
  • Microsoft Azure: Deploy enterprise-ready consortium blockchain networks that scale in just a few clicks. More at aka.ms/epicenter.
Transcript

Sebastien: So we are here today with Mike Pieciak. Mike is the Commissioner of the Vermont Department of Financial Regulations and the president of the North American Securities Administration’s Association. Mike thanks for joining us today.

Mike: Yeah my pleasure. Thanks for having me. It’s a pleasure to be here and happy to participate in the podcast.

Sebastien: Great. So tell us a bit about your background. So you’ve been in financial regulation for some time as the Commissioner of the Vermont DFR. What did you come from and how did you get involved in this position.

Mike: Yeah sure so happy to talk about that I grew up in Vermont and always had an interest in going to law school and being interested in a legal career. Also I had always been interested in policy development, politics things of that nature. So I did go to law school and I did start off my legal career working in a major law firm in New York City where I was focusing on a lot of merger and acquisition deals, a lot of international companies that were doing business transactions. And the thing that first got me interested in Securities Laws was not really you know the work that we were doing in connection with those everyday transactions, it was the work that we were doing in connection with the S.E.C. with those transactions was really non-equity crowdfunding. So it was the kick starters of the world, the Indigo Go’s of the world. I remember being in New York City and hearing about some really interesting Kickstarter crowdfunding campaigns and some really interesting Indiegogo crowdfunding campaigns and was looking into some of the products and some of the companies and I thought to myself boy this would be really fun to invest in these products. This is sort of as at the time I understood that to be sort of the whole concept that you can invest in these projects with a little dollar amount and then you know you could see them grow. And lo and behold I sort of all of a sudden became aware of the very protective in some ways framework that exists around smaller upstart offerings localized offerings. Basically the crowdfunding offerings. So I got really interested in what is this framework, why does it exist and then is it appropriate for the way that businesses want to raise capital in the 21st century particularly businesses that would be prime for localized crowdfunding or national or international crowdfunding. So I got really interested in those issues. I came back to Vermont because the deputy commissioner position opened up of our securities division and I certainly saw an opportunity to come back and work on those issues which I did. We created a couple of different crowdfunding exemptions for Vermont. We also worked with the S.E.C. to make their regulations more modern in terms of being able to offer products over the Internet within a single state so that you were in compliance with the federal securities laws. And Vermont has always had this tradition of localized investing and sort of crowdsourced investing, Ben and Jerry’s which was one of our most well-known brands started from a Vermont only offering, they raised seven hundred and fifty thousand dollars from about three thousand Vermonters in the early 80s. And that allowed them to expand their production facility that allowed them to widen their distribution network. And the next year they did a national IPO. So that was really a success story that started with the ability of neighbors and consumers of products of friends and family being able to legally invest small amounts of money but legally invest into a startup business. So that was really what intrigued me that crowdfunding movement to get involved in regulation. Then about three years ago I became the commissioner of our department. So we as a department oversee the securities industry, the banking industry and then also the insurance industry as well and a subset of insurance called Captive Insurance which Vermont is actually an international leader in. We have about half of the Fortune 100 companies have a captive insurance company based here in Vermont. 18 of the Dow Jones Industrial 30 companies have a captive base here in Vermont. So we have a rich tradition generally in insurance but specifically in captive insurance world. And many of those captive insurance companies are experimenting with various fluctuating projects so that got me interested more certainly in the space that we’re going to talk about today but so did the concept of an ICO I mean the ICO sort of to me is sort of an out shoot of this crowdfunding movement that in some ways that you could have a project, have an idea and instead of doing it through the federal crowdfunding regime that was created, you know you could get the same type of bang for your buck by doing an ICO and raising a tremendous amount of money as you certainly know some of these ICOs have achieved an extraordinarily short period of time. So in some ways I became interested in the space also as capital formation tool and how this might be a new way for tech businesses for startup businesses to raise considerable money again in that period of time that’s much less than a traditional roadshow through an IPO or other means that currently exist.

Friederike: That’s super interesting and when we get into the potential of blockchain based projects and fundraising and a little bit later and also the president of NASAA which is not what it sounds like, can you tell us a little bit about NASAA, what it stands for and what it does.

Mike: Yeah I’d be happy to. You know everybody has their own funny story but mine was I came and worked here at the Department for you know my first week in and we were talking about crowdfunding regulations and somebody in the meeting said well, you know so-and-so used to work at NASAA and this was his position on the regulation and I thought to myself wow like I guess that’s impressive that this guy used to work for the space agency but what does it have to do with financial services regulation. So then I had my introduction to our NASAA the North American Securities Administrators Association. So NASAA is a membership association made up of all of the jurisdictions in the United States. So the 50 states plus the District of Columbia plus some of the United States territories, Puerto Rico is a member, but then we also have members from Canada the provinces and territories in Canada and Mexico as well. So all in all there are sixty seven jurisdiction members that make up the NASAA community. We are celebrating as an organization our one hundredth anniversary this year in 2019. So we were founded 100 years ago in Kansas. And the reason that NASA was founded the reason that state securities regulators were founded was that during that time period there was a lot of fraud occurring in the central part of the country in America’s heartland and Kansas and Iowa and other parts of the Mid Atlantic and Midwestern states. And unfortunately people were coming from the East Coast and providing great investment promises and great expectations of returns to these farmers that really didn’t know any better and really they were just fly by night fraudsters taking people’s hard earned money taking their life savings and then vanishing without a trace. So NASAA and state securities regulators were founded on the concept that people that are going to sell investments in our jurisdiction in our state should be registered with a central regulatory body. In this case the Department of Financial Regulation, and that their product should be vetted by some means to determine its legitimacy and then also that the individual selling the product. So the brokers the dealers the investment advisors should similarly have impeccable backgrounds in terms of being honest people, having sufficient education and knowledge to be able to guide these people in their investments. You know handling your life savings, handling your investments is a really obviously critically important item to many families. All families really but many people in the United States and worldwide it means how much you’re going to be able to spend on your next home or how much you’re gonna be able to help your children go to college, what your retirement is going to be like once you leave the professional workforce. So all of these things are really determined on how smart you are in investing throughout your career. So certainly we want people that are honest and knowledgeable selling good products to our constituents and providing them good investment advice. So at the heart of it that’s why state securities regulators were founded. We were founded decades before the S.E.C.. And NASAA was found decades before the S.E.C.. We were the quintessential cops on the beat if you will within all of these local jurisdictions trying to ensure that the capital markets were clean and safe so that the American economy could succeed. So now today I mentioned NASAA as a membership association, so the main purpose that NASAA serves now is really getting these various jurisdictions in three different countries to come together and work together on model policy, model law, model regulation. So we have a deliberative process where various project groups, we have a corporate finance project group, an enforcement project group a broker dealer project group, an investment advisor project group, and then also an investor education group and they all work on policy to try to improve the marketplace to try to keep up with technological changes. Try to keep up with the change in these various financial services industries and then we pass these models within NASAA as a body. And then each individual jurisdiction goes back to its legislature or its legislative body and implements these model rules so that we have uniformity. Among 67 different jurisdictions acting on separate cases in a separate way but that we have a uniform sort of playbook that we’re all working on.

