What Crypto Users Need Know About Gary Gensler’s SEC
Acting SEC Enforcement Director Berger to Step Down. What Crypto Users Need Know About Gary Gensler’s SEC
Berger presided over the enforcement division when it launched the Ripple lawsuit.
The U.S. Securities and Exchange Commission’s Acting Enforcement Director Marc Berger will leave the agency this month, the SEC said Tuesday.
* Berger assumed SEC’s top investigative post after former Director Stephanie Avakian’s departure at the end of 2020. He had been moving up the agency ranks since December 2017.
* SEC said Berger presided over the agency’s prosecution of the Telegram initial coin offering and its initiation of the unregistered securities suit against Ripple Labs.
Ultimate Resource On Insider Trading (Congress, Senators, Corporate America)
Ultimate Resource On BlockFi, Celsius And Nexo (Including Regulatory Scrutiny From States And The SEC)
* Enforcement staff pursued “meaningful relief” for victims of cryptocurrency fraud during Berger’s tenure, SEC said.
Gensler Said To Be Named SEC Chairman
Gensler has testified before Congress about cryptocurrency and blockchain on multiple occasions.
Gary Gensler, a Washington and Wall Street veteran who has closely studied the cryptocurrency field, is expected to be named chairman of the U.S. Securities and Exchange Commission (SEC) in the next several days by President-elect Joe Biden, two sources familiar with the matter told Reuters on Wednesday.
* A former chairman of the Commodity Futures Trading Commission (CFTC), Gensler served as a key financial regulator for former President Barack Obama, spearheading new derivatives rules after the 2008 financial crisis. He also served in the Treasury Department during the Clinton administration.
* More recently, he has also testified before Congress about cryptocurrency and blockchain on multiple occasions, pushing back against comparisons between cryptocurrencies and Ponzi schemes and declaring that the still-unlaunched libra token met the requirements of being a security under U.S. law.
* At MIT’s Sloan School, Gensler taught a course on cryptocurrencies and blockchains, calling the technology “a catalyst for change in the world of finance and the broader economy.”
Cryptocurrencies Face Greater Oversight Under Gensler-Led SEC
Gary Gensler’s expected nomination to lead the U.S. Securities and Exchange Commission is seen ushering in an era of greater federal oversight of the $1 trillion cryptocurrency market.
Gensler, who most recently taught about cryptocurrencies and their underlying technologies at the Massachusetts Institute of Technology, previously chaired the Commodity Futures Trading Commission and was a partner at Goldman Sachs Group Inc. He is known for pushing back at banks and corporations in search of greater investor protections.
In talks and editorials over the last several years, he’s advocated for a nationwide way to register and monitor cryptocurrency exchanges, instead of leaving oversight to the states.
That could have implications for online exchanges like Coinbase Global Inc., which is planning to go public. The SEC is also likely to continue to go after thousands of initial coin offerings, as Gensler has said he believes that most of these digital tokens are unregistered securities.
“It is good to have an ex-banker in there who is smart enough to recognize the value of Bitcoin and other cryptocurrencies to building wealth and value in society,” said Tim Draper, a billionaire venture capitalist who is a large investor in cryptocurrencies. “He will understand the importance of allowing innovation, while watching over banks who might try to restrain trade by blocking the use of superior currency.”
In a 2018 Bloomberg Television interview, Gensler said that the pure-cash cryptocurrencies like Bitcoin would “need more protection.” The world’s biggest cryptocurrency by market capitalization quadrupled last year, and has continued to surge in volatile trading since the start of 2021.
Gensler has also advocated for greater regulation of cryptocurrency exchanges. He didn’t respond to a request for fresh comment.
“If it gets broad adoption, if we really think the crypto world is going to be part of the future, it needs to come inside of public policy envelope,” Gensler said in the 2018 interview. “That means we need to guard against illicit activity. And yes, we need to protect investors. The crypto exchanges, big exchanges like Coinbase, need to come within the SEC or the CFTC.”
Greater oversight could lead to greater mainstream adoption, he said.
“I would say, you want some form of regulation, you want traffic lights and speed limits, because then the public is confident to drive on the roads,” Gensler said in the 2018 Bloomberg interview.
He has also long railed against illegal offerings of securities, which the SEC has been actively pursuing.
In December, the agency filed a lawsuit against Ripple Labs Inc. for issuing more than $1 billion in unregistered tokens XRP. In a 2019 keynote at Harvard Law School, Gensler said “I don’t think the SEC is going to leave many ICOs off the hook.”
In his 2019 Congressional testimony, Gensler appeared to favor projects like Facebook-led Diem, which used to be called Libra — an effort to create a cryptocurrency for payments. But he did suggest that the effort may need to have banking regulations applied to it.
“Gary is extremely dialed-in on the crypto markets and understands them extremely well,” said Nic Carter, co-founder of researcher Coin Metrics. “If his stated views are any indication of his priorities as commissioner, I would expect the SEC to continue with or even accelerate its agenda of discouraging unregulated securities issuance in the form of tokens.”
An Old Foe of Banks Could Be Wall Street’s New Top Cop
Gary Gensler is expected to be Joe Biden’s pick to take over the Securities and Exchange Commission. ‘He will do things that are controversial.’.
President-elect Joe Biden’s expected pick of Gary Gensler to lead the Securities and Exchange Commission could give Wall Street its most aggressive regulator in two decades.
The finance industry has thrived under the Trump administration’s light regulatory touch. Mr. Gensler, who sources familiar with the transition say is likely to be tapped by Mr. Biden for SEC chairman, has a history of shaking up the status quo. If he gets the assignment, he would be tasked with toughening regulation and enforcement of public companies and the finance industry.
He did that when he ran the Commodity Futures Trading Commission, a smaller regulatory sibling to the SEC, from 2009 to 2013. There, he steamrolled the opposition to write rules from scratch governing the markets for hundreds of trillions of dollars of derivatives. Some of these complex financial instruments were blamed for the 2008-09 financial crisis.
Lawyers, regulators and lobbyists say Mr. Gensler would likely be the most active, pro-regulatory SEC chairman since William Donaldson ran the agency in the wake of the corporate scandals of the early 2000s, or Arthur Levitt’s tenure during the Clinton administration. They also expect a renewed eagerness to pursue enforcement cases against major corporations and Wall Street banks. At the CFTC, Mr. Gensler earned a reputation for an aggressive, sharp-elbow style of management more reminiscent of Wall Street than Washington, at times even clashing with officials in his own party.
“He’s a totally different cup of tea than we’ve had at the SEC,” said Hal Scott, a professor of capital markets law at Harvard Law School. “He will do things that are controversial.”
Mr. Gensler’s nomination hasn’t been formally announced by the Biden transition team. People familiar with the matter say it is no coincidence that his name emerged only after Democrats won control of the Senate following runoffs in Georgia on Jan. 5. The irony is Mr. Gensler is a product of Goldman Sachs Group Inc., a Wall Street giant that attracts criticism from progressives. He made partner at Goldman at 30 and then served in the Treasury Department and led the CFTC after an 18-year stint on Wall Street. Since leaving the CFTC, Mr. Gensler has been teaching at Massachusetts Institute of Technology’s business school.
A spokesman for the Biden transition team declined to comment for this article. Mr. Gensler didn’t respond to requests for comment.
Mr. Gensler’s record at the CFTC fits with the Democratic Party’s progressive wing, which hopes to use the SEC as a lever for driving domestic policy goals. These include combating climate change and racial injustice, forcing more transparency around corporate political spending and tilting the balance of power from executives to workers and small investors.
But the firms the SEC regulates are hopeful Mr. Gensler’s understanding of finance and markets would make him a pragmatist when balancing progressive demands against the implications of causing widespread disruption.
Among Democrats’ top priorities are for the SEC to require more-comprehensive reporting from public companies about the risks they face from climate change or government efforts to curb it. They say financial disclosures should also include more information about companies’ diversity and worker pay. And Mr. Gensler is already facing calls to further tighten a 2019 rule that stopped short of requiring brokers to put their clients’ interests ahead of their own.
“We are really looking for someone to be bold,” said Lisa Gilbert, executive vice president at consumer-advocacy group Public Citizen, adding that Mr. Gensler has shown an ability to challenge entrenched interests.
Critics of the SEC in recent years have said it focused too much on helping companies raise capital and not enough on investor protections. Rick Fleming, the SEC’s in-house investor advocate, said in a Dec. 29 report that the agency “engaged in numerous rule-makings of a deregulatory nature” last year that “often had the effect of diminishing investor protections.”
Some have also called for the SEC to refocus enforcement efforts on large banks and hedge funds. Under recently departed chairman Jay Clayton, the enforcement program emphasized wrongdoing that harms less-sophisticated investors, including cryptocurrency scams, Ponzi schemes and investment advisers who fleeced clients with murky fees.
Mr. Gensler dealt with the big banks at the CFTC when he oversaw enforcement actions against banks accused of manipulating a key interest rate known as Libor.
Another target of Democrats may be private-equity firms and hedge funds, lightly regulated investment firms that are off limits to small investors. The firms captured 69% of the capital raised in 2019, while the regulated public markets accounted for 31%, according to SEC estimates.
At the CFTC, Mr. Gensler faced fierce opposition from Wall Street over his push to make trading of derivatives more transparent as required by the 2010 Dodd-Frank Act. He advanced a series of regulations that required so-called swaps to be traded on public platforms, in an effort to eliminate the unseen buildup of risks that precipitated the 2008-09 financial crisis.
Former colleagues said Mr. Gensler wasn’t afraid to say no to powerful financial firms in meetings at the CFTC and that he was unflappable in sometimes-heated congressional hearings. Mr. Gensler’s nomination could face opposition in Congress from Republicans, Ms. Gilbert of Public Citizen said.
He clashed at times with Republican members of the CFTC, who accused him of leaving them out of key discussions over proposed rule makings. He was accused of implementing rules too fast, exposing the agency to legal challenges. A Republican commissioner in 2013 said in a speech that lawsuits challenging CFTC regulations were evidence of a “flawed rule-making process that prioritized getting the rules done fast over getting them done right.”
But he also demonstrated an unusual ability to navigate the competing interests of industry, lawmakers and other regulators to churn out a prolific volume of work. That track record likely made Mr. Gensler a front-runner for the SEC nomination.
At the SEC, Mr. Gensler would have to manage a much larger staff—4,500 employees to the CFTC’s 700—and a five-member commission that tends to be more partisan. He also has fewer congressionally mandated reforms to tackle than during his tenure at the CFTC, which was dominated by implementation of the Dodd-Frank financial reforms.
“The policy agenda for the SEC is pretty obvious…the question is who can get it done, sequence and prioritize,” said Dennis Kelleher, a Biden transition team adviser who is president of Better Markets, a group that advocates for stricter Wall Street oversight. “Gary proved at the CFTC that he has the ability to operate in multiple arenas at the exact same time.”
Biden Team Announces Pick To Lead SEC
Biden’s pick to run the SEC has some serious crypto and blockchain chops.
President-elect Biden’s team recently unveiled additional folks it plans on nominating for various positions after the inauguration on Wednesday.
One key pick is Gary Gensler as Chairman of the Securities and Exchange Commission, or SEC, according to a statement from Biden’s transition team on Monday. On Jan. 12, Reuters reported on anonymous sourcing forecasting Gensler as Biden’s choice. Today’s statement from the Biden team confirms the President-elect’s expected choice.
“Gary Gensler served as chairman of the U.S. Commodity Futures Trading Commission from 2009 to 2014,” the statement said. Coming immediately after the financial crisis, Gensler’s term at the CFTC saw him enforcing the provisions of the nascent Dodd-Frank Act in commodities markets.
Formal nomination will have to wait until Biden actually takes office, and will further need confirmation from the U.S. Senate. January run-off elections in Georgia, however, secured the Senate for the Democrats.
Gensler also taught classes on blockchain and crypto at MIT. Having someone knowledgeable on the crypto and blockchain industry leading the SEC could pave the way for educated regulation and guidelines. The SEC has been critical for its role in regulating the initial coin offering market, which has quieted down significantly since the commission began treating many ICOs as unregistered public securities offerings.
Biden’s Wall Street Watchdogs Signal New Era of Tough Oversight
President-elect Joe Biden’s team of financial regulators is taking shape, with progressive favorites being chosen for the top jobs at the Securities and Exchange Commission and the Consumer Financial Protection Bureau — moves that mean Wall Street should prepare itself for a new era of tougher oversight and stricter rules.
Biden’s SEC pick, former Commodity Futures Trading Commission Chairman Gary Gensler, 63, is known for sparring with the industry as the nation’s top derivatives watchdog during the Obama administration and for his deep knowledge of finance as an ex-partner at Goldman Sachs Group Inc.
That means he not only knows how to mobilize a bureaucratic federal agency but also understands the often impenetrable ways that Wall Street makes money — and how firms use that complexity to turn regulation in their favor.
His top targets likely will include Chinese companies that list on U.S. stock exchanges while bypassing American regulations, the surge in trading by neophyte investors during the coronavirus pandemic, cryptocurrencies and pushing Corporate America to reveal more about workforce diversity and how climate change impacts bottom lines.
Biden’s pick for the consumer agency, Rohit Chopra, 38, will seek to revive an agency that progressives contend was put to sleep during the Trump administration.
Chopra also is an acolyte of Senator Elizabeth Warren, the Massachusetts Democrat who conceived of the CFPB and is a renowned Wall Street adversary. If he succeeds in turning the agency around, life will almost certainly get less pleasant for student lenders, for-profit colleges, payday lenders and credit-card companies that progressives say prey on consumers.
The pending nominations send a clear signal that the rule-cutting and lax enforcement that Wall Street has grown accustomed to during four years of President Donald Trump are over. Here’s an overview of what the pending appointments mean for the agencies and for the financial industry.
Robinhood and SPACs
Robinhood Markets and special purpose acquisition companies — or SPACs — were among the finance industry’s hottest phenomenons in 2020. Both are sure to draw Gensler’s attention.
Robinhood, with its popular smartphone app, rode a wave of Covid 19-fueled day trading to add millions of customers. But critics say the company represents a disturbing trend of brokerages encouraging less-sophisticated investors to take risks that they don’t understand — and Gensler is likely to face pressure from progressives to erect new guardrails.
Robinhood has disputed claims that its platform promotes a “gamification” of trading as an inaccurate depiction of its business, saying its goal is to “democratize” wealth creation and investing by enabling a new class of consumers to trade shares and other assets.
Critics, including former SEC Chairman Arthur Levitt, say what’s needed is an aggressive examination by the regulator of whether apps use technological nudges to inappropriately stimulate excessive and even addictive trading. Robinhood has also faced repeated calls to improve its customer service, something the firm says it’s doing.
There’s another concern that the Robinhood-led boom in retail trading is inflating a stock bubble that could pop, triggering steep losses for investors — something that also worries progressives.
SPACs, which list on public exchanges to raise money to buy companies, have already been drawing scrutiny from the SEC. The attention is a direct result of how hot they are, with the vehicles used to raise a record $79.2 billion from U.S. investors in 2020.
Jay Clayton, who stepped down as SEC chairman last month, has said he’s concerned that potential investors aren’t receiving appropriate disclosures about conflicts and insiders’ lucrative pay structures. That prompted the agency to launch a review, which would now fall to Gensler.
Volcker Rule and Private Equity
After the 2008 financial crisis, Gensler solidified his status with progressives by insisting on a tough version of the Volcker Rule. The regulation, which banned proprietary trading by Wall Street banks, was eased during the Trump administration. Goldman and other firms will now be watching to see whether Gensler leads an effort among regulators to bolster its restrictions.
Another area in which Gensler is likely to square off with big names in finance is over the SEC’s approach to regulating private-equity firms. During the Trump era, the SEC sought to remove regulatory barriers that prevent private equity from raising money from retail investors. Progressives are hopeful that Gensler will move in the other direction, by bringing more transparency to buyout firms, which Warren and other lawmakers blame for loading companies with unsustainable debt burdens and cutting jobs.
A Crackdown on Chinese Stocks
One area that will demand Gensler’s attention is rising tensions between the U.S. and China — fighting that is now being waged in financial markets.
Congress passed legislation late last year that could lead to Alibaba Group Holding Ltd., Baidu Inc. and other Chinese companies getting kicked off of U.S. stock exchanges if they continue their non-adherence to American auditing rules.
At issue are longstanding American requirements that all publicly traded companies in the U.S. allow their auditors to be inspected by the Public Company Accounting Oversight Board. Gensler will be responsible for writing rules that make Chinese companies comply. Their penalty is possible ejection from U.S. markets.
The crackdown would follow a separate one already initiated by the Trump administration, which issued an executive order in November that requires American investors to sell their stakes in Chinese companies deemed a threat to U.S. national security.
New Rules For Crypto
Bitcoin is on a tear again, having surged roughly four-fold last year. That means it and other cryptocurriencies are likely to get renewed attention from Gensler’s SEC.
He’s quite familiar with the industry, having taught a class about it at the Massachusetts Institute of Technology, and has called for more regulation.
Some in the industry argue that more oversight wouldn’t necessarily be a bad thing because, right now, many institutional investors shy away from the space, as they see it as akin to the Wild West. As a result, stiffer rules might bring more capital flows to digital tokens.
Environment And Diversity
Progressives have long contended that the SEC should have just as strong a role in responding to climate change as more obvious agencies such as the Environmental Protection Agency.
A change at the top of liberals’ wish list is for the SEC to require public companies to boost disclosures of how a warmer planet and less-reliance on fossil fuels could impact profits, a move that could hit oil companies particularly hard.
Gensler could show he’s serious about such concerns by prioritizing whats known as environmental, social and governance investing, or ESG. One way he may do that is by establishing a new SEC office that’s dedicated to ESG issues.
The diversity of C-Suites and public companies’ employees is also a top focus for progressives, who want the SEC to force businesses to disclose more information on race and gender.
Chopra’s Quick Fix
One reason Chopra was picked for the CFPB, progressives say, is that he’s uniquely qualified to get a fast start in reversing some of Trump’s policies on day one.
Since he already holds a Senate-confirmed post as a Democratic member of the Federal Trade Commission, federal law allows him to join the CFPB immediately as its acting chief. In such an arrangement, he would be able to retain his position at the FTC and run the CFPB for about 300 days before the Senate signs off on his nomination.
While an official nod from the Senate is likely with Democrats poised to take control of the chamber, the several weeks or months it might require for confirming a CFPB chief is much longer than progressives are willing to wait.
The regulator’s shift under Trump has been impossible to miss. Since the outgoing president’s appointees took over in late 2017, it has imposed just a single fine against one of the U.S.’s six largest banks — a $500 million penalty against scandal-ridden Wells Fargo & Co. for allegedly overcharging auto lending and mortgage customers.
Banks from Wall Street to Main Street are expecting the CFPB to review the controversial — and lucrative — practice of lenders penalizing depositors when they spend money that they don’t have in their accounts. Known as overdraft fees, such charges generate some $12 billion annually for U.S. banks.
Consumer advocates also want Biden’s incoming CFPB chief to bring back an Obama-era rule that required payday lenders to assess prospective borrowers’ abilities to repay their loans.
Companies that provide short-term credit such as Enova International Inc., Curo Group Holdings Corp. and Elevate Credit Inc. could come under pressure, Height Capital Markets analyst Edwin Groshans told clients earlier this month.
Bitcoin Dips After Gensler Says SEC Must Root Out Crypto Fraud
Cryptocurrency enthusiasts exhibited a bit of nerves during Tuesday’s Senate confirmation hearing for Gary Gensler, the nominee for chairman of the U.S. Securities and Exchange Commission.
Bitcoin dipped to the lowest levels of the day after Gensler said that insuring that cryptocurrency markets are free of fraud and manipulation is a challenge for the agency. The largest cryptocurrency declined as much as 3% to $47,341 in New York trading. It has jumped about 65% since December.
Gensler, who served as a Commodity Futures Trading Commission chairman during the Obama administration, has been viewed as a strong advocate for digital assets. He serves as a senior advisor to the MIT Media Lab Digital Currency Initiative and teaches about blockchain technology and digital currencies.
State of Crypto: How SEC Chair Gary Gensler Could Differ From Predecessor Jay Clayton
Gary Gensler will testify before the U.S. Senate Banking Committee today for a confirmation hearing on his nomination to lead the SEC.
Gary Gensler ran the Commodity Futures Trading Commission (CFTC) after the 2008 financial crisis. Now, he’ll get a chance to run its securities-regulating counterpart.
Former Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler has been nominated to run the Securities and Exchange Commission (SEC) by President Joe Biden. Gensler unites a pro-regulation history with a pro-crypto viewpoint, and could finally implement the regulatory clarity many in the industry have desired.
In this, he’s likely to depart from predecessor Jay Clayton, who repeatedly said he believed initial coin offerings are securities but did not provide much guidance on when or how tokens might be classified as something other than a security.
Today, the U.S. Senate Committee on Banking, Housing and Urban Affairs will hold a hearing to consider his nomination for chairman of the SEC.
Why It Matters
Should he be confirmed, Gensler will shape crypto policy over the next several years, though it’s an open question if the industry will love the rules he implements. Under his tenure, the CFTC approved nearly 70 rules or pieces of guidance, and he may just regulate the hell out of crypto. He told the Senate Banking Committee he intends to continue focusing on consumer protection at the SEC.
“We have seen that when the SEC does its job – when there are clear rules of the road and a cop on the beat to enforce them – our economy grows and our nation prospers.,” Gensler said in his prepared remarks.
Companies are already hinting at or have announced plans to file to launch a bitcoin exchange-traded fund (ETF), a retail-accessible product that the industry has been pursuing for years. Some in the industry hope that under Gensler the SEC might finally create “bright-lines” regulatory guidance that clearly defines when a token is a security and when one is not.
He’ll also oversee litigation against companies that SEC staff believe have violated federal securities laws, including the high-profile lawsuit against Ripple Labs.
Breaking It Down
Like many of Biden’s nominees, Gensler was an official in former President Barack Obama’s administration. As CFTC chair, he had a major role in the Dodd-Frank Act, which sought to bring some consumer-focused reforms to Wall Street. Gensler has been a part of Team Biden since the president won the White House last year; Biden announced Gensler would lead his Wall Street reform team just days after news organizations projected his victory.
Many of his views on the digital asset space can be found in the transcripts of his lectures at MIT, some of which my colleague Danny Nelson went through. Gensler gave these lectures in 2018, though he has remained active in the industry as a member of the MIT Digital Currency Initiative.
He’s also spoken out about blockchain over the past several years. Below is a summary of his views on some issues that are important to the crypto industry.
A day before former SEC Chair Jay Clayton stepped down, the securities regulator filed a lawsuit alleging Ripple Labs, the San Francisco startup closely associated with the XRP cryptocurrency, had violated securities laws for over seven years by selling XRP in unregistered securities transactions.
Other senior SEC staff, including now-former Director of Enforcement Stephanie Avakian, also departed around that time. If approved, Gensler will inherit an agency overseeing one of its highest-profile crypto cases.
In his own words, Gensler believes XRP is “a non-compliant security,” though he said (again, this is from 2018) that it would require the courts to make that determination, “whether it’s appellate courts or the Supreme Court.”
He went on to explain that he believes XRP meets the requirements of the Howey Test, the Supreme Court case often used to determine whether something is a security.
The SEC has spent years suing companies that conducted initial coin offerings (ICOs) without registering their tokens as securities, often because they raised money specifically to build a project that could issue a token that investors could re-sell at a profit.
Gensler raised concerns about information asymmetry in one of his lectures, noting that U.S. law is designed to protect investors and consumers. He’s also expressed concern that ICOs, which were numerous in 2018, might violate securities laws, particularly given the projects that launched without having any code or tokens developed.
“Jay Clayton, who runs the SEC, has said in congressional testimony in February that he hadn’t met an ICO that he didn’t think was a security … But it wasn’t quite enough,” Gensler said.
He said early tokens may fail, but as some projects go live they could provide a roadmap for how future projects could succeed, pointing to Telegram (which ended its blockchain ambitions after the SEC sued) and Filecoin (which went live last year).
Central bank digital currencies (CBDCs) are becoming increasingly popular, with multiple central banks now trialing different types of sovereign digital currencies. In Gensler’s view, CBDCs could bring efficiencies to cross-border remittances or local payments.
Central Banks Have To Understand Why They Would Launch A CBDC And What The Benefit Would Be, He Said, Explaining:
“The strategic question for the central banks is, should we allow direct access to digital reserves? We have this intermediated central bank digital reserve called bank deposits, but should we have something direct to us? Like cash is a direct relationship between the central bank and the holder.”
Still, in that same lecture Gensler noted that a CBDC doesn’t necessarily need to rely on a blockchain platform, a view echoed by Boston Fed and MIT Digital Currency Initiative researchers looking into different technology bases that could support a digital dollar.
In 2019 Gensler participated in a wargaming exercise that looked at a hypothetical future where the digital yuan, China’s effort at a central bank digital currency, was live and used by the government of North Korea to bypass U.S. sanctions. The premise of the exercise was the U.S. may need to revisit how it enforces its sanctions regime, which basically seeks to lock individuals or entities out of the global financial system.
“I think it’s good to have a healthy debate about where we stand with the U.S. dollar, our reliance on SWIFT – the international messaging system – for a tool in our sanctions regime that we the U.S. have,” Gensler told CoinDesk ahead of the exercise. “We’re using it as a tool in geopolitics, a digital form of blockade that in the 17th and 18th and even in the 19th century, what one would have to do with ships we’re doing digitally.”
Gensler further noted during his MIT lectures that other countries could use CBDCs as part of an effort to bypass U.S. sanctions, citing Venezuela and Iran, both of which had announced efforts to create sovereign digital currencies at the time.
Does Crypto Fund Terrorism?
Last week, the U.S. House Financial Services Committee’s Subcommittee on National Security, International Development and Monetary Policy held its long-awaited hearing on domestic terror financing. You can read my preview and summary but my immediate impression was that it seems good crypto wasn’t being scapegoated as this tool for terror financing, despite multiple statements of concern by Treasury Secretary Janet Yellen and other lawmakers.
The hearing almost went in that direction at the beginning, when Rep. James Himes (D-Conn.), the subcommittee’s chair, asked the witnesses to speak to whether cryptocurrencies were enabling easier terror financing.
Instead, the witnesses compared cryptocurrencies to systems like PayPal or GoFundMe, and called for better moderation efforts by the companies behind these tools.
That said, the proposed FinCEN counterparty rule was raised multiple times, and so it is worth keeping an eye on any next steps here.
Robinhood, GameStop and Whether Blockchain Fixes This™
I wasn’t planning on talking about the Robinhood-GameStop thing again but the Depository Trust and Clearing Corporation (DTCC) published a proposal to shorten settlement times from T+2 to T+1, on the same day GameStop’s stock jumped like 100%. So let’s take a quick look.
First Off: If the bit about T+2 to T+1 didn’t make sense, read this article first, then come back to the newsletter.
Okay, so moving to T+1 requires industry agreement, meaning participants have to get together and say, “We think one-day settlement makes financial and operational sense and that we are all capable of handling it.” Robinhood CEO Vlad Tenev has come out in favor of shortened settlement times, blaming T+2-related margin requirements for why his company had to suspend trading in volatile securities last month.
