Gary Gensler asserts the SEC’s broad powers over digital assets, and puts consumer protection at the forefront.
On August 3, 2021, Gary Gensler, chairman of the US Securities and Exchange Commission (SEC), gave a speech on the digital asset industry. The speech offered some indication of what he expects the SEC to focus on in this area but did not provide concrete guidance for industry participants looking for clarity on regulatory uncertainties. He did, however, make clear that he believes “we just don’t have enough investor protection in crypto” and that the SEC will play a more active role in regulating the industry.
Ever since Mr. Gensler’s confirmation as chairman of the SEC in April 2021, observers have been eager to find out what his stance will be on regulating the crypto ecosystem. Not simply because he is the new chairman of the world’s most influential securities regulator, or because he is the former chairman of the world’s foremost commodities regulator (the US Commodity Futures Trading Commission), but also because of his “street cred.” Mr. Gensler taught a course on blockchain and cryptocurrencies at the Massachusetts Institute of Technology for three years.
Due to this familiarity with crypto that stems both from his time as a regulator as well as an academic, many assume that Mr. Gensler brings a greater understanding and broader perspective of the digital asset industry than did his predecessors. While that presumption may be valid, those who assumed that Mr. Gensler will be a “crypto-friendly” regulator appear to be headed for disappointment.
Consumer Protection Is Paramount
With respect to crypto, Mr. Gensler is particularly focused on the investor protection pillar of the SEC’s mission. In the speech, he took a broad view of the securities laws and spoke of digital asset innovation primarily through the lens of consumer and market protection. Mr. Gensler was also clear that he believes the mandate of the SEC and other regulators is far-reaching, asserting that “we have taken and will continue to take our authorities as far as they go.”
Below is a sampling of Mr. Gensler’s views as outlined in the speech:
Cryptoassets and initial coin offerings (ICOs): Because the SEC retains jurisdiction over securities, the definition of a security is critical. According to Mr. Gensler, the oft-cited Howey test (see this Latham blog post for more information) is only one of the ways the SEC determines whether a digital asset must comply with the securities laws. Mr. Gensler also echoed former SEC Chairman Jay Clayton views when Mr. Gensler testified in 2018 that “to the extent that digital assets like [initial coin offerings, or ICOs] are securities — and I believe every ICO I have seen is a security — we have jurisdiction, and our federal securities laws apply.” Whether this view includes more modern iterations of token distributions that do not include a public sale remains to be seen.
Crypto derivatives: Consistent with the current laws, Mr. Gensler said that tokens or other products that derive their price from the value of securities or are backed by securities are likely securities within the SEC’s jurisdiction, whether or not they are security-based swaps.
Stablecoins: He said that stablecoins could be securities and the platforms hosting them may be investment companies. He noted that stablecoins that are based on a basket of securities operate like derivatives and thus are likely securities.
Decentralized finance (DeFi): According to Mr. Gensler, decentralized crypto trading platforms and lending platforms may fall under the SEC’s jurisdiction to the extent that the trading and lending activity involves securities, and the platforms are not otherwise exempt from the securities laws.
Crypto exchange-traded funds (ETFs): Quite a few applications for digital asset ETFs are pending the SEC’s review. Mr. Gensler seemed to indicate that the SEC staff would prioritize review of those seeking to register under the Investment Company Act of 1940 (the 1940 Act), “if those [registrations] are limited to … CME-traded Bitcoin futures.” Where filings related to vehicles involving anything other than CME-traded Bitcoin futures stand remains to be seen. Since delivering the speech, a wave of new ETF applications have been filed that are limited to CME-traded Bitcoin futures or are pursuant to the 1940 Act.
Custody of cryptoassets: On December 23, 2020, the SEC issued a statement and request for comment (“Custody of Digital Asset Securities by Special Purpose Broker-Dealers”) (see this Latham blog post) outlining its position on how broker-dealers must operate when acting as custodians of digital asset securities in order to avoid enforcement action. The SEC’s statement is in effect for five years, and comments may be submitted at any time throughout the five-year term. According to Mr. Gensler, crypto custody is an area in which the SEC “will be looking to maximize regulatory protections.” He did not draw a distinction between custodial solutions that take “possession” of the digital asset as opposed to non-custodial solutions that do not (such as in the case of most DeFi platforms), so where these regulatory protections will be implemented remains unclear.
Taming the Wild West
To Mr. Gensler, the crypto industry currently looks like the “Wild West.” Of course, the industry does suffer from a lack of legal and regulatory clarity in the US. And, one might hope that along with Mr. Gensler’s desire to improve investor protection, he intends to bring a bit more order to the industry. Though, he noted that only Congress can prevent digital asset “transactions, products, and platforms from falling between regulatory cracks” by establishing bright-line definitions and specific regulatory parameters for the (often competing) sister agencies.
While Mr. Gensler’s speech indicates that he believes the SEC’s authority extends to many aspects of the crypto industry, many in the industry believe the SEC’s authority is narrower and worry Mr. Gensler is overstepping the legislative limits of the agency’s mandate. This group appears to include CFTC Commissioner Brian Quintenz, who addressed this point in response to Mr. Gensler’s speech, by noting that “the SEC has no authority over pure commodities or their trading venues, whether those commodities are wheat, gold, oil …. or crypto assets.”
Given Mr. Gensler’s background, the industry can again hope that he will consider balancing public interest and protection measures with the risk of “over” regulation. The digital asset ecosystem is largely pseudonymous, open source, and equipped with distributed work forces, and as such it has likely never been easier for an entire industry to move off-shore or underground — a fact that Mr. Gensler is surely cognisant of given his history and knowledge of the industry. Regulators are therefore tasked with balancing competing aims of investor protection and market stability while avoiding the implementation of premature or overly burdensome regulations that stifle innovation or drive it off-shore or underground.
How Mr. Gensler will approach this admittedly difficult problem largely remains to be seen. But further SEC engagement and action under his leadership appears a certainty.