Sebastien: OK so most of these regulatory bodies are actually quite independent in their local jurisdictions but rely on the guidance that comes from these working groups to implement policy locally.

Mike: Yeah that’s exactly right. We try to have a lot of internal discussion at NASAA among this policy. We try to get consensus so that you know if there is disagreement it gets ironed out at that level so that people do go back and implement these regulations. We also hear from industry and consumer stakeholders during our process so that we get a full understanding of the pros and cons of various policies. But at the end of the day NASAA as an association that does have it does have a corporate office it does have staff it does provide a lot of services to our members, but our members are the autonomous independent regulatory authorities that at the end of the day have to decide to take an enforcement action, have to decide to implement a policy or pass a model regulation. So at the end of the day each jurisdiction like Vermont maintains its regulatory authority.

Friederkie: How many people work at NASAA.

Mike: So it’s an interesting question, the NASAA corporate office has about 20/25 people that work in the corporate office but we’re really driven by our membership. So we have about 400 people that are on volunteer committees in those various categories that I mentioned. So all in all you know there’s about four to five hundred state securities regulators staff people and corporate office members that are working to staff the NASAA organization, staff the resources that we’re providing back to our jurisdictions and also helping us develop the model regulations that I mentioned and expand our message out beyond state securities regulators so that we are a known quantity within the financial services world.

Sebastien: So I actually learned about NASAA when someone mentioned that you guys were involved in the takedown of Jordan Belfort, the infamous Wolf of Wall Street. Could you tell us a little bit briefly about that and I think this relates to your enforcement power and what kind of law enforcement bodies you rely on in order to coordinate you know countrywide or continent wide in this case action.

Mike: So the Jordan Belfort the Stratton Oakmont case is a great example of NASAA working together in a multi-state enforcement action to bring enforcement action that doesn’t just impact one jurisdiction or two jurisdictions but really the national scope in terms of its impact. So NASAA has a multi enforcement mechanism where all of the states together will act against an individual or an entity. And the Stratton Oakmont example is certainly one of those where we were able to get a national settlement using NASAA as a mechanism to do that. Certainly in the 1990s and 2000s beyond Stratton Oakmont and the very publicized Wolf of Wall Street there were certainly other cases related to the auction rate securities, Prudential settlement. Some of these settlements totaled in the billions of dollars. I mean these were really large impactful settlements that NASAA was able to achieve and in many ways although we regulate the industry in different ways certainly when we’re acting together through enforcement means in some ways as when we as state regulators are the strongest and doing some of our best work. So protecting the investment public. But again at the same time all enforcement actions certainly are derived for going after bad actors. But by going after those bad actors we are also helping the integrity of our capital markets system so that you and I and everybody that’s listening has confidence that they can invest money in the United States in a business and they are not they might be investing in a business that will go defunct. They might make wrong business decisions they might go bankrupt but that it’s not a business that’s going to steal their money. That is an important element of a free market. Capitalist system that we have in the United States that there is some confidence that there is legitimacy in the capital markets within the businesses and the advisory firms that work within that space.

Friederike: Basically NASAA launched Operation Cryptosweep about a year ago. So between May and August 2018 NASAA investigated 200 crypto projects, mostly for securities violations and it’s resulted in 50 plus enforcement actions. It was in the news somewhat last year. Can you tell us the story and maybe give us an update.

