Biden continues Trump-era trade war on China

Topline

• White House bans investment in sensitive Chinese tech

• Fed issues stablecoin guidance as PayPal announces new stablecoin

• SEC gatekeeper actions extending to fund admin

• IRS counters lobbying with PR campaign

• SEC moves to appeal Ripple decision

White House takes action to prevent new investment in sensitive Chinese tech

This week, President Biden issued a long-awaited executive order (EO) that directs the Treasury Department to establish a program to oversee outbound investments in certain critical sectors. The program would require notification of, and in some instances, prohibit private equity and venture capital investments in Chinese companies that develop sensitive technologies in three targeted sectors: semiconductors, quantum computing, and artificial intelligence. The outbound investment EO is narrower in scope than originally anticipated and would only ban new investment in Chinese tech after Treasury drafts and implements rules. Previous draft versions of the EO would have required investors to provide notifications of investments in China and permit the government to review and potentially restrict them, including on a retroactive basis. Alongside the EO, Treasury issued a rulemaking notice to outline the intended scope of the program and solicit public feedback.

Why it matters:The prospective scope of the EO is a win for the private fund industry, as any retroactive review would have created divestment risk and compliance challenges that could have ultimately penalized investors and harmed U.S. competitiveness.

Fed chimes in on stablecoins as PayPal enters the fray

On Monday, PayPal announced they launched a stablecoin, thus becoming the first major financial technology firm to embrace digital assets. The stablecoin, PayPal USD, is backed by U.S. dollar deposits and short-term U.S Treasuries, and will be issued by Paxos. Once available in the United States, PayPal USD will be redeemable for U.S. dollars at any time, and can also be used to buy and sell the other cryptocurrencies PayPal offers, including bitcoin. 

PayPal’s announcement will impact the discussion around regulation stablecoins in Washington. The House Financial Services Committee approved a stablecoin bill last month, despite bipartisan talks devolving at the last minute. HFSC Chair Patrick McHenry, stated that the PayPal announcement underscores the importance of regulation and confirmed his view that  stablecoins “hold promise as a pillar of our 21st century payments system.”

Fed gets involved as Congress dithers

A day after the PayPal announcement, the Fed clarified the process for banks to transact in stablecoins. The Fed’s guidance indicates that state banks who are members of the Federal Reserve system should obtain a “written supervisory non-objection” from the Fed before issuing, holding, or transacting with dollar tokens, such as stablecoins.

Why it matters:A lack of clarity from Congress has allowed both federal agencies and industry players to push forward on their own. The last time a major U.S. company tried to launch a stablecoin ( Meta in 2019), pressure from regulators severely halted progress. Now PayPal is trying again—and this time, the regulatory environment seems friendlier. However, the future of stablecoin legislation is still uncertain as a partisan stalemate in the House muddied the waters. Republicans are using the PayPal announcement to put pressure on Dems, but so far, there hasn’t been substantial movement.

SEC gatekeeper actions extending to fund admin

This week, the SEC announced charges against fund administrator Theorem Fund Services LLC (TFS) for failing to respond to red flags relating to a fraud against a private fund and its investors.

• According to the SEC, TFS “failed to live up to its gatekeeper responsibilities and distributed inaccurate account statements to investors despite clear red flags.” 

• Recently, the SEC’s Chief Accountant cautioned that auditors could be held liable under the antifraud provisions of the securities laws for providing “material misstatements.”

Bottom line: The SEC has increasingly been focused on holding gatekeepers—auditors, accountants, lawyers, and now fund admins—accountable in their roles to prevent financial misconduct. Expect this pattern to continue, particularly as the SEC ramps up its scrutiny of private fund advisers.

IRS signals warning to ESOPs

The IRS has identified employee stock ownership plans (ESOPs) as the focus of their latest enforcement campaign – noting noncompliance issues and abusive arrangements. 

• ESOPs are retirement plans that allow employees to own stock in their employer’s company. Companies that have stock offerings can sponsor an ESOP for its employees as long as the ESOP invests primarily in the securities of the employer. ESOPs can often become complex arrangements involving loans between third parties and the employer. 

• Concerns raised include valuation issues with employee stock, prohibited allocation of shares to disqualified persons, and failure to comply with tax rules for ESOP loans.

Why it matters:The IRS has increasingly aimed its attention towards high-income taxpayers and small businesses. This is the latest alert in that effort. 

SEC moves to appeal Ripple decision

The SEC announced its intentions to challenge a New York judge’s ruling in favor of Ripple that certain secondary sales of its XRP tokens did not violate federal securities law. 

• In SEC v. Ripple, Judge Analisa Torres held that sales of XRP tokens purchased on the secondary market were not securities because the identity of the seller was unknown, so buyers could not reasonably rely on the efforts of others—and therefore did not satisfy one of the prongs of the Howey test. 

• In a subsequent case in the same court, Judge Ted Rakoff rejected Torres’ approach in Ripple and denied Terraform Labs’ motion to dismiss its case with the SEC. 

Why it matters: The SEC is seeking to resolve conflicting legal conclusions from the SDNY; an interlocutory appeal would provide the Second Circuit—the preeminent court for securities and financial regulation—an opportunity to provide clarity before other pending actions move forward. A determination of whether tokens purchased on digital asset platforms would be considered securities will have broad implications not only for the Ripple and Terraform actions, but for many of the SEC’s pending enforcement actions against crypto platforms, including Coinbase. And assuming the SEC’s request for appeal is granted, that determination could be made in the next year.

New from Carta Policy: Corporate Transparency Act issue brief 

The Corporate Transparency Act (CTA) requires the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) to collect beneficial ownership information (BOI) from millions of entities, mainly startups and small businesses. The new requirements, which support efforts to combat illicit financing and its ill effects, begin January 1, 2024, and business entities subject to the rules will face significant new reporting and recordkeeping obligations. Carta is working to get clarity on how companies can best comply and how intermediaries like Carta can help support broader compliance. 

Learn more: Corporate Transparency Act Issue Brief 

News to know 

• Wall Street firms to pay $549M to settle SEC, CFTC messaging charges. The SEC announced charges against 11 firms for “widespread and longstanding failures” to maintain records, including by allowing employees to use unsupervised side channels such as messaging apps WhatsApp and Signal.

• Sherrod Brown calls on Fed to toughen scrutiny of mergers. In a letter to the Federal Reserve, a group of Democratic banking committee senators asked regulators to review their bank merger approach, particularly in the aftermath of the four large regional bank failures earlier this year. 

• Democrats press Gensler to finalize SEC climate risk rule. Over 75 House Democrats signed a letter urging SEC Chair Gensler to quickly finalize its proposed climate disclosure rule.  If finalized, this would mark the first time public companies are required to report their greenhouse gas emissions, along with details of how climate change impacts their business.

• Ad blitz on IRS free filing system commences. A six-figure ad blitz in support of the IRS free-filing system has been deployed, in direct response to lobbying efforts by tax prep companies who are pushing back on the IRS. 

• FTC and DOJ extend public comment on proposed changes to HSR form. With the extension, the agencies will now be accepting comments on the proposed changes until September 27, 2023. 

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