The DTCC said in a blog post after that incident that it didn’t have the authority to unilaterally make that decision, but now “based on extensive industry engagement conducted throughout 2020,” it seems the industry could be open to faster settlement.
The DTCC has looked into whether blockchain in particular can offer a T+0/1 settlement solution through its Project Ion last year. In short, a distributed ledger-based settlement system can effectively shorten settlement times, though the Project Ion proof-of-concept paper noted that its PoC focused on usability over scalability.
“It’s important to note that NSCC and DTC can support T+1 and even same-day (T+0) settlement today, using existing technology. In fact, NSCC clears T+1 and T+0 trades every day and DTC is already a T+0 settlement platform. However, the current T+2 settlement cycle is a convention of market practice,” last week’s white paper said.
Gary Gensler’s confirmation hearing is today, as is that of CFPB Director-Nominee Rohit Chopra. I’ll be live-tweeting the hearing (shameless plug here). As of press time, there’s still no formal nomination for the next heads of the CFTC or OCC.
What Gary Gensler Thinks About Bitcoin’s Future
Cryptocurrency enthusiasts have been eyeing Joe Biden’s pick to run the US Securities and Exchange Commission for clues about how he might regulate the technology. In his confirmation hearing today, nominee Gary Gensler suggested that more government oversight of cryptocurrencies was in the offing.
He also hinted that the type of oversight will depend on which form of cryptocurrency is under discussion. With crypto prices on a tear in recent months, the frenetic debate about whether the rapidly evolving market constitutes a legitimate new asset class or a bubble ripe for abuse has turned into a regulatory conundrum, as institutional and retail investors race ahead of rules to govern the space.
As head of the SEC, Gensler would be in charge of cryptocurrencies deemed to be securities. During the Senate Banking Committee hearing, Gensler said that while the SEC should promote innovation in blockchain technology, if there are securities involved that trade on exchanges, “we want to ensure that there’s appropriate investor protection.”
This thinking isn’t new. Using the definition of a security to determine how a financial instrument should be regulated, known as the Howey test, dates back to a 1946 Supreme Court ruling, devised to help define which transactions constitute an investment contract. It’s a rule Gensler knows well.
He is known in progressive circles as a tough financial sector reformer from his post-financial crisis days as head of the Commodities Futures Trading Commission, but he is also hailed by the crypto crowd for his understanding of blockchain technologies, as an MIT economics professor who teaches about blockchain, digital currencies, and financial innovation.
Gensler’s comments during the hearing echo his teachings on the Howey test. By this logic, cryptocurrencies are generally either defined as utility tokens, which act like a form of tender, or security tokens, which represent equity or share in a company that would be regulated by the SEC.
If a coin offering is meant to give investors an ownership stake, then the company’s token should be subject to the regulations of a security, he told an audience at a 2018 MIT blockchain conference, even if it doesn’t offer a dividend, or have the typical attributes of an equity or bond.
“The investing public is clearly hoping for possible appreciation,” Gensler said. “When you quack like the duck, when you swim like the duck, when you walk like the duck…I think the bird’s a duck.”
Bitcoin, the most ubiquitous virtual currency, doesn’t qualify as a security, according to Gensler. “Bitcoin came into existence as mining began as an incentive in validating a distributed platform,” he said at the conference. Unlike other cryptocurrencies being offered by companies like Ripple, bitcoin had no initial token offering and no common enterprise.
Ripple, on the other hand, “sure seems like a common enterprise,” he concluded.
The SEC has since followed that logic. In December, it sued Ripple for selling a bitcoin-like digital asset called XRP, a high-profile case Gensler will inherit if he’s confirmed as the agency’s new chair.
Bitcoin’s value dipped on jitters about Gensler’s comments during the confirmation hearing. But according to the Howey test, those investors should be in the clear.
Former SEC Chairman Jay Clayton Joins Crypto Advisory Board
Clayton, who stepped down from the SEC in 2020, joins the regulatory advisory council of One River Asset Management.
Three months after resigning from the United States Securities and Exchange Commission, or SEC, Jay Clayton has joined an advisory board of crypto investment manager One River Asset Management, signaling a changing of the guard for the former securities regulator.
Clayton, along with Kevin Hassett of The Lindsey Group and Jon Orszag of Compass Lexecon, joins One River Asset Management’s newly formed academic and regulatory advisory council, the company announced Monday.
Although Clayton’s exact role within the advisory group wasn’t specified, One RIver CEO Eric Peters said his goal was to bring together distinguished individuals with “varying regulatory and policy experience.”
“We were impressed by Eric’s willingness to hear our varying views on the digitization of our monetary, banking and capital markets ecosystem and One River’s commitment to transparency,” Clayton said.
Clayton served a three-and-a-half-year stint at the SEC before resigning on Dec. 23, 2020. His tenure was defined by a substantial increase in monetary remedies, possibly to the tune of over $14 billion, and returning billions to harmed investors.
He was also present during the last cryptocurrency bull market when Bitcoin (BTC) mania reached mainstream investors. In 2019, Clayton warned investors they would be “sorely mistaken” if they expect that the cryptocurrency would be tradeable on major exchanges without more stringent regulations in place.
One River Asset Management emerged as a pivotal Bitcoin player in late 2020 by scooping up $600 million in crypto assets. At the time, the firm said it expected to own roughly $1 billion worth of BTC and Ether (ETH) by the first half of 2021. Those targets may have already been met, given the rapid appreciation of crypto assets so far this year.
Former SEC Chair Jay Clayton Tips New Bitcoin Regulations Are Coming
The former SEC chairman warns that regulation will come both directly and indirectly.
Former US Securities and Exchange Commission Chair Jay Clayton has stated that Bitcoin has not been classified as a security for a long time.
But speaking on CNBC’s Squawk Box on March 31, Clayton warned that its status as a non-security still does not protect it from the imposition of new regulations which, he warned, could be coming soon.
“Where digital assets land at the end of the day–will be driven in part by regulation both domestic and international, and I expect that regulation will come in this area both directly and indirectly,” says Former SEC Chairman Jay Clayton on #bitcoin. pic.twitter.com/voWcgCFqOH
— Squawk Box (@SquawkCNBC) April 1, 2021
Host Andrew Ross Sorkin pointed out that under Clayton’s watch the SEC did not take a position on Bitcoin regulation. Clayton responded that was because the asset was declared not to be a security before he even took up his position as the head of the regulatory body.
“Bitcoin was decided to be not a security before the time I got to the SEC. Therefore, the SEC’s jurisdiction over Bitcoin was rather indirect.”
Clayton has remained in the industry following his departure from the SEC in December 2020 and currently advises One River Asset Management on cryptocurrencies.
Although he professes not to have any special insights into what new laws are coming from his time heading up the SEC, he believes the regulatory environment is due for a shake up.
“Where digital assets land at the end of the day […] will be driven in part by regulation—both domestic and international—and I expect, and I’m speaking as a citizen now, that regulation will come in this area both directly and indirectly whether it’s through how these are held at banks, security accounts, taxation and the like. We will see this regulatory environment evolve.”
Clayton’s comments come just a week after billionaire hedge fund manager Ray Dalio warned that the U.S. may ban Bitcoin outright just as they did with gold in the 1930s.
His comments about Bitcoin’s status as a non-security are also interesting in light of Ripple’s appeals to the SEC for documents from the agency to determine how exactly it came to the conclusion that Bitcoin and Ethereum were not securities.
The company and its backers have repeatedly argued that XRP is not a security however the SEC believes it is markedly different due to being morcentralized. Former SEC attorney Marc Powers told Cointelegraph that the agency is executing significant overreach in its case against Ripple and its executives.
US Senate Votes To Confirm Gary Gensler As SEC Chair
Gensler’s confirmation comes almost three months after President Joe Biden first announced he was his pick for the SEC.
Voting mostly along party lines, the U.S. Senate confirmed the nomination of Gary Gensler to chair the Securities and Exchange Commission, or SEC.
In a vote of 53-45 today, the Senate members confirmed the former chair of the Commodity Futures Trading Commission, or CFTC, to lead the Securities and Exchange Commission. Gensler, a professor at the MIT Sloan School of Management, volunteered to join then President-elect Joe Biden’s team as a financial expert in November. Biden announced the former CFTC was his pick to chair the SEC shortly before his inauguration in January.
During his confirmation hearings with the Senate Banking Committee last month, Gensler was seemingly evasive about whether he would implement changes to SEC policy regarding crypto. However, he said he supported some of the body’s prior decisions, like the exclusion of Bitcoin (BTC) from the commission’s regulatory purview.
“Bitcoin and other cryptocurrencies have brought new thinking to financial planning and investor inclusion,” said Gensler at the time. “I’d work with fellow commissions both to promote the new innovation but also, at the core, ensure investor protection. If something were a security, for instance, it comes under security regulation, under the SEC.”
Gensler served as chairman for the CFTC under President Barack Obama from 2009 until 2014. He was known as a stringent regulator during his time as CFTC head, overseeing reforms to the $400 trillion financial derivatives market.
SEC Chair Hints At Greater Regulatory Oversight For US Crypto Exchanges
Gary Gensler said a regulatory framework for digital assets from the SEC or CFTC “could instill great confidence” for investors.
Recently confirmed U.S. Securities and Exchange Commission chair Gary Gensler punted to congress on providing more regulatory oversight to the crypto space, but also said the commission would act within its purview.
In a virtual hearing held by the House Financial Services Committee today, North Carolina Representative Patrick McHenry asked Gensler what the regulatory body would be doing to ensure a “vibrant digital asset marketplace with legitimate money and the rule of law.” McHenry highlighted collaborations across regulatory agencies regarding digital assets and cryptocurrencies.
Gensler said the crypto market could benefit from “greater investor protector” within the Securities and Exchange Commission’s, or SEC’s, current authority around securities and other financial products.
He added that he believed only the U.S. Congress had the power to address such regulatory oversight rather than having the commission overreaching its authority under his leadership.
“Right now, the exchanges, trading in these crypto assets, do not have a regulatory framework either at the SEC or our sister agency, the Commodity Futures Trading Commission,” said Gensler. “That could instill great confidence. Right now, there’s not a market regulator around these crypto exchanges, and thus there’s really not protection against fraud or manipulation.”
The hearing today was the third held regarding the controversy over GameStop stock shorts earlier this year. Lawmakers have been exploring allegations of market manipulation from Robinhood and major hedge funds in response to Redditors’ short squeeze of GameStop stock and others. The price of GME has been volatile since peaking at $469.49 on Jan. 28, falling to under $50, and since fluctuating between $100 and $300.
Senate members officially voted on Gensler’s nomination last month, meaning this was his first hearing on the GameStop controversy as SEC chair. During his confirmation hearings with the Senate Banking Committee, Gensler said he supported the SEC excluding Bitcoin (BTC) from its regulatory purview.
Gary Gensler’s Regulatory Clarity Sounds Awfully Familiar
Gary Gensler said Congress should provide clarity around crypto exchange regulation. A 2020 bill sought to do just that.
SEC Chair Gary Gensler’s been on the job for three weeks. He’s just revealed what increased regulatory clarity might look like for crypto.
Securities and Exchange Commission Chairman Gary Gensler, three weeks into the job, said the U.S. Congress could help protect cryptocurrency investors by drafting some laws around crypto exchange regulation, noting the current, limited jurisdiction of the SEC.
“I think that this market, which is close to $2 trillion, [this] crypto asset market is one that could benefit from greater investor protection,” he said.
“I think if [Congress were to take action] – because right now the exchanges trading in these crypto assets do not have a regulatory framework, either at the SEC, or our sister agency, the Commodity Futures Trading Commission – that could instill greater confidence. Right now there’s not a market regulator around these crypto exchanges, and thus there’s really no protection against fraud or manipulation.”
Why It Matters
Okay, some thoughts. First off, a (HUGE!) caveat that this is all speculation on my part.
With that out of the way, the entirety of the crypto industry’s support of Gensler comes from the idea that he understands crypto in a way his predecessor did not, and that this would lead to regulatory clarity. We now have a hint of how Gensler thinks he can provide this clarity.
Any number of issues pertinent to the crypto industry will depend on how the U.S.’ regulatory framework develops, including whether a bitcoin exchange-traded fund (ETF) is approved and how retail investors can tap the crypto market. The question becomes: Will Congress act with Gensler’s backing?
Breaking It Down
What we don’t know are the specifics. There’s no concrete SEC or CFTC framework from Gensler right now. What we do know is that he thinks one of these agencies should have clearer oversight authority to address possible fraud or manipulation around the cryptocurrency markets.
Of course, exchanges are regulated right now at the state level. There are problems with this, though. For one thing, an exchange must secure money transmitter licenses in every state where it wants to operate (except Montana, which doesn’t have a licensing regime), which takes money and time. I’m not sure whether Gensler’s proposed federal framework would supersede the state-by-state approach, but if it did, does that would be massive.
It’s the same problem that former Comptroller of the Currency Brian Brooks (now Binance.US CEO) tried to address with a federal trust charter to crypto companies. (While a few crypto custodians now have trust charters, it remains to be seen whether any exchanges will receive one.)
Both the SEC and CFTC have also demonstrated their oversight of the crypto markets with enforcement actions, but it sounds like Gensler’s going for something bigger. Though the CFTC has also laid claim to a number of crypto spot markets, there’s questions as to whether it actually has the authority to do so. So, in essence, it appears that what Gensler wants is some form of codified confirmation that a federal agency has oversight jurisdiction over the crypto markets in the U.S.
Here’s the next thing: We’ve seen this type of proposal in Congress already. Rep. Michael Conaway (R-Texas) introduced the Digital Commodity Exchange Act in the House of Representatives last year before he retired. That bill outlined how digital currencies could be treated similarly to commodities under federal law and, more importantly, it would create a federal jurisdiction for crypto exchanges.
To the best of my knowledge, there are no immediate plans to reintroduce the DCEA but it does seem like Gensler’s first recommendation has a frame all ready to go if someone in Congress does want to act on it.
It could also, if passed, have a somewhat more immediate impact than the Eliminate Barriers to Innovation Act, sponsored by Rep. Patrick McHenry (R-N.C.), who asked Gensler about digital asset regulation. McHenry’s bill, which has been passed by the entire House, would form a working group that studies the issue sends Congress recommendations after a year, versus the DCEA, which would skip the study aspect.
This extends beyond just the possible impact on exchanges. If Gensler believes the crypto industry in the U.S. needs more oversight, and in particular is concerned about market manipulation on exchanges, that might mean regulated products dependent on trustworthy exchanges won’t be approved before that oversight is in place.
Market manipulation, after all, is an issue the SEC has brought up repeatedly in denying approval of bitcoin exchange-traded fund (ETF) applications. As Bloomberg senior ETF analyst Eric Balchunas tweeted, Gensler may want this oversight to be formalized into law before an ETF is approved.
The possible downside I see here is if a new federal regulatory framework comes on top of the existing state-by-state regime. That would just become an additional burden on exchanges.
There’s also the risk a federal framework would benefit larger, more established exchanges and become too difficult for smaller competitors to match, which would lead to some consolidation. The DCEA, as envisioned last year, would offer exchanges a choice of federal or state regimes to follow, so theoretically it wouldn’t result in a greater burden or consolidation.
I don’t know whether Gensler’s first public comments on crypto as SEC chair are a positive or negative sign for the industry. My view on Gensler’s nomination and confirmation has always been that he is likely to provide regulatory clarity, but it may not necessarily be the type of regulatory clarity the industry wants.
That being said, my impression so far is that if Congress gets together and acts on this recommendation, this will be a long-term positive, both by giving exchanges some of that clarity they want and by giving retail or institutional investors more comfort about how their assets are regulated.
Last Wednesday, the Federal Reserve published a proposal to allow financial institutions with novel banking charters access to accounts and services offered by the Fed. In other words, non-traditional financial institutions – like, say, crypto exchanges with certain charters – would be able to tap the Fed directly for an account rather than have to go through an intermediary bank.
If finalized (there’s currently a 60-day comment period on the proposal), the rule would mean entities like Wyoming-licensed Special Purpose Depository Institutions would be one step closer to acting as a full bank native to the crypto industry.
“The payments landscape is evolving rapidly as technological progress and other factors are leading to both the introduction of new financial products and services and to different ways of providing traditional banking services (i.e., payments, deposit-taking, and lending).
Relatedly, there has been a recent uptick in novel charter types being authorized or considered across the country and, as a result, the Reserve Banks are receiving an increasing number of inquiries and requests for access to accounts and services from novel institutions,” according to the 20-page proposal.
David Kinitsky, the CEO of Kraken Bank, one such Wyoming-chartered bank, told CoinDesk his company had already applied for an account with the Fed, meaning this proposal is “of vital importance to us.”
The fact the Fed has taken the step of publishing this proposal is a good sign in and of itself, he said.
“We’re stoked about how they’re approaching it, with a risk-based approach,” he said. “There’s nothing novel in terms of the factors that they’re including here. It’s exactly the type of things that the Federal Reserve is looking at, in terms of risk to the reserve itself, risk to the payment system [and] risk to the economy.”
In other words, fintech or crypto platforms won’t have to jump through extra hoops simply because they’re within the fintech or crypto industries.
Kraken Bank intends to maintain full reserves for the assets it holds rather than operate any fractional lending services or otherwise engage in fractional banking, Kinitsky said.
This means the liquidity and solvency risks that other banks might face aren’t an issue for Kraken Bank, he said. Kraken Bank does not intend to apply for Federal Deposit Insurance Corporation insurance at this time for that reason.
That’s not to say the Fed is comparing these alternate-charter institutions to banks. In Kinitsky’s view, the U.S. central bank is trying to determine how best to evaluate novel financial institutions in their own right.
“I think it’s a really positive acknowledgement of the validity of some of these alternative charters that are eligible,” Kinitsky said. “… We don’t want big banks to be gatekeepers, in effect, for them through banking as a service platform. It’s super, super important. It keeps us up to speed with other kinds of global regions like the U.K. faster payments initiative.”
On Friday, Treasury Secretary Janet Yellen announced Michael Hsu would be taking over as the Acting Comptroller at the Office of the Comptroller of the Currency, effective Monday. Hsu comes from the Federal Reserve, where he was a part of the bank supervision division, so he’s got experience overseeing major financial institutions.
I’m not sure if he has any crypto background or where he’ll take former Comptroller Brian Brooks’ work from the past year. I’m also not sure if Hsu will eventually be nominated to become the full comptroller.
Has anyone heard anything about the CFTC?
Gensler Says SEC Should Be ‘Ready To Bring Cases’ Involving Crypto
The SEC chair continued to highlight investor protection as he previewed the regulator’s cryptocurrency enforcement efforts.
U.S. Securities and Exchange Commission (SEC) chief Gary Gensler said Thursday that federal financial regulators should “be ready to bring cases” against bad actors in crypto and other emerging technologies.
“As we continue to stay abreast of those developments, the SEC and FINRA [the Financial Industry Regulatory Authority] should be ready to bring cases involving issues such as crypto, cyber and fintech,” Gensler told FINRA conference attendees. He highlighted investor protection throughout his brief remarks.
The statements come as federal agencies propose upgrades to their crypto-monitoring efforts, from the Internal Revenue Service asking businesses to disclose high-value transactions to lawmakers calling for reviews of crypto-friendly banking policies.
“We need to do whatever we can to ensure that bad actors aren’t playing with working families’ savings and that the rules are enforced aggressively and consistently,” Gensler said.
He said regulators should be ready to pursue deceptive private funds, accounting fraud, insider trading and a bevy of other potential regulatory pitfalls rippling throughout the capital markets.
While hardly offering a playbook, Gensler’s remarks may bolster the perception that investor protection is a top priority for the Biden Adminstration’s SEC – especially when it comes to crypto.
Perhaps more telling was the SEC’s May 11 warning to investors in mutual funds that trade bitcoin futures. Though it contained no allegations of fraud, the memo highlighted bitcoin’s legendary volatility and instructed SEC staff to consider suspicious activity in the space.
US SEC Wants To Work With Congress To Regulate Crypto Exchanges
SEC head Gary Gensler said that the authority spends only $325 million per year on tech, which is less than some industry players spend in two weeks.
The United States Securities and Exchange Commission is looking to cooperate with Congress and other regulators to increase its oversight of cryptocurrency exchanges.
Gary Gensler, the newly appointed chairman of the SEC, said that the commission is looking forward to working with fellow regulators and Congress to fill gaps in investor protection in crypto markets.
The official announced the plans at a Wednesday hearing before the Financial Services and General Government subcommittee of the House of Representatives.
Gensler said that the SEC needs to provide similar protections for crypto exchanges that an investor would get on the New York Stock Exchange or Nasdaq:
“If you placed an order on an app, and you said, ‘Alright, I want to buy a stock,’ there are rules that protect you that somebody won’t use your order and get ahead of you. […] So, it’s trying to bring the similar protections to the exchanges where you trade crypto assets as you might expect at the New York Stock Exchange or Nasdaq.”
The new SEC head also outlined some of the challenges to regulating the cryptocurrency industry, stating that the SEC is “under-resourced” in financial terms when compared with some of the big players in the industry. “We only spend about 16% or 17% of our budget, about $325 million a year, on technology, which is less than probably some large firms spend in a month. Some of them even spend that much in two weeks,” he noted.
Gensler previously suggested that the SEC should be cooperating with Congress to properly address crypto exchange regulation in a market volatility-related hearing of the House Financial Services Committee in early May.
Last week, Michael Hsu, the new head of the Office of the Comptroller of the Currency, announced that the agency has been in talks with the U.S. Federal Reserve and the Federal Deposit Insurance Corporation about setting up an “interagency policy sprint team” focused exclusively on crypto.
US Regulators Must Collaborate On ‘Regulatory Perimeter’ For Crypto: OCC Head
Acting OCC head Michael Hsu wants greater interagency cooperation in establishing regulatory guidelines for the crypto sector.
The acting comptroller of the currency, Michael Hsu, has stated that regulatory agencies in the United States should establish a “regulatory perimeter” for digital assets and cryptocurrencies.
In an interview with Financial Times, Hsu indicated that U.S. regulators will look to take a more active role in policing the crypto-asset sector with an emphasis on minimizing the associated risks faced by investors and consumers.
“It really comes down to coordinating across the agencies,” Hsu said, adding: “Just in talking to some of my peers, there is interest in coordinating a lot more of these things.”
Hsu noted that the first meeting of the interagency, crypto-focused “sprint” team took place earlier this month. The team comprises representatives from the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency.
Hsu described the group as “small” but “senior,” adding that it is tasked with presenting “ideas in front of the agencies to consider” rather than formulating policy. Hsu emphasized the speed of growth and innovation in the crypto sector, asserting that a failure to begin acting now will only make policing the sector harder in the future:
“The idea is that time is of the essence and if it’s too big that gets harder.”
Hsu is not alone in thinking the United States lacks robust regulatory guidelines for crypto assets, with Securities and Exchange Commission Chairman Gary Gensler highlighting “gaps” in the “current system” regarding crypto while speaking to a House committee last month.
Gensler noted the Treasury Department has recently focused on “anti-money laundering and guarding against illicit activity” in the digital asset industry.
SEC Chair Wants Robust Crypto Regulatory Regime For The US
America’s securities chief has crypto regulatory ambitions beyond ETFs and token offerings, which include markets like lending and DeFi.
Gary Gensler, chairman of the United States Securities and Exchange Commission, is reportedly keen on bright-line regulations for the country’s crypto space.
Gensler expressed the SEC’s desire to install safeguards for crypto investors in the U.S. in a Bloomberg interview, stating, “If somebody wants to speculate, that’s their choice, but we have a role as a nation to protect those investors against fraud.”
The SEC chairman identified seven crypto-related policy changes currently being examined by the Commission. These include matters concerning token offerings, decentralized finance (DeFi) and stablecoins. Other focus points for Gensler’s SEC are custody, exchange-traded funds (ETF) and lending platforms.
According to Gensler, crypto exchange regulations might be the most straightforward way to achieve SEC oversight of the crypto trading arena. However, such legal policies may also include decentralized exchanges as well as other DeFi players.
Gensler also identified the crypto lending market as coming under the SEC’s radar. Indeed, as previously reported by Cointelegraph, the flurry of state regulatory actions against crypto lending giant BlockFi might be a bellwether for future SEC action in the market segment.
For Gensler, the interest-rate advertising aspect of these companies and the pooling of digital assets to offer returns serve as entry points for the SEC to impose regulations akin to those enforced on mutual funds.
While Gensler is indeed keen on introducing regulatory clarity to the U.S. crypto market, these measures are reportedly not on the agenda for the SEC at the moment.
With close to 50 non-crypto-related policy matters on the Commission’s plate, crypto regulations might be on the backburner for now. Indeed, with environmental, social and corporate governance and meme stocks issues, some market commentators say a Bitcoin ETF in 2021 is unlikely.
Meanwhile, members of Congress, including Senator Elizabeth Warren, continue to push for stricter cryptocurrency policing.
SEC Chief Gary Gensler Braces For Clash With Crypto Traders
Gensler wants to regulate digital assets to the same extent as stocks, bonds and commodity-related trading instruments.
Securities and Exchange Commission Chairman Gary Gensler this week declared war on what he called the Wild West of crypto trading, promising a vigorous attack on fraud and misconduct. But progress is likely to be more piecemeal and incremental than wholesale and sudden.
Mr. Gensler outlined his desire to regulate digital assets such as bitcoin and other crypto products to the same extent as stocks, bonds and commodity-related trading instruments. He told the Aspen Security Forum on Tuesday that his priorities include newer innovations such as stablecoins and decentralized finance, products that are beginning to draw more mainstream investors.
The impulse to regulate these markets is growing more evident around the globe. Japan’s top financial regulator said Wednesday that plans to combat money laundering would also include digital currencies.
Mr. Gensler’s mission faces several obstacles, including the cryptocurrency industry’s historical resistance to following SEC rules. Because so many crypto developers have bypassed the SEC’s front door, the agency has tried to rein them in through enforcement, a slow process that requires investigating a particular product and either suing the team behind it or convincing them to settle and adopt the SEC’s requirements.
“There is going to be a more aggressive enforcement posture, and I think that is one way to bring order to chaos,” said Lee Schneider, a securities lawyer who has worked at several broker-dealers and cryptocurrency firms. “That is one way, but perhaps not the most effective or the most evenly distributed way.”
One of the biggest problems for Mr. Gensler is bitcoin, a cryptocurrency with a market capitalization of $710 billion and one that Washington has acknowledged is a commodity. Market regulators don’t have authority to write rules for how commodities are bought and sold—only for financial products such as futures whose value is tied to the real-world products.
Mr. Gensler has said Congress should create an investor-protection regime for bitcoin trading. But lawmakers tend to move slowly on financial-regulation overhauls, and typically write laws only after a crisis.
That means Mr. Gensler must use the SEC’s existing powers, which limit him to policing crypto assets that qualify as securities. Many are, but crypto developers insist SEC oversight doesn’t fit their technology and trading protocols.
To date, the SEC’s strategy has centered on suing token sellers on a case-by-case basis. The SEC has prevailed—through settlement or trial verdicts—in every such enforcement action it has filed. As a result, public sales of crypto tokens largely stopped, with startups limiting the deals only to private investors.
