January 12, 2023
While there was considerable public attention in the U.S. last week on the soap opera drama surrounding the election of a new Speaker of the House, the real work of government has continued throughout the political power transfer in Washington.
As we are seeing in Washington, along with London and Europe, there is a sharp focus on the very important issues of the day, including − of course! − climate and crypto. This week we also take a look at an important development at the SEC, along with banking policy updates from the Federal Reserve and the European Banking Authority.
Any comments or questions? Just drop me a note here.
Daniel Meade
Editor, Cabinet News and Views
Federal Reserve Board (“FRB”) Chair Jerome Powell spoke at a symposium hosted by the Swedish Central Bank on Tuesday. In his speech, Chair Powell highlighted three main points: (1) that Federal Reserve monetary policy independence “is an important and broadly supported institutional arrangement that has served the American public well”; (2) “the Fed must continuously earn that independence … by providing transparency to facilitate understanding and effective oversight by the public and their elected representatives in Congress”; and (3) “stick to our knitting.”
Regarding monetary policy independence, he noted that “[t]he absence of direct political control over our decisions allows us to take these necessary measures [e.g., raising interest rates] without considering short-term political factors.” He went on to note that “grants of independence to agencies should be exceedingly rare, explicit, tightly circumscribed, and limited to those issues that clearly warrant protection from short-term political considerations,” and most public policy decisions ought to be made in most cases by the elected branches of government in a well-functioning democracy. Chair Powell also noted that the Federal Reserve’s dual mandate of maximum employment and price stability is a good example of where the goals of the Federal Reserve are not independent of the elected political branches, but rather are set and subject to oversight by Congress. The Federal Reserve’s independence in how it conducts monetary policy is an example of “operational or instrument independence.”
Chair Powell’s comments on sticking to the Fed’s knitting are the parts of the speech that seemed to make the most news, particularly the closing of his speech that “[w]e are not, and will not be, a ‘climate policymaker.’” Chair Powell compared the Fed’s mandate to those of some of the other central banks at the symposium and noted that the Fed’s mandate is narrower than many other central banks, and the Fed should “resist the temptation to broaden our scope to address other important social issues of the day” lest it risk the Fed’s case for independence. He went on to note that “[d]ecisions about policies to directly address climate change should be made by the elected branches of government and thus reflect the public's will as expressed through elections.”
Notwithstanding, Mr. Powell’s comment that, without a Congressional mandate, the Fed should not be a climate policymaker did draw a distinction between being a climate regulator vs. supervising banks’ management of their climate-related financial risks. He noted that “in my view, the Fed does have narrow, but important responsibilities regarding climate-related financial risks” as a bank supervisor.
On 20 December 2022, the European Banking Authority (“EBA”) published the final report on its draft Regulatory Technical Standards on the identification of a group of “connected clients” under Article 4(4) of the Capital Requirements Regulation (Regulation (EU) No 575/2013) (“the RTS”).
The RTS transfers sections of existing own-initiative EBA Guidelines (“GL”) (in force since January 2019) into technical standard format. Those transferred sections essentially discuss the conditions required to form a group of connected clients, which concept is used in: the large exposures regime; categorisation of clients in the retail exposure class for the purposes of assessing credit risks; rating systems (development and application); criteria for STS securitisations qualifying for differentiated capital treatment; the SME supporting factor; and liquidity reporting in the context of stable funding. The GL will continue to provide guidance in its existing form on due diligence and governance expectations and the alternative approach to be used when the head of the group in question is a central government, as well as the descriptive examples currently used to assist in determining whether a connected group has been formed.
This means that the RTS sets out the elements that go towards creating the interrelationships that lead to the transfer of financial problems among a group of two or more natural or legal persons closely linked by idiosyncratic risk factors − that is, when a group of connected clients is created. In the face of an absence of industry push-back, these elements are being transferred without amendment from the GL. They cover how the two types of interconnectedness − control and economic dependency − arise and how they can interact. Control continues to arise when the would-be controller has legally enforceable rights that lead to a “strong form of financial dependency” which can lead to a domino effect should the controller encounter financial problems. Parent-subsidiary relationships and being members of the same accounting group continue to be strong indicators of the existence of a connected group. The RTS also provides a non-exhaustive list of circumstances when control criteria arise and of indicators of a parent-subsidiary or analogous relationship.
