SEC Says Crypto Markets Should be Regulated as Exchanges; Extends Comment Period

The SEC reopened the comment period for a proposal that would amend the statutory definition of "exchange" to include trading systems that facilitate the trading of crypto asset securities. In reopening the comment period, the SEC provided supplemental information and economic analysis as to impacts on such trading systems.

The original comment period closed on April 18, 2022, and was subsequently extended to June 13, 2022. The new comment period will remain open for 30 days after publication of this release in the Federal Register.

Proposed Rulemaking

As previously covered, the SEC proposed rulemaking would:

1. expand the definition of "exchange" under SEA Rule 3b-16 to include systems that only display "trading interest" (as opposed to "orders"), including by use of "communication protocols"; and
2. remove the exemption that Regulation ATS ("Alternative Trading Systems") currently provides to systems that trade only government securities.

Both of these changes would materially expand the number of institutions that must comply with Reg ATS by (i) lowering the bar as to what constitutes an alternative trading system and (ii) removing the exemption from Reg ATS registration for systems that trade government securities. In addition, systems that become an automated trading system may not also become subject to Regulation SCI ("Systems and Compliance Integrity").

Reopening of Comment Period

In the SEC release reopening the comment period, the SEC stated that the agency received numerous inquiries about the application of the proposed rulemaking to trading systems for crypto asset securities and trading systems that use distributed ledger technology ("DLT"), to include decentralized finance (or "DeFi") systems. The SEC said that commenters requested information about how these trading systems can comply with existing federal securities laws and the proposed amendments, and that the purpose of reopening the comment period is to (i) address the potential effects on such systems and (ii) request feedback on other aspects of the proposal more generally. This release supplements economic analysis from the original proposal by adding further analysis on the estimated impact on trading systems that trade crypto asset securities and those that use DLT.

Commissioner Statements

SEC Chair Gary Gensler stated that the proposed amendments would close regulatory gaps with respect to certain entities in the government securities markets and said amending the definition of "exchange" would benefit investors and markets by ensuring "exchange-like platforms follow [the SEC’s] exchange-specific rules." Mr. Gensler reiterated his position that "the vast majority of crypto tokens are securities." He further stated that "given how crypto trading platforms operate, many of them currently are exchanges, regardless of the reopening release." He criticized these platforms for "acting as if they have a choice to comply" with the securities laws, saying: "Calling yourself a crypto platform is not an excuse to ignore the securities laws. Calling yourself a DeFi platform is not an excuse to defy the securities laws."

Commissioners Jaime Lizárraga and Caroline A. Crenshaw supported the proposal and reopening of the comment period. Mr. Lizárraga echoed support for closing "regulatory gap between registered and unregistered trading platforms" through the current proposal. Ms. Crenshaw stated that the existing definition of "exchange" does not have "an exception or carve-out for entities that trade crypto asset securities and the updated definition would not include one, either," adding that there should be "a level playing field for entities performing similar functions."

Commissioner Mark T. Uyeda voted against the reopening of the comment period. Mr. Uyeda said there is a "distinct danger" in expanding the scope of "exchange" in an "ambiguous manner," saying it could "suppress further beneficial innovation." He voiced concern over the potential unintended consequences of the "expansionary" language of the proposed amendments, and criticized the supplemental information provided in the request for missing an opportunity to address the "economic impact reflected in the commentary received to date." He questioned whether it was merely a "paper exercise" so that the SEC can "finalize a decision that has already been made - namely that nearly all crypto assets are securities and are subject to the Commission’s jurisdiction."

Commissioner Hester M. Peirce also dissented, saying the release "perfectly captures the Commission’s new way of doing things" and that - rather than addressing concerns around ambiguity, workability and breadth - the reopener "doubles down on the defects identified by commenters." Ms. Peirce said that the proposal takes the statutory definition of "exchange" beyond its current scope to "reach a poorly defined set of activities with no evidence that investors will benefit." She criticized the "Commission’s cavalier approach" and said that the release "sends a message that [the SEC is] uninterested in facilitating innovation and competition in the financial markets and instead seek to protect incumbents."