Mike: Yeah and I’ll be happy to, so you know the Operation Cryptosweep was again taken out of the sort of NASAA multi jurisdictional playbook. It basically tried, instead of at each individual state trying to bring enforcement actions against these cryptocurrency CEOs that were operating within many jurisdictions if not all jurisdictions. There was a collective effort to work together to leverage each other’s staff and resources so that for example Vermont and New Hampshire weren’t working on an investigation against the same ICO, the same cryptocurrency, that we would decide which state was going to handle which matter. And then in that way we could look at a much broader spectrum of cases and bring a much broader number of enforcement cases rather than us not coordinating with each other. So again this was a classic example of state regulators working well together working through this multi jurisdictional process to get some results. So the main reason that again we saw this as an opportunity for state regulators and an opportunity to protect the marketplace was because so much of the ICO activity, I mean you see a report from 2017 that suggests 70/ 80 percent of the activity had some fraudulent element to it or was in some way illegitimate, either the project just wasn’t going anywhere, they didn’t invest any resources in developing what they said they were going to develop. So with that being the backdrop we thought we could play an important role in helping this space innovate, helping the space grow and develop by taking out the clearly bad actors that were promising 100 percent investment return, 70 percent investment return, you know they were promising that you would get all your money guaranteed no risk. So these are the classic red flags and fraud that we see whether it’s cryptocurrency or whether someone come into your grandmother’s door knocking and trying to sell her something. These are the hallmarks of fraud that you know again are timeless in some way regardless of the mechanism that’s being used to try to perpetrate it. And again that was in the backdrop of the big run up in the price of bitcoin through 2017. So at the end of 2017 when everyone was sort of in this manic phase about Bitcoin buying, and was it too late and what other ICOs are out there that I can buy. You know there was a lot of fever around let’s get in on the next best thing. And there may very well be the next best thing out there and there very well may be good investments to be made or good opportunities to be had but they’re also unfortunately a lot of criminals a lot of fraudsters and bad actors that we’re trying to take advantage of that mania, trying to take advantage of that hype, and simply trying to steal people’s money. They weren’t trying to do any legitimate projects. So in that way we really I think as an organization have played a helpful role in weeding out some of the bad actors and trying to clarify you know those that are attempting to comply with the securities laws or in fact our securities laws.

Sebastien: OK so I think when a lot of people see regulatory bodies or government agencies come out with either advisories on crypto projects or in this case the actual enforcement, I think the sentiment for a lot of people is oh here we go in other regulatory body trying to assert power over our innovative space where we’re just trying to innovate and do all kinds of interesting things. But it sounds like that wasn’t really the case, the case was like OK here is some actual fraud. I mean we in the crypto space I think were amongst the first to be able to notice these and specifically like having a podcast we were bombarded with requests for people to come on the show and like we see these projects and think this is clearly a fraud like this is a Ponzi scheme.

Mike: Feel free to refer those to us if you like.

Sebastien: Sure. I’ve got an inbox full of them I don’t know if any of them are still around but yes. So we see these things and I think in our eyes it’s quite obvious which ones are frauds and which ones are the more reputable projects. Now whether or not those are risk complying with securities regulations is another story but it sounds in this case NASAA was actually just doing what it’s meant to do is protect investors and go after those that were actually frauds.

Mike: That’s exactly right. I mean I as a regulator and I think every regulator whether they’re at the federal level or at the state level insurance and banking, I mean you really have two core balancing principles as part of your mission. One is to protect investors or protect consumers. And the other is to ensure that the capital markets or that the products that are out there that there is innovation occurring. That there is efficiency in those marketplaces, that there is an innovation in those marketplaces, that those markets are robust and strong because if you really are focusing too much on the investor protection element it’s really at the end of the day to the detriment of those investors because they’re going to have more expensive products they’re going to have less innovation they’re gonna have less choice they’re going to have less available to them. And then if you focus too much on the other side of that problem, if you focus too much on the innovation and focus too much on on the on the robustness of the marketplace, then you’re going to see bad actors come in you’re going to see fraudulent deals come in and those bad apples are going to destroy the trust and the legitimacy of that capital market. So you really need to have those two elements in mind and you really need to balance them and have a good perspective to allow innovation to occur. But at the same time think about what new innovation means to investors and how do they need to be protected. I know the you know the S.E.C. has set up a cyber unit within its agency. And I think NASAA and the S.E.C. have a very similar mindset. We see basically three buckets of companies, three buckets of ICOs if you will. There’s those that are just the outright frauds. There are those that are trying to comply with securities laws or maybe they’re not even aware that there are such a thing as securities laws but their white papers are trying to be transparent they’re trying to provide a detail about their project, they have a legitimate project. And then there’s a final bucket which is doing the belt and suspenders and following all of the regulations and all of the requirements and our interest is in going after that first bucket, the bad actors and helping that bucket understand the securities laws and helping them comply with the regime so that they can offer their product. And then just monitoring that last bucket. So we really don’t have an interest in trying to stifle innovation by going after these people in the middle that maybe are forgetting to file a notice filing or forgetting you know in some cases they might even be doing something that is more severe but again unintentionally. So it’s not an attempt to play gotcha regulation but it’s really trying to educate and help them get into compliance. I think that’s an important role that we play.

Friederike: How are these projects brought to your attention. So do you join a really scamming telegram groups or.

Mike: Well I’ll tell you some of the obvious ones I think probably are not giving away any state secrets by saying this but you know we can monitor Reddit, we can  monitor Craigslist. we can monitor various sites out there that are going to be places where Vermonters and other citizens are going and trying to find more information out about the newest ICO, newest cryptocurrency. So those are really effective ways of just beating back some of the nonsense that’s out there. So that’s sort of certainly number one. At the end of the day we really do get a lot of our cases through complaints. So investors that are harmed will be complaining to us. Unfortunately that’s more of a reactive method because at that point that means someone who’s been out there selling something for quite a period of time. The investor has been dragged along for some period of time and then finally they realize that they’re probably involved in fraud or they’re not getting their money back. And that could be three or four years after they made the investment.

Sebastien: We’ve seen the rise of the ICO busts. I mean you know these projects were raising money and you guys went after them. I mean is this crypto sweep occurred just around the end of it. You must have been monitoring quite a few projects like actively monitoring the space to figure out which projects were fraudulent. Did you have any clear criteria that you were looking for here.