The RTS also sets out circumstances when economic dependency can connect a group, leading to a significant uptick in the likelihood of financial difficulties spreading. Economic dependency can be mutual or one-way and should be looked at from the perspective of business interconnections in the round. The RTS sets out a non-exhaustive list of situations in which the spread of financial difficulties within a connected group can prove problematic for the full and timely repayment of liabilities. Note that the GL continue to advise that institutions should investigate the economic dependencies of particular clients when exposure to an individual client amounts to more than 5% of Tier 1 Capital.
The next stage for the draft RTS is adoption by the European Commission, followed by scrutiny from the EU Parliament and Council and publication in the EU’s Official Journal.
In November 2022, the International Organization of Securities Commissions (“IOSCO”) published two reports − one on Compliance Carbon Markets (“CCMs”) and one on Voluntary Carbon Markets (“VCMs”). IOSCO continues to seek comments from market participants on key structural considerations for these markets, such as optimal design, efficient regulation, and improved integrity of the carbon credits. Comments are due by February 10, 2023. It is expected that several industry groups will be providing comments as part of their overall Environmental, Social and Governance (“ESG”) work.
In the CCM report, IOSCO discussed generally the “cap-and-trade” markets and “emission trading schemes” (“ETS”) that have been established by several national governments and governmental organizations in the EU, Asia and in the U.S. At this time, there are only two CCMs in the U.S.: the State of California’s Air Resources Board (“ARB”)-administered “cap and trade” market that has been linked with Canada through the Western Climate Initiative (“WCI”), as well as the Regional Greenhouse Gas Initiative (“RGGI”) in the northeastern U.S. These ETS generally mandate the maximum amount of carbon that covered entities are allowed to emit (the “cap”) and where the excess credits can be traded and purchased by those that have a compliance shortage (the “trade”).
In the VCM report, IOSCO discussed the markets that are not mandated by a government authority but where “entities buy credits generated from emission-reduction projects to offset some or all of their own carbon emissions.” These offset credits are generated by projects that either avoid carbon emissions (e.g., by generating energy through wind or solar) or remove carbon or greenhouse gasses (“GHG”) from the atmosphere (e.g., by planting trees). To ensure reliability, these projects are generally certified by a standard-setting body that also acts as a registry, such as Gold Standard or Verra.
The CCM and VCM reports provide several recommendations designed to address identified vulnerabilities in these markets, such as integrity, lack of transparency, reliability, lack of standardization, fragmentation, lack of legal certainty, greenwashing, and conflicts of interest, among others. IOSCO’s effort provides a much-needed analysis of VCM and CCM markets from the spot, commodity, derivatives and securities markets’ perspectives and calls for existing regulatory schemes to apply to VCM and CCM markets.
In the U.S., this effort follows on multiple climate initiatives in 2021 and 2022, such as White House executive orders on clean energy and tackling the climate crisis, efforts by the Commodity Futures Trading Commission (“CFTC”) to address issues arising out of VCMs and the impact of climate risk on US financial markets, the rule proposed by the Securities and Exchange Commission (“SEC”) regarding climate-related disclosure, climate risk initiatives from the Office of the Comptroller of the Currency (“OCC”), and the Inflation Reduction Act of 2022.
We are currently providing guidance and assistance in preparing comments to these IOSCO reports.