Late last year, the SEC sued Ripple Labs Inc. and two of its executives, Chris Larsen and Brad Garlinghouse, accusing them of raising $1.3 billion by selling an unregulated cryptocurrency, XRP, that should have been registered with the SEC.
Larger U.S. crypto exchanges reacted by halting trading in XRP. More crypto exchanges should reckon with whether they are dealing in unlicensed securities, the SEC chairman told CNBC on Wednesday.
“They’ve got to come in and let’s talk to them,” Mr. Gensler said. “Many of them right now are trying to say, ‘you know, well, well, we’re not going to come in.’”
Newer crypto innovations, such as stablecoins and decentralized finance, or DeFi, could form the next wave of enforcement targets, according to securities lawyers. Some stablecoins may meet the definition of mutual funds, while certain DeFi applications could be investments that should be registered with federal regulators, Mr. Gensler said.
Stablecoins, which seek to track the value of national currencies such as the U.S. dollar, are used by traders to shift value between exchanges and move between strategies. Total stablecoin supply is about $113 billion, more than triple the level from the start of the year, according to The Block, a news and data provider.
Forcing stablecoin issuers to register the assets as securities could be painful for some players, said Charles Cascarilla, chief executive of Paxos, a blockchain company that developed Binance USD, a dollar-backed stablecoin. But the industry would ultimately benefit from transparency into the reserves that underpin the coins’ value, he added. “Oversight creates trust, and trust can lead to widespread adoption,” Mr. Cascarilla said.
DeFi encompasses a range of projects that seek to replicate traditional financial activities, such as trading and lending, using cryptocurrencies and the internet. DeFi has boomed during the past year, with many projects avoiding the most basic regulation such as anti-money-laundering controls.
Regulators may have trouble applying securities laws to DeFi, where projects are often set up as automated peer-to-peer networks with no central entity operating them. In contrast, the SEC and other federal agencies largely focus on people and companies. Mr. Gensler suggested that legislation might be needed to impose investor protections on DeFi.
“The problem is that regulation applies to entities,” said Lee Reiners, executive director of the Duke University’s Global Financial Markets Center. “But with a decentralized trading or lending platform, it’s not clear who that entity is.”
The industry could potentially avoid an enforcement blitz by agreeing to follow SEC rules or pursuing exemptions on a case-by-case basis. The SEC has exempted a few digital assets from oversight. In those cases, the token wasn’t sold to raise capital and was used for purposes such as videogames or flights on business jets.
Some still argue Mr. Gensler should stop enforcing old rules and propose an updated code tailored to how crypto works. But Mr. Gensler and other regulators have shown little interest in that.
“Many in the crypto industry are saying that the SEC should come up with new rules,” said Michael Didiuk, a former SEC lawyer and now a partner at Perkins Coie LLP. “The SEC, on the other hand, has repeatedly said that, for the most part, the rules are there.”
‘Nakamoto’s Innovation Is Real,’ Says SEC Chair Gary Gensler
Gary Gensler describes Satoshi Nakamoto as an important innovator in cryptography and that their “innovation spurred the development of crypto assets and the underlying blockchain technology.”
Gary Gensler, chair of the United States Securities and Exchange Commission, or SEC, believes that the blockchain revolution started by Satoshi Nakamoto in 2008 is more than just a fad, but a real value proposition for the future of the internet.
In an interview with the Aspen Security Forum on Tuesday, Gensler talked about his role at the Massachusetts Institute of Technology, where he taught about the intersection of finance and technology:
“[…] in that work I came to believe that though there was a lot of hype masquerading as reality in the crypto field, Nakamoto’s innovation is real.”
— Documenting Bitcoin (@DocumentingBTC) August 3, 2021
Gensler noted that, while some within the public sector wish that cryptocurrency would just go away, the technology likely has a big role to play in the future of finance.
“I really do think there’s something real about the distributed ledger technology, moving value on the internet,” he said.
Some within the crypto community took Gensler’s comments to mean that he’s studied the entire field of blockchain and concluded that Bitcoin is the only real innovation. A transcript of Gensler’s address to the Aspen Security Forum appeared to be hyper-focused on the Bitcoin (BTC) white paper published by Satoshi Nakamoto more than a decade ago.
— Rohun vora (@rohunvora) August 3, 2021
“At its core, Nakamoto was trying to create a private form of money with no central intermediary, such as a central bank or commercial banks,” Gensler said in his remarks. Although he acknowledged that no single cryptocurrency broadly fulfills all the functions of public currencies like the dollar, he said assets like Bitcoin provide a different value proposition:
“Primarily, crypto assets provide digital, scarce vehicles for speculative investment. Thus, in that sense, one can say they are highly speculative stores of value.”
After being confirmed by the Senate Banking Committee in April of this year, Gensler assumed the role as SEC chair in June, replacing the outgoing Jay Clayton, whose term expired the same month. Gensler’s five-year term is scheduled to last through 2026. He believes in creating a “robust” regulatory framework for cryptocurrencies in the United States, especially in emerging DeFi markets such as lending.
Crypto’s ‘DeFi’ Projects Aren’t Immune To Regulation, SEC’s Gensler Says
Some peer-to-peer trading and lending projects have features that may trigger the need for regulation, chairman says.
A new breed of digital asset exchanges is potentially the holy grail for cryptocurrencies: online places for people to trade and lend that purportedly involve no middleman setting the rules or taking fees.
But these peer-to-peer networks, so far completely unregulated in the U.S., may not be immune from oversight, said Gary Gensler, chairman of the Securities and Exchange Commission. Some decentralized finance projects, known as DeFi, have features that make them look like the types of entities the SEC oversees, Mr. Gensler said in an interview Wednesday.
DeFi developers write software that automates transactions and say they then step away from the project, allowing it to operate with no central entity in charge. They argue that such decentralization defeats the need for oversight by the SEC, which has said that some cryptocurrencies, such as bitcoin and ether, are sufficiently decentralized to avoid regulation.
But Mr. Gensler, who took over in April, said projects that reward participants with valuable digital tokens or similar incentives could cross a line into activity that should be regulated, no matter how “decentralized” they say they are.
“There’s still a core group of folks that are not only writing the software, like the open source software, but they often have governance and fees,” Mr. Gensler said. “There’s some incentive structure for those promoters and sponsors in the middle of this.”
The SEC under Mr. Gensler has doubled down on an effort, started several years ago, to look for cryptocurrency projects that are offering investments that should be regulated. In the past, that strategy has leaned heavily on enforcement actions that target digital-asset issuers or exchanges on a one-by-one basis.
Mr. Gensler, a longtime policy maker and former banker at Goldman Sachs Group Inc., two weeks ago promised a vigorous attack on fraud and misconduct in the market. He also said he would ask Congress to help legislate a solution to fill regulatory gaps, such as cases in which some digital assets don’t fall neatly into an existing regulatory framework.
A variety of DeFi platforms have popped up, with some rivaling the trading volumes of more established centralized cryptocurrency exchanges.
Unlike conventional crypto exchanges, DeFi apps don’t require users to hand their digital tokens to an exchange to be able to trade. That appeals to traders worried about losing their assets to hackers who steal digital coins from exchanges. There is also no central authority deciding who is allowed to trade, or what tokens can be traded.
DeFi projects generally don’t have safeguards against money laundering, or “know your customer” measures in which an exchange confirms the identity of traders using the platform. That also could raise red flags for authorities.
The SEC earlier this month brought its first enforcement action against a DeFi firm, Blockchain Credit Partners, and two men who ran it.
The project recruited investors to contribute their digital assets in exchange for a slice of income-generating car loans. The business was supposed to be decentralized because a separate “governance” token granted owners the right to make decisions about the business and share in the management company’s profits.
The SEC said the project’s creators misled investors about how the business worked and sold $30 million of digital tokens in violation of investor-protection laws.
The term DeFi is “a bit of a misnomer,” Mr. Gensler said, speaking generally and not about the Blockchain Credit case. ”These platforms facilitate something that might be decentralized in some aspects but highly centralized in other aspects.”
Mr. Gensler said questions about how DeFi may be regulated recall a debate that occurred about 15 years ago over other peer-to-peer lending platforms. Lenders such as Prosper Marketplace Inc. and rival LendingClub Corp. lined up individual investors to fund small loans to consumers that the companies made in partnership with banks.
Prosper, for instance, then sold interests in the loans in the form of promissory notes, with individual investors receiving interest payments as the loans were repaid. The company didn’t initially register the loans with the SEC, which in 2008 said they were securities.
After an SEC investigation, Prosper agreed in 2008 to register the loans, which involved providing information to investors about the borrower’s creditworthiness. That same year, LendingClub agreed to do the same.
Can SEC’s Gary Gensler Offer More Than Tough Talk?
The new chairman has taken a not-so-gentle stance on Bitcoin and U.S.-listed Chinese companies like Alibaba. But does his agency have any real bite?
Gary Gensler, the U.S. Securities and Exchange Commission’s new chair since April, has been making hawkish sounds about risky assets lately. In August alone, he slammed the crypto world as “the Wild West,” one that’s “rife with fraud, scams and abuse.”
He labeled the likes of Alibaba Group Holding Ltd. and other New York-listed, Cayman Islands-incorporated Chinese tech companies as mere “shell companies.”
Keen to rein in his bêtes noires, Gensler is engaged in a turf fight with the Commodity Futures Trade Commission, over the nature of crypto tokens. On Aug. 3, he staked out his territory by saying many of them may be “unregistered securities.”
That claim was rebuffed a day later by the outgoing CFTC chairman Brian Quintenz, who is seen as an ally by crypto traders.
Gensler is now seeking Senator Elizabeth Warren’s help for authority to regulate such exchanges.
To deal with Chinese companies, Gensler called for a “pause” in their U.S. initial public offerings last month. The SEC is starting to issue new disclosure requirements to those contemplating a New York listing, asking about their corporate structure. That would be their “shell” nature, in Gensler’s vocabulary.
It will also require listed companies to disclose more regulatory and political risks, Bloomberg News reported.
With the passing of the Holding Foreign Companies Accountable Act last year, the SEC can now force a delisting if a company refuses to provide information requested by the agency or by the Public Company Accounting Oversight Board, the auditor of auditors established as a result of the 2001 Enron scandal.
Despite all the thundering, can Gensler’s SEC, which has an annual budget of about $2 billion, simply march in and police this wild, wild west? The agency already has a full plate, overseeing about $100 trillion in annual securities trading, 24 national exchanges, and the disclosures of 7,400 reporting companies, among others.
For one thing, forcing a delisting is much easier said than done. There are 248 Chinese corporate names on U.S. exchanges, boasting over $2 trillion market cap as of early May; the SEC cannot possibly have the time nor the money to investigate them all.
The agency’s record isn’t promising. It was slow and reactive between 2018 and 2020, despite the Trump administration’s hardline rhetoric on China. That was the conclusion of a study by CLSA and Mithra Forensic Research.
By looking at the exemptions the SEC used to deny Freedom of Information Act requests, the study found that only five companies — iQiyi Inc, TAL Education Group, GSX Techedu Inc., Alibaba and China Petroleum & Chemical Corp. — were investigated in that three year period. All, except for the state-owned China Petroleum, were short-seller targets.
In other words, the SEC appeared to have relied mostly on whistleblowers instead of its own internal investigative methods — such as accounting forensics or big data — to identify suspect companies.
In June, Gensler fired William Duhnke as chair of the PCAOB, a win for liberal senators Warren and Bernie Sanders, powerful voices on the Senate’s banking and budget committees. The Trump appointee was criticized for being ineffective and taking record low actions against auditors.
The SEC’s long-standing trouble with China Inc. is just one example of its inefficiency. Apart from a lack of resources, the chairman is swamped. He has more than 20 direct reports who deal with everything from enforcement to economic and risk analyses.
If investigating Chinese companies proved elusive for the agency, how can it regulate crypto, a much murkier world where the issues go beyond accounting fraud? The agency’s main weapon is to bring civil charges.
Gensler has a reputation for being a tough regulator. But it’s worth remembering that the SEC chairman needs to appease powerful politicians, mainly because of the makeup of the commission.
All decisions are made by majority vote of a five-person bipartisan group — two Republicans, two Democrats, and the chairman, who is in theory a political independent, appointed by the U.S. president.
As such, the SEC’s enforcement, as well as its budgets, vary from administration to administration. Or even within a presidential term. Five years ago, Warren called on President Barack Obama to replace his SEC appointee Mary Jo White for her refusal to develop a political spending disclosure rule. White stayed on till Obama left the oval office.
In the meantime, despite Gensler’s posturing, the world is moving on. Bitcoin has recovered from Gensler’s not-so-gentle remarks and reclaimed the $50,000 level this week.
And despite the Chinese government’s broad, brutal crackdown on big tech, retail investors continue to buy on the dip — or, depending on your point of view, catch the falling knife — in U.S.-listed ETFs such as KraneShares CSI China Internet Fund in July and August. It’s tough to regulate away day traders’ love for roller coaster rides. The SEC is lots of bark and very little bite.
State of Crypto: SEC vs. CFTC
A Crypto Turf War May Be Brewing Between Two U.S. Regulators.
While the Senate’s bipartisan infrastructure bill has been top-of-mind for the past month, the U.S. Securities and Exchange Commission has been signaling its own importance to the crypto industry, which may lead to an eventful autumn.
What A Year This Month Has Been
What dog days? August has been a pretty crazy month. While the Senate’s infrastructure bill has sucked up a large amount of the oxygen, there’s been quite a lot of other news. Maybe the most important items in the U.S. came from the Securities and Exchange Commission (SEC), which seems to be gearing up for a busy autumn.
Why It Matters
The SEC is one of the most important federal regulators to the crypto industry in the U.S., and in recent months it’s been signaling a more aggressive approach to the crypto industry.
Breaking It Down
There are three key things I’m watching for with the SEC this fall. The first is the possible approval of a bitcoin (BTC, -0.37%) futures exchange-traded fund (ETF). We’ve talked about bitcoin ETFs before, and judging from comments from SEC Chair Gary Gensler, it sure seems like a futures-based ETF is more likely than a spot-based ETF.
An approval wouldn’t be the same as if the SEC approved a full bitcoin ETF, but it’d still be a regulated investment product that people curious about crypto, yet hesitant about directly investing in bitcoin, could look to as an alternative.
There are two interesting signals on the ETF front that seem to support the idea that one (or more) futures-based products might be approved this year.
The first signal came when Gensler told the Aspen Security Forum that he looks forward to SEC “staff’s review of such filings, particularly if those are limited to these CME-traded bitcoin futures.”
A handful of companies immediately filed bitcoin futures ETF applications in the wake of his remarks.
More recently, VanEck and ProShares applied for ethereum (ETH, -0.84%) futures ETF products, but simultaneously withdrew them on Aug. 20. This suggests that the SEC spoke to these companies privately. The SEC has asked companies to withdraw their ETF applications in the past (particularly 40 Act funds, so named because they operate under a 1940 law).
There’s still no guarantee that a bitcoin ETF – or even a bitcoin futures ETF – will receive the SEC’s green light this year, but the fact that agency officials are sending signals about how they’re approaching these applications says something.
The second big thing on my radar is what kind of, sort of, maybe looks like a brewing turf war between the SEC and its sister agency, the Commodity Futures Trading Commission (CFTC), over jurisdiction within the crypto market. It’s too early to say this is happening for sure, and it’s obviously way too early to predict how it’ll play out, but it’s worth keeping an eye on what agency officials say about what falls under their purview.
However, we’ve seen comments from current and former CFTC officials about the agency’s role in regulating the crypto markets, including Commissioner Brian Quintenz, Commissioner Dawn Stump and former Chair Chris Giancarlo.
These comments seem to be a response to Gensler asking for greater authority over the crypto markets.
I Think The Discussion Is Going To Become:
* Who Has Oversight Of Specific Spot Markets?
* Is An Exchange Subject To Sec Jurisdiction Just Because Some Of Its Listed Assets Might Be Securities While Others (Like Bitcoin) Aren’t?
* Does The Cftc Have Oversight Of Exchanges That List Spot Markets For Cryptocurrencies That Aren’t Securities?
Stump said the CFTC doesn’t oversee these spot markets, but it’s unclear to me the SEC necessarily has a clear case in favor of this supervision either.
This goes back to the ETF question as well. The SEC has said in the past that it’s uncomfortable approving ETF applications unless it can closely track the market for potential fraud or manipulation.
A futures market operated by CME is far more likely to meet this standard because CME and the futures product it lists are regulated by the CFTC. The bitcoin spot market, spread across scores of exchanges around the world, is somewhat more unwieldy.
Finally, I’m keeping tabs on regulatory issues faced by decentralized finance (DeFi). I wrote about this earlier this month, but the SEC seems to be building precedent for more enforcement actions in this part of the crypto world.
Last week, AnChain.AI, an analytics firm, told Forbes it had signed a deal with the SEC to monitor DeFi transactions.
This comes on top of enforcement actions against DeFi trading platforms.
And, just to tie this back to the infrastructure bill we’ve all been looking at for the past four weeks, I understand that the Treasury Department does want to capture data from so-called decentralized exchanges with intermediaries, so I imagine there may well be some crossover there as well.
Today will be CFTC Commissioner Brian Quintenz’s last day at the agency. Biden has yet to formally nominate a chairperson to a full term at the agency (though rumors are he’ll tap Acting Chair Rostin Behnam), and it’s unclear how long it may take to fill Quintenz’s seat.
Crypto Market Won’t ‘Last Long Outside’ Regulatory Framework, Gensler Says
Platforms should be “asking for permission” rather than “begging for foregiveness,” the SEC chair said.
The crypto market may struggle to survive in the U.S. outside the country’s regulatory framework, according to U.S. Securities and Exchange Commission Chair Gary Gensler.
* The industry’s future in five to 10 years lies “within a public policy framework,” Gensler said in an interview with the Financial Times Wednesday.
* “History just tells you, it doesn’t last long outside. Finance is about trust, ultimately,” the SEC chair said.
* Gensler reiterated his desire for crypto trading platforms to register with the SEC because a number of cryptocurrencies can be deemed as securities. “Talk to us, come in,” he said.
* “There are a lot of platforms that are in operation today that would do better engaging. Instead there is a bit of … begging for forgiveness rather than asking for permission.”
* Gensler has said previously that he is weighing up more robust regulation of the crypto market, dampening hopes held by many in the industry that his interest in the space may lead to a rather hands-off regulatory approach.
SEC boss Gary Gensler believes crypto assets need to act within a public policy framework to survive over the long term.
Crypto assets will not last long outside of a public policy framework because “finance is about trust,” warns Gary Gensler, the chair of the United States Securities and Exchange Commission.
Speaking to The Financial Times, Gensler stressed the need for a regulatory framework for crypto platforms for their own survival. He explained that crypto assets should be under the same public policy imperatives to protect investors and fight illicit financial activities.
He said that the global market capitalization for cryptocurrencies has already surpassed $2 trillion and, if crypto is “going to have any relevance five and 10 years from now, it’s going to be within a public policy framework,” adding:
“History just tells you, it doesn’t last long outside. Finance is about trust, ultimately.”
Echoing his earlier suggestion for crypto trading platforms to register with the SEC, he said, “There are a lot of platforms that are in operation today that would do better engaging and instead there is a bit of […] begging for forgiveness rather than asking for permission.”
Gensler argued that the lack of traditional brokers makes crypto and decentralized finance (DeFi) platforms a challenge for regulators because it’s unclear to whom the law applies in the DeFi ecosystem. Calling DeFi a variation of the peer-to-peer lending businesses, he argued that those platforms have “a fair amount of centralization” with governance mechanisms, fee models and incentive systems:
“It’s a misnomer to say they are just software they put out in the web. But they are not as centralized as the New York Stock Exchange. It’s sort of an interesting thing that is in between.”
Since his appointment in April, the new SEC chair has repeatedly called for robust regulations for the crypto ecosystem. On the other hand, some crypto leaders argue that stricter regulations would not necessarily help to prevent fraud.
Gary Gensler Focuses On Crypto Trading Platforms, Payment For Order Flow In Senate Hearing
Securities and Exchange Commission chairman says many crypto assets meet definition of securities.
Securities and Exchange Commission Chairman Gary Gensler said he was taking a hard look at cryptocurrency-trading platforms in a hearing Tuesday in which he called for more funding for the regulatory agency.
Mr. Gensler also reiterated his openness to potentially banning payment for order flow, a practice in which stockbrokers sell customers’ trades to high-speed trading platforms.
The official appeared before the Senate Banking Committee to outline a far-reaching policy agenda that would shake up some Wall Street firms’ business models and require heftier disclosures from public companies. He emphasized the SEC’s mission of protecting investors while pointing to challenges stemming from emergent technologies like cryptocurrency and sophisticated data analytics used by financial firms.
“More retail investors than ever are accessing our markets,” Mr. Gensler told the committee. Noting that the SEC’s staff has declined 4% since fiscal 2016, he repeatedly called for Congress to provide more resources for the agency to police capital markets that have grown in size and complexity. “Funding-wise, we could use a lot more people.”
Since being confirmed by the Senate in April, Mr. Gensler has laid out a regulatory agenda that some experts say would amount to the most significant revamp of U.S. securities law in decades.
Among the major fights looming with industry groups are potential rule changes for brokers that sell customers’ orders to high-speed trading firms, the SEC’s plans to increase public companies’ disclosure requirements about their workforces and risks stemming from climate change, and efforts to police the fast-growing cryptocurrency market.
Republicans have argued that the SEC’s agenda under Mr. Gensler is partisan and risks limiting investors’ opportunities in the effort to protect them. They also warned him to tread lightly in his effort to police cryptocurrency markets, citing industry arguments that greater regulation could force financial innovation overseas.
“As to the people and the companies that you regulate as chairman of the SEC, do you consider yourself to be their daddy?” said Sen. John Kennedy (R., La.). “Why do you impose your personal preferences about cultural issues and social issues on companies and therefore their customers and their workers?”
Mr. Gensler replied that investors are seeking more information about issues such as the risks to companies posed by climate change.
“If investors want information about climate risk—and it looks like tens of trillions of dollars of assets under management are asking—then we at the SEC have a role to put something out to notice and comment, do the economic analysis, and really see what investors are saying.”
In his testimony, Mr. Gensler discussed efforts to improve the resilience of the market for U.S. Treasury debt, which seized up in March 2020 as the coronavirus pandemic struck.
He also mentioned plans to enhance disclosures from private funds—a category that includes venture capital, hedge funds and private equity—to their investors and to enhance competition.
Mr. Gensler renewed calls for cryptocurrency-trading platforms to “come in and talk to us,” given the SEC’s view that many of the assets they offer to investors meet the agency’s definition of a security. In an unusual move for an SEC official, he publicly singled out one firm, Coinbase Global Inc., after Sen. Elizabeth Warren asked him about a possible outage at the exchange last week.
“They haven’t yet registered with us, even though they have dozens of tokens that may be securities,” Mr. Gensler said.
Coinbase Global didn’t immediately respond to a request for comment. Last week, the firm said the SEC was investigating its plans to launch a crypto-lending platform.
He also repeatedly referred to the fact that another firm, Citadel Securities, executes nearly half of all retail trading volume, in explaining the SEC’s wide-ranging review of payment for order flow. The practice involves brokerages such as Robinhood Markets Inc. selling clients’ stock and option orders to Citadel and other high-speed traders for execution.
SEC Chair Gensler: Coinbase Should Register With Regulator
SEC Chair Gary Gensler wants to boost the agency’s headcount to better regulate crypto.
U.S. Securities and Exchange Commission (SEC) Chair Gary Gensler warned that crypto exchanges like Coinbase should register with the regulator, an escalation of his previous statements regarding whether crypto trading platforms qualify as securities exchanges.
Gensler told the Senate Banking Committee on Tuesday that the SEC, like other federal regulatory agencies, does not have direct oversight over crypto exchanges, in response to a hypothetical scenario from Sen. Elizabeth Warren (D-Mass.) about selling cryptocurrencies during last week’s exchange outages.
“They haven’t yet registered with us, even though they have dozens of tokens that may be securities,” Gensler said.
That is the most explicit Gensler has been about having crypto trading platforms register as a securities trading platform. In prepared remarks for the committee published Monday, he wrote that any exchange that has a security listed must register with the SEC.
At the time, he did not name any specific companies. Warren used Coinbase as an example during a question about whether crypto actually bolsters financial inclusion.
“Let’s say that last Monday, I took out the last sliver of my savings, I went on the crypto exchange Coinbase, I bought $100 worth of ether, and then I woke up early on Tuesday morning, I saw that the market looked like it was beginning to tank and I thought I better sell right now, but when I tried to sell Coinbase, the exchange was down,” she said.
Gensler broadened his pitch for greater regulatory oversight of the crypto markets by asking for more resources to regulate different projects.
Sen. Catherine Cortez Masto (D-Nev.) asked if the SEC was sufficiently equipped to regulate crypto. Gensler said Congress can help coordinate oversight among banking regulators, as well as stablecoin supervision.
“I think funding wise we could use a lot more people. I just have to be frank with you, I mean there’s 6,000 projects. And while some of those are commodities, many of them are securities under the law,” he said.
A Call For Clarity
Sen. Pat Toomey (R-Pa.), one of the senators who pushed for an amendment to the Senate’s bipartisan infrastructure bill to narrow the definition of a “crypto broker” in a tax provision, pushed Gensler on a lack of explicit guidance on how a cryptocurrency might qualify as a security under federal law.
“A really important question is whether a cryptocurrency is a security for regulatory purposes under the Howey or some other tests.
Based on your public statements, it’s pretty clear that you believe that some are securities, but others are not. So I’m frustrated by the lack of helpful SEC public guidance, explaining how you make this distinction. What makes some of them securities, while others are not securities,” Toomey asked in his opening remarks.
For his part, Gensler said in his remarks that “a small number” of cryptocurrencies are not securities, but he believes many are.
Toomey brought the issue up again during the back-and-forth segment of the hearing, asking about stablecoins as one example.
While Gensler pointed to different features of judicial precedent, including the Supreme Court’s “Reves” case, Toomey reiterated that his key point is a lack of explicit guidance from the SEC.
“I’m just saying as a layman who can read English, when I read those tests, stablecoins don’t seem to meet that test to me,” he said. “Maybe I’m wrong, but if I can misinterpret this, I think others could too and clarity, public clarity could be helpful.”
SEC Is ‘Open To Discussion’ When It Comes To Crypto: Kraken Chief Lawyer
Kraken’s Marco Santori points to the adversarial stance taken by some crypto firms toward regulators.
Amid a fraught period for some high-profile United States crypto firms and financial regulators, Kraken chief legal officer Marco Santori is calling for a dose of pragmatism going forward.
Speaking on Bloomberg’s QuickTake Stock broadcast on Thursday, Santori told viewers, “You’re living in a fantasy world if you don’t believe that this industry is going to face heavier, more Wall Street-like regulation from governments in the U.S. and abroad.”
Santori’s comments follow threats by the U.S. Securities and Exchange Commission earlier this month to sue the well-known crypto exchange Coinbase over a crypto yield program the commission deemed to be a security. The move sparked the exchange’s CEO, Brian Armstrong, to adopt a combative and resistant stance on social media, although the exchange has since announced it will scrap the program at issue, in line with the SEC’s wishes.