Mike: Yes. So you’re absolutely right. So in this space we were trying to be more proactive and monitoring and taking action quickly. So really you know first and foremost we tried to understand if the company was registered anywhere, if they had had any conversations with securities regulators. That was just sort of a baseline question that wasn’t something that decided if we did an enforcement action. But then we were looking for again these hallmarks of fraud. Was there a promise that this was risk free was there a promise that this was a guarantee. How far along in developing the project were they was it really just sort of a pie in the sky idea or was it something that could actually be operationalized through the investments that they were seeking. Again did they promise outsized returns so were they saying you could get 50/60/70 percent return on your investment. These are things we would be looking for if we were just in the traditional sort of Ponzi scheme you know type of fraud and we saw the same exact things here in the ICO space. People that were over promising and were unable to deliver and we can detect you know we can pretty easily sort of understand those red flags and then we would go in and subpoena the companies for information. And then based on that we would decide do we need to bring an enforcement action or not. And you know we mentioned that we had two hundred investigations. You know I know we had investigations here in Vermont and we would you know if you’d send a subpoena that company very well might just all of a sudden fold up shop. But in other cases we had to go out and bring an enforcement action which we did from a number of different states Texas being one of the big leaders, North Carolina as well, against some of the actors out there that either disputed that they were not acting inappropriately or fraudulently or against some of the people that we thought were the more egregious situations that we had to take action against.

Friederike: And how many enforcement actions has this resided and how many do, I mean basically this was one big sweep but I assume you also do this on an ongoing basis. And so how much of your time do you actually spend with the crypto scams and can you put some numbers on how many you bring enforcement actions against.

Sebastien: How many are in jail.

Mike: Well the jail takes some more time but our membership has various authorities some of them do have criminal jurisdiction. And you know they very well could bring criminal charges. But because we were proactive in all honesty for example the cases that we brought in Vermont did not yet have any investors in Vermont. So by acting proactively we believe we prevented a lot of people from losing their money where if we had sat back these more of the scammy type ICOs would have unfortunately raised some money and then either failed to deliver or outright left with the proceeds. But to answer your question you know we had about 200 investigations during the first six months of Operation Cryptosweep with 50 enforcement actions. That number I think is now almost double and the enforcement actions I think it’s closer to 100. So that’s a pretty significant number when you think about the type of due diligence that we have to do in bringing in enforcement action and the fact that this Operation Cryptosweep although certainly a point in time effort it continues and that has only been about a year and a half or 18 months where it’s really been in earnest in terms of investigating these matters so that’s a pretty significant amount of cases to have brought in that period of time.

Sebastien: So moving on now to the broader topic of regulation in the blockchain and crypto space. First, what do you see as the main innovation that blockchain and more specifically I think we should focus the conversation at least this part on permissionless networks, you know public networks like Ethereum and Bitcoin and others what’s the main innovation that you see here with regards to securities law. How do you think it sort of changes the focus or changes how one should look at these regulations in the future.

Mike: Yeah I mean I think you’ve hit the the key issue as it relates to financial services or global finance or even international business, is how do permissionless blockchains enable. How do companies operationalize concepts on a permission blockchain. What are the projects that are able to meet the problems that these financial service companies or these international firms are facing. And to date in all honesty there have been hurdles that companies have not quite been able to get over. In the financial services space I think there are a lot of discussions and a lot of concerns around the concept of privacy. So in a public fully transparent permissionless blockchain how does a bank or insurance company, a securities firm do the transactions, make the accounting that it needs to make. And at the same time protect the identity of a transaction, protect the identity potentially of the individuals or any of the other sensitive business information that needs to be protected. And in some ways it could even you know it could just be the fact that the transaction is happening and that people could learn from that determine who the various participants are and then take advantage of that some way in the public investment arena. So I think that that concept is something that people are still struggling with. You certainly see private blockchains be utilized in financial transactions. Just today I was reading about a French lender that was issuing bonds via a blockchain. First there was some discussion that this was going to be a public blockchain but then they had to clarify that it was really the French lender issuing the bonds to a subsidiary of itself. So it was a private blockchain transaction. So we continue to try to see examples of it in this public space but again they’re struggling a little bit with that first question and a couple of more questions that I’ll mention. But just a note on that transaction I just mentioned the thing that’s pretty interesting to me is that the credit rating agency that rated the bonds when they took into account that the blockchain was used. They gave that as a credit positive element. And basically what that means is they looked favorably on that. And the reason they look favorably is they said it provided greater transparency to the transaction. So that cuts a little bit against the privacy element that the credit rating agency saw that as a benefit. And then they also said that it was going to cut down on mistakes, it was going to cut down on human error that it was going to make it more accountable and better from that perspective. So that’s an interesting development certainly when thinking about other players that are operating in this space that businesses need to take account for like regulators, credit agencies, banks and the like. There’s also been a lot of discussion in this permissionless blockchain space, certainly in the insurance community among interoperability. So how will various public blockchains connect with each other and interact with each other and there’s some companies out there that are trying to provide a solution to this and that’s one area where I know you’ve had guests recently on your podcast that have talked about this. So that’s one area where I’m certainly personally interested and how does that develop. I know industry is interested in how that develops. So I think that probably solves a lot of the questions that people have about what does this look like in five years. There’s one company I know that’s trying to make an attempt at this and they have made plays in the financial services space and in the insurance space. They have one interesting insurance play that Ernst & Young and a company called Guard Life are attempting. It’s a very discrete type of insurance but it’s for marine vessels so for big ships and this same point that I’m going to make can apply to any insurance transaction for the most part. But they see the process as being inefficient because there is the thing that they are insuring, the boat, there is the owner of the boat. There is an insurance broker that’s brokering the insurance. And then there is an insurance company that’s providing the insurance. Then there is a reinsurance broker that’s working with the reinsurance company and then there’s the reinsurance company providing the reinsurance. Maybe there’s even another layer on top of that depending on how far they go on the reinsurance side. So they view that as being an inefficient. process. And also when you have a process like that similar to the bond example I gave, it invites inefficiency and it invites human error. So Ernst & Young have created with Cordia blocking solution that would allow a new vessel that comes into somebody’s possession to be entered into this distributed ledger program and immediately be underwritten for the criteria that they have plugged in for that contract to have been immediately issued. And then for the reinsurance underwriting to occur almost simultaneously and for that policy also to be issued. So that’s one example of trying to allow for a permissionless public block to be incorporated into financial services. But again that interoperability remains a question. And then the other thing I hear and I’d be interested in your thoughts on this as well, but I was just recently at an insurance panel with the NAIC the National Association of Insurance Commissioners. And there was discussion about the scalability of permissionless or public blockchains and whether the speed of transactions that need to happen in financial services will be able to be achieved through a permissionless blockchain. They were talking about how their current databases and private blockchain potentially could complete thousands of transactions in the same amount of time that a public blockchain might only be able to complete a dozen or so of those transactions. So I’ve heard a lot of discussion around the scalability issue, how quickly can these transactions be verified and implemented. And then the flipside of that too is what is the cost of that both in terms of dollars and energy consumption as well. Somebody mentioned that I think it’s the country of Iceland spends more money on mining Bitcoin than it does on all energy consumption through their entire households in the entire country which was kind of an interesting fact I don’t know if that’s been verified or not. But I think it does bring a point that you know how do you account for that scalability in terms of the speed and then also in terms of the secondary impact of energy consumption. And the cost of that both in terms of financial cost and also in terms of environmental cost.

