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SEC Commissioners Critique Regulatory Approaches to Crypto

Steven.Lofchie@friedfrank.com's picture
Commentary by Steven Lofchie

SEC Commissioners Hester M. Peirce and Caroline A. Crenshaw critiqued current regulatory approaches to the crypto industry.

In a speech at the Texas Blockchain Summit, Ms. Peirce questioned the SEC's approach to cryptocurrencies. Alluding to SEC Chair Gary Gensler's comparison of the "cryptoverse" to the "Wild West," Ms. Peirce pointed out similarities between the two "frontiers," such as the lack of regulatory oversight freeing the community to "collectively figure out how to deal with unanticipated problems." Ms. Peirce explained that, as cattle ranchers in the Wild West established codes for their own ranches, the markets during this period have created their own "protection and arbitration agencies." She noted, for example, that the crypto industry has "[p]rotocol users, competitors, bug bounty hunters, and sophisticated skeptics [to] monitor protocols for hints of centralization, administrator keys vulnerable to compromise, slow speed, high costs, lax security, and so forth." Considering these efforts from participants of the crypto industry and their calls for regulatory clarity, Ms. Peirce asserted that the crypto industry is not "lawless"; rather, she argued, the SEC's regulatory approach is "causing people to question [the SEC's] commitment to the rule of law."

Ms. Peirce questioned whether:

  • the SEC has provided sufficient legal clarity on what constitutes a digital asset security and which crypto offerings trigger securities regulations in the absence of a safe harbor (see previous coverage on Ms. Peirce's proposed safe harbor for digital tokens);

  • the SEC is exacerbating regulatory ambiguity by taking an aggressive enforcement approach to the crypto industry;

  • regulatory authorities are attempting to regulate the crypto industry to protect investors or to expand their jurisdiction; and

  • the SEC's heavy enforcement approach to the crypto industry captures bad actors or puts crypto platforms in a "Catch-22" situation by forcing them to register in order to operate, but preventing them from registering because it is unclear which regulations apply to them.

Separately, in remarks before the Practising Law Institute's 2021 SEC Speaks program, Ms. Crenshaw criticized the idea of a safe harbor or specialized exemptions for digital assets because, she argued, such specialized exemptions (i) are insufficient at protecting investors and preventing previously seen failures, and (ii) would give an inappropriate advantage to crypto businesses. She stated that a safe harbor during 2017 and 2018, when there was a spike in initial coin offerings, would have resulted in more significant harm to investors and markets, and, in turn, would have "depressed the digital asset market for years."

Ms. Crenshaw suggested that participants in the crypto industry that wish to offer products that might be securities should proactively approach the SEC with "detailed plans for how you will offer a comparable level of disclosure, investor protection, market access, and other important protections guaranteed by the securities laws." Ms. Crenshaw stated that this approach would facilitate better communication between the SEC and the crypto industry, considering its rapid developments, and would help the SEC employ its resources more efficiently.

Commentary

Commissioner Crenshaw asserts that the idea of a total exemption from the securities laws for digital assets that are nothing more than equity or debt interests makes no sense. This is unquestionably true. There is no magic to the representation of an equity or debt interest in digital asset form, rather than in electronic or paper form, that should provide an automatic exemption from the securities laws.

However, the fact that some digital assets are securities does not mean that all are. When former SEC Chair Jay Clayton announces that he has never seen an initial coin offering that is not a security, and that statement is repeated by now SEC Chair Gary Gensler, there is no incentive for any digital business to seek guidance from the SEC: the SEC has seemingly already determined that the business is breaking the law.

Similarly, why would a digital business approach the SEC with a plan that is an alternative to ordinary securities regulation when there is no indication that the SEC (other than Commissioner Peirce) has given anything to what such an alternative might be, and the SEC's consideration of any such alternative would likely take years.  If the SEC really wants to encourage active engagement by participants in the digital assets market, it must first take some initiative to demonstrate that it is receptive to arguments that not all digital assets are securities and ideally to agreements as to how to regulate digital assets that are in some gray area between securities and utility tokens.  Otherwise, market participants will simply view the SEC as a risk of doing business.  

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