On December 14, 2022, the U.S. Securities and Exchange Commission (“SEC”) unanimously adopted final rules adding new conditions applicable to Rule 10b5-1 trading plans and requiring disclosure of the adoption, modification or termination of Rule 10b5-1 trading plans by directors and officers of public companies. In addition, the new rules require disclosure of option grant practices and insider trading policies and procedures of public companies and amend disclosure requirements for option grants to named executive officers close in time to an issuer’s disclosure of material nonpublic information. Finally, the new rules amend Forms 4 and 5 to require reporting persons to identify transactions made pursuant to a Rule 10b5-1 trading plan and disclose all gifts of equity securities on Form 4.[1]
The final rules go into effect 60 days after their date of publication in the Federal Register (February 27, 2023). After such date, any new or amended Rule 10b5-1 trading plan must comply with the requirements of the final rules. Existing 10b5-1 trading plans will be grandfathered in, and the new conditions of Rule 10b5-1(c) will not apply to such plans. However, any subsequent termination of such a plan will need to be disclosed, and any amendment to such a plan to change the amount, price or timing of transactions under the plan after the effective date will be treated as the adoption of a new plan and will need to comply with the final rules. The amendments to Forms 4 and 5 will go into effect with reports filed on or after April 1, 2023. Public companies are required to comply with the disclosure requirements regarding Rule 10b5-1 trading plans described below in periodic reports on Forms 10-Q, 10-K and 20-F and in any proxy or information statement starting with the first filing that covers the first full fiscal period that begins on or after April 1, 2023 (i.e., for calendar year companies), the second quarter 2023 Form 10-Q (for the adoption, modification or termination of programs) and the fiscal 2023 Form 10-K/20-F filed in early 2024 (for the filing of the programs as an exhibit). In addition, public companies are required to comply with the disclosure requirements regarding their insider trading policies and procedures in periodic reports on Forms 10-K and 20-F that cover the first full fiscal period that begins on or after April 1, 2023. Smaller reporting companies have an additional six-month phase-in period and are required to comply with the disclosure requirements described below in periodic reports on Forms 10-Q, 10-K and 20-F and in any proxy or information statement starting with the first filing that covers the first full fiscal period that begins on or after October 1, 2023.
The final SEC adopting release is available here and the SEC fact sheet is available here.
Practical Tips on How to Revise Public Company Internal Policies and Procedures to Comply with the New Rule 10b5-1 Trading Plan Rules
As public companies kick off fiscal year 2023 and begin a typical annual review of their internal policies and procedures, we recommend that the following documents be reviewed carefully for compliance with the new rules.
Rule 10b5-1 Trading Plan Templates – Add the new cooling-off period and certification requirements:
- For officers and directors, add a cooling-off period that no trades can be initiated until the later of: (1) 90 days after adopting the plan and (2) two business days after the release of final results on Form 10-Q or 10-K for the fiscal quarter in which the plan was adopted (but not to exceed 120 days after adoption).
- For persons other than directors and officers or the issuer (e.g., non-officer employees), add a 30-day cooling-off period.
- For directors and officers, add a certification that at the time of adoption of the Rule 10b5-1 plan: (1) they were not aware of material nonpublic information and (2) they adopted the plan in good faith and not as part of a plan or scheme to evade Section 10(b) of the Securities Exchange Act of 1934 or Rule 10b-5.
Disclosure Controls and Procedures Documentation – Add provisions to the disclosure controls and procedures documentation regarding the following items:
- 10b5-1 Trading Plan Information – Add provisions to disclosure controls and procedures such that information regarding the adoption, termination and modification of material terms of a Rule 10b5-1 trading plan or non-Rule 10b5-1 trading arrangement is appropriately collected at the end of the close process each quarter from the relevant legal or compliance team and communicated to the public company reporting team responsible for preparing the Form 10-Q and Form 10-K. A non-Rule 10b5-1 trading arrangement is defined in Item 408(c) of Regulation S-K and includes certain pre-planned trading arrangements that do not meet the conditions of the Rule 10b5-1(c)(1) affirmative defense (for example, trading arrangements that were entered into before the new rules became effective and did not observe the applicable cooling-off period).
- Disclosure Requirements for Insider Trading Policies and Procedures – Disclosure of whether an issuer has insider trading policies and procedures regarding the purchase or sale of issuer securities by directors, officers, employees or the issuer will now be required, and any such policies or procedures must also be filed as an exhibit to annual reports on Form 10-K (on Form 20-F for foreign private issuers). Accordingly, such policies should be carefully reviewed and updated as needed before they are publicly filed.