Friederike: You make very interesting points and so I think there’s a couple of things here that I’d like to talk about for sure. One being the interoperability. The other being scaling, and the third being the energy consumption that comes from the proof of work and mining that’s going on in Bitcoin and Ethereum and so many other chains. And the one thing that I want to talk about first is privacy. So you talked about privacy in the very beginning and while it’s completely true that Ethereum and Bitcoin in terms of privacy are terrible because everything is out there, there are now technologies that preserve privacy. Right. So I don’t know whether you know about them, Zero Knowledge and things like Zcash and you can have shielded transactions where it’s no longer public knowledge. And who does what. And how do you feel about these.

Mike: Yeah. I’m not familiar with those particular companies but I am familiar with some that I think are aligning the same type of concept. I think the one I mentioned is working on similar items where basically if two parties are doing a deal that a competitor third party wouldn’t have the information about your deal stored on their network. If they were operating in a distributed public distributed ledger network so that they are protecting the information in that way, and I think that’s a good advancement because although again it’s not that the business world or financial service world doesn’t want to be transparent but that there is certainly sensitive business information that individuals want to keep private. Certainly you see this with S.E.C. filings. I mean people need to make confidential filings with the S.E.C. all the time because they don’t want that information to become public before it needs to be public or at the appropriate time and they don’t want people to manipulate the stock market because if they’ve gotten non-public information, so certainly those are I think are good advancements on a global perspective and able to protect the sensitivity of transactions and the sensitivity of this information. And then the next question of course in the privacy piece is personal privacy and personal information and certainly you know on the one hand in all honesty you know the current ways that corporate entities and and financial services firms are protecting folks identity is lacking. I mean there have been a number of cyber security breaches that have been quite well-known throughout the last three or four or five years. Companies certainly are doing everything they can do, I think most of them at least the good actors in protecting privacy and the confidentiality of individuals information. But in the current structure you can’t prevent it you’re just trying to mitigate it, minimize it and then respond to it when it happens. So you know if a distributed ledger technology does have some hope in securing our networks to even greater degree that equally would be a good development. But I just I personally continue to wait and see what will come about that on both of those points in terms of individual privacy and on the sensitivity or privacy if you will of transit of transactions generally.

Friederike: I would like to come back to a point you made in the very beginning about crowdfunding because I also think that is a tremendous benefit to blockchain technology. And you said that you became interested in crowdfunding in the times of Indiegogo and Gofundme and Kickstarter. And I would like to add and maybe discuss why in traditional crowdfunding campaigns you actually fund a product right. So basically you buy say a super cool hoodie or something that you really want because it has 20 functionalities whatever.

Mike: I think the one that was like the best was that one that was the cooler that was maybe also a radio or something or stereo.

Friederike: Yes something like that and you pay 70 dollars for the promise that if they managed to build them they would ship you one fast for these 70 dollars but they only sell you the product they don’t sell you a share in the company. So basically if this company becomes fantastically successful you as someone who actually funded the development do not benefit from that. And I think we have seen this time and time again for instance in the Oculus Rift case I don’t know whether  you’re familiar with this but people crowdfunded this VR headset and got a fairly lacking prototype. The company was sold for several billion dollars to I think Facebook, the founder cashed out and support for it the things that had already been delivered was phased out. So the people who actually kickstarted this in the best sense that they didn’t actually have any part in the success that this company had in the end and with ICOs in the best case, you become a stakeholder in that company and you benefit from the future successes.

