Samuel Katz shares great knowledge in Compliance & the STO of a Fund with Blocklike
Samuel Katz is a partner at Nellis & Katz LLP in New York and VP and General Counsel of Rivver Inc., which is developing a fund administration and issuance platform using blockchain technology.
We are pleased to welcome Samuel for our interview . Samuel Katz is a partner at Nellis & Katz LLP in New York and VP and General Counsel of Rivver Inc., which is developing a fund administration and issuance platform using blockchain technology.
He shares great knowledge in Compliance & the STO of a fund with us. Enjoy the Interview!
I will start by stating that my statements here are not legal or investment advice. Readers should get a lawyer before proceeding with an STO. While an STO of equity interests or debt of an operating company is relatively simple, assuming it is aimed at accredited investors, an STO of a fund is more complicated. As an investor is placing their funds with a fund manager who makes the investment decision, laws and regulations place a significant additional burden on fund managers who need to exercise significant care when it comes to managing the money of others. Therefore, in most jurisdictions, the legal compliance for funds is significantly more complex than compliance of an operating company. For this reason, issuers of tokenized funds need to consider a wider range of compliance issuers.
In the case of funds, in many jurisdictions, the sale of fund interests by itself does not need to be registered with local authorities if it is sold to sophisticated or institutional investors in that jurisdiction. The requirements vary among jurisdictions.
In the case of funds, there are other legal requirements relating to operation of pooled investment vehicles like funds. In the US, these include the Investment Company Act of 1940 and the Investment Advisers Act of 1940, which have their own registration requirements and regulations, including requirements to have a greater amount of assets in order for investors to meet certain exemptions or requirements with respect to internal compliance and custody of assets. Therefore, issuers need to make sure that their funds and the fund managers comply with all of these regulations.
STO issuers need to ensure that before investors are accepted, they are whitelisted after having met the local requirements for exemptions under relevant regulations (including as noted, for fund-specific laws that require higher levels of income or assets) and for AML. Finally, depending on how the fund is marketed, a licensed broker-dealer may be required.
Smaller funds tend to have lower risk, as the legal compliance requirements are usually less stringent. In most cases, a more focused offering process targeting specific investors, including through a broker-dealer, can limit risk as the broker-dealer reviews the fund prior to marketing. The larger the target market and greater number of jurisdictions, there is increased risk, as compliance becomes more complex.
Indeed, real estate is an excellent target, as it is relatively stable and from an economic perspective, tends to have lower risk. In this case, the STO can provide an opportunity for sophisticated investors who otherwise wouldn’t be able to participate in certain markets to be able to participate. In addition, through the REIT structure, many tax advantages of real estate can be retained even in the case of an STO. In the case of funds that invest in other assets (such as private equity or venture capital), this is not the case in some jurisdictions. In addition, tokenized funds can take advantage of other information that may be available on chain in order to create more transparent pricing. Of course, we would anticipate that tokenized funds would have greater liquidity than existing funds, as transfers can take place without papers and the fund interests can be made available on security token exchanges, which are already operating in places like the US.
In my opinion, tokenized funds will become a trend, but it will take a few more years. Even so, there will always be a limited number of funds that will tokenize. In order to get started, funds need to see the benefit in tokenizing and the cost of doing so. If the tokenization doesn’t result in liquidity and doesn’t provide other immediate benefits to the fund and its investors (such as transparency or additional trust) then fund managers are less likely to proceed with digital securitization of funds.
From the fundraising perspective, easing the process of onboarding investors through digitizing can allow fund managers to widen the number of investors they allow into a fund and thereby expand their investor base. I believe that with the technology that a company like Rivver is working on, digitization will impact all aspects of the fund and eventually, all fund activities will be monitored on the blockchain, allowing investors, auditors and even regulators, if necessary, to have access to fund transactions as they are recorded. This can have a major impact on how fund accounting and administration works and save significant time and work for auditors and regulators. This can be the basis for the initial introduction of blockchain to funds before securitization of the fund interests. Eventually, we anticipate that there will be an increase in liquidity of fund interests, but we can’t be sure when that will happen.
One of the issues that still require resolution is a custody solution for security tokens. In many jurisdictions, it is legally required or investors insist that funds hold their assets with a qualified custodian. Regardless, there are still many investors that aren’t comfortable holding tokens. They aren’t prepared from the technical or cybersecurity perspective. Therefore, solutions are necessary (such as custody) for the holding of digital fund interests. We know those are in process, but until they exist, adoption will be slow.
Rivver looks at the fund as a whole and the goal is to provide an end-to-end management solution for funds that incorporates issuance and trading. Even funds that have their own fund managers may be able to incorporate DLT solutions in their fund management through Rivver’s Hyperledger Fabric-based platform, being developed with the assistance of IBM. Rivver is working with funds formed in numerous jurisdictions and is expanding its reach to allow for issuance in as many jurisdictions as possible.
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Establishing an STO in the USA and other tokenization aspects of this topic will be discussed today with Sam Katz, attorney and co-founder at New York-based Security Token Lawyers
Liquidity is often talked about as a potential benefit of security tokens, but what are the opportunities for liquidity with regards to tokenization?