- Disclosure on Timing of Option Awards Close in Time to the Release of Material Nonpublic Information – In addition, specific disclosure of the issuer’s policies and practices on the timing of option (or stock appreciation right or similar) awards in relation to the disclosure of material nonpublic information will be required, and issuers will be required to provide detailed disclosure of such grants made to named executive officers within four days preceding or one day after filing of a 10-Q, 10-K or certain 8-Ks. Accordingly, issuers will need to carefully monitor and consider the timing of any such awards which might be viewed as part of a problematic “spring-loading” or “bullet-dodging” grant practice.
Employee Benefit Plans – Confirm that such plans are compliant with the new certification requirements, cooling-off periods, and limitations on single-trade plans and overlapping plans.
Insider Trading Policies – Review such policies to confirm that they align with the new SEC rules. These policies often contain provisions that parallel requirements in the securities laws. For example, restrictions around cooling-off periods and certifications may need to be updated or added to align with the new rule. A requirement should also be added for directors and officers to notify the issuer when they adopt, modify or terminate a 10b5-1 plan.
Director and Officer Questionnaires – Consider adding a requirement for directors and officers to provide confirmation that all 10b5-1 plans have been reported to the issuer over the past fiscal year.
Form 4 Filing Procedures – Modify existing Section 16 reporting procedures to include new provisions that gifts by insiders will need to be reported within two business days on Form 4 (rather than being eligible for delayed reporting on Form 5, as was previously the case). Confirm that all Form 4 filings after April 1, 2023 include the mandatory check box that will indicate whether a trade was made pursuant to a plan that is intended to satisfy Rule 10b5-1(c).
[1] The final amendments will require registrants to tag the information specified by new Items 402(x), 408(a), and 408(b)(1) of Regulation S-K, and new Item 16J(a) of Form 20-F, in Inline XBRL in accordance with Rule 405 and the EDGAR Filer Manual.
The “crypto winter” of 2022 brought a bear market and a recent wave of bankruptcies to the crypto industry, leaving some retail customers of crypto exchanges frozen out of their accounts. As the bankruptcy filings mounted from Voyager Digital and Celsius Network (“Celsius,” or the “Company”) to FTX US and BlockFi, lawyers, industry experts, market participants and retail customers wondered alike – who owns the cryptocurrency stored on a debtor’s platform in the event of a bankruptcy? Although limited to the specific terms of the customer agreements at issue in Celsius, Judge Martin Glenn issued a ruling in the Celsius bankruptcy proceedings giving an initial indication as to how this inquiry may be assessed.[1]
On the date of its bankruptcy filing, Celsius had approximately 600,000 accounts in its “Earn” program (the “Earn Accounts”). The Earn program allowed customers (the “Depositors”) to deposit cryptocurrencies on the Celsius platform and receive from the Company as much as 18% interest annually. The Earn Accounts at Celsius held approximately $4.2 billion in cryptocurrency assets as of July 10, 2022, including $23 million worth of stablecoins. From the beginning of the Celsius bankruptcy proceedings, the Depositors advocated that cryptocurrencies held on the Celsius platform should be returned to them as quickly as possible. However, with respect to Earn Accounts, the Company took the position that the Celsius terms of use (the “Terms of Use”) unambiguously provide that all rights to such cryptocurrencies, including ownership rights, belong to the Company. The issue came to a head when the Company brought a motion seeking to sell certain of the stablecoins held in the Earn Accounts.
Judge Glenn’s 45-page decision agreed with the Company, and overruled objections supported by hundreds of individual Depositors, as well as the objections of a number of governmental entities, including the Texas State Securities Board and the United States Trustee. Judge Glenn determined that the $4.2 billion in cryptocurrency deposited by customers into the Earn Accounts belongs to the Company – not the depositors. As a result, the Company can sell or exchange the stablecoins held in Earn Accounts in the ordinary course of business to fund the Company’s operations and pay the expenses of the bankruptcy case.