Mike: Yeah I think that’s right. I mean that’s why I see this connection between crowdfunding and the ICO space and how it can be you know in many ways you know there’s been some amount of crowdfunding the equity crowdfunding space at the federal level but I don’t think it’s been as great as many of us or the S.E.C. or those in that space may have anticipated. And it’s interesting because at that same time when federal crowdfunding finally had the rules finalized and it was allowed this concept of the initial coin offering an initial token offering came in at the same time. And all of a sudden you had businesses that could raise capital not just from the United States but internationally in a way that again was in some ways more efficient, some ways they were not doing it in compliance with regulations which made it more efficient, but they were able to do it more quickly and more efficiently in terms of the mechanism of raising the money. So it is quite a fascinating and interesting concept and I do agree with you in terms of the non equity crowdfunding Oculus Rift case I remember I talk about it quite frequently because I think if I remember right the headsets were three or four hundred dollars something in that range. And if that three or four hundred dollars had instead been an equity investment they would have gotten sixty seven to seventy thousand dollars of return on that investment. So that would be quite substantial. And instead like I say you know many people were waiting by the mailbox for their cheque to come in not appreciating that they had bought the product and not invested in the company. So I do think there is great value in giving normal people and people like us I mean people that are not investment banks that are not pension funds, they’re not hedge funds, that are not extraordinarily wealthy individuals that get the private deals that are going on and are the first ones to get in on the IPOs that are going on within the New York Stock Exchange and others. But to give every day you know investing public an opportunity to get in on some of these opportunities at the very earliest stages. That is I think a tremendous upside to crowdfunding and then also to ICOs. So I mentioned earlier that balance between you know between facilitating capital and facilitating investment and then also investor protection. And the rub is that although these are exciting opportunities for the businesses and for the investors that get in with the business of the ground floor, putting aside the fraud putting aside any of bad actors startup companies you know for every Oculus Rift there is probably 10 to 20 companies that have fallen on their face and the investment went nowhere. So you know it’s up to us a little bit to teach the traditional concepts of financial literacy to understand that you need to do some due diligence on the business you need to not put more money than you can put in that business assuming that you lose everything in terms of your investment. You don’t put more than you can afford to lose. Make sure you have a diversified portfolio. So certainly you know in terms of advances and what you’re talking about when you get to a place where you’re starting to have a fund that is investing in various ICOs that you can achieve that immediate diversification or an ETF. I know there’s a number of ETF they’re trying to get licensed regulated on the New York Stock Exchange when you get to that next level. That also will be a positive development both for businesses and for investor protection.

Sebastien: Yeah that’s a good point. But to go back on Friederike’s point that when you look at this this Oculus Rift story it has a lot more of the same characteristics as a fraud in the security space where there was a promise that they would deliver this product but in the end the product was never delivered and you know people were disappointed. Of course the amount invested in it wasn’t as much as say you would maybe put a nice ICO and the outcome expectation was maybe the same. But in a sense people were promised something and in the end they didn’t receive it and I don’t know if crowdfunding regulation actually takes that into account or not.

Mike: So in just a general consumer sense as a business as promise you something they don’t deliver, every state attorney general would have the ability to bring a consumer action against that company. Some attorney generals did in fact bring actions against businesses on Kickstarter and other non-equity platforms that failed to deliver because just to your point just because it’s a three hundred dollar product versus three hundred dollar investment if they took that money making false promises they should be certainly held accountable.

Sebastien: I’d like to move on to another point which is the transnational aspect of blockchain. So blockchain projects and the teams themselves are often transnational so a lot of teams working in the space have remote workers and the projects themselves are targeted and can potentially be attractive to people from all around the world. But the securities regulation itself is very national or state level type of activity. How do you make the square and circle fit together in a way that you can have innovation and I think to some extent have this these organizations that are truly global and also have regulation that protects investors.

Mike: Yeah it’s a it’s a great question. It’s both a practical question and a theoretical question almost in one and I have a couple of different ways that I want to answer it. I first want to give a very specific example as relates to Operation Cryptosweep and some of the enforcement actions that state securities regulators are bringing. so to your point that you know both the good and the bad but focusing on the bad ICOs are international. You know when we are bringing an action and it turns out that the individuals are located not just outside of our jurisdiction meaning our state or our province in Canada but they’re outside of our country they’re over in a country or a territory that maybe we’ve never even heard of on the map and we have to look it up. And how do you enforce a subpoena against that person or that entity that’s far outside of our jurisdiction. Even the S.E.C has challenges with that even the Department of Justice have challenges with that in terms of enforcing subpoenas and then enforcing legal actions against individuals that are operating outside of the United States. So that’s a really practical issue that we’re now confronting in a way that really in some ways we’ve never confronted before because there certainly was the Internet and there certainly made communication effort less around the globe but you hadn’t seen on such a large scale, the ability to make investments in companies that really weren’t. corporate international multinational companies that were trading on the New York Stock Exchange but operating everywhere in the world. These were companies that were coming out of ICOs and crypto currencies that were coming out of nowhere and blockchain projects coming out of nowhere that are able to operate anywhere in the world and in many ways do. So we are confronting that real sort of jurisdictional limitation. To your point just about how do you develop a policy that around that worldwide infrastructure certainly incumbent companies struggle with that. I mean to be frank I mean companies have to deal with the United States and its securities laws the United States and its privacy laws the European Union and its new regime relating to privacy and its securities laws and certainly in Asia there are laws and can be even considerably different and even the approaches that these countries are taking. So that’s something that international companies certainly have to struggle with and they they have the resources and the ability to navigate that but a lot of startup companies a lot of new projects might struggle pretty severely with that and it could certainly stifle and prevent innovation. So I think on the solution, there is just one historical note. You know in the United States when somebody did a national IPO nowadays you go to the S.E.C. and they register your offering and then you offer it nationally. It used to be that you actually had to bring that offering to each of the individual states in the United States and get it approved. And if it wasn’t approved in Vermont you could do your IPO in the other forty nine states but not in Vermont. So you basically had 51 regulators if you take the 50 states the S.E.C. approving an IPO and then in 1996 much to the chagrin of state regulators but federal Congress passed something called NSMIA basically a national improve the markets act and the intent was to take this to state securities regulators out of that decision and put that authority with the S.E.C. because it was a national offering it wasn’t localized, it did have an impact on a local jurisdiction but it was a much broader national scope in terms of its impact and a national regulator should be the one with primary authority over that. So my point in telling you that historical anecdote is you know could you see a situation many years down the road where an international multinational securities offering is being regulated by some body that is overseen by multiple member country nation members. And maybe that’s a solution if you’re trying to think again on the theoretical side but certainly first steps to get there. There’s certainly two concrete first steps to get there I think. One is that individual jurisdictions have to wrestle with this and wrestle with the guidance that should be provided. So the S.E.C. recently put out a framework for ICOs. That was a helpful first step. But then on the national level and international level the S.E.C, NASAA other regulators internationally need to start working and communicating with each other in a more concrete way. We certainly have organizations that have facilitated that interaction in the past but more so now than ever is the need for national regulators to interact with each other because it’s no longer a United States issue, no longer a Canadian issue, it’s a worldwide issue whether you’re talking about blockchain development, ICOs, cybersecurity issues these are really matters that are impacting a business anywhere in the globe by anybody anywhere in the globe. So we really need to start facilitating better communication. So those are sort of two concrete steps better formalize your guidance within your jurisdiction and then work to harmonize that guidance with other international regulatory bodies.