Commenting directly on the developments, Santori said, “I’ve certainly followed Brian’s tweets, and I’ll say that look, you’re just not being honest with yourself about the crypto community if a little bit of you doesn’t think he’s saying what a lot of people are thinking.” He soon pivoted, however, taking pains to articulate the more pragmatic agenda he’s pursuing at Kraken:
“I can’t support that kind of approach with regulators. It’s never been successful historically, and from our experience, we’ve found the SEC to be open to discussion.”
U.S. financial regulators, particularly under SEC Chair Gary Gensler, have indicated they intend to introduce a host of policy changes this year that will affect token offerings, decentralized finance, stablecoins, custody, exchange-traded funds and lending platforms.
Despite his hawkish tone, Gensler has appealed to industry actors to engage with the agency going forward. With the regulatory outlook still evolving, the crypto markets, meanwhile, remain highly sensitive to the possible implications of each of the regulator’s crypto-related public interventions.
The Fight To Control The $2 Trillion Crypto Market Is Heating Up
Investors are being rattled by volatility as the two biggest economies — the U.S. and China — seek to tighten their grip on Bitcoin and other digital currencies.
It’s not that governments like China are banning cryptocurrencies because they necessarily expect the technology to fail. It’s that they want to be in charge of an experiment with potentially trillions of dollars in play.
With its latest move, China joins a small list of nations that are crypto prohibitionists.
And it is a swing in the opposite direction of El Salvador, which adopted Bitcoin as legal tender this year and was lauded by Libertarians as well as Bitcoin believers. In the U.S., where crypto trading is allowed but regulators are taking a close look, some see an opportunity in China’s deepening crackdown.
Understanding the many dimensions of this multi-pronged battle to control the market will be key for the millions of investors hoping to cash in on the crypto craze.
The fight is set to reverberate through the global financial system, where every day brings news of products such as Bitcoin exchange-traded funds, bizarrely named digital tokens and NFT assets. The ultra-rich are also involved, and mainstream financial institutions are embracing digital currencies.
More broadly, the fight will also influence socio-cultural discussions over everything from climate change to inequality, and trade to fiat currencies. How the world’s two biggest economies — the U.S. and China — fare in their effort at oversight over the market will likely have the most far-reaching impact.
“Crypto has become too big to ignore,” said Matt Hougan, chief investment officer at Bitwise Asset Management. “Five years ago, at least in regulators’ minds, it was people wearing hoodies playing Dungeons & Dragons and trading among themselves. Today it’s a $2 trillion industry and every major Wall Street bank is helping investors gain exposure to it, and now they have to deal with it.”
China rattled financial markets this week by announcing that all crypto-related transactions will be considered illegal, echoing less definitive exclusions dating back to 2013 that cracked down on initial coin offerings, crypto exchanges and cryptocurrency mining — in which it had become the world’s leader.
Instead, the Chinese government aims to unleash its own cryptocurrency. It’s one of 81 nations that are exploring their own digital currencies, a list that started with early adopters like Venezuela and Estonia but now includes larger nations, including the U.S.
China’s 1.4 billion population will likely give it an edge when it begins rolling out the digital yuan on a global scale at the winter Olympics in Beijing in 2022 — a prospect that has some U.S. politicians wanting to ban American athletes from using the e-coin while there.
“For China, I think it’s pretty clear they want to promote the digital yuan, and that they are simply taking care of the competition,” said Nicolas Christin, an associate professor at Carnegie Mellon University.
China said that 10 regulatory agencies, including the central bank, would work together to track down crypto-related activity. The ban even says that overseas exchanges are barred from providing services to mainland investors.
The country’s moves over the past few years already had the effect of squeezing local trading volumes, said Randall Kroszner, deputy dean at the University of Chicago Booth School of Business and former governor of the Federal Reserve System. “Even with a VPN, it can be very difficult to connect and can be slowed down,” he said.
Governments crack down on crypto for two reasons, Bitwise’s Hougan says. They want to curb crypto mining — the energy-intensive computing process involved in creating the digital currency and verifying transactions. And second, perhaps more critically, they want to be able to monitor currency transactions and negate any challenge to their homegrown digital currencies.
Gary Gensler’s Approach
In the U.S., the government’s regulatory strategy has been different. The approach is aimed at trying to avoid problems, according to Christin at Carnegie Mellon University. For example, financial markets have historically held up high barriers of entry for certain types of transactions, but no such stringent controls are in place for cryptocurrency trades.
That leaves the door open for inexperienced investors to take highly leveraged positions that could lead to potentially catastrophic financial losses.
“Now of course there is a line of thought that people should be able to do whatever they want — after all, it’s their money,” Christin said. “But the question is whether a lot of retail-level folks engaging in these markets are actually equipped to judge the risks rationally, as opposed to engaging in gambling-like behavior.”
U.S. Securities and Exchange Commission Chair Gary Gensler, who has termed crypto as the “Wild West,” is signaling a robust oversight regime over the industry. Coinbase Global Inc.’s planned Lend program, which would have let users earn 4% by lending their tokens, was a flash point in growing tensions between the regulator and the industry. BlockFi CEO Zac Prince recently said the SEC and other regulators needed to give his industry clarity on what’s allowed.
Gensler has in fact been interested in the crypto world for years and once taught a class at MIT’s Sloan School of Management called “Blockchain and Money.” He’s even signaled a pathway for the SEC to approve an ETF tracking Bitcoin futures.
Caution from regulators is understandable. Scammers have ripped off billions of dollars in crypto pump-and-dump schemes, using myriad tactics to draw in unsuspecting investors.
“The government is worried about consumer protections,” said James Seyffart, an analyst for Bloomberg Intelligence. “The U.S. government generally doesn’t ban new technology, they usually embrace innovation. There is going to be new regulation but they just need to give guidance for people.”
Former U.S. Treasury Secretary Lawrence Summers says that rather than resist regulation, the crypto industry should embrace it for its own good. Given the large financial sums involved in crypto, it’s unrealistic for the industry to expect to operate in secrecy without government oversight, Summers said in an interview on Bloomberg TV.
The crypto industry should shed the idea that it’ll function as a “libertarian paradise” where government rules can’t be imposed, Summers said.
Gary Gensler, You Should Be Watching How Canada Is Regulating Coinbase
In Canada, there’s no question whether crypto exchanges offer securities and if they should be regulated as such.
The question of how to regulate cryptocurrencies, and by extension cryptocurrency exchanges, is getting heated.
Securities and Exchange Commission (SEC) Chair Gary Gensler has been regularly hinting that exchanges such as Coinbase should be registering with the SEC because they offer “dozens of tokens that may be securities.” A frustrated Brian Armstrong, Coinbase’s CEO, has accused the SEC of “sketchy behavior” and is planning to publish his own advice on how authorities should regulate crypto.
Up north in Canada, all is quiet. The debate over whether cryptocurrency exchanges need to register with Canada’s version of the SEC has already been settled. In a March 2021 notice, the Canadian Securities Administrators confirmed that crypto exchanges do need to be registered with a securities regulator. Exchanges that want to keep serving Canadians are rushing to comply.
J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog.
Given how excruciatingly vague the status of cryptocurrency regulation remains in the U.S., it’s striking how Canada’s version of the SEC has been able to bring rapid clarity to the issue.
Is it possible that countries casting around for a definitive solution to regulating cryptocurrency exchanges adopt the Canadian blueprint?
You Probably List Some Securities, So Get Regulated
Before turning to Canada, let’s review the situation in the U.S. The SEC’s jurisdiction over cryptocurrency exchanges like Coinbase and Kraken hinges on whether the tokens these exchanges list are deemed to be securities. The SEC has said that bitcoin and ether aren’t securities. XRP is.
If tokens are securities, and Kraken and Coinbase list them, then Kraken and Coinbase are securities exchanges and they must register with the SEC. Delisting security tokens like XRP is how exchanges like Kraken and Coinbase avoid the registration requirement.
But what about shibu inu, dogecoin, USDC or the thousands of other tokens? Are they securities?
Divining the security-or-not status of a token seems to be more art than science. It rests on how lawyers interpret the SEC’s definition of security, which includes a long list of instruments like notes, stocks, bonds, investment contract, fractional undivided interest and more.
Now, perhaps SEC officials could comb through every one of the thousands of crypto tokens created over the last 12 years and make a list of which of them are securities or not. And then Coinbase and Kraken could delist everything that the SEC says is a security and thus avoid SEC registration requirements.
But in his recent public pronouncements, SEC Chair Gensler has taken a less helpful approach. It goes a bit like this: “Coinbase, you list 300 tokens, and odds are that a bunch of them are securities (we’re not going to say which), so you should register with the SEC anyways.”
Not Your Keys, Not Your Coins (And Definitely A Security)
If Gensler’s approach to pulling crypto exchanges under the ambit of securities law seems oblique and vague, the Canadian Securities Administrators (CSA) has taken a much more direct approach. The CSA is an umbrella organization for Canada’s provincial and territorial securities regulators, the biggest of which is the Ontario Securities Commission (OSC).
To bring Coinbase and Kraken under the jurisdiction of securities law, the CSA has created a new catch-all term: a crypto contract. Crypto contracts are securities, and because Coinbase and Kraken offer them these platforms come under the ambit of Canadian securities law.
Let me explain a bit more.
Pretty much everyone (including Canada’s regulators) agree that bitcoin is not a security. But according to the CSA, the bitcoin that a Coinbase client holds in their Coinbase account isn’t actually bitcoin. It is a contractual right or claim to underlying bitcoin, or as the CSA terms it, a crypto contract.
Furthermore, the CSA deems all crypto contracts to be securities, even if the underlying crypto, say bitcoin, isn’t itself a security. Since Coinbase and other exchanges deal in crypto contracts and offer a marketplace for them, they must register with one of Canada’s provincial securities regulators.
This approach is remarkably different from the U.S. In the words of law professor Ryan Clements, the CSA’s assertion about crypto contracts is one that “no other international securities regulator has yet taken.”
The CSA’s list of requirements is long and demanding (see Appendix B of this document). Canadian exchanges and dealers, a category that now includes Coinbase, must abide by a set of universal market integrity requirements that cover things like abusive trading, front running, client priority, and more. Coinbase would be required to consider appropriateness and suitability when dealing with clients. And that’s just a sample.
Many exchanges won’t meet the CSA’s requirements, or can’t. Binance quit Ontario in June. FTX no longer onboards users from Ontario either. OKEX stopped serving Quebec and Ontario customers and Huobi has declared all of Canada to be a ‘restricted jurisdiction.’
But Canadian cryptocurrency venues such as Wealthsimple and Coinberry have fallen into line. And they don’t seem too salty about it, either. Coinberry’s CEO Andrei Poliakov has welcomed the CSA’s “measured” regulations as an “end to the ‘wild west’ of cryptocurrency in Canada.”
You can see why regulation would be welcome up north. Canadians were collectively stunned by the collapse of local cryptocurrency exchange QuadrigaCX, which at the time was Canada’s largest. Regulation is seen by all parties – customers, regulators, and cryptocurrency businesses – as a way to purge Canada of future crypto awfulness.
Will large U.S. exchanges like Kraken and Coinbase that serve Canadians choose to comply with Canadian securities laws?
To bring Coinbase and Kraken under the jurisdiction of securities law, the CSA has created a new catch-all term: a crypto contract.
Kraken has long disputed Canada’s assertion that a Kraken customers’ bitcoin balances are a type of Kraken IOU, and thus a security. In a 2019 letter to Canadian securities regulators, Kraken’s lawyers likened Kraken to a “bailee;” that is, in the same way the provider of a safety deposit box doesn’t take title to the box’s contents, Kraken doesn’t take title to the customer’s bitcoins. And so Kraken is offering a service, namely storage, and not a security.
But Canadian regulators never bought Kraken’s claim. The CSA has taken the old bitcoin maxim “not your keys not your bitcoin” to heart and ruled that crypto held at a platform like Kraken is not true crypto, but a contract for crypto.
It remains to be seen if any of the big U.S. crypto exchanges will go to court to defend what they see as their bailee business model against the CSA’s concept of a “crypto contracts.”
That would mean wading into Canadian securities law, which like its U.S. cousin boasts a long list of bewildering instruments that are defined to be securities, including the amorphous “investment contract” category. (Whereas the U.S. relies on Howey to define what an investment contract is, Canada has Pacific Coin vs the OSC.)
Or maybe Coinbase and Kraken will just suck it up and comply with CSA guidance.
From the perspective of consumers, I’d argue the Canadian approach makes a lot of sense.
Coinbase may not be regulated by the SEC, but it does operate under a specific U.S. regulatory framework. It holds 43 different money transmitter licenses, each one issued by a state financial department.
This is a strange fit, though. State money transmittal law is geared towards regulating remittance companies like Western Union or MoneyGram. Coinbase is very different from Western Union.
It facilitates billions of dollars worth of trading each day, rivaling large, regulated securities exchanges such as the Toronto Stock Exchange, NYSE American, and the Nasdaq BX. It’s not apparent how a supervisory official who oversees remittance agents is equipped to deal with an international trading platform.
By contrast, the Canadian approach says that if you are a payments company like Western Union, then you’ll be regulated like a payments company. And if you are an exchange like Coinbase, you can’t pass as a payments company for regulatory purposes. You’re going to fall under securities law because that’s the most appropriate regulatory category for you and your customers.
Whether Canada’s approach to crypto regulation becomes another export to the U.S., along with maple syrup or hockey, remains to be seen. But you can be sure that Gary Gensler is watching and pondering the idea of crypto contracts.
Dan Berkovitz To Become SEC’s New General Counsel Under Gensler
Dan Berkovitz will join the U.S. Securities and Exchange Commission as the Wall Street regulator’s general counsel in November.
Berkovitz, who previously said he plans to leave his seat on the Commodity Futures Trading Commission next month, will replace John Coates, who had been serving as the SEC’s top lawyer, the agency said in a statement Tuesday. Since September 2018, Berkovitz has been serving as a Democratic CFTC commissioner and earlier in his career was the derivatives regulator’s general counsel.
Gary Gensler, who took over as SEC chairman in April, relied on Berkovitz’s advice while leading the CFTC during the Obama administration as the agency wrote rules to regulate the swaps market following the 2008 financial crisis. At the SEC, Gensler has also laid out an ambitious agenda that includes writing dozens of new rules, as well as plans to clamp down on cryptocurrency trading.
As a CFTC commissioner, Berkovitz recently has raised concerns over a fast-growing corner of crypto known as DeFi, or decentralized finance.
SEC’s Gensler Aims To Save Investors Money by Squeezing Wall Street
Chairman of Securities and Exchange Commission has filled important staff jobs with academics and policy advocates from progressive lobbying groups.
Wall Street’s new overseer has outlined an aggressive regulatory agenda that threatens to squeeze the financial industry’s profit margins.
Securities and Exchange Commission Chairman Gary Gensler is working on tougher rules for high-speed trading firms, private-equity managers, mutual funds and online brokerages. Mr. Gensler, less than six months on the job, says he wants to make the capital markets less costly for companies raising money as well as for ordinary investors saving for retirement.
His main targets are what he says are profits and salaries earned above what a purely competitive market would allow, known as economic rents.
“I hope that we address, and try to lower, the economic rents in our capital markets,” Mr. Gensler said. He noted that finance as a share of U.S. economic output had more than doubled since the 1950s to roughly 8% of today’s gross domestic product.
“If we ever got back to what it was,” he said, “that’s a lot of savings.”
The regulatory push risks shaking up some of Wall Street’s most lucrative business models. Some Republicans accuse him of overreach. People close to the industry say Mr. Gensler’s plans are likely to spark opposition. But because the SEC hasn’t issued formal proposals for most of the items on his agenda, few industry representatives have been willing to publicly criticize it.
“I do think it’s very easy for anyone who comes into one of these regulatory roles to become paternalistic,” Republican SEC commissioner Hester Peirce said. “And so we have to guard ourselves against that tendency, because we all think we know what’s best for everyone else.”
Mr. Gensler developed a reputation as a hard-charging regulator during his 2009-14 stint as chairman of the Commodity Futures Trading Commission, or CFTC. Despite legal opposition from Wall Street, he wrote dozens of rules to govern the vast swaps market, which had previously been mostly unregulated and contributed to the 2008 financial crisis.
The SEC, a much larger agency, has been working remotely since Mr. Gensler took over in April. Leading its 4,400 staffers from a bedroom in his 135-year-old house north of Baltimore, Mr. Gensler, 63 years old, has assembled policy experts, lawyers and economists to write proposals for each of the roughly 50 rule-making items on his agenda.
Rather than selecting senior staff from inside the SEC or large corporate law firms, as many of his predecessors have done, Mr. Gensler has filled important positions with academics and policy advocates from progressive lobbying groups.
One example is Barbara Roper, a longtime proponent of tougher rules for stockbrokers, whom Mr. Gensler tapped as a senior adviser focused on investor protection.
Perhaps the biggest fight he has picked is over the plumbing of the stock market, in which a handful of large firms execute a majority of individual investors’ trades.
Under an arrangement known as payment for order flow, brokerages such as Robinhood Markets Inc. send many client orders to high-speed trading firms such as Citadel Securities or Virtu Financial Inc. rather than to a stock exchange. The high-speed traders pay brokerages for the orders and profit from the difference between the buying and selling price of the shares being transacted.
The SEC has previously approved the decades-old practice, which has enabled many brokers to stop charging trading commissions for individual investors in recent years. Citadel Securities and Virtu say they often execute trades at a slightly better price than exchanges, further saving money for investors.
“Concerns about concentration and conflicts are theoretical,” said Douglas Cifu, the chief executive of Virtu. “The actual results are overwhelmingly beneficial to individual investors.”
But Mr. Gensler and other critics say payment for order flow poses a conflict of interest for brokers and reduces transparency in the market by channeling data away from exchanges. He said in August that he was open to banning it altogether, a remark that sent shares of Robinhood and Virtu falling sharply.
“You’ve got some big actors here whose entire business model in the equity market space is based on current rules,” said Chris Iacovella, who worked with Mr. Gensler at the CFTC and now runs a trade association representing regional brokerages. “They’re going to do everything they can to not have to change their business model.”
Mr. Gensler is also scrutinizing the new generation of brokerages like Robinhood. Instead of human brokers taking orders from clients and recommending investments by phone, they use data analytics to study how clients behave. Their algorithms can tailor messages to individual clients and influence investment decisions through push notifications and other features.
“While these developments…can increase access, increase choice, and lower costs, they also raise new questions about potential conflicts, biases in the data, and yes, even systemic risk,” Mr. Gensler told the Senate Banking Committee in September.
Robinhood has said it looks forward to working with the SEC and that its platform has made the stock market accessible to millions of first-time investors.
Mr. Gensler has also signaled plans to require more information from fund managers who offer products they claim to be environmentally or socially responsible.
Public interest in addressing issues such as climate change and racial inequity has made so-called sustainable investing a growing profit source for money managers who have seen their fees decline amid the decadeslong shift by investors toward low-cost index funds.
The problem, Mr. Gensler says, is that the funds don’t use consistent metrics to back up their marketing claims, making it hard for investors to compare them.
Conservatives say some of Mr. Gensler’s plans could undermine his goal of saving investors money. For instance, rules to require more disclosure from companies about the risks they face from climate change could saddle firms with higher compliance costs, which are ultimately borne by shareholders.
A former Goldman Sachs Group Inc. banker, Mr. Gensler’s skepticism of Wall Street goes back decades. After serving in President Clinton’s Treasury Department from 1997 to 2001, he and a former colleague, Greg Baer, co-wrote a 2002 book titled “The Great Mutual Fund Trap.”
In it, they criticized professional stock pickers for charging high fees and delivering poor returns, and urged savers to buy index funds rather than actively managed investments.
“Do not delude yourself into believing that your interests are the same as your broker’s interests,” Messrs. Gensler and Baer wrote. “In the great majority of cases…expert money management advice simply leads investors to underperform the market and enrich Wall Street.”
As SEC chief, Mr. Gensler also is now looking at similar fees charged by private-equity firms. While the SEC traditionally has considered big institutions like pension funds more sophisticated than individual investors, Mr. Gensler has said these investors in private-equity could benefit from more disclosures.
“If private equity had lower fees,” Mr. Gensler said, “the pension funds would get more. Now, maybe the private-equity general partners would get a little less.”
Gensler Confirms SEC Won’t Ban Crypto… But Congress Could
Representative Patrick McHenry believes Gary Gensler’s SEC has disregarded standard practice when going after crypto.
Gary Gensler, head of the United States Securities and Exchange Commission, has confirmed that his agency does not have the authority or intention to ban cryptocurrency.
While responding to questions during a House Committee on Financial Services hearing on Tuesday, Gensler emphasized that prohibiting crypto does not fall within the SEC’s mandate, stating, “That would be up to Congress.”
“It’s a matter of how we get this field within the investor consumer protection that we have and also working with bank regulators and others — how do we ensure that the Treasury Department has it within Anti-Money Laundering, tax compliance,” Gensler said.
“Many of these tokens do meet the test of being an investment contract, or a note, or a security,” he added, emphasizing the need to bring crypto “within the investor protection remit of the SEC.”
Gensler also noted “the financial stability issues that stablecoins could raise” as a priority for the agency.
Representative Patrick McHenry took aim at the actions and stance taken by the SEC regarding digital assets under Gensler’s leadership during the hearing, accusing the SEC head of failing to act in accordance with the agency’s “long-held practice of noticing comment on rulemaking and procedures.”
“Some of those comments you have made have raised questions in the marketplace and made things less than clear. You’ve made seemingly off-the-cuff remarks that move markets, you’ve disregarded rule-making by putting a statement out without due process, and you’ve essentially run roughshod over American investors.”
Gensler responded that the SEC follows the Administrative Procedures Act.
McHenry also cited comments made by Gensler to the Committee in 2019, while he was teaching at the Massachusetts Institute of Technology in which he criticized past rulings from the SEC classifying Bitcoin (BTC) and Ether (ETH) as commodities.
When asked of his current views on the matter, Gensler stated, “I’m not going to get into any one token, but I think the securities laws are quite clear — if you’re raising money […] and the investing public […] have a reasonable anticipation of profits based on the efforts of others, that fits within the securities law.”
The hearing came on the same day that McHenry proposed the Clarity for Digital Tokens Act of 2021, which draws heavily on the safe harbor proposal put forward by the pro-crypto SEC Commissioner Hester Peirce in February 2020.
During the hearing, McHenry pressed Gensler on whether he had taken the time to review Peirce’s proposal. Gensler evaded answering whether he had reviewed Peirce’s proposal specifically, saying:
“Commissioner Peirce and I have talked on her thoughts around a potential safe harbor. I think that the challenge for the American public is that if we don’t oversee this and bring in investor protection, people are going to get hurt.”
Gensler’s Crypto Testimony: 6 Key Takeaways
The SEC chairman laid out his stance on crypto regulation during a House Financial Services Committee hearing on Tuesday. CoinDesk breaks it down.
U.S. Securities and Exchange Commission (SEC) Chairman Gary Gensler was on the hot seat on Tuesday during a House Financial Services Committee oversight hearing, and many committee members – 19 of them – took the opportunity to ask Gensler about crypto regulation.
The committee’s focus on crypto revealed the fascination – and pent-up frustration – with the growing crypto industry and the SEC’s role in regulating it.
The SEC’s Regulatory Authority
Rep. Patrick McHenry (R-N.C.), the committee’s top Republican, questioned Gensler about his “concerning and contradictory” statements about crypto regulation and whether the SEC has the authority it needs to regulate crypto.
In May, Gensler told Congress that the SEC would need additional legislation to regulate and define digital assets and exchanges, but McHenry pointed out on Tuesday that in subsequent interviews with the media, Gensler’s position on that has changed: The SEC chairman now posits that the SEC has the authority it needs to regulate crypto under existing legislation.
“I think that the SEC’s authorities in this space are clear,” Gensler told McHenry. “I think that Congress painted with a broad brush for the definition of ‘security’, and included 30 or 35 separate areas that are within the definition of a security to protect the public against fraud.”
Gensler told McHenry that Congress could help “fill gaps” in the coordination between the SEC and the Commodity Futures Trading Commission (CFTC).
Despite the seemingly brewing turf war between the CFTC and SEC over crypto regulation, Gensler was clear in his opinion that Congress doesn’t need to create another regulatory body to oversee crypto.
”We don’t need another regulator,” he said. “There are things that can be done to ensure the smoothness between the two agencies … even if Congress doesn’t act.”
Gensler also commented on the SEC’s shrinking budget and reiterated his request that Congress provide additional funding to the SEC so that it can hire more staff and upgrade its data analytics software.
“We’ve shrunk about 4 or 5% in the last four or five years. I would have hoped that we might have grown 4 or 5% at this period of time,” Gensler said. “I know resources are tight, but it would help us to do our mission.”
Are Cryptocurrencies Securities?
When asked by McHenry and other committee members whether he considered cryptocurrencies like bitcoin and ether to be securities, Gensler dodged the question. ”I’m not going to get into any one token,” Gensler said.
“But I think that the securities laws are quite clear. If you’re raising money from somebody else, and the investing public has a reasonable anticipation of profits based on the efforts of others, that fits within the securities law.”
Gensler testified that “most” of the 5,000-6,000 existing cryptocurrencies fall under the definition of a security and are thus subject to regulation by the SEC – a similar position to that of his predecessor Jay Clayton.
Rep. Tom Emmer (R-Minn.), chairman of the Congressional Blockchain Caucus and a vocal supporter of the crypto industry, pushed back against Gensler’s assertion, saying that he considers most cryptos to fall under the definition of a commodity or currency.
Rep. Warren Davidson (R-Ohio), another member of the blockchain caucus, asked Gensler what it would take for cryptocurrencies to go from being securities to being commodities or currencies, referencing 2018 statements in which Gensler said that ether could be “off the hook” from being considered a security because it had switched to a decentralized network.
“You’ve repeatedly said that you believe initial coin offerings (ICOs) are securities,” Davidson said. “Can you clarify when a token is sufficiently decentralized to no longer be a security in your view?”
Gensler refused to comment on ether or any other specific token, instead saying that any token that passed the Howey Test would be considered a security.
Gensler Is Coming For The Exchanges
In response to a question from Rep. Jim Himes (D-Conn.), Gensler discussed his reasoning for focusing on regulating trading and lending platforms, including decentralized ones.
“Investors are basically giving ownership rights up. They transfer what’s called a private key to the platform … and the platforms take custody,” Gensler said.
Gensler Continued, Saying:
“I think that such a tremendous amount of activity happens there, and it’s a place where we could get better investor protection … even in the decentralized platforms, or so-called DeFi platforms, there is a centralized protocol. And though they don’t take custody in the same way, those are the places where we can get the maximum amount of public policy.”
Gensler repeatedly urged exchanges to register with the SEC, something he has done in past appearances, and decried the exodus of exchanges to friendlier jurisdictions.
“I think firms should just come in and register,” Gensler said. “But what’s happened over the last four or five years is they’ve either chosen not to or they’ve stood up in Singapore or Malta or Hong Kong or other countries and offered their services indirectly through a virtual private network.”
