Earlier this week, SEC Chair Gary Gensler gave a speech addressing various aspects of digital assets (Prepared Remarks).1 In the Prepared Remarks, Chair Gensler stressed that “our existing laws [do not] just go away” and that “most crypto tokens are investment contracts under the Howey test.” To this end, Chair Gensler urged cryptocurrency issuers to register the offers and sales of tokens with the SEC. Despite Chair Gensler’s comments, there is still uncertainty as to how the facts and circumstances of particular tokens should be analyzed. The Framework for “Investment Contract” Analysis of Digital Assets published by the SEC staff2 remains the primary guidance on this point, which raises questions in the context of secondary transactions for many tokens currently supported on crypto exchanges. Nonetheless, these recent comments suggest increased scrutiny on tokens, and further comments from the SEC can be expected.
Crypto Trading Platforms
In the Prepared Remarks, Chair Gensler also suggested that given his position that many tokens are securities, a significant proportion of crypto trading platforms are operating as unregistered securities exchanges by supporting digital assets that are securities. Chair Gensler stated that “the probability is quite remote that any given platform has zero securities.” As such, he explained that he is urging the SEC to take action to get crypto exchanges “registered and regulated much like [national securities] exchanges.” Industry participants should expect further action from the SEC regarding trading platforms and should consider taking steps now to limit exposure to digital assets that may be securities.
For digital assets that are not securities, Chair Gensler acknowledged that crypto exchanges facilitate trading of commodity tokens and explained that the SEC should work jointly with the Commodity Futures Trading Commission (CFTC) to address regulation of such exchanges. This statement suggests that there may be overlapping jurisdiction where crypto exchanges may be regulated by both the CFTC and SEC.
Last, Chair Gensler’s Prepared Remarks highlighted that crypto trading platforms often custody user assets while also offering trading services. He suggested that the SEC staff is considering whether it would “be appropriate to segregate out custody functions” from trading services.
Alternative Trading Systems
In January 2022, the SEC published a proposed rulemaking regarding Regulation ATS that would expand the definition of “exchange” under Rule 3b-16 of the Exchange Act to include certain communication protocol systems that bring together buyers and sellers of securities.3 Such changes, if adopted, would allow the SEC to argue that certain crypto trading platforms that support instruments that are securities must become alternative trading systems (ATSs) that are registered with the Financial Industry Regulatory Authority and supervised by the SEC. However, Chair Gensler suggested in his Prepared Remarks that ATSs may not be the proper venue to support trading of digital asset securities because retail investors would benefit if relevant crypto trading platforms are regulated by the SEC in a way that incorporates more of the investor protections that apply to the SEC’s regulation of national securities exchanges. Although certain ATSs are already approved for trading digital asset securities, it remains unclear how such a framework would be implemented more broadly for at least some crypto trading platforms.
On March 28, 2022, the SEC proposed to further define activity that requires registration as a securities “dealer” with the SEC.4 The proposed definitions would apply to entities that have or control $50 million or more in assets, that are not registered as investment companies under the Investment Company Act of 1940, and that surpass certain thresholds of securities trading for their own account.
While the primary focus of the proposed changes does not target digital asset securities, the proposal could affect many market participants in the digital asset ecosystem, including those participating in centralized exchange activity and decentralized finance activities such as automatic market making and liquidity pools. Indeed, the SEC highlighted in a footnote to the proposal it would apply to activities involving digital assets that are securities.
Along those same lines, in the Prepared Remarks, Chair Gensler highlighted that certain crypto trading platforms “also may act as market makers and thus as principals trading on their own platforms for their own accounts on the other side of their customers.” This presents obvious risks of conflicts of interest for those trading platforms, and as such, Chair Gensler said that he has asked SEC staff to consider whether the market-making functions on crypto trading platforms should be segregated out from trading services.
Securities-Based Swaps Rules
On April 6, 2022, the SEC also proposed new rules relating to security-based swaps and securities-based swap facilities.5 The SEC’s stated goal with these rules is to bring security-based swaps and their execution facilities in line with other regulations regarding how swaps are regulated. In the proposal, the SEC noted that these new security-based swap rules will apply equally to digital asset securities. In light of this, digital asset market participants need to be thoughtful about their product offerings and consider how these new proposed regulations could affect them.
On March 31, 2022, the SEC issued a new Staff Accounting Bulletin addressing how public reporting companies and applicants that filed a registration statement should account for digital assets held in custody on behalf of their customers, even if the assets are held with an agent acting on behalf of the company.6 The bulletin provided that public companies that custody crypto assets on behalf of others must record such assets as liabilities on their balance sheet to represent the technological, regulatory, and legal risks associated with safeguarding the digital assets. At the same time, such entities should also record digital assets as assets on their balance sheet. The bulletin also stated that public filings should add new disclosures addressing which crypto assets the company holds and the unique risks associated with each. The SEC stated that it will begin applying these new standards no later than June 15, 2022. Crypto industry participants should begin taking action to ensure that they are in compliance with these new standards.
In the Prepared Remarks, Chair Gensler highlighted that there remains uncertainty as to how to regulate stablecoins, which he argued are similar to and compete with money market funds and bank deposits. Chair Gensler noted that stablecoins raise public policy issues related to effects on financial stability and monetary policy, may be used to support illicit activity, and raise investor protection concerns. Critically, Chair Gensler believes “[t]here are conflicts of interest and market integrity questions that would benefit from more oversight.” Nonetheless, unlike in some past speeches, Chair Gensler did not expressly state that he views some stablecoins as likely to be securities, and in another speech several days later, Secretary of the Treasury Janet Yellen indicated that the administration was working with Congress on stablecoin legislation
The SEC is strongly urging market participants to ensure compliance with securities laws, including
- registering tokens or digital asset lending products as securities or relying on an applicable exemption from U.S. federal securities laws,
- registering a crypto trading platform that supports trading in digital asset securities as either a national securities exchange or as an alternative trading system,
- restating public company financial statements to comply with the new Staff Accounting Bulletin, and/or
- submitting comment letters in response to the rule proposals related to Regulation ATS, definition of securities “dealer,” and the new securities-based swaps rules.
Based on these recent actions and communications, the SEC is strengthening its stance that regulations apply to digital asset market participants, compliance should be possible, and industry participants ought to take action soon or face potential enforcement actions for noncompliance.
1Gary Gensler, Prepared Remarks of Gary Gensler On Crypto Markets, Penn Law Capital Markets Association Annual Conference (April 4, 2022). Available at https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422?utm_medium=email&utm_source=govdelivery.
2SEC Staff from the Strategic Hub for Innovation and Financial Technology, Framework for “Investment Contract” Analysis of Digital Assets. Available at https://www.sec.gov/files/dlt-framework.pdf.
3Amendments Regarding the Definition of “Exchange” and Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities, SEC Proposed Rule (January 26, 2022). Available at https://www.sec.gov/rules/proposed/2022/34-94062.pdf.
4Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer, SEC Proposed Rule (March 28, 2022). Available at https://www.sec.gov/rules/proposed/2022/34-94524.pdf.
6Staff Accounting Bulletin No. 121, SEC (March 31, 2022). Available at https://www.sec.gov/oca/staff-accounting-bulletin-121.
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