Friederike: Despite the fact that in principle these steps that are being developed by companies would be usable all over the globe, many companies have actually chosen to geo block the US in order to not get in a sticky situation with US securities law. So USA securities laws are seen as much more restrictive in many terms compared to other jurisdictions. Do you think that in itself stifles innovation.

Mike: Yeah it certainly can. Certainly can stifle innovation and I do have just a couple of of reactions to that. First and foremost is even as a state regulator I’ve been surprised by how open the SEC is to having conversations with cryptocurrency ICO blockchain products that that impact the securities marketplace or implement or have an involvement in the securities marketplace. They have been very open and interested. They have a Fintech group at the SEC that has had individual meetings with companies that has provided them guidance both in terms of guidance that is individualized and also for companies generally that are operating in that space. State securities regulators similarly are certainly open to hearing new ideas and new projects. So certainly my first piece of advice to those companies is to engage with the regulators here in the United States to make sure that you fully understand the avenues that are available to you to get either registered or to get an exemption from registration. Basically at the very broadest levels three different categories that an investment can fall into it can be a registered offering which means you go through the full registration process at the SEC or at the state level or there can be an exemption from registration so you know the SEC and the states have found that certain transactions don’t need to be fully regulated by a body here in the United States, or the joke is that the rest of the third category are all illegal transactions and you know I think it just illustrates the point that that folks should think about how do you get into compliance either from registering and I do agree that registration process is largely for companies that are more mature that have more sophisticated you know sort of a footprint and offering and it costs a lot of money it costs money to get professionals attorneys accountants investment bankers. So that is certainly an opportunity that does not present itself to everybody particularly startup companies. And then if it’s not through a registration process what are the exemptions that are available to this community and largely as it circles back a little bit to a point we had earlier largely those exemptions that are available are private exemptions meaning that you can sell to wealthy individuals to accredited investors but largely mainstream investors are shut off from that opportunity. So there have been discussions at the SEC recently and we’ve been engaged with them on this to change the definition of an accredited investor to broaden it so that different categories of people come into that definition and certainly that’s something on a personal level that I’ve been supportive of particularly younger people they might not have developed the assets to become an accredited investor they might not have the income yet to become an accredited investor but they have sufficient knowledge to make them a sophisticated investor. And certainly the FCC should think about that. And can you allow people to make investments in these private offerings if they have sufficient knowledge and expertise. And I would suggest that you should look to allowing them to do that but at the same time you should try to protect and mitigate the amount of money that could be lost so maybe you put an investment cap on those type of individuals so that they could only invest twenty five thousand dollars a year or fifty thousand dollars a year whatever it might be. So to answer your point you know the US laws can be complex as they exist now. It’s hard to get a token offering into the hands of a main street investor but it is possible and there are other exemptions that people are trying out in an effort to do that. So I do encourage any projects to sit down with the regulator to try to get more information to try to work with them to see how you could structure your deal to make that plausible. But at the same time there is certainly more work that needs to happen on our side of the equation on our side of the ledger as regulators. To think about what’s the appropriate balance to allow folks to get into this marketplace as investors while still making sure they have a level of protection and don’t lose their entire retirement or life savings an investment that goes south.

Sebastien: Yes I think that’s a decent approach to look at investors more on on the basis of  sophisticated and unsophisticated rather than wealthy or non wealthy because in today’s day and age I think probably this obviously wasn’t the case before, maybe this is why these laws were implemented today. People having access to an abundance of resources that allow them to become highly knowledgeable and gain this sophisticated amount of knowledge about things like ICOs, things like investing in these types of projects that didn’t happen didn’t exist before. And so I think that changed the landscape. And I think that the European approach to this  is it is a nuanced approach to that where you know when you open an investment bank account for instance that you get asked a lot of questions about your level of sophistication. And of course any investment product has to come with a prospectus and all these guidelines and what the investment entails etc. So since we’re coming towards the end of our show here I’d like to talk about Vermont. Vermont has positioned itself as a place that is likely to attract blockchain companies. One interesting thing that I learned right before this podcast is that Vermont has or was in the process of implementing a blockchain based LLC that would allow daos to have some sort of a corporate status. Tell us a bit more about what’s going on in Vermont and about this LLC.

Mike: Yeah happy to talk about the blockchain LLC. And that was one we had a bill last session and our legislature, this was one element of that bill that I really did get  interested in and excited in because you know oftentimes particularly with regulators but legislators we need to try to see some of the practical applications of some of these laws or even some of these blockchain projects we want to see you know how does this get employed. How does it make people’s lives better. How does it save money. And this  blockchain LLC was one where I didn’t see it solving a quite legitimate problem or confusion in the corporate world which is you know when you have all of these various players that are operating in a token offering or in a cryptocurrency you know what is the legal relationship between these participants, are they someone that’s helping mine public blockchain. Are they an independent contractor or are they an employee or are they a shareholder or are they you know whatever. And I think you can make theoretical and legal arguments as to what they might be or what they might not be but what the blockchain LLC was attempting to do was give a legal entity and a legal framework for the projects to decide what those legal relationships would be for themselves. So there are certain parameters that they have to fall within like any corporate entity but really it provides much greater level of flexibility for them to legally define the relationships of all of the various players in a public blockchain. So again this was a little bit theoretical but again trying to make it more operational and more practical. We have had I think just about a half dozen to maybe just close to 10 blockchain LLCs that have filed with the secretary of state’s office here in Vermont over the last six months. So there has been some interest. We will at the appropriate time, I think it’s a year out, take stock of who has been availing themselves of this new entity how is it working in practice and then how might it need to be improved upon. Or what other features do we need to think about adding to it. But at the heart of it again the concept was to allow the projects to define these legal relationships which otherwise are unique and undefined and ambiguous so that they are providing themselves some level of certainty as they operate.