Rep. Anthony Gonzalez (R-Ohio) pointed out that simply “coming in and registering” with the SEC might not be feasible for some exchanges.
“I’ve been speaking with multiple companies in the space, and the common theme in these discussions is that they want to come in and describe their product to the SEC; however, they’re concerned that these meetings could lead to a potential enforcement action,” Gonzalez said. “This sort of friendly open door conversation is not something they believe they’re experiencing.”
When asked his thoughts on investment platforms like Robinhood that offer digital assets alongside stocks, Gensler stressed the need for crypto exchanges to register with the SEC.
“I think if we don’t get these exchanges, these lending platforms inside of the public policy framework, a lot of people are gonna be hurt,” Gensler said. “I think it’s clear that many of these projects are within the securities laws. We’re gonna use our authorities to try to get more of these projects and companies to register and be within the investor protection framework.”
Coming Stablecoin Regulation
Though Gensler asserted several times during Tuesday’s hearing that the SEC already has sufficient authority to regulate cryptocurrencies, he suggested that Congress could be helpful in deciding how to regulate “stable-value coins.”
When asked if he considered stablecoins a systemic risk to the U.S. economy, Gensler doubled down on his previous analogy comparing stablecoins to “poker chips” at a crypto “casino.”
“I think the $125 billion of stablecoins we have right now are like the poker chips at a casino, and I think they create risks in the system,” Gensler said. “Yes, I think if this continues to grow – and it’s grown about 10-fold in the past year – it can present those system-wide risks.”
The statements came hours after CoinDesk first revealed that Circle, a key backer of the USDC stablecoin along with Coinbase, had been hit with an investigative subpoena from the SEC’s enforcement division.
“You can see where it could start to undermine things if it continues to grow,” Gensler said. “[How it could] undermine traditional banking systems if it’s not brought inside the remit of banking.”
Gensler, however, seemed to suggest that dollar-backed stablecoins with “clear and clean reserves” could be “different,” from what one representative called “junk coins” with unknown reserves.
“Wrapping something computer graphically around fiat money could be different, it could be directly around deposits at a bank or, at the other end of the spectrum, it could look a lot like a money market fund,” Gensler said. “It really depends on the underlying assets.”
Gensler also stressed that part of the SEC’s issue with stablecoins is that they have been used within exchanges “in part to avert laws around tax compliance and illicit activity.”
Crypto’s Long-Term Outlook
Gensler also doubled down on previous statements he made to the Washington Post that he didn’t see a long-term future for the majority of crypto projects.
“It’s unlikely that 5,000 or 6,000 private forms of currency are gonna persist. Economic history tells us that’s unlikely. A handful might be competing with gold or silver as a digital speculative store of value … but not many of them. Most of them are speculative asset vehicles.”
Although Gensler repeatedly said he wouldn’t comment on any token in particular, he called bitcoin a store of value.
“Bitcoin … is a highly speculative asset, but it is a store of value that people wish to invest in as some would invest in gold,” he said.
No One Is Banning Crypto (Right Now)
Rep. Ted Budd (R-N.C.) brought up China’s most recent crackdown against cryptocurrencies and crypto mining, and asked Gensler if the SEC was planning to implement similar bans.
After initially demurring, Gensler was forced to answer when Budd asked again directly: “But no bans that you’re interested in implementing via the SEC as China has done, really to funnel everyone through their own digital currency?”
“No, that would be up to Congress,” Gensler said
SEC Chief To Wall Street: The Everything Crackdown Is Coming
The joke in Washington is that Gary Gensler could inspire his own version of the game, “Drink Every Time…”
The Rules: Down a shot every time the U.S. Securities and Exchange Commission chief says he’s “asked the staff” to consider new regulations.
Gensler has “asked the staff” about oversight for crypto — drink. For online brokers — drink. For green investment funds — drink. During two recent congressional hearings, Gensler used the phrase no fewer than 30 times, enough, one lobbyist quipped, to induce alcohol poisoning.
But for Wall Street, Gensler’s plans are hardly something to laugh about. He’s laying out one of the most ambitious agendas in the SEC’s 87-year history — some 49 proposals, many already drawing opposition from hedge funds, stock exchanges, online brokers and public companies.
He’s been similarly aggressive on agency enforcement cases, which can tank share prices, spur fines and trigger embarrassing publicity.
Gensler, an ex-Goldman Sachs Group Inc. executive whose earlier Washington experience includes a hard-fought battle against big banks to bring oversight to the vast derivatives market, says he’s confident the SEC can move ahead on many issues at once.
In an interview, he added that he sometimes thinks of the famous Martin Luther King Jr. speech about the “fierce urgency of now” when it comes to the regulator’s agenda.
The frenetic pace has some SEC veterans, and even Gensler’s supporters, worried that he may be so overextended that he ultimately fails to get much accomplished.
They wonder if he’s leading the commission into a morass of politicking, lawsuits and even a rebellion by the regulator’s unionized workers. Many are asking: how will Gensler pull this off?
“You have to think it will be quite a challenge for the SEC staff to achieve,” said Frank Kelly, a former agency official who now runs Fulcrum Macro Advisors, a Washington policy research firm.
A few Democrats and outside advisers have urged Gensler, 63, to narrow his scope to a more manageable load. The policies he’s advocating, they argue, may take years to complete and have prompted powerful corporate interests to start discussing strategies for suing the SEC.
For his part, Gensler insists he has no priorities because everything is at the top of the list. “Don’t ask me about my three daughters and which one I spend more time with,” he said.
There is plenty of action inside the agency. Gensler has set up some 50 teams involving about 200 people to write rule proposals. Each has staff from the general counsel’s office as well as economists to carefully weigh the costs and benefits, a key requirement of federal law.
He is keeping close tabs on the progress; the groups have been directed to send regular updates to the chair’s office on the state of play.
Gensler also faces political pressures. The Biden administration and congressional Democrats — two constituencies he doesn’t want to disappoint — are keenly interested in particular policies, especially a pending SEC rule that would address climate change through more-robust corporate disclosures.
Lawmakers’ other priorities include reining in special-purpose acquisition companies, or SPACs, responding to this year’s implosion of family office Archegos Capital Management and getting a handle on the unchecked growth of cryptocurrencies.
One area vexing Wall Street is Gensler’s pledge to overhaul the equity market’s plumbing in response to this year’s meme-stock mania. The wild trading has prompted several congressional hearings and put firms, including Robinhood Markets Inc. and Citadel Securities, on edge because new regulations could hurt their lucrative businesses.
Executives who’ve met with SEC officials have been privately cautioned that the market structure rules being developed may be extreme, according to people familiar with the matter.
The warning from inside the agency shouldn’t come as a surprise. Interviews with more than two dozen people who have served in the government with Gensler or clashed with him when he ran the Commodity Futures Trading Commission during the Obama administration say he won’t pare back his ambitions or shy away from a fight.
Most of those willing to discuss Gensler candidly requested anonymity. Some said they admire him, while others had a hard time mentioning his name without adding an epithet. But all said they would never bet against him.
They painted a picture of a relentless and skilled manipulator of the bureaucracy who cares little about making enemies or exhausting staff members.
Those qualities, the people noted, explain how Gensler became one the youngest partners ever at Goldman Sachs and how he was able to force Wall Street to bring swaps out of the shadows after the 2008 financial crisis while leading the CFTC.
“If anyone underestimates his ability to get things done, they do so at their own peril,” said Micah Green, a lobbyist at law firm Steptoe & Johnson.
Still, much of Gensler’s agenda is daunting. Finding a solution to the social-media driven surges of GameStop Corp., AMC Entertainment Holdings Inc. and other meme stocks, for example, entails confronting several complicated issues. Tampering with any one could have unintended consequences for millions of investors.
Take “gamification,” the video-game like prompts that, critics say, encourage excessive trading by customers of Robinhood and other app-based brokerages. The SEC is examining whether such nudges are akin to offering investment advice, which would trigger a thicket of additional regulations. However, securities rules developed decades ago to police human brokers may not be effective in helping investors who are addicted to buying and selling stocks on their smartphones.
A related issue is so-called payment for order flow, in which trading firms pay brokerages to execute clients’ stock orders. Major online brokers rely on the practice to offer customers commission-free trades, but Gensler has suggested that it could be banned.
Eliminating the payments would cut right though the business models of electronic-trading firms that control much of U.S. stock trading, including Citadel Securities and Virtu Financial Inc. They are already vigorously opposing such a move, as are Robinhood, Charles Schwab Corp. and other brokers.
Other policy changes Gensler is contemplating have their own enemies list. Hedge funds, for example, are concerned that they will have to reveal much more about their investing strategies, including short positions.
Crypto firms bristle at Gensler’s contention that they are peddling securities, which would trigger SEC oversight for the unregulated industry. Last month, Brian Armstrong, the chief executive officer of the exchange Coinbase Global Inc., went on a Twitter rant, accusing the SEC of “intimidation tactics” after the agency threatened to sue if the company rolled out a product that would let customers earn interest on their token deposits.
Several white-collar defense lawyers who used to work at the SEC said they couldn’t remember a similar situation and called it an inappropriate use of the agency’s enforcement powers. Still, for a regulator that’s perpetually outgunned by industry, the strategy was effective. Coinbase shelved the product.
As Gensler combats outside forces, he also faces internal challenges.
When he led the CFTC, Gensler drove people hard to implement post-crisis swaps rules and they formed a union after he left.
The SEC is already unionized and in what could be a harbinger of labor troubles, workers recently filed a grievance against Gensler for not extending a Covid-related benefit that let employees care for children during business hours.
Gensler’s progress could also be impeded by the SEC’s painstaking rulemaking process. It typically takes SEC lawyers months to write regulations, which are subject to votes by the agency’s five commissioners.
In addition, any misstep opens up a legal challenge, and several of Gensler’s predecessors have had major policies overturned.
Gensler “has a very challenging job and I think as a practical matter, his legacy is likely to be written in the courts,” said Joseph Grundfest, a former SEC commissioner who’s now a law professor at Stanford University.
Nevertheless, it’s undisputed that Gensler has a record of achievement. The Dodd-Frank Act called for the CFTC to pass more than 60 rules and he completed the bulk of them by the time he stepped down in 2014.
Workers at the futures regulator recall that he personally took charge of the mission, giving teams strict deadlines. Gensler would frequently drop in to meetings unannounced in his stocking feet for status updates. Leaders who slowed things down were removed.
A common tactic Gensler used was to push the CFTC staff to initially take the harshest position possible, thus setting the terms for negotiation with financial firms. The rules that emerged may not have been as tough as he wanted but they still allowed him to claim a win over Wall Street.
SEC Chair Gary Gensler Actually Is pro-Bitcoin, Volt Equity CEO Argues
Volt recently received approval for an ETF that includes stocks in various crypto-related companies.
The founder of Volt Equity believes that United States regulators have a fair reason to be slow in approving a pure Bitcoin (BTC)-related exchange-traded fund (ETF).
Volt Equity CEO and founder Tad Park voiced support for the U.S. Securities Exchange Commission regarding the regulator’s unwillingness to approve an ETF that would track Bitcoin directly.
In a Tuesday Fox Business interview, Park argued that SEC Chair Gary Gensler “actually is pro-Bitcoin” but is also “a little bit misunderstood” regarding his perspective on crypto regulation in the United States.
Park specifically referred to the SEC’s investor protection concerns, namely that crypto custody providers have yet to assure the commission that they can actually ensure proper asset protection:
“I can say ‘I have a gold ETF or a Bitcoin ETF,’ but I’m storing that gold in my basement. Is the SEC going to allow that? Probably not. Unless companies can show they can custody it and actually address a lot of the issues Gensler specifically mentioned, it’s not going to work.”
The CEO added that “at least half” of current crypto ETF applications with the SEC “are not even valid” because “they are not addressing what Gary Gensler is saying.”
Park emphasized that Volt Equity’s crypto ETF does not provide direct exposure to Bitcoin but instead tracks major Bitcoin-correlated companies, including MicroStrategy, Tesla, Twitter, Square, as well as Bitcoin mining companies such as Bitfarms.
“We try to get at what people are actually looking for, which is correlation to Bitcoin’s price movement. These companies are really focusing on Bitcoin and get the majority of their income and revenues from Bitcoin. It makes sense that they tend to move along with Bitcoin’s price,” Park noted.
Approved on Oct. 1, Volt Equity’s Volt Crypto Industry Revolution and Tech ETF tracks “Bitcoin Industry Revolution Companies,” a list of firms holding a majority of their net assets in Bitcoin or derive a majority of their earnings from Bitcoin mining, lending or transactions.
The SEC has yet to approve a pure Bitcoin ETF. On Oct. 1, the SEC extended the deadline for four Bitcoin ETFs, including Global X Bitcoin Trust, Valkyrie XBTO Bitcoin Futures Fund, WisdomTree Bitcoin Trust and Kryptoin Bitcoin ETF. In August, Gensler suggested that the regulator might be open to approving Bitcoin futures ETFs.
SEC Chair Gary Gensler Responds To Concerns About First Bitcoin-Linked ETF
In the same interview, ProShares head of investment strategy Simeon Hyman opined that regulated futures traded in a 40-act ETF will open the opportunity to get BTC exposure to a lot of folks who may have been waiting on the sidelines.
United States Securities and Exchange Commission Chair Gary Gensler and ProShares head of investment strategy Simeon Hyman discussed the launch of the first Bitcoin-linked exchange-traded fund (ETF) with CNBC on Tuesday.
ProShares Bitcoin Strategy ETF, also known as BITO, is based on CME Bitcoin (BTC) futures contracts. CNBC commentator Bob Pisani shared concerns from some investors that BTC futures could deviate from the BTC spot price.
“The futures market is a better place for price discovery,” said Hyman. “The CME futures market trades more volume than the largest U.S. crypto exchange. We launched a similar mutual fund on 7/28, and since we launched on Friday, the Bitcoin Reference Rate is up 52%, our BTC mutual fund is up 52% and the BTC Greyscale Trust is up 37%.”
The debut of BITO follows announcements that other BTC-linked funds, including Valkyrie’s Bitcoin Strategy ETF, are set to start trading on the Nasdaq. A new blockchain-industry-based fund, called the Volt Crypto Industry Revolution and Tech ETF, intends to begin trading soon as well.
Pisani asked Gensler about earlier comments where he said he did not have the same concerns with issuing BTC futures-linked funds versus a fully-linked BTC fund. Gensler confirmed:
“What we are trying to do is bring new projects into the investor-protected perimeter. BTC futures have been overseen by the SEC’s sister agency, the Commodities Futures Trading Commission, for the past four years. You have something that’s been overseen for the past four years by a federal regulator, and it’s also been wrapped up in the SEC’s jurisdiction through the Investment Company Act of 1940.”
Hyman expressed his confidence in the new fund noting the history of BTC’s price action, U.S. securities laws, and the opportunity for a new opportunity for investors:
“There’s a lot of history here. We think it’ll track quite well and, most importantly, we think that a combination of a regulated futures market and a 40-act ETF will really open up the opportunity to conveniently get Bitcoin exposure to a lot of folks who may have been waiting on the sidelines.”
Lassoing A Stallion: How Gary Gensler Could Approach DeFi Enforcement
The SEC may “pierce the veil” of “decentralization theater” by going after individuals involved in DeFi projects, observers say.
Earlier this week, we considered the challenges of creating viable long-term regulations for decentralized finance (DeFi) protocols. These systems can ostensibly remove intermediaries from the trading of any asset represented on a blockchain, but those intermediaries have been the ones enforcing rules on behalf of regulators for the better part of a century.
That means workable DeFi regulation will likely be much different in substance, and enforced differently, than current securities and finance rules.
That rethink may be years away from occurring, but U.S. regulators aren’t sitting idly in the meantime. With Securities and Exchange Commission chief Gary Gensler signaling that he’s paying attention, there’s significant expectation that enforcement actions could target DeFi well before any new regulations become official.
Those enforcement actions will likely prioritize instances of clear lawbreaking, such as fraud or money laundering, taking place on DeFi systems.
They will be significant tests for the legal implications of decentralization. And they could get very, very ugly – particularly for individuals running “DeFi” systems that aren’t very decentralized at all.
Here, based on conversations with lawyers, former regulators and DeFi executives, are three key points about how things are likely to play out over coming months and years.
1. Enforcement Will Come Before New Rules
The first ugly truth about DeFi regulation is that it will inevitably come too late. Systems like UniSwap and Celsius were built in ways that challenge the fundamental premises of conventional financial regulation, but regulators will not be quick to shift their models to conform with the reality on the ground. Meanwhile, DeFi systems continue to grow, guaranteeing they’ll face increasing scrutiny.
Jai Massari, a partner focused on trading and markets at the law firm Davis, Polk and Wardwell, predicts a three-step process of reconciling those conflicting truths. Call it the Stages of Regulatory Grieving.
“I think it starts off with enforcement,” she says, “because enforcement is easier than regulation.” Those enforcements could be similar to recent actions that have led to large fines for crypto exchanges like Kraken or services like Tether. But they could also go further to include criminal charges against individuals, on which more below.
Then we’ll begin to “see an effort [by regulators] to push these DeFi activities into existing regulatory categories,” Massari says. “But I don’t think that’s going to go well. I think it could be quite messy.”
In other words, she doesn’t expect serious consideration of a new regulatory framework that actually fits how DeFi works until after regulators spend time trying to hammer square pegs into round holes. In the U.S. context that could include jurisdictional fights between the SEC and other financial regulators.
Plenty of crypto operators will rightly view putting enforcement ahead of regulation as shutting the barn door after the horse is loose. To some extent, it’s a consequence of the shifting priorities of a new administration.
Trump administration regulators, for better or for worse, made only incremental progress on laying out rules for crypto, much less DeFi, as crypto and DeFi grew from marginal to meaningful between 2016 and 2020.
There are signs regulators see things as running out of control. “It appears [Gary Gensler is] aligned with people like [Massachusetts Sen.] Elizabeth Warren that it’s the wild west, that it’s under-regulated,” says Katherine Kirkpatrick, co-chair of the Financial Services working group at the law firm King & Spalding.
Gary Gensler and Co., in other words, see themselves as trying to lasso a galloping stallion. That may lead to particularly strong enforcement tactics.
“They’re operating from the perspective of trying to solve something that’s the most egregious thing going on using traditional law enforcement tools,” Duane Pozza, a former Federal Trade Commission staffer who is now a partner at Wiley Law. “Because it means there will be fewer limits.”
2. Investigators Will “Pierce The Veil” Of Decentralization
In principle, DeFi protocols run without owners, leaders or managers. Much like Bitcoin, the protocols are in principle just software run by a collection of node operators or validators who neutrally facilitate transactions while collecting liquidity yield and fees.
Governance decisions, including changes to the protocol itself, could also in principle be managed by users.
But there are still few examples of this in practice today; instead, the reality of “DeFi” in the present is often that it’s a fig leaf for a very clear group of core leaders who are actually in charge.
The clearest evidence of this is instances where accounts, tokens or entire “decentralized” systems have been frozen or shut down.
“One of the design decisions in an autonomous system is whether there’s a kill switch,” says Stephen Palley, a lawyer focused largely on crypto regulation at Anderson Kill. “The problem with a kill switch is, what’s the liability or exposure of the person who controls it? To be truly autonomous, you can’t have a kill switch. The absence of that is a way to say you’re not responsible.”
It’s a grim irony of DeFi’s coming collision with legal reality: DeFi administrators who have been taking direct action to control problematic activity may have given law enforcement clear evidence that they’re actually the ones in charge, making themselves targets.
Particularly in cases where there is no legal entity affiliated with a DeFi platform, experts say this could lead to regulators and investigators “piercing the veil” in their DeFi enforcement actions.
“Piercing the veil” is a legal term of art normally applied to prosecutions of corporate wrongdoing that target individual officers of the company, not just the legal corporation itself.
At least two recent crypto prosecutions have shown the willingness of the SEC and others to pierce the veil of crypto organizations, even those that have conventional corporate structures.
One was the SEC’s charging of individuals at Ripple, including CEO Brad Garlinghouse, with an unregistered securities offering. The other was the filing of money laundering-related criminal charges against officers of BitMEX, including CEO Arthur Hayes.
Similar direct action against individuals with control over DeFi systems may not be far off. SEC chief Gensler has already made clear that he views most claims of decentralization in DeFi with skepticism.
In addition to use of kill switches, law enforcement may look for evidence of control and responsibility in public representations of a protocol’s team, or control of multisig wallet keys.
3. Clarity will not come soon.
It will be extremely tricky to craft regulation that controls risks like fraud and money laundering through DeFi while preserving technological advantages like open access, self-custody and democratic governance. That could be worth the trade-off in the long term if new rules are truly crafted carefully.
“We’re at a moment where a bit of enlightened thinking about regulation, a little creativity, a little open-mindedness would result in a much better outcome,” says Jai Massari. “I think the best approach is to take a step back and think about the policy objectives we’re looking for.”
That process could easily take years. In the meantime, enforcement actions will likely ramp up, perhaps leaving DeFi creators and administrators in the difficult position of defending themselves for breaking rules that simply can’t be fairly applied to the new technology.
Even then, there’s no guarantee that competent and well-considered regulation will be the end result. As we saw over the summer with the poorly crafted reporting requirements in the U.S. infrastructure bill, there is still a large technical deficit in technical knowledge among legislators and regulators, and it can have serious consequences.
“The technological shortfall is pretty significant,” says Duane Pozza. “The lawmakers have a million other things going on. We’re far away from getting to the point of understanding DeFi. I do think the infrastructure bill was a wakeup call – at least some influential people on [Capitol] Hill had to learn, had to think through this new technology.”
That leaves an uncomfortable status quo, at least for those in the world’s largest financial market. For a period that could stretch for years, there will be no changes to U.S. financial regulations to accommodate the way DeFi really works.
But at the same time, law enforcement and regulators will likely be making life very uncomfortable for anyone who could be seen as having authority or control over DeFi systems.
Unless something changes very soon, that will almost certainly push innovation in DeFi out of the United States, much as huge, centralized crypto exchanges including Binance and BitMEX found it more comfortable to center their operations elsewhere. It’s a message that at least some would-be creators are getting directly from their legal advisers.
“I might not agree with the application of certain laws to what my clients do, but I’m not the [Commodity Futures Trading Commission], I’m not the SEC,” says Palley. “I’m just a simple country lawyer and I have to call balls and strikes.”
“So I spend a lot of time just telling people to stay out of the United States. I hate it, but it’s good advice.”
SEC’s Gensler Says Crypto ‘Fits in Our Broad Remit’
The U.S. regulator also restated his request to crypto exchanges to “come in, work with the SEC.”
Crypto fits into the “broad remit” of the U.S. Securities and Exchange Commission (SEC), Chair Gary Gensler said in an interview with the Wall Street Journal on Sunday.
* In the interview Gensler restated his desire for more robust measures to protect crypto investors.
* “The public’s anticipating some profit based upon the efforts of some entrepreneur or computer-science group that’s raised money from the public. That fits in our broad remit at the SEC,” he said.
* Turning to crypto platforms, Gensler said that exchanges are “doing a lot more than just trading,” given that they also hold crypto tokens and sometimes trade against their customer base.
* ‘I’ve said publicly, come in, work with the SEC, get registered. They are fundamentally exchanges, but they also have this other activity going on inside of it. It’s really important to get that investor protection,” he said.
* Gensler had previously said that while not all crypto tokens can be classed as a security, the fact that platforms offer the trading of so many tokens, it is likely that at least some will be.
‘I’m A Huge Believer In Crypto Technology,’ Says Former US SEC Chair
Jay Clayton said that cryptocurrencies have numerous purposes and are connected to a variety of industries, and the SEC should be in charge of regulating only those sectors that are linked to it.
Former chairman of the U.S. Securities and Exchange Commission, or SEC, Jay Clayton, was appointed by former President Donald Trump to serve in 2017.
During his tenure as head of the SEC, Clayton often defended Bitcoin (BTC) as a store of value. This past Wednesday, during an interview with CNBC’s Squawk Box show, Jay shared his thoughts on cryptocurrency and how it should be regulated going forward.
The former SEC chair said that he is a “huge believer in crypto technology” and that its efficiency advantages in the financial system and tokenization are enormous.
— Squawk Box (@SquawkCNBC) December 15, 2021
Clayton’s remarks come as the current SEC chair, Gary Gensler, recently confirmed that the watchdog has no plans to ban crypto, but that the United States Congress could. Gensler warned, however, that crypto, in its current form, is comparable to the Wild West without proper regulation.
When asked whether the present chairperson is creating too many restrictions for the crypto industry, Jay said that cryptocurrencies have numerous purposes and are connected to a variety of industries, and the SEC should be in charge of regulating only those sectors that are linked to it.
“Crypto is a wide variety of products, with a wide variety of functions, and the rules of our financial system are clear and long-standing. If you are raising capital for a project, you have to register your capital raising with SEC. If you are trading securities it has to be on a registered venue, But there are many crypto sectors like stablecoins that are not securities and outside of SEC purview.”
According to Clayton, cryptocurrencies should be implemented but with appropriate regulation. He said that the government should be “reactive to people who are violating our well-defined laws but proactive in encouraging the adoption of this technology throughout our financial system.”
Clayton did not allow the approval of a Bitcoin exchange-traded fund (ETF) during his term —that did not occur until 2021 under Gary Gensler. The agency has since come under fire for rejecting spot ETF applications and approving Bitcoin futures ETFs.
Grayscale submitted a letter to SEC’s secretary, Vanessa Countryman, in which it stated that “there is no basis for the position that investing in derivatives for an asset is acceptable for investors but not investing in the asset itself.” The SEC was accused of treating the two Bitcoin ETF proposals unequally under the Administrative Protections Act, or APA.
SEC Chair Has A New Senior Adviser For Crypto
Corey Frayer has worked as a staff member of the Senate Banking Committee as well as a senior policy adviser for some members of the House Financial Services Committee.
United States Securities and Exchange Commission (SEC) chair Gary Gensler has added a new staff member who will offer advice related to crypto policymaking and interagency work.
In a Thursday announcement, the SEC said Corey Frayer would be joining Gensler’s executive staff as a senior adviser on the agency’s oversight of cryptocurrencies.
Frayer has worked as a professional staff member of the Senate Banking Committee as well as a senior policy adviser for the House Financial Services Committee with Representatives Maxine Waters and Brad Miller.
Frayer’s appointment to the SEC chair’s executive staff came alongside those of Philipp Havenstein, Jennifer Songer and Jorge Tenreiro, who will be working as operations counsel, investment management counsel and enforcement counsel, respectively.
Gensler cited the new staff members’ “valuable counsel on policy, enforcement and agency operations” in appointing them to the team.
The SEC, the Commodity Futures Trading Commission and the Financial Crimes Enforcement Network handle digital asset regulation in the United States, but each with different jurisdictional claims, resulting in a patchwork approach that crypto firms must navigate to legally operate. Having been confirmed by the U.S. Senate in April, Gensler will likely continue to serve as chair of the SEC until 2026.
Appointing Frayer to his staff could potentially affect Gensler’s public position on crypto-related policy changes.