A Dispute over Ownership of Crypto-Assets
On September 15, 2022, the Company filed a motion seeking authority to, among other things, sell a portion of the cryptocurrency held in the Earn Accounts (the “Stablecoin Sale Motion”) to fund its bankruptcy case, which lead to a spate of objections falling into two broad categories:
- Several state regulators contended that any ruling on the ownership of the Earn Assets should come after the Celsius chapter 11 examiner completes its report.[2] The regulators argued that until then it is not clear how ownership of the Earn Assets could have been transferred to Celsius. Moreover, several state regulators argued that the Company is under investigation for marketing securities without necessary registrations and without complying with state regulatory frameworks and federal law, and therefore cannot rely on the arguably unlawful Terms of Use to determine the purported ownership of these assets.
- The objecting Depositors argued, among other things, that the Terms of Use relied on by Celsius were actually ambiguous, as they use the terms “loan” and “lending” which would mislead a layperson to believe that title and ownership remained with the customer. The account holders also argued that they have defenses to contract formation and modification, as well as breach of contract claims against Celsius that should prohibit the Company from claiming ownership of the crypto deposited.
In support of the Stablecoin Sale Motion, Celsius argued that 99.86% of Depositors accepted the Terms of Use through a “clickwrap contract”,[3] and thereby agreed that Celsius held “all right and title to such Eligible Digital Assets, including ownership rights” in the cryptocurrency in question.
The Celsius Terms of Use at issue provide:
Assets using the Earn Service . . . and the use of our Services, you grant Celsius . . . all right and title to such Eligible Digital Assets, including ownership rights, and the right, without further notice to you, to hold such Digital Assets in Celsius’ own Virtual Wallet or elsewhere, and to pledge, re-pledge, hypothecate, rehypothecate, sell, lend, or otherwise transfer or use any amount of such Digital Assets, separately or together with other property, with all attendant rights of ownership, and for any period of time, and without retaining in Celsius’ possession and/or control a like amount of Digital Assets or any other monies or assets, and to use or invest such Digital Assets in Celsius’ full discretion. You acknowledge that with respect to Digital Assets used by Celsius pursuant to this paragraph:
- You will not be able to exercise rights of ownership;
- Celsius may receive compensation in connection with lending or otherwise using Digital Assets in its business to which you have no claim or entitlement; and
- In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations, any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws.[4]
The Terms of Use Are a Valid, Enforceable Contract That Transferred Title and Ownership of the Assets in the Earn Accounts to Celsius
The bankruptcy court noted that the requirements for contract formation are no different for electronic contracts than they are for more traditional pen-and-paper agreements, as courts have “adapted traditional principles of contract formation to fit the digital era.” This is the case even where, as in Celsius, a “clickwrap” agreement does not necessarily require the account holder to actually view the terms of use, and may contain provisions allowing for the company to unilaterally modify its terms.[5]
Using traditional contract analysis, the Celsius court found that mutual assent, consideration, and intent to be bound − the elements of a valid, enforceable contract − were present. The Court recognized that (i) the Depositors manifested assent and intent to be bound by clicking that they accepted the Terms of Use and (ii) that New York Courts overwhelmingly accept such “clickwrap” agreements. As such, the court held that the Depositors unambiguously transferred title and ownership of the Earn assets to Celsius pursuant to the plain language of the Terms of Use, regardless of how those terms may have been understood.[6]
The court also addressed the argument of certain objecting Depositors that the crypto assets held in the Earn Accounts were merely loaned to the Company. The court observed that even if these assets were loaned to Celsius, such loans would create a traditional creditor-debtor relationship between the parties where Celsius maintains possession of the assets, and the Depositor has a claim to payment. Under such circumstances, Depositors would still be unsecured creditors unless they held a perfected security interest in the property. However, the court recognized that digital assets such as crypto generally are regarded as a general intangible upon which a lien may be perfected only by the filing of a financing statement. Finding that “the Terms of Use . . . [make] it very clear that no ownership interest or lien in favor of the Account Holders was intended . . . [a]nd certainly no lien in favor of the Account Holders was perfected,” the court held that the “clear and consistent” Terms of Use granted Celsius all right and title to the assets in the Earn Accounts.