Friederike: Very cool and you’re absolutely needed in this space. Vermont also announced the pilot project in captive insurance, could you explain very briefly what captive insurance is and then talk a little bit about this project.

Mike: Yeah. Captive insurance, what is it is a question that we get asked pretty often. So the 30 second summary is that it’s a formalized mechanism of self insuring so all of us on this podcast if we need it auto insurance or homeowner’s insurance we would go to one of the big insurance companies and purchase that policy from an independent third party.  Large corporate entities however might not find it to be the most cost efficient to go to you know AIG or some other large Lloyd’s of London Travelers some other large insurance companies to purchase their insurance. Instead they might decide to form their own insurance company internal to their company. And that’s essentially what a captive insurance company is.  They can better control their risks. They can better manage the risks. They can have immediate access to the reinsurance markets. So at the end of the day it ends up costing them less money just to have a formalized self-insured insurance company within their corporate structure rather than buying the insurance from a third party insurance company. So as I mentioned Vermont we are really the gold standard when it comes to captive insurance. We have about 600 of these companies in our state. They write about 30 billion dollars of premium through these 600 companies in Vermont. So a very large marketplace. And the reason why we thought this pilot project with the secretary of state relating to the block chain technology was was useful in this space because those 600 companies belong to really large international companies that are familiar with distributed ledger technology familiar with its upsides trying their own pilot programs within their companies. So they have a level of interest in participating in a similar pilot. And then from our perspective you know what it really accomplishes and again I’ll get back to this concept that I really am trying to appreciate the academic and theoretical nature of a lot of the discussion that I’ve had with many people in this space but trying to bring it back to a practical and operational concept, an idea. And for me this is a really really small first step that Vermont can take as it relates to the way that government operates to better understand the technology and not just myself but our staff here at the department. The staff at the secretary of state’s office here in Vermont that on a granular level individual staff members here and state government get more familiar with the technology that companies can file. Basically what the pilot would do is allow new captive insurance companies to file with us, their corporate registration documents, their annual filings and the like through a distributed ledger rather than the traditional paper or online filing. And again I don’t think we’re gonna get a tremendous amount of great efficiencies I don’t think this is going to be the greatest thing that any state government or the industry has ever done. But what it’s really going to do on a practical level again get us more familiar with the technology and then allow us to identify areas where we can scale up. So the secretary of state handles thousands and thousands of filings. Is there ways where they can use a private or public blockchain in a way that makes their operation more efficient from a regulatory standpoint. Are there ways that we can use the technology to make the way that we take in information or the way that we regulate the marketplace. Can we make it more efficient. Can we make it more transparent. Can we make it more accurate. Those are all of the answers that we’re hoping to get out of this pilot project. So we’re very excited about it. We’re one of the first if not the first insurance departments in the country to actually step out and try to take on their own distributed ledger pilot program so again we’re very excited about the prospect of making an incremental step. And then seeing where that will take us.

Sebastien: Great. That’s that’s really fascinating. And so finally I’d like to ask you a little bit about your  goals as president of NASAA. What do you hope to achieve here. You’ve been with the organization now for I think over just over six months.

Mike: Yeah. Yeah that’s exactly right we’re halfway through my presidential term.

Sebastien: OK. So OK so presidential terms are quite short. Then what do you what do you hope to have achieved during this short time.

Mike: Yes. Sure. So you’re actually right I mean you can’t achieve much during a single year. So really what you have to do is make sure that you start early you lay the groundwork for any initiatives that you have early and that you develop initiatives that those that are going to follow you are going to be interested in continuing on. So personally what I hope to achieve I’m the first millennial president of NASAA. We wanted to have more focus on millennial issues as it relates to investing as it relates to retirement savings and the like. So basically as you probably familiar with millennials are saddled with student loan debt they’re delaying decisions that are the traditional hallmarks of adulthood like purchasing homes. By having children saving for retirement. And it really in some ways is causing many different social impacts than people are I think even appreciating a realize and certainly states like Vermont you’re seeing that millennials have to leave the state to get jobs or higher paying to pay off their student loan debt. That’s having a direct and immediate impact on our economy. And then you’re seeing again young young folks that are just starting out or folks that are in the middle part or early part of their career having nothing save for retirement. And that’s going to be a considerable issue when they don’t have time on their side anymore and they’re getting closer to retirement age. So highlighting those types of issues is one of the things I really wanted to accomplish as NASAA president get that congress conversation started and to get policymakers in congress at the SEC and at the states more focused on on millennial issues as it relates to financial services.

Sebastien: Great. Well that’s very encouraging. Well thank you for joining us on our podcast today. And good luck for the rest of your term.

Mike: Well thank you it’s been my pleasure. I really do appreciate it and I do congratulate you as well for sticking with this podcast. Understand you guys are doing it now for five years and every week that is something that’s really difficult to keep up with and to do so I applaud you for your perseverance and focus on these issues that are really important issues.

Sebastien: Thank you. Thanks a lot. It has been five years and it is not always easy. But thank you Michael.