The SEC chair is arguably one of the most informed people on crypto and blockchain technology to ever hold his position but has expressed concerns about exchange-traded funds with exposure to cryptocurrencies like Bitcoin (BTC). He has long urged crypto projects to register with the SEC, specifically saying they should “come in” and work with regulators.
The SEC’s leadership will likely change in 2022 following the departure of commissioner Elad Roisman in January and the expiration of commissioner Allison Lee’s term, which is set to be in June.
This leaves President Joe Biden with an opportunity to pick financial experts who could have a significant influence on policy related to crypto.
Crypto Exchanges Will Face More Scrutiny From SEC, Gensler Says
Crypto exchanges are set to be a primary focus of the U.S. Securities and Exchange Commission’s crackdown on digital assets in 2022.
SEC Chair Gary Gensler said on Wednesday that he’s hopeful that trading platforms will take steps in coming months to be more directly regulated by Washington’s financial regulators. The additional scrutiny is crucial for crytpo investors to get the types of protections they get when trading stocks or other assets, according to Gensler.
“I’ve asked staff to look at every way to get these platforms inside the investor protection remit,” Gensler told reporters in a virtual press conference. “If the trading platforms don’t come into the regulated space, it’d be another year of the public being vulnerable.”
Gensler rattled the crypto industry last year, including when he argued that most tokens were akin to securities that should be covered by the SEC’s tough rules. Many coin enthusiasts, however, argue that the assets shouldn’t be subject to the same regulations that have long covered equities and bond trading.
SEC Looks To Bolster Market’s Cyber Defenses
Chairman Gensler says agency wants to improve resiliency of the financial sector against online attacks.
The Securities and Exchange Commission is exploring ways to improve cybersecurity in capital markets, including by extending compliance obligations to companies that currently don’t have to meet them, Chairman Gary Gensler said Monday.
“The economic cost of cyberattacks is estimated to be at least in the billions, and possibly in the trillions, of dollars,” Mr. Gensler said in a virtual speech to the Northwestern Pritzker School of Law’s annual Securities Regulation Institute conference. “We at the SEC are working to improve the overall cybersecurity posture and resiliency of the financial sector.”
Mr. Gensler said the agency is considering extending a rule known as Regulation Systems Compliance and Integrity, or Reg SCI, to large financial firms it doesn’t currently cover, such as market makers and broker-dealers.
The rule, which currently applies to stock exchanges, clearinghouses and similar entities, requires firms to conduct testing for cybersecurity issues, back up their data and have business-continuity plans in the event of a breach.
At a meeting of SEC commissioners Wednesday, officials plan to propose extending Reg SCI to trading platforms that match buyers and sellers of Treasury securities, Mr. Gensler said.
Regulators have recently stepped up scrutiny of how companies respond to attacks by hackers.
Mr. Gensler reiterated Monday that publicly traded companies might have an obligation to disclose ransomware incidents that result in payments or data breaches that expose client information.
Kenneth Bentsen, president of the Securities Industry and Financial Markets Association, said he welcomed Mr. Gensler’s remarks, adding that cybersecurity is already a top priority for the financial industry.
“To say whether policy makers need to adopt new rules or not, I don’t know, but I think what you have to look at first is everything that’s going on right now across the industry,” Mr. Bentsen said. “You have to constantly be updating. And it’s got to be very much collaborative between the regulated and the regulators.”
The SEC chairman said he also has directed staff to look into updating the timing and substance of the notifications that brokers, fund managers and investment advisers are required to send clients when their data have been accessed in a cyber incident.
In addition, the SEC is examining ways to raise cybersecurity standards for service providers—such as index providers, custodians, investor-reporting systems and others—that aren’t directly covered by current regulations, Mr. Gensler said.
Possible measures include requiring SEC-registered firms to identify service providers that could pose risks or holding firms accountable for their service providers’ cybersecurity measures.
“This could help ensure important investor protections are not lost and key services are not disrupted as financial-sector registrants increasingly rely on outsourced services,” Mr. Gensler said.
SEC Seeks More Disclosures From Private-Equity And Hedge Funds
Proposal aims to help regulators spot risks growing in private markets.
Federal regulators proposed measures that would significantly increase their visibility into private-equity funds and some hedge funds, the first in a range of plans to expand oversight of private markets.
The Securities and Exchange Commission voted 3-1 to issue a proposal that would increase the amount and timeliness of confidential information that private-equity and hedge funds report to the agency on a document known as Form PF.
The main goal, Chairman Gary Gensler said, is to allow regulators to better spot risks building up in private markets, stepping up an effort that began after the 2008 financial crisis.
The commission, in a meeting Wednesday, also voted 3-1 to propose expanding oversight of some trading platforms that match buyers and sellers of U.S. Treasury securities. The agency will seek comment on the proposals before completing the rules, a process that could take several months at least.
Hester Peirce, the commission’s only Republican, voted against both proposals. She questioned the need for increased disclosures from private funds and dissented from the trading-platforms rule because she said the 30-day comment period is too short.
Net assets managed by private funds, which are accessible only to institutional investors or relatively wealthy people, rose to $11.7 trillion in the first quarter of last year from $5.3 trillion in 2013, SEC data show.
With the growth have come concerns from some policy makers about the potential for unseen risks to accumulate in a corner of the market that is far less transparent than mutual funds or publicly traded companies.
The SEC adopted Form PF as part of the regulatory overhaul after the 2008 financial crisis. Currently, it is filed by private-equity funds and large hedge funds on an annual or quarterly basis with a 60-day lag.
The form includes information such as net assets, borrowings and derivative holdings. The SEC and federal financial-stability regulators then aggregate that confidential data in public reports.
“We have identified significant information gaps and situations where we would benefit from additional information,” Mr. Gensler said in a written statement.
He added that regulators have nearly a decade of experience with Form PF data. “For example, we would benefit from more timely information during fast-moving market events.”
Among other changes, Wednesday’s proposal would require large hedge funds to file reports within one business day of incidents such as extraordinary investment losses, large increases in margin requirements or defaults by major counterparties.
Private-equity funds would have to file reports within one business day of events such as removal of a fund’s general partner or termination of a fund’s investment period.
In addition, the proposal would reduce the threshold that triggers reporting as a large private-equity adviser to $1.5 billion from $2 billion in assets under management. It would also require such entities to provide more information about their use of leverage and their portfolio companies.
Ms. Peirce said the proposed changes would turn Form PF into a “tool for the government to micromanage” private funds.
“A hedge fund suffering losses equal to or greater than 20% of its net asset value over the course of 10 days is unquestionably significant for that hedge fund and its investors,” Ms. Peirce said. “But why is it appropriate or even wise for the commission to insist on being notified of this within one business day? Surely the fund adviser will have its hands full in such a fraught period, and will have little time to spare to fill out government forms.”
The Managed Funds Association, which lobbies Washington on behalf of hedge funds, said it supports the SEC’s objective of gathering relevant data from market participants in a crisis.
“We want to study the details to ensure that this proposal is calibrated to collect information at the right interval and granularity without inadvertently capturing routine activity,” spokesman Noah Theran said in a statement.
Mr. Gensler, who was nominated last year by President Biden, said Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell highlighted the need for more-timely information on private funds during his first meetings with those officials.
“When I was coming into office last April, it was very much on everybody’s mind,” he said, noting the rapid deterioration in financial markets that had occurred at the onset of the Covid-19 pandemic in March 2020. “There were dysfunctions across various markets at that point in time.”
The SEC chief has outlined additional ways to address some Democrats’ concerns that private markets have become too big and risky over the past decade or so.
Last year, he said the SEC is considering new rules to increase disclosures by private-equity firms and hedge funds to their investors about their conflicts of interest and sometimes opaque fee structures.
The agency is also working on a plan to require more private companies to routinely disclose information about their finances and operations, and potentially increase the amount of information that some nonpublic companies must file with the agency.
Wednesday’s proposal for Treasury trading platforms would target entities the SEC calls Communication Protocol Systems, which aren’t subject to the agency’s current regulations for securities exchanges even though they bring together buyers and sellers of stocks and bonds.
The platforms, which are operated by companies including Tradeweb Markets Inc., would be required to register with the SEC as either exchanges or broker-dealers.
“Tradeweb is a proponent of thoughtful regulation that promotes greater efficiency and transparency, and we look forward to providing comment on today’s proposal,” a spokesperson for Tradeweb said.
You Get The Crypto Rules You Pay Gary Gensler For
Here is a dumb model of financial regulation. There are two general ways for authorities to regulate financial activities. Call one “rulemaking.” A regulator thinks about some financial things, decides how they should work, solicits comments from industry participants and the general public, and writes a rule explaining in some detail how things will work. After that, everyone who does those things knows what the rules are and what things they are and are not allowed to do.
Surely the $100m will go to pay back the victims, right?
Oh wait there weren’t any victims. https://t.co/DuQpTdMWzM
— Erik Voorhees (@ErikVoorhees) February 14, 2022
Call the other “regulation by enforcement.” The regulator doesn’t spend much time writing specific new rules, but just relies on some general old rules saying things like, you know, “don’t use an artifice to defraud.”
What that means can be unclear and, more to the point, if the regulators decide to go after you for using some artifices, your life will be unpleasant even if you ultimately win. Knowing this dynamic, the regulators can use enforcement actions to decide and declare what is and is not allowed.
Everyone goes around doing things, and then some of them get sued by the regulator and have to pay a bunch of money to settle the lawsuits. Everyone watches those lawsuits, and each lawsuit tells everyone a bit more about what is and is not allowed.
If the regulators sue someone for doing X, and you’re also doing X, you stop doing X. “Don’t do X” has become a rule without any rulemaking. The first person to get sued for X didn’t know that that was the rule, though, and gets in trouble and has to pay a fine.
One way to think about this is that it is unfair: That person didn’t know X was against the rules, why should she get in trouble? Often though it does not feel that unfair, because X probably does look pretty bad; it probably was at least arguably against some general rule like “don’t use any artifices.” It’s a little random that this person got in trouble for doing X, but it’s not like she was totally innocent either.
The people who get fined were in some gray area; they didn’t know that what they were doing was not allowed, but they had some notice that it might not be allowed.
But another way to think about it is that regulation is expensive, and regulation by enforcement is a way to make the industry pay for regulation. In rulemaking, the regulator has to put a lot of expensive effort into figuring out what should be allowed; this is particularly hard when a lot of novel activities are going on, and there is a risk that the regulator will get it wrong, miss things, move too slowly, etc.
In regulation by enforcement, the industry has to put a lot of expensive effort into figuring out what is not allowed, and the risk of missing things is on the industry; the regulator gets to focus its attention on what is actually happening and what it wants to prevent rather than theoretical generalities.
More concretely, each time the industry gets a little more clarity — each time it learns a new X that is or is not against the rules — it pays a big fine.
“Fines are a cost of doing business,” people complain about financial regulation, but perhaps sometimes it is more like “fines are a cost of figuring out what the rules are.” The regulators will tell you what the rules are, but one at a time, and for $10 million per rule.
If a crypto startup went to the U.S. Securities and Exchange Commission and said “we want regulatory clarity about what we need to do to run crypto lending programs, so you should write some rules about it,” the SEC would say “sure, we’ll give that some thought in like 2036.” If it went to 50 different U.S. states and asked them for clarity it would get even more confused.
If it went to the SEC and said “look, to speed this process along, why don’t we pay you $50 million to prioritize writing these rules,” that would be a very bad crime and it would to go prison.
But BlockFi Will Give The Sec $50 Million, 1 And It Will Give Some States Another $50 Million, And Now It Has Clarity About Crypto Lending Programs:
Crypto proponents have argued for years that regulators shouldn’t apply decades-old rules to the burgeoning asset class. But in a move with sweeping implications for the industry, at least one prominent company is now planning to register its offerings with the Securities and Exchange Commission.
* BlockFi Inc. announced on Monday that it’d seek SEC approval for accounts that pay clients high yields for lending out their crypto as part of a record $100 million settlement with federal and state securities watchdogs. The plan would give the Jersey City, New Jersey-based firm the first SEC sanctioned product of its kind, immediately adding pressure on competitors to follow suit. …
* As part of the agreement announced by the SEC, current BlockFi customers can continue to earn interest on their existing investments, but the company must not sell the products to new American clients. The company has 60 days to seek to comply with SEC regulations and it’s also seeking to register a new crypto-lending product that will satisfy the agency’s rules.
That is from a Bloomberg article about BlockFi’s big new plans that will give it a first-mover advantage and also about the $100 million fine it paid. The headline is “BlockFi’s Plans to Register with SEC Augurs New Era for Crypto.” The Wall Street Journal’s headline is “BlockFi to Pay Record Penalty to Settle SEC Probe of Crypto Lending Business.” Both true!
Or here is Bloomberg’s Emily Chang interviewing BlockFi Chief Executive Officer Zac Prince about the settlement, and while she starts the interview by asking why BlockFi broke the law — which is after all what the SEC concluded here (BlockFi neither admitted nor denied it) — Prince stays on message that this settlement is about “blazing a path” and “finding a regulatory construct” for crypto lending. And here’s this:
Kristin Smith, the executive director of the Blockchain Association, said her trade group is “committed to working with Washington to establish common-sense guardrails for industry in which to operate.” She called the BlockFi settlement “a step forward toward that goal.”
I think that you can read this story as “BlockFi did something illegal and got in trouble,” or you can read it as “BlockFi has worked with the SEC to develop the first U.S. regulated crypto lending product, giving it a competitive advantage,” but I do not really think you have to choose. BlockFi ventured out into the gray area, which got it (1) a big fine and (2) clarity.
It is certainly possible that I am exaggerating here. The SEC has been saying for some time that crypto yield products like this — in which retail customers deposit their cryptocurrency with an exchange, which then lends it out to institutional borrowers and pays the retail depositors a fixed interest rate — are securities under standard interpretations of U.S. law, and I have in the past agreed that they are pretty obviously securities.
BlockFi has real lawyers and apparently disagreed, but I do not think that the SEC would say that this was a gray area. Thus the $100 million fine.
It also may be an exaggeration to say that BlockFi has gotten a ton of clarity here, or a clear path to a legal product. It still has to write a registration statement and indenture for its SEC-registered yield product, and the SEC’s examiners could object when it does file that statement. Still it seems like both sides here think that they have found a path to compliance that works.
The headline on the SEC’s press release is not just about the fine; it says “BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of its Crypto Lending Product.” And the SEC’s order goes so far as to include a picture of what it expects BlockFi’s legal lending product to look like:
That’s an approving picture; that’s, like, “this thing is a thing that we could see our way to allowing.” You don’t include a picture of BlockFi’s proposed product if you think the proposal doesn’t work.
And it is in both sides’ interests to make this work: BlockFi of course wants to have a profitable lending product, but the SEC also wants to demonstrate that it can regulate crypto activity. “We will ban all crypto activity” is not, I think, a particularly viable approach for the SEC to take at this point.
The SEC wants to send a message along the lines of “lots of crypto things are securities and thus subject to securities regulation, but that’s fine because securities regulation is totally workable for crypto things.” So making securities regulation work for a popular crypto product is a goal for the SEC too.
We Are Still In The Very Early Stages Of Crypto Regulation In The U.S., And If You Are A Crypto Firm You Have To Think A Bit About The Meta-Regulatory Landscape. There Seem To Be Roughly Three Approaches:
* Try to make yourself as immune as possible to U.S. regulation by setting up abroad, running your firm as a decentralized entity with no one for the SEC to yell at, staying anonymous, and doing whatever egregious things you want. So far this seems to work! Not everyone will want to move abroad and be anonymous though, and this approach seems to carry some big risks.
* Try to be as law-abiding as possible, consult with the relevant U.S. authorities before doing anything adventurous, and make your case to the regulators for rules that you think will be good for crypto. This sounds good, but I am not sure it works. When Coinbase Global Inc., a U.S. public company, wanted to launch a lending product like BlockFi’s, the SEC told it not to and it didn’t.
Last October Coinbase put out an ambitious “Operational Framework of the Digital Asset Policy Proposal,” which it clearly hoped would spark a conversation in Washington about how best to build a new crypto regulatory framework for crypto; I don’t think anyone has mentioned it since.
When Facebook (now Meta Platforms Inc.) wanted to launch a stablecoin, it put on a big show of working with regulators, which gave regulators lots of chances to say no, which they did, and now Facebook’s stablecoin dream is dead.
“There is a certain drunk-under-the-lamppost element to current U.S. crypto regulation,” I wrote recently: “If you incorporate a company in the U.S. and walk into the SEC’s office and ask ‘hey what are we allowed to do,’ the answer is ‘almost nothing.’”
* Try to be, you know, a medium amount of law-abiding. Keep doing stuff, stake out aggressive but plausible legal positions, and when the SEC complains be quick to settle. “Move fast and break things,” “better to ask forgiveness than permission,” etc. Each time the SEC says you broke the law, you get a little more information about what the law is, and each time you negotiate a settlement, you get an opportunity to influence the law.
This is expensive, but maybe it works? Nothing in this column is ever legal advice, and in particular I hate to say “maybe you should break the law a little bit.” But, uh, what do you conclude from this?
Here’s What Sec Commissioner Hester Peirce Concluded, In Dissenting From The Settlement:
* We often tell companies wanting to offer products that could implicate the securities laws to “come in and talk to us.” To make that invitation meaningful, however, we need to commit to working with these companies to craft sensible, timely, and achievable regulatory paths. Working with an earnest desire to reach a prudent, properly calibrated regulatory outcome is important for a number of reasons.
First, these products matter to people. A program that allows people—and not just affluent people—to keep their crypto assets, while still earning a return is valuable to many Americans, as evidenced by the programs’ popularity in the United States to date. The investor protection objective of today’s settlement will be poorly served if retail investors are ultimately shut out from participation in these products.
Second, our process speaks volumes about our integrity as a regulator. Inviting people to come in and talk to us only to drag them through a difficult, lengthy, unproductive, and labyrinthine regulatory process casts the Commission in a bad light and thus makes us a less effective regulator.
Third, a company that tries to do the right thing should be met across the table by a regulator that tries to get to a sensible result in a reasonable timeframe. For the sake of the American public, our own reputation, and the companies that heed our call to come in and talk to us, we need to do better than we have so far at accommodating innovation through thoughtful use of the exemptive authority Congress gave us.
I dunno, BlockFi seems weirdly happy that it talked to the SEC. But it was an expensive conversation.
Also block trade investigation and top-performing hedge funds.
Trading desks at investment banks are, famously, in the moving business, not the storage business. If you want to sell a big block of stock, an investment bank will not want to own it; they are just not set up to own big blocks of stock. But they are in the moving business, and if you come to them looking to sell a big block of stock they will buy it from you, both because that is how they make money (buying it from you and then reselling it at a higher price) and more deeply because that is their job and their customers won’t like them if they say no.
They are in the business of standing ready to buy or sell stocks or bonds from their customers, and if they said no a lot they wouldn’t be in that business anymore.
And so the bank is in the business of buying stocks and bonds and then quickly turning around to resell them. 4 It does not want to own the stocks, but does not want to say no to buying them. So it has to have a lot of confidence that it can resell them, preferably at a higher price than it paid.
For small stock trades this is essentially a statistical question and a computer answers it, but for large blocks of stock it is a harder question.
When you call the bank asking it to buy $500 million of Stock X, the goal is for the bank’s Stock X trader to be so knowledgeable about the market for Stock X, to have so much insight into who is looking to add to or subtract from their Stock X positions and what the drivers of demand are, that she can instantly put a price on it that is competitive (high enough that you will sell to her) and yet profitable (low enough that she’ll be able to resell quickly at a profit).
She gets this knowledge by long practical experience, by watching the tape, and by talking to investors (and analysts and salespeople) all day; this is her business; her whole job is knowing who is looking to buy and sell what. So when you call her for a price she thinks “I bet Hedge Fund A will buy $100 million of this down 2% and Asset Manager B is looking to add about $200 million down 1.5%” and keeps going down the list until she has a clear picture of how she will sell the stock and at what price. And then she gives you a bid.
But this is hard and risky; she might think that Hedge Fund A wants Stock X but actually it bought a bunch yesterday and is all full up. So it will make her life easier if she can say “hang on a minute,” put you on hold, and go call some potential buyers to see if they’re interested before giving you a price. The best way to get market knowledge is sometimes to ask directly.
Sometimes Some Version Of This Is Allowed, But Often It Is Not. For Instance:
* Federal investigators are probing the business of block trading on Wall Street, examining whether bankers might have improperly tipped hedge-fund clients in advance of large share sales, according to people familiar with the situation.
* The Securities and Exchange Commission sent subpoenas to firms including Morgan Stanley and Goldman Sachs Group Inc. as well as several hedge funds, asking for trading records and information about the investors’ communications with bankers, some of the people said. The Justice Department also is investigating the matter, some of the people said. …
* Investigators are looking at whether bankers improperly alerted favored clients to the sales before they were publicly disclosed and whether the funds benefited from the information—for example by shorting the shares in question. (In a short sale, an investor sells borrowed stock in hopes of buying it back at a lower price later and pocketing the difference.)
* Shares of companies selling stock often fall because of an increase in supply hitting the market—and they do so frequently in the hours before a big block is sold, a phenomenon that has long raised questions on Wall Street.
* Some of the funds that received subpoenas act as “liquidity providers” to Wall Street firms, according to some of the people, standing by to purchase large amounts of stock or other securities, including those that have few interested buyers.
* The rules governing when and how Wall Street firms can tell clients about coming block trades are murky. In some cases, there are questions around whether divulging certain information or acting on it is improper or illegal, lawyers say.
“Block trades” can mean a number of different things, but often it means a trade in which the company itself sells a big block of stock. Instead of doing a traditional offering (in which it announces the deal and banks spend a day marketing it, then come to the company with a price), it can get a bank to commit to a price (typically just after the market closes at 4 p.m., at a discount of a few percent to the closing price); the bank will try to find buyers after the close and be out of the block by the time the market opens in the morning.
But if it can’t find buyers, that’s the bank’s problem. Sometimes a company will just go to its favorite bank and ask for a price, but often the company will have multiple banks bid on the block and take the highest price.
Generally the banks will have some advance notice — the company might tell them at 10 a.m. that it wants bids for a block at 4 p.m. — and the bank will spend some time thinking about the right price.
One way to do that thinking would be to call up a bunch of hedge funds and say “hey if we did a block for Company X how much would you want and at what price,” though that is very much frowned upon; the block trade is material nonpublic information. Thus the investigation.
By The Way, There Are Lots Of Ways For This Information To Leak, Beyond The Obvious One Of The Banks Just Telling Everyone. Here Are A Few:
* A bank considering bidding on a block might call up some investors and ask them some general questions. “Hey how are you feeling about the tech sector today,” the bank might ask. A smart hedge fund that is following the sector might say “aha, you have block coming for Tech Company X” and short the stock.
* A bank considering a block trade might wall-cross a few investors, asking them to agree not to trade in the company’s stock for 24 hours; then the bank can feel more comfortable asking the investors about the stock without worrying that it is tipping them. But this is a fraught process. “We would like to talk to you about a tech name, would you take a wall-cross,” the bank might ask, and the hedge fund might say “aha you definitely have a block coming for Tech Company X,” decline the wall-cross and short the stock.
* The investor might agree not to trade Stock X — but what if it shorts Stock Y, a correlated stock in the same sector, as a hedge?
That has always been a bit murky, but recently the SEC has gone after this sort of “shadow trading,” in which you use inside information about one company to trade a correlated stock. That case was about a corporate insider using information about his own company to shadow trade a competitor, but you could imagine the SEC extending the theory to hedge funds in this sort of scenario.
Hedge Fund Performance
If I ran a hedge fund and had a time machine, what I would probably do would be buy Tesla Inc. stock on Jan. 1, 2020, and then nothing else. I mean, first I would negotiate really good investor agreements with long lockups, so that if any of my investors called me and said “wait is your hedge fund’s entire strategy just owning Tesla stock?” I could say “yep” and hang up without them withdrawing their money.
But then I would buy as much Tesla as I could get, tell everyone to go home, lock the doors and come back at the end of the year.
Tesla was up a ludicrous 743% in 2020, which would put me among the all-time greats of hedge fund performance. My performance fees would be 20% or whatever of 743%, meaning that at the end of the year I would be able to pay myself more than all of the money my investors put in at the beginning of the year, and they would be thrilled about it because they were up like 600% net of fees.
And then I’d go back to them, ask for an even longer and stricter lockup, move all the money into GameStop Corp. for 2021 5 and go back to the beach.
If you had a hedge fund and a time machine, you could probably find better trades. 6 Tesla had more than a 50% drawdown between mid-February and mid-March 2020; if you had done a little active trading — even just selling in February and buying back in March — you could have had, like, a 1,500% return instead of 743%.
My colleague John Authers runs a time-machine-driven paper hedge fund called Hindsight Capital, which regularly finds great trades that probably have a higher Sharpe ratio than mine and are certainly easier to explain to clients. Mine, however, maximizes the ratio of returns to effort. I buy one stock and forget about it.
I do not do a ton of digging to identify that stock, either; my investment process here consisted of (1) asking myself “what is the stock that has most famously gone up a ton recently” and (2) looking at historical prices on Bloomberg to get a number to write down. It took me two minutes.
Of course I cannot actually turn this insight into billions of dollars because I do not have a time machine but, you know, imagine how cool it would be if I did. I’d get to spend all year at the beach, and at the end of the year I’d go buy myself five beach houses.
Meanwhile actual hedge fund managers, limited by their own lack of time machines (and, in most cases, of really strict lockups), have to go around making sensible trades and hedging and diversifying and trying to capture uncorrelated returns and all that stuff, and it ends up being a hard and demanding job, even though in theory you could do the job by just buying one thing and holding it, if it’s the right thing. Sometimes it works like that though:
Karthik Sarma outearned Steve Cohen last year.
The little-known hedge fund manager made an estimated $2 billion in 2021, mostly thanks to an 11-year-old wager on Avis Budget Group Inc., a bet that paid off handsomely as the stock soared 456%. …
At SRS Investment Management, he avoids the hefty leverage many other funds embrace, and runs a much more robust short book. Moreover, he isn’t afraid to go big on a single investment — and hang on for as long as it takes.
That helps explain how Sarma appeared near the very top of Bloomberg’s 2021 ranking of hedge fund earners, only slightly outdone by Citadel’s Ken Griffin and TCI Fund Management’s Chris Hohn.
SRS owns about 50% of Avis through common stock and swaps, helping to roughly triple Sarma’s net worth to $3 billion, according to an analysis by the Bloomberg Billionaires Index, and rewarding investors in his flagship fund with a 35% gain. …
The Avis wager is unusual for him. It’s the largest and longest he’s made, and the only one where he — or anyone else at the firm — sits on a company’s board. Hedge funds generally avoid board seats because that limits when they can buy and sell shares. …
The jump in Sarma’s net worth was particularly large because the investment is spread across several of the firm’s portfolios, and he personally owns about 90% of one fund that only holds the Avis stake.
Imagine being Sarma and sitting down to write your investor letters for 2021. You start with the flagship fund: “I am happy to report that we were up 35% this year.
Our long positions did well, led by Avis Budget, which was up 456%. On the short side, our best bet was …” and you’d go on in that vein, analyzing your hits and misses, thinking about what you got right and what you could have done better.