Judge Glenn’s decision makes clear, however, that the Depositors have not been left empty-handed:
To be clear, this finding does not mean holders of Earn Assets will get nothing from the Debtors. Account Holders have unsecured claims against the Debtors in dollars or in kind (depending on the terms of any confirmed plan). The amount of allowed unsecured claims is subject to later determination in this case (through the claims allowance process) and may potentially include damages asserted by Account Holders, including breach of contract, fraud or other theories of liability. . . .
The Court takes seriously potential violations of state law and non-bankruptcy federal law, as well as the litany of allegations including, but not limited to, fraudulent inducement into the contract, fraudulent conveyance, breach of contract, and that the contract was unconscionable. These allegations may (or may not) have merit, and the creditors’ rights with respect to such claims are explicitly reserved for the claims resolution process. But importantly, as a prerequisite to those claims, the Court first must establish that a contract was formed and must interpret the contract terms.
Stablecoin Sales & Chapter 11 Funding
After his findings on ownership, Judge Glenn held that the Company had made a sufficient showing to sell the stablecoins held in the Earn accounts. Judge Glenn’s decision on this point seemed premised on the fact that time is not a luxury the Company possesses:
A rare point of agreement among all parties is that the Debtors’ liquidity is precipitously running out. The Debtors need to generate liquidity to fund these Chapter 11 cases and continue down the path either of a standalone plan [of] reorganization, a section 363(b) sale, or even a liquidation plan. The Debtors project that additional liquidity will be needed in early 2023. The Debtors demonstrate a sound business justification for selling stablecoins, and the Court agrees that it is appropriate to [grant] authority to do so.
Thus, the Company will be permitted to sell stablecoins held in the Earn Accounts to continue funding the bankruptcy cases.
Critical Crypto Ownership Issues Remain Open
Although Judge Glenn’s decision is specifically limited to the customer agreements in Celsius, he continues to blaze judicial trails in the crypto bankruptcy space.[7] Participants, customers and others in the crypto industry should take note of how Judge Glenn analyzed the Terms and Conditions in Celsius, as careful analysis of contractual language will be critical to the outcome of future crypto ownership disputes. It is clear that other substantial issues remain to be resolved in the crypto “winter of our discontent.”
(The authors wish to thank New York associates Anthony Greene and Raymond Navaro for their contributions to this article.)
[1] In re Celsius Network LLC, Case No 22-10964(MG), 2023 WL 34106 (Bankr. S.D.N.Y. Jan. 4, 2022).
[2] An examiner was appointed in the Celsius case to investigate various issues arising from the Company’s prepetition operations such as: (i) where the cryptocurrency was stored, (ii) whether the cryptocurrency was commingled, (iii) the procedures for paying taxes and complying with other non-bankruptcy law, and (iv) the status of utility obligations relating to the Company’s mining operations.
[3] See Plazza v. Airbnb, Inc., 289 F. Supp. 3d 537, 548 (S.D.N.Y. 2020) (“Clickwrap agreements are generally defined by the requirement that Account Holders ‘click’ some form of ‘I agree’ after being presented with a list of terms and conditions”).
[4] Celsius, 2023 WL 34106, at * 4.
[5] There were multiple versions of the Terms of Use (versions 1 through 8), though the court determined that 90% of account holders representing 99% of the assets held in Earn Accounts had assented to version 6 or later. The Terms of Use, beginning with version 1, provide that (1) the Company can unilaterally modify the Terms of Use without notice, and (2) the account holders’ continued use of the platform following an update constitutes consent to the amended Terms of Use. Id. at *16. Accordingly, the court found that the account holders were bound by the language from version 8 of the Terms of Use, including the excerpt above. Id. at 17.
[6] Judge Glenn’s decision noted that although a number of objectors argued that Celsius modified the Terms of Use through advertisements and media uploaded to the Company’s social media channels, such media was not submitted to the court as evidence. Id. The decision further notes that even if this media was submitted as evidence, advertisements and other similar statements “generally do not constitute offers, and an offer is a necessary predicate for any ‘amendment’ to the Terms of Use.” Id.
[7] https://www.cadwalader.com/resources/clients-friends-memos/quantifying-cryptocurrency-claims-in-bankruptcy-does-the-dollar-still-reign-supreme