And then you go on to write the letters for your other funds, and you get to the Just Holding Avis fund, which does have some money that is not yours, so I guess those investors expect a letter. And you write “the Just Holding Avis fund was up 456% this year (365% net of fees), on the back of very strong performance by Avis, which was also up 456%. It was a good year to be invested entirely in Avis stock, and I’m glad we were. I guess that’s it?”
Anyway Sarma is No. 3 on “Bloomberg’s 2021 ranking of hedge fund earners”; Nos. 1 and 2 are Citadel’s Ken Griffin and TCI Fund Management’s Chris Hohn. Many of the people on the list — there’s also Izzy Englander of Millennium, Jim Simons of Renaissance Technologies, Steve Cohen of Point72, David Shaw of D.E. Shaw, Ray Dalio of Bridgewater, etc. — run big institutions with multiple strategies that try to use rigorous processes to generate uncorrelated alpha; they also have enormous amounts of assets under management and so can make a lot in fees.
Meanwhile Sarma’s on the list because he bought a lot of one stock and that stock went up a lot. Just seems more pleasant, you know?
“Flush with profits from buoyant equity markets, Blackstone, KKR and Carlyle Group earmarked $2mn in total pay and benefits per employee in 2021.” U.S. Accuses Zero Hedge of Spreading Russian Propaganda. Half of Wall Street Staff May Be Back At Their Desks.
ECB warns eurozone lenders over leveraged loan risk. US banking regulators warn of risks in leveraged loan market. Crédit Agricole under fire over financing of companies with coal projects. Warren Buffett bought $1bn stake in Activision weeks before Microsoft deal.
At Trial, Lawyers Present Clashing Portraits of Goldman Sachs Banker. Elon Musk Donated $5.7 Billion of Tesla Shares to Charity. SpaceX Tourists Will Make Attempt at Spacewalk During Flight. Trump’s Accountants Sever Ties, No Longer Stand By Statements. Carl Icahn is a “great guy but he’s about smooth as a stucco bathtub.” Ohio mayor resigns after linking ice fishing to prostitution.
What Block Trades Are And Why The SEC’s Investigating
Selling one share of stock can be simple: It generally goes for whatever price other shares of the same company are trading for at the moment. Selling large numbers of shares can be complicated, since the very act of selling can drive down the price — especially if others get wind of a big stake being sold. The U.S. Securities and Exchange Commission and Justice Department are digging into how such “block trades” work, specifically into how bankers work with hedge funds to privately carry out such deals, which have been booming in recent years.
1. What Are Block Trades?
Stock sales big enough to send market prices tumbling. Highly secretive, market moving and potentially treacherous — block trading has been one of Wall Street’s most delicate arts since it emerged as a major business line more than a half century ago. Legendary Goldman Sachs dealmaker Gus Levy pioneered the business in the 1960s, helping position his firm to become the trading powerhouse that it is today.
2. Why Potentially Treacherous?
Things can go wrong both for the seller and for the bank or broker who’s helping. The seller wants to move quickly to get the benefit of an existing price before the sale of the block of stock can drive it down. Banks win that business in part by offering to buy the block themselves — which leaves them with the problem of how to dispose of it without losing money in the process.
3. How Do They Do That?
Banks typically agree to acquire a slug of stock at a discount from an investor — such as a company founder, venture capital firm, private equity investor or hedge fund — and then split the block up into smaller chunks that are sold discreetly to other large investors. The aim is to sell the pieces at a slight discount to the stock’s last closing price, and to avoid sending the price into a dive before the transaction is done. A number of hedge funds have set up their own equity capital markets desks to catch pieces of block trades, selling them onward for their own gains, too.
4. What’s Been Happening?
Block trades have been popular on Wall Street since 2005, when the SEC revised registration processes for so-called Well Known Seasoned Issuers. This gave sellers the ability to liquidate shares quickly, sometimes within 24 hours, compared to the alternative of waiting about a week for the SEC to review a filing ahead of the sale. But the market has swelled in recent years; banks managed more than $70 billion of block trades in the U.S. in 2021, according to data from Dealogic.
5. What’s Changed?
More companies are staying private longer. Rather than going public while still small, so-called unicorns grow into multibillion-dollar firms before offering stock for sale. That means that every time a large startup goes public, there’s a long list of Silicon Valley entrepreneurs, venture capital firms and other early investors left with big stakes that they can unload once so-called lockup periods expire.
6. What’s The Problem?
Sellers have long complained about block trades that seemed to be preceded by stock drops, hurting their proceeds when they cash out. They have pointed to practices that have been seen as existing in a legal gray area.
7. Like What?
To gauge demand from buyers and potentially gin up interest from sellers, bankers send out lists of shares with upcoming lockup expirations, according to market participants. It’s essentially an invitation to hedge funds and family offices to express interest in buying, even if banks don’t have a mandate yet. The practice is considered legal. Sometimes, bankers also engage in hypothetical conversations with buyers before they have a mandate. Asking prospective buyers whether they might be interested in certain stocks is one thing. But if there are indeed plans afoot for block sales, such conversations, even phrased hypothetically, can tip off savvy money managers who can move to sell the stock. While there is technically no transfer of material nonpublic information — the usual line for running afoul of U.S. laws — the practice has drawn criticism, and now, governmental scrutiny. It’s possible that some deals have confidentiality agreements between the block’s seller and the banks and between the banks and the block’s buyers not to trade on information about potential deals.
8. What Are Investigators Looking At?
The probe is gathering information on the activities of a slate of money managers at Morgan Stanley and at least one other competitor, Goldman Sachs Group Inc. The SEC began investigating block trading in 2018. It ramped up its investigation and was joined by the DOJ after the blowup at Archegos Capital Management, the family office of Bill Hwang. When his holdings tanked in March 2021, the banks he’d been working with unloaded tens of billions of dollars of stocks through a spree of huge sales. Authorities haven’t accused anyone of wrongdoing.
The Biden Budget Provides Additional Funding For SEC
New SEC Guidance On Accounting And Disclosures Rankles Commissioner Peirce
Peirce, sometimes referred to as the Crypto Mom, found the new guidance to be an example of the SEC’s “scattershot and inefficient approach to crypto.”
U.S. companies that safeguard their clients’ crypto-assets received new accounting guidance Thursday in the form of a Securities and Exchange Commission, or SEC, Staff Accounting Bulletin. The guidance got a strong response from SEC commissioner Hester Peirce, a steadfast crypto advocate.
Staff Accounting Bulletin 121 noted the high technological, legal and regulatory risks associated with the custody of crypto-assets, relative to traditional assets. Those risks impact the operations and financial condition of companies such as Coinbase, PayPal and Robinhood, which safeguard users’ crypto-assets and allow the users to trade them on their platforms.
For this reason, companies are advised to list their users’ assets on their books as liabilities as well as assets at their fair value at initial recognition.
In addition, the bulletin advised companies on disclosing the risks from crypto-assets and reminds them of existing rules on disclosure.
Commissioner Peirce released a response to the bulletin the same day. She wrote, “My concern is not with the accounting determination itself, which may be appropriate, but with the way the change is being made,” which she characterized as
“Yet another manifestation of the Securities and Exchange Commission’s scattershot and inefficient approach to crypto.”
Peirce’s first objection to the bulletin was its timing, since the bulletin cites an October 2020 Report of the Attorney General, which in turn cites information from 2018. SEC staff has been reviewing statements provided by the companies in question the whole time since the 2020 report, Peirce noted.
Commissioner Peirce also pointed out that the bulletin “does not acknowledge the Commission’s own role in creating the legal and regulatory risks that justify this accounting treatment” by not providing regulatory and legal clarity. Recognizing its own role in the problem “would be appropriate,” Peirce said.
She noted that the guidance is narrowly targeted and highly specific, and it reads as though the guidance were enforceable. But, as a staff statement, the bulletin is not enforceable.
“If we are trying to encourage companies to enter our public markets, we ought to embrace a more deliberate approach to changing rules—one that involves consulting with affected parties,” Peirce concluded.
Cryptocurrency Firms Push Back Against Proposal To Police Treasury Markets
SEC rule doesn’t target crypto trading platforms, but industry fears increased legal risks.
A Securities and Exchange Commission proposal intended to make Treasury markets more resilient has sparked a backlash from cryptocurrency companies, which say it could increase legal risks for so-called decentralized finance, or DeFi, platforms.
The rule, proposed by the SEC in January, would expand the agency’s definition of an exchange to include a broader array of communication systems that enable prospective buyers and sellers of securities to find each other.
Such entities would have to register with the SEC either as exchanges akin to the New York Stock Exchange, or as a category of broker-dealers called alternative trading systems, or ATSs, which perform exchange-like functions but face lighter regulations.
An SEC-imposed deadline for public comment on the proposal ended last week. The agency’s next step will be to analyze feedback from investors, companies and industry groups in the coming months before deciding whether to finalize a rule.
Many of the proposal’s loudest opponents are in the cryptocurrency industry, which isn’t the rule’s intended target. Companies including trading platform Coinbase Global Inc., venture-capital company Andreessen Horowitz, and stablecoin issuer Circle Internet Financial Inc., as well as several cryptocurrency-focused lobbying groups, warned that the plan would create more legal uncertainty.
The SEC’s current definition of an exchange involves an entity that matches orders from multiple buyers and sellers, and “uses established, nondiscretionary methods” for determining how those orders interact with each other.
Under the proposal, the definition would replace the word “uses” with “makes available” to capture so-called communication protocol systems that take a more passive role in enabling prospective traders to interact, negotiate and reach an agreement.
SEC officials say their goal is to bring oversight to messaging systems that professional traders use to obtain price quotes for Treasury bonds and other fixed-income securities.
These electronic platforms perform essentially the same function as exchanges but face little or no oversight from regulators. In 2019, the largest electronic trading platform for Treasurys, BrokerTec, suffered a roughly 90-minute outage on a Friday afternoon that could have shaken the broader market if it had occurred at a different time, the SEC noted.
“I think it’s important that we consider revising the SEC’s rules to reflect the increased use of electronic trading platforms in fixed income markets,” SEC chief Gary Gensler said in a speech Tuesday.
The agency’s nearly 600-page proposal makes no mention of cryptocurrency. However, critics say its language could potentially capture DeFi platforms, which allow users to trade cryptocurrencies without a conventional intermediary.
“The proposal may not have been designed with this developing ecosystem in mind,” lawyers for Andreessen Horowitz, which invests in crypto projects, wrote in a comment letter to the SEC. “Nevertheless, broadening the definition of an exchange in a manner that could apply to DeFi protocols, at a time when it is unclear which digital assets are considered securities, will create tremendous regulatory uncertainty and deter responsible innovation.”
An SEC spokesman said the agency generally responds to comments it receives as part of a final rule making and not beforehand. The SEC benefits from robust engagement with the public and will review all submitted comments, he said.
In the year that he has been on the job, Mr. Gensler has said little to suggest he would be sympathetic to the DeFi industry’s concerns. He has repeatedly said that any trading platform that lists securities is required to register with the SEC unless it meets an exemption.
Mr. Gensler has also noted that, despite their marketing claims, DeFi platforms still typically rely on humans to write software and make governance decisions.
Cryptocurrency advocates say DeFi software is often the work of multiple developers, who may or may not remain involved after contributing. Requiring them to register with the SEC and abide by its rules would be difficult or impossible, they say.
The SEC received 170 identical comment letters copied and pasted from a website, protectdefi.org, that was promoted on Twitter by a group called DeFi Education Fund. “Merely making software available to the public should not be captured under the SEC’s exchange or ATS registration framework, and the SEC should clearly state that,” the letter said.
The DeFi Education Fund is financially supported by Uniswap, the largest DeFi platform.
The Wall Street Journal reported last fall that the SEC was investigating the platform’s main developer, Uniswap Labs. Earlier this month, plaintiffs’ lawyers also filed a class-action lawsuit against Uniswap and its backers alleging that they illegally promoted, offered and sold unregistered securities.
Under federal law, anyone who buys an unregistered security can sue the seller to recover their money.
A spokeswoman for Uniswap Labs said that the plaintiffs’ allegations are meritless and that the group plans to vigorously defend against the lawsuit.
Representatives of asset managers and broker-dealers also raised concerns about the proposal, saying the new language could have far-reaching consequences for their businesses.
“The broad concept of communication protocol systems could theoretically capture hundreds, if not thousands, of systems across asset classes,” the Securities Industry and Financial Markets Association, which represents broker-dealers, said in a comment letter dated April 18. By comparison, the SEC estimates that 22 so-called communication protocol systems would be subject to the new rule.
US Appeals Court Orders SEC To Bring Enforcement Actions To Jury Trials
The 5th Circuit Court of Appeals found that the targets of SEC enforcement actions had their constitutional rights violated by the use of in-house judges.
A U.S. appeals court ruled the Securities and Exchange Commission (SEC) violated a hedge fund manager’s constitutional rights by having an in-house judge try a securities fraud case brought against the individual.
The SEC alleged in 2013 that George Jarkesy Jr. and his firm, Patriot28 LLC, violated federal securities law by misstating his two hedge funds’ assets. The case was tried before an administrative law judge rather than before a civil court.
These administrative law judges, or in-house judges, may have violated Jarkesy’s seventh amendment constitutional rights to a jury trial, the 5th Circuit Court of Appeals said in its ruling Wednesday.
“In sum, we agree with Petitioners that the SEC proceedings below were unconstitutional. The SEC’s judgment should be vacated for at least two reasons: (1) Petitioners were deprived of their Seventh Amendment right to a civil jury; and (2) Congress unconstitutionally delegated legislative power to the SEC by failing to give the SEC an intelligible principle by which to exercise the delegated power,” the decision said.
The ruling remanded the case “for further proceedings,” indicating that it was not vacating Jarkesy’s conviction entirely.
According to The New York Times, the impact of the case is limited to just SEC cases brought in Texas, Louisiana and Mississippi, and only in cases that do not “involve solely ‘public rights.’”
The SEC has taken on a number of enforcement actions in the crypto industry in recent years, bolstering the part of its enforcement division responsible for such cases earlier this month to just over 50 individuals.
Before Wednesday’s ruling was announced, SEC Chair Gary Gensler testified before the House Appropriations Committee, arguing his agency needed more resources to continue taking on fraud and other crimes in the sector.
“I wish we had more to be able to dedicate to this,” he told lawmakers.
Are The SEC’s “Regulation By Enforcement” Actions Unconstitutional?
Article I, Section 1 of the US Constitution says: “All legislative Powers herein granted shall be vested in a Congress of the United States, which shall consist of a Senate and House of Representatives.” One way to paraphrase that is: Federal law is made by Congress.
In the modern US, this is not quite true. Some federal law is made by Congress, but quite a lot of federal law is made by government departments and administrative agencies. In many cases, Congress passes fairly general laws, and those laws instruct the relevant agency to write rules implementing the laws, and then the agencies write more specific rules.
Sometimes these rules just fill in details in a comprehensive statutory scheme. Other times the agencies have pretty broad mandates to write rules that are in the public interest, and they get to set their own agendas and decide what that means.
There is quite a large body of law and procedure governing how those agencies write those rules, and those rules are pretty important.
Around here, we have talked recently about a bunch of proposed rules from the US Securities and Exchange Commission that would, for instance, crack down on special purpose acquisition companies, require more disclosure of activist stakes and swap positions, limit stock buybacks and executives trading in their own stocks, and most notably implement a climate disclosure regime.
This is mostly stuff that the SEC is doing on its own initiative under laws passed mostly in the 1930s and 1960s. Congress largely set up the SEC and its underlying system of securities laws in the 1930s, and the SEC took it from there.
There are obviously good reasons to do things this way. Congress does not have time to write all the rules, so delegating rulemaking to agencies is efficient. Congress also has limited subject-matter expertise: The SEC knows more about securities law and financial markets than the average congressperson, so it makes sense for the SEC to write most of the securities rules.
The rulemaking process is often both more flexible and more thoughtful than the legislative process; agencies have to consider public comments and explain their reasoning in a way that Congress does not.
Agency rules can be overturned by a court if they are “arbitrary and capricious,” which is not generally true of laws passed by Congress; Congress can be as arbitrary as it wants.
There are also objections though. Congress is elected, and the SEC isn’t. Letting agencies write rules is more technocratic but less democratic; the agencies might be more captured by industry or just by longtime staffers who are less politically accountable. Also, let’s be clear, in the modern US, a lot of people simply think that there should be fewer rules overall.
If you think that then you will object to the whole idea of agencies writing rules: If only Congress could make law, then there would be fewer rules about, say, securities fraud. (Or environmental regulation or workplace safety or bank capital or whatever else you are interested in.)
Also the constitution does say “all legislative powers” are vested in Congress. If you take that literally, you might think that it’s unconstitutional for the SEC to make any rules at all.
The rise of the US administrative state — all these agencies making all these rules — is most identified with the New Deal in the 1930s. At the time, people objected that it was in fact unconstitutional for agencies to make rules. The US Supreme Court occasionally agreed: In two 1935 cases, the Supreme Court struck down laws that delegated rulemaking authority to executive agencies.
Then that stopped, and the administrative state grew. Since 1935, lots of people have challenged agency rulemaking under the “nondelegation doctrine,” the theory that Congress cannot delegate legislative authority to agencies, but they have never won.
The Supreme Court has adopted an “intelligible principle” test, saying that if Congress delegates authority to an agency and gives it an “intelligible principle” to follow, then the agency can constitutionally make rules guided by that principle. This is a vague test and in practice, for the last 87 years, it has always been met.
For instance, Congress has given the SEC pretty broad authority to make disclosure rules that are “necessary or appropriate in the public interest for the protection of investors,” which gives the SEC a lot of discretion but which is probably “intelligible” enough under current law.
That is changing now, though. I am enough of a legal realist to say that it is changing because there have been a bunch of Republican judicial appointments, including to the Supreme Court, in recent years, and elite Republican lawyers are skeptical of the modern administrative state and want to revive the nondelegation doctrine.
Here is where I need to make a personal disclosure-brag. My wife is a federal criminal defense lawyer, and a few years ago she argued a case in the Supreme Court. The case — Gundy v. United States — concerned a fairly technical Justice Department rule about sex offender registries.
But the argument was about the nondelegation doctrine: It was about whether it was constitutional for the Justice Department to make rules like that under delegated authority from Congress.
It was the sort of case that would not have made it to the Supreme Court a decade earlier — obviously this is constitutional, everyone would have said — but times were changing. The nondelegation doctrine might be coming back.
Arguing in the Supreme Court is kind of a big deal, and I came to the argument to watch. Sitting in the audience before the argument, I ran into Jay Clayton, who was then the chair of the SEC.
We said hello, and I asked if he was there because of the implications of the case for his agency. He looked puzzled: No, this was a sex-offender case; he was there because his friend was arguing the case for the government.
After the argument he said to me something to the effect of “I see what you mean.”
My wife lost. Barely. The Supreme Court ruled, in a strange 5-3 vote, that the delegation at issue there was constitutional. Justice Neil Gorsuch wrote a dissent in Gundy, and it’s stuff like this:
Why did the framers insist on this particular arrangement? They believed the new federal government’s most dangerous power was the power to enact laws restricting the people’s liberty. An “excess of law-making” was, in their words, one of “the diseases to which our governments are most liable.” To address that tendency, the framers went to great lengths to make lawmaking difficult.
In Article I, by far the longest part of the Constitution, the framers insisted that any proposed law must win the approval of two Houses of Congress—elected at different times, by different constituencies, and for different terms in office—and either secure the President’s approval or obtain enough support to override his veto. Some occasionally complain about Article I’s detailed and arduous processes for new legislation, but to the framers these were bulwarks of liberty. …
Restricting the task of legislating to one branch characterized by difficult and deliberative processes was also designed to promote fair notice and the rule of law, ensuring the people would be subject to a relatively stable and predictable set of rules.
And by directing that legislating be done only by elected representatives in a public process, the Constitution sought to ensure that the lines of accountability would be clear: The sovereign people would know, without ambiguity, whom to hold accountable for the laws they would have to follow.
In Gorsuch’s view, if “Congress makes the policy decisions,” it is okay for executive agencies to “fill up the details.” And “once Congress prescribes the rule governing private conduct, it may make the application of that rule depend on executive fact-finding.” But policy decisions have to be made by Congress, not by agencies. He added:
Nor would enforcing the Constitution’s demands spell doom for what some call the “administrative state.” The separation of powers does not prohibit any particular policy outcome, let alone dictate any conclusion about the proper size and scope of government.
Instead, it is a procedural guarantee that requires Congress to assemble a social consensus before choosing our nation’s course on policy questions like those implicated by SORNA. What is more, Congress is hardly bereft of options to accomplish all it might wish to achieve.
It may always authorize executive branch officials to fill in even a large number of details, to find facts that trigger the generally applicable rule of conduct specified in a statute, or to exercise non-legislative powers. Congress can also commission agencies or other experts to study and recommend legislative language.
Respecting the separation of powers forecloses no substantive outcomes. It only requires us to respect along the way one of the most vital of the procedural protections of individual liberty found in our Constitution.
That was several years ago, though, and since then the personnel of the court has changed some more. It is plausible that there are now as many as six votes for Gorsuch’s position.
Yesterday the U.S. Court of Appeals for the Fifth Circuit, in Texas, ruled that the SEC is unconstitutional? Not really. But here is an opinion in Jarkesy v. SEC, where the SEC brought an administrative action against a hedge fund manager named George Jarkesy, accusing him of fraud.
Instead of suing Jarkesy in federal court, the SEC, as it sometimes does, brought an administrative action against him in its own internal hearing system; instead of a judge and jury, the case was heard by an SEC official called an “administrative law judge.”
The ALJ found against Jarkesy, fined him almost a million dollars and banned him from the industry; Jarkesy appealed to the commissioners of the SEC, who upheld the ALJ’s judgment. Then he appealed to the Fifth Circuit, arguing that all of this was unconstitutional.
The Fifth Circuit panel, by a 2-1 vote, agreed, for three reasons. One reason is that, by suing him in its own tribunal, the SEC deprived him of the right to a jury trial: The SEC fined him a million dollars for fraud, without having to prove its case to a jury.
The Fifth Circuit found this unconstitutional under the Seventh Amendment, which guarantees a right to a jury in civil cases. I think I agree? At Bloomberg Opinion back in 2015, Noah Feldman wrote a good column about this case, saying that it was “worth noting, and mourning, this impending incremental erosion of the constitutional protections of a civil trial and the jury right that goes hand in hand with it.”
The SEC has always had the power to bring fraud cases in federal court, and has a pretty good record there. But in 2010, Congress gave the SEC the power to pursue monetary penalties in its own courts if it wanted to. This always seems to cause more trouble than it saves, and is apparently unconstitutional, and I am not sure the SEC will miss it all that much.
Another reason is that the process for appointing and removing SEC ALJs is unconstitutional, for reasons that honestly I find unbearably boring and so will not talk about.
But the third reason is the nondelegation doctrine: The Fifth Circuit found that Congress unconstitutionally delegated to the SEC the power to decide whether to bring cases in federal court or before its own ALJs:
Congress has delegated to the SEC what would be legislative power absent a guiding intelligible principle. … Through Dodd–Frank § 929P(a), Congress gave the SEC the power to bring securities fraud actions for monetary penalties within the agency instead of in an Article III court whenever the SEC in its unfettered discretion decides to do so.
Thus, it gave the SEC the ability to determine which subjects of its enforcement actions are entitled to Article III proceedings with a jury trial, and which are not. That was a delegation of legislative power.
This strikes me as a little weird — surely deciding what forum to sue in is an executive action, not a legislative one? — and not at all necessary to the decision. The court could have thrown out Jarkesy’s fine by saying that he was deprived of a jury trial, without talking about the nondelegation stuff.
But the panel is making a broader point here. The broader point is Justice Gorsuch’s point about political accountability, an excess of lawmaking, etc.; the opinion talks about those principles at length and cites Justice Gorsuch’s Gundy dissent.
The point is that the nondelegation doctrine is alive again, and the Fifth Circuit is making a bet that the next time it goes before the Supreme Court it will win.
The point is that the SEC’s actual legislative actions — writing rules about stock buybacks or swaps disclosure or climate change — are now in danger. It used to be accepted as a routine matter that the SEC could make rules under a very broad grant of power from Congress to regulate securities markets in the public interest. I am not sure that is true anymore.
This may not be a particularly big deal. Two judges on one panel of one appeals court found that one small part of what the SEC does is an unconstitutional delegation of power.
It is possible that this decision is fairly narrow: Congress did delegate this decision — about whether to bring cases in federal courts or its own forums — to the SEC, fairly recently, without any guidance at all, which is unusual.
Perhaps the “intelligible principle” standard allows the SEC to do all of its other rulemaking (because Congress has mostly given it some broad guidance about protecting investors in the public interest, and because SEC rules do help to fill in a fairly detailed statutory system), but not to make this particular decision.
Still. I think the Fifth Circuit went out of its way to find a nondelegation problem because the Supreme Court has changed and now there will be a lot more courts finding a lot more nondelegation problems. I think this might be a sign of where things are going.
One immediate upshot of this is that some of the SEC’s recently proposed rules — on swaps disclosure, on climate, etc. — are hotly controversial, and there have been unusually aggressive comments from industry participants to the effect of “if you implement these rules, we will sue, and we will win.”
When people say this, what they mean is generally that they will go to court saying that the SEC’s rulemaking process was not good enough. Under the rules for rulemaking, agencies like the SEC need to consider costs and benefits, solicit and consider public comments and give a rational explanation for their rules.
If you don’t like a rule, you can sue, arguing that the SEC’s process was arbitrary and capricious, and people sometimes win these lawsuits. And certainly people were gearing up to bring those sorts of cases against the climate and swaps rules.
But now you can throw in at the end of your brief: “Also it is unconstitutional for the SEC to make any rules at all about this stuff.” If “this stuff” is climate change, you’ll … probably win? (Not legal advice!) If “this stuff” is swaps disclosure — which does seem closer to the core of the SEC’s job? — you’ve also got a shot.
Because now there is a live possibility that federal courts might say it is unconstitutional for the SEC to make any rules about anything.
US Probes Binance Over Token That Is Now World’s Fifth Largest
* SEC Investigating Whether BNB Was A Security When Sold In 2017
* Agency Has Brought Numerous Cases Over Initial Coin Offerings
US regulators are investigating whether Binance Holdings Ltd. broke securities rules by selling digital tokens just as the crypto exchange was getting off the ground five years ago, according to people familiar with the matter.
The Securities and Exchange Commission’s review pries into the firm’s origins and those of its BNB token, which is now the world’s fifth-biggest. Investigators are examining if the 2017 initial coin offering amounted to the sale of a security that should have been registered with the agency, said the people who were granted anonymity to discuss the confidential probe.
Scrutiny of BNB’s beginnings may be a troubling development for Binance as it faces multiple investigations in Washington. The SEC has brought dozens of enforcement actions over ICOs, which involve issuing virtual coins to raise money. BNB has been a feature of Binance’s expansive crypto empire
In a statement, Binance said “it would not be appropriate for us to comment on our ongoing conversations with regulators, which include education, assistance, and voluntary responses to information requests.” The company added that it works with authorities and “we will continue to meet all requirements set by regulators.”
The SEC declined to comment.
A virtual currency may fall under the SEC’s remit if investors buy it to fund a company or project with the intention of profiting from those efforts. That determination is based on a 1946 US Supreme Court decision defining investment contracts.
Binance, which runs the world’s biggest exchange and says it’s not domiciled in any one country but has affiliates scattered across the globe, has emerged as a focal point for American investigators seeking to rein in the crypto industry.
Bloomberg News has previously reported it faces investigations from the Justice Department, the Commodity Futures Trading Commission and the Internal Revenue Service.
Ahead of BNB’s launch in 2017, Binance laid out its plans in a white paper. The document said its circulation would be limited to 200 million with half of the tokens being sold through the ICO, which took place on multiple platforms throughout the world. Another 80 million would be reserved for Binance’s founding team, which includes its billionaire chief executive officer, Changpeng Zhao.
In the white paper, which was reviewed by Bloomberg, Binance said as much as 85% of the funds raised in the ICO were to be used to build and market Binance’s global exchange. It made no mention of restrictions on who could participate.
In order to entice investors to BNB, Binance has offered lower fees for traders paying with the token. It’s also paid many of its contractors in the currency, including at least one US resident who said said he purchased BNB during the ICO — a detail that could be key for the SEC asserting jurisdiction in any case it might bring.
An SEC enforcement investigation may not lead to the regulator suing a firm or individuals. The probe involving BNB is likely months away from any conclusion, one of the people familiar with the matter said.
Beyond BNB, the SEC is also probing possible trading abuses by Binance insiders and whether Binance.US, an American affiliate formed in 2019, is appropriately hived off from its global counterpart, one of the people said.
Another person with direct knowledge of the review said the SEC is also looking at market-making companies tied to Zhao, who is widely known as CZ. The SEC has expressed interest in Zhao’s ownership stakes of market makers on Binance.US and whether the exchange has conducted broker-dealer activities, the person said.
Binance emphasized that Binance.com and Binance.US “are separate entities,” with the former only for non-US users.
“Binance.US is a separate US-focused trading platform that services US users by offering products and services that are compliant with US federal and state regulations,” the firm said.
In a separate statement, Binance.US said it was “committed to upholding the highest standards of compliance.”
Amid crypto’s meteoric rise during the Covid-19 pandemic, BNB has surged in value. The coin is currently valued around $300 and has a market capitalization of about $48.5 billion. It’s also been an integral part of Binance’s ever-expanding crypto ecosystem, which now includes everything from digital wallets to its own blockchain.
Recently, as part of a broader rebranding of its blockchain, Binance switched BNB’s full name to Build and Build from Binance Coin. The company said it made the changes based on feedback from users about “the need to further solidify the decentralized nature of the chain and reinforce the community’s governance over the chain.”
The firm also backed away from plans laid out in the ICO’s white paper to spend 20% of the exchange’s profits every quarter to buy back BNB. Zhao in a 2020 blog post said the change was made in response to legal advice “indicating the potential for being misunderstood as a security” in some regions.
A finding that the BNB is a security could put Binance in a similar position as Ripple Labs Inc., which is locked in a bitter court battle with the SEC after the regulator sued the firm and two of its executives in December 2020 for allegedly breaking rules in selling a crypto token known as XRP.
Ripple argues the token functions as a medium of exchange for virtual currency rather than a security, and that the SEC’s legal theory is flawed.
Since taking over in April 2021, SEC Chair Gary Gensler has said that virtually all ICOs are securities and should be regulated by his agency.
SEC Closes In On Rules That Could Reshape How Stock Market Operates
Chairman Gary Gensler is expected to outline ideas for improving market efficiency Wednesday.
The Securities and Exchange Commission is preparing to propose major changes to the stock market’s plumbing as soon as this fall.
Chairman Gary Gensler directed SEC staff last year to explore ways to make the stock market more efficient for small investors and public companies.
While aspects of the effort are in varying stages of development, one idea that has gained traction is to require brokerages to send most individual investors’ orders to be routed into auctions where trading firms compete to execute them, people familiar with the matter said.
SEC staffers have begun floating plans with market participants in recent weeks, and Mr. Gensler is planning to detail some of the potential changes in a speech Wednesday, these people added.
The most consequential change being discussed would affect the way trades are handled after an investor places a so-called market order with a broker to buy or sell a stock. Market orders, which account for the majority of individual investors’ trades, don’t specify a minimum or maximum price the investor is willing to pay.
Mr. Gensler has said he wants to ensure that brokers execute orders at the best possible price for investors—the highest price for when an investor is selling, or the lowest price if they are buying.
Current rules require brokers to perform “reasonable diligence” to determine the likely best market for executing a trade.
Many brokers route orders to big electronic trading firms called wholesalers, including Citadel Securities or Virtu Financial Inc., rather than to exchanges such as the Nasdaq Stock Market, arguing that the wholesalers provide the best prices.
Some brokers, including Charles Schwab Corp. and Robinhood Markets Inc., accept compensation from wholesalers for routing trades to their venues. Mr. Gensler has said this practice, known as payment for order flow, creates a conflict of interest and limits competition for individual orders.
Under the auctions being considered by the SEC, different firms would compete with each other to fill an individual investor’s trade, according to people familiar with the agency’s plans.
Such a mechanism would fundamentally alter the business model of wholesalers, which can make more money by trading against small investors than they do on public exchanges, where they might find themselves trading with other sophisticated trading firms or institutional investors.
An SEC spokesman declined to comment.
A number of Wall Street firms pushed back forcefully last year when it became apparent that Mr. Gensler was targeting their business models. Wholesalers and brokers ramped up their lobbying and campaign spending in Washington and published their own plans for improving the stock market.
Virtu and Citadel Securities, in particular, have argued against the sort of changes the SEC is considering. They say the current system, including payment for order flow, has underpinned a broad reduction to trading costs that has made the stock market more accessible.
Douglas Cifu, chief executive of Virtu, said the order-by-order competition sought by Mr. Gensler could allow trading firms more discretion in choosing which trades they fill. This could end up being more profitable in the short term for wholesalers, he said, but wouldn’t necessarily help investors.
SEC Weighs Sending Retail Stock Orders To Auctions For Execution
* Plan Under Consideration Could Impact Major Trading Firms
* Agency Has Been Reviewing Rules Underpinning Stock Market
The US Securities and Exchange Commission is weighing changes to stock-market rules that could force trading firms to directly compete to execute trades from retail investors, according to people familiar with the matter.
A move by the SEC to press major wholesale brokerages to win auctions for orders by mom-and-pop investors would be a major change for the stock market. While nothing has been announced, the change is among those being considered by staff at Wall Street’s main regulator, said the people who asked not to be named discussing the plans which remain private.
The specifics of the SEC’s plans, which are still taking shape, follow a months-long review of regulations. Almost exactly one year ago, SEC Chair Gary Gensler said he’d asked the agency’s staff to examine best execution requirements — legal mandates that ostensibly force brokers to process customers’ orders at advantageous prices.
The SEC didn’t respond to a request for comment on the possible rule changes, which were earlier reported by The Wall Street Journal.
Gensler rattled financial firms last year when he refused to rule out prohibiting the practice of brokers getting paid to send customers’ stock orders to trading as part of the agency’s rule changes. Currently, firms including Virtu Financial Inc. and Citadel Securities pay retail brokerage firms to execute their clients’ trades, a practice known as payment-for-order-flow.
Doug Cifu, Virtu’s chief executive officer, said the SEC should be careful not to make changes that unintentionally make trading more expensive. “Order-by-order competition enables selective competition because it removes the retail brokers’ ability to demand best execution from wholesalers on every order,” he said in a statement.
“The current market structure has resulted in tighter spreads, greater transparency, and meaningfully reduced costs,” a spokesperson for Citadel Securities said in an emailed statement. “We look forward to reviewing the proposals and working with the SEC and the industry towards our longstanding objective of further improving competition and transparency.”
Changes would also impact the exchange businesses which display prices and aggregate trading data. Representatives from Nasdaq Inc. and the New York Stock Exchange declined to comment.
Online brokers argue that replacing customer-paid commissions with revenue that comes from market makers has opened up investing to millions of young people, including women and minorities who traditionally have kept their money out of the securities markets.
Firms also argue that the vast majority of the retail orders they offload are executed at a lower price. That complies with SEC rules that demand investors get the “best execution” for trades.
Opponents, however, say the order payments are difficult to understand and include hidden costs that investors pay without even knowing. They also say it gives massive trading firms knowledge of where the market is heading.
Crypto Bill Condemned By Consumer Advocates In Washington
Consumer group gadflies were predictably ready with a damning quote shortly after the bi-partisan legislative proposal was made public.
The wide-ranging crypto bill introduced Tuesday by U.S. Senators Cynthia Lummis and Kirsten Gillibrand didn’t draw any praise from consumer advocate groups.
“The bill gives the industry what it wants most: the Commodities Futures Trading Commission (CFTC) as its primary regulator, even though it exists to police markets where physical producers and purchases of commodities like corn, wheat, oil, natural gas, hogs, and cattle hedge their price risk to facilitate the delivery of everyday goods to the American people,” said Dennis Kelleher, CEO of Better Markets, a Washington-based group that often seeks to counter financial industry lobbying.
Kelleher noted that the crypto industry wants the CFTC as a watchdog because it’s the smallest regulator with the smallest budget.
Lummis (R-Wyo.) and Gillibrand (D-N.Y.) released their long-awaited legislation – the Responsible Financial Innovation Act – Tuesday. While it’s not expected to get serious consideration in Congress before next year, it represents a comprehensive and bi-partisan attempt to regulate much of the industry.
The bill would favor CFTC as the primary regulator for much of crypto, eliminate taxes on small purchases of goods and services, set rules for stablecoins and establish a regulator-approved “sandbox” for the industry to try innovative products without the worry of government sanctions.
“Too many lawmakers are rushing to introduce legislation that, in the name of fostering innovation, could legitimize bad actors and bad practices,” said Mark Hays, a policy analyst for Americans for Financial Reform. “Just because an industry that pumps millions into the political process claims it is innovative does not mean it deserves its own special rulebook.”
For their part, crypto industry groups applauded the proposal, with Kristin Smith, the executive director of the Blockchain Association, calling it “a major step forward for the crypto industry in Washington.”
SEC Chief Gensler Considers New Rules Governing Market Makers, Payment For Order Flow After Gamestop Drama
Last January’s GameStop saga focused the world of retail trading on issues of market plumbing — the nuts and bolts of how brokers execute orders to buy and sell stocks and derivatives — like few previous episodes.
Eighteen months later, U.S. Securities and Exchange Chairman Gary Gensler is launching an effort to comprehensively overhaul this market structure for the first time in nearly 2 decades, in a Wednesday speech to Piper Sandler’s Global Exchange Conference.
Americans were outraged that stock brokers like Robinhood Markets Inc. temporarily blocked users from buying shares of GameStop Corp. and other so-called meme stocks, and many blamed financial arrangements between brokers and market makers like Citadel Securities and Virtu Financial Inc. as the culprit.
Such market makers now execute more than 90% of retail orders, Gensler said, and they typically pay stock brokers for the privilege of executing these orders, on which they make a small profit on the spread between the price at which they’ll buy and sell a security. Add those small profits up — Citadel Securities reportedly posted a record revenue total of $7 billion last year.
In fact, brokers restricted trading in order to manage risk and obligations to the clearinghouse that guarantees retail traders orders will be executed even if their broker goes bankrupt.
There’s no evidence that payment for order flow was the reason brokers restricted trades, but the episode underscored the appearance of a conflict of interest between retail brokers’ clients and the market makers that are their main source of revenue.
“Payment for order flow can raise real issues around conflicts of interest,” Gensler said. “Certain principal trading firms seeking to attract Robinhood’s order flow [said] that there was a tradeoff between payment for order flow and price improvement for customers.”
To remedy these potential conflicts, Gensler said he has asked staff to recommend rules that could require retail brokers to submit retail orders to an auction process, whereby each market maker would transparently compete for a retail trade based on the best price offered.
“I’ve got a client that’s 330 million Americans, and all the folks on the Reddit posts, those are our clients and they’re not getting the full benefit of full and fair competition when they put a retail market order in right now,” Gensler said during a press conference following the speech, referring to the active community of retail traders on the social-media website.
“American retail investors enjoy one of the most efficient, low cost investing environments in history. Robinhood’s model of commission-free, no account minimums investing has saved investors billions,” Dan Gallagher, chief legal officer at Robinhood said in a statement. “We look forward to reviewing the Commission’s eventual rule proposal and engaging with the SEC during a meaningful notice and comment rulemaking process.”
The regulator also proposed a series of other reforms, including setting a marketwide minimum pricing increment— called tick size—that all market makers and exchanges would adhere to. As it stands now, stock exchanges like the New York Stock Exchange can price stocks to the penny, while market makers can offer prices in much smaller increments, providing them a pricing advantage.
Furthermore, Gensler suggested changing the method by which the National Best Bid and Offer prices — used as a benchmark for brokers who are required to find the best price for their customers — by creating a separate measure for trades of fewer than 100 shares, order sizes typically associated with retail traders.
SEC’s Revamp of Stock-Trading Rules Faces Criticism From Wall Street
Agency considers requiring brokerages to route individual investors’ stock orders into auctions.
Brokerages and trading firms pushed back forcefully against Securities and Exchange Commission Chairman Gary Gensler’s proposed changes to U.S. stock-trading rules, saying the market is functioning well for ordinary investors.
Mr. Gensler outlined the potential changes Wednesday and was greeted with skepticism from an array of financial-industry executives who said the SEC’s far-reaching plans are unnecessary.
A top executive with Robinhood Markets Inc. argued that individual investors are winners in the current system, enjoying benefits such as zero-commission trades.
“It is a really good climate for retail, so to go in and muck with it right now, to me, is a little worrisome,” Robinhood Chief Legal Officer Dan Gallagher said at the Piper Sandler Global Exchange & FinTech Conference in New York.
In one of the key elements of the SEC’s proposed package of rule changes, Mr. Gensler said he has asked agency staff to consider requiring brokerages to route individual investors’ orders to buy or sell stocks into auctions, as part of an effort to increase competition in the market.
“There’s a cost to retail, to this current system,” Mr. Gensler said in a virtual appearance at the same conference. “And the cost is that two or three highly concentrated market makers are buying your order flow.”
The potential change would represent a major shake-up to the lucrative business of executing trades in the stock market. The Wall Street Journal reported Monday that the plan was under consideration.
The objective would be to “assure full competition among all market participants to provide the best prices for retail investors,” Mr. Gensler said.
Those market participants are gearing up for a bruising fight with the agency. “Switching to an auction system seems ill-timed, unneeded and a step in the wrong direction,” said Kirsten Wegner, chief executive officer of Modern Markets Initiative, a lobbying and advocacy group for high-speed trading firms.
Kenneth Bentsen, president of the Securities Industry and Financial Markets Association, urged the SEC to proceed with caution in its review of key stock-market rules.
“Any changes to the rules governing the current equity market structure should be considered holistically with a view to ensuring there are no negative, unintended consequences for investors,” Mr. Bentsen said in an emailed statement. He suggested the proposals could affect low trading costs that investors currently enjoy.
Dennis Kelleher, head of advocacy group Better Markets, called the critics of the SEC’s plans “whining billionaires.”
“Who are you going to believe?” Mr. Kelleher said. “The financial firms whose leaders became billionaires from extracting wealth from retail investors in nontransparent, anticompetitive markets or a regulator with nothing to gain?”
The auctions outlined Wednesday would likely be the most consequential change in a broader effort to make the market more competitive and transparent for investors and public companies.
People familiar with the matter say the SEC could begin issuing proposals under the initiative as early as this fall, kicking off a formal rule-making process that potentially would take many months to complete.
Under current rules, brokers must perform “reasonable diligence” to determine the likely best market for executing a trade.
Many brokers route orders to big electronic trading firms called wholesalers, including Citadel Securities or Virtu Financial Inc., rather than to exchanges such as the Nasdaq Stock Market, arguing that the wholesalers provide the best prices.
Some brokers, including Robinhood, accept compensation from wholesalers for routing trades to their venues. Mr. Gensler says this practice, known as payment for order flow, creates a conflict of interest and limits competition for individual orders.
In addition, Mr. Gensler said he has directed SEC staff to potentially allow stock exchanges to quote shares in increments of less than 1 cent. This could enable venues such as Nasdaq or the New York Stock Exchange to better compete with wholesalers, which can beat the prices publicly displayed on exchanges by adding or subtracting hundredths of a penny to the price of a stock.
“Why not allow all venues to have an equal opportunity to execute at sub-penny increments?” Mr. Gensler said in the speech.
SEC staff are also weighing a possible requirement that brokers file monthly reports showing the quality of the prices their customers receive for stock trades, according to Mr. Gensler. Currently, only so-called market centers—including exchanges and wholesalers—disclose such information.
The agency is also considering creating its own version of the so-called best-execution rule that directs brokers to find the most favorable terms for their customers, Mr. Gensler said. The rule that brokers currently follow was written by the Financial Industry Regulatory Authority, an industry body overseen by the SEC.
“It’s not clear, given the current market segmentation, concentration, and lack of a level playing field, that our current national market system is as fair and competitive as possible for investors,” Mr. Gensler said. “I think we can do better here for retail investors.”
The key question for Mr. Gensler’s planned changes is whether they will clearly identify a problem for retail investors and make a compelling case that the proposed solution would be better than the status quo, said Brett Redfearn, a former SEC official who now leads an independent market-structure advisory firm.
“That’s a tall order as investors today generally have a very good experience,” Mr. Redfearn said. “Whatever is proposed will almost certainly be modified as a result of a lively comment period, and there’s a good chance that any approved rule will end up in court.”
Wall Street And The SEC Are Headed For Clash On Commission-Free Trading
* Gensler Wants Agency To Overhaul Rules For Retail Stock Trades
* Some Executives Say Trades Without Fees Could Be Collateral
Gary Gensler’s bid to overhaul rules for the stock market is reigniting a longstanding debate over how good mom-and-pop investors really have it and whether anything Wall Street is selling is actually free.
Some industry insiders say it’s never been better to be a small-time trader. Buying and selling shares is cheap and easy, they say.
But, Gensler, the chair of the US Securities and Exchange Commission, argues the $45-trillion US equities market is actually littered with hidden costs and rife with conflicts-of-interest. There’s a “lack of a level playing field,” the SEC chief said on Wednesday.
The two sides are headed for a major clash and one issue is already taking center stage: the future of commission-free trading.
Since 2019 most major online brokerages haven’t charged retail clients fees for their transactions, following a model made popular by Robinhood Markets Inc. A legion of traders who put money in the market for the first time during the Covid-19 pandemic have known nothing else.
According to some executives, the lack of commissions is a direct result of Robinhood and other retail brokerages bringing in revenue from arrangements known as payment-for-order flow, which let them sell their clients’ trade orders to market-making firms like Citadel Securities and Virtu Financial Inc. for execution.
Larry Tabb, director of market structure research at Bloomberg Intelligence, said that there’s evidence that retail investors are getting a better deal than institutional traders in the current system, which involves payment-for-order flow.
But Gensler is not a fan because while a trade may be free, there are questions over the quality of the execution and whether an investor is getting the best price. He’s repeatedly suggested ending the practice and this week he again refused to rule out pushing to ban it in the US.
The SEC chief also suggested creating an auction mechanism where the major market-making firms would have to compete directly to fill retail orders, rather than purchasing them from Robinhood and others.
While any changes would take months to make their way through the SEC’s byzantine rule-making process, Gensler’s latest comments nonetheless have unleashed a flurry of speculation over what an overhaul could mean for commission-free trading.
“This could be much worse for retail investors, especially if payment-for-order flow goes away and retail traders go back to paying $5 or more for each trade,” said Mike Bailey, director of research at wealth-management firm FBB Capital Partners. “If the SEC kills payment-for-order flow, then yes, commissions go higher and friction comes back into part of the capital markets.”
Chris Grisanti, chief equity strategist at MAI Capital Management, said regulators “may be trying to solve a problem that isn’t there.” However, he was skeptical that what Gensler laid out would actually result in the end of commission-free trading.
“Who’s going to want to be the first one to raise fees, and are others going to follow?” Grisanti said. Instead, brokers could try to hold onto their margins by adding fees elsewhere.
There are also retail brokerage firms seeking to gain a foothold in the market that see an opportunity in Gensler’s plans.
Kerim Derhalli, founder of the investing app Invstr which offers commission-free trading but says it doesn’t sell clients orders through payment-for-order-flow, asserts that the changes could bring more transparency. Even without paying brokerage fees for each transaction, ordinary traders still bear a cost, he says.
“Retail investors already understand they’re paying a price somewhere or other,” he said. “If the cost of buying and selling becomes more explicitly known, it might discourage people from thinking they’re Gordon Gekko,” Derhalli said, referring to the fictional character played by Michael Douglas in the 1987 film “Wall Street.”
Wall Street Gets Ready To Rumble Over Stock-Trading Rules
The SEC’s Gary Gensler is proposing big changes to the system that’s fueled the rise of free brokerage apps.
A battle is brewing in Washington and on Wall Street over how stocks get traded. At issue is whether retail investors get the best bang for their buck.
The controversy may be puzzling to anyone outside the industry, given that commissions have fallen to zero on trading apps and discount brokerage services.
But US Securities and Exchange Commission Chair Gary Gensler is asking whether those trades come with hidden costs, or if it’s even possible to tell under the current system whether retail investors are getting the best prices when they buy and sell stocks.
“The markets have become increasingly hidden from view,” Gensler said in a June speech delivered remotely to an investment banking conference in New York. As he previewed a sweeping proposal for new rules, finance executives in the room sat furiously typing on their phones and shaking their heads, while neglecting their chicken entrees.
The current market plumbing has been around for well over a decade. When you buy shares of a stock over an app, that trade often doesn’t get made at a well-known venue such as the New York Stock Exchange. Instead, the order may go to a high-frequency trading firm, or wholesaler.
These companies make money by paying a little less to buy the stock that they sell to you, or by getting a little more when they sell a stock they’ve bought from you.
This small “spread” is essentially part of the price you pay for a trade, even when there’s no commission. To get the chance to earn these tiny profits—which add up to serious money in the aggregate—the trading firms pay brokerages to have trades sent their way, a practice called payment for order flow.
This is all nearly invisible to the typical investor, but it’s had one very noticeable effect: Payment for order flow helped to usher in the no-fee trading era.
It gave the upstart financial technology company Robinhood Markets Inc. a reliable source of revenue that let it knock its price down to zero, pushing most of its competitors to follow suit starting in 2019. The popularity of commission-free trading, especially with young investors, powered the meme stock frenzy of 2021.
Such payments are allowed if brokers are providing what regulators consider “best execution” on trades, which is a combination of price, speed, and other factors.
And high-frequency trading firms, which employ sophisticated technology, can often get retail customers better prices for their stocks than what’s advertised on the exchanges, even while slicing off profits for themselves.
Gensler—who’s seen as an uncommonly energetic SEC chair by admirers and detractors alike—has expressed concerns about the current system. One is a lack of transparency. During the height of the meme boom, almost half of US equities traded off stock exchanges. Two wholesalers, Citadel Securities and Virtu Financial Inc., dominate the market for handling many of those retail trades.
“It’s not clear, given the current market segmentation, concentration, and lack of a level playing field, that our current national market system is as fair and competitive as possible for investors,” Gensler said in his June remarks. He suggested creating an auction mechanism where the major market- makers would have to directly compete to fill retail orders.
The rough idea is that each order would be like a jump ball in a basketball game. This might make payment for order flow less important, but Gensler also hasn’t ruled out banning it altogether. Despite rules about best execution, Gensler said payments can raise a conflict of interest and noted they aren’t allowed in the UK, Canada, and Australia.
Trading firms say investors are already getting some of the best prices ever. “Switching to an auction system seems ill-timed, unneeded, and it is highly doubtful that it will pass a thorough economic analysis,” says Kirsten Wegner, chief executive officer of the Modern Markets Initiative, an advocacy group for quantitative trading firms.
Joe Mecane, who heads execution services for Citadel Securities, warns of a potential “unintended consequence” that hurts retail investors if the rules change. But others say more transparent markets can attract more competition and lead to better prices.
Hitesh Mittal of BestEx Research Group LLC, which sells algorithmic trading tools, says today’s situation is “like playing poker, and you’re playing with your cards open and someone else is playing with their cards closed.”
Whatever happens, a change would shake up the business model of brokers that rely on payment for order flow. The current system functions a bit like social media, says Mike Bailey, director of research at wealth management firm FBB Capital Partners. Online, companies show you ads, and “in exchange you get free email, free music videos, free everything,” he says.
Likewise, payment for order flow has subsidized cheap trades. If the SEC limits it, then “commissions go higher, and friction comes back into part of the capital markets,” he says.
A little friction in retail trading might not worry Gensler. That’s because of another worry he’s raised: the “gamification” of investing. Since brokerages earn more when customers trade more, they have an incentive to make their apps more engaging.
Features such as free stock rewards, leaderboards, and notifications may encourage investors to make more trades than they would have otherwise. “We need to ensure investors using apps with these types of features continue to be appropriately protected,” Gensler told Congress in May last year.
Reducing payment for order flow may not end free trades. Long before fees went to zero, they’d been steadily falling. Brokers might focus on other ways to make money, such as nudging investors into fee-based wealth management products or earning income on the cash that traders park with them.
Proposed rules are still being crafted by SEC staff, and Gensler will need at least two of the other four commissioners’ votes to approve both a proposed and final version.
But the industry is bracing. New rules will ripple through a complicated market, says Christine Parlour, a professor of finance at the University of California at Berkeley’s Haas School of Business. “If you change one piece of it, it potentially has all sorts of complex knock-on effects in other corners,” she says.
Crypto Is More Attractive As SEC Gets Aggressive, Investors Say
Bitcoin will trade between $17,600 and $25,000 until the end of this year, survey of market participants shows.
A crackdown by the US Securities and Exchange Commission and other watchdogs who have been investigating crypto’s naughtiest companies is proving to be a boon for the industry, with market participants saying they’re more likely to invest in the space following greater enforcement action.
Almost 60% of the 564 respondents to the latest MLIV Pulse survey indicated they viewed the recent spate of legal action in crypto as a positive sign for the asset class, whose trademark volatility has all but dissipated in recent months.
Major interventions include the US regulatory investigations of bankrupt crypto firms Three Arrows Capital and Celsius Network, as well as an SEC probe into Yuga Labs, the creators of the Bored Ape collection of nonfungible tokens, or NFTs.
“I’m in the ‘yes’ camp. As a professional investor, you need a regulated investment opportunity and it opens the doors for more professional investors to get involved in crypto, if it’s more regulated,” said Chris Gaffney, president of world markets at TIAA Bank. “The more they can get crypto out of the Wild West and into traditional investing, the better off it’s going to be.”
The sentiment extends to Bitcoin. Most investors were slightly more optimistic about the crypto than they were when asked in July.
Almost half of respondents expect the world’s largest cryptocurrency by market value to continue trading between $17,600 and $25,000 until the end of this year — a departure from this summer’s sour outlook, when most said it was more likely to first drop to $10,000 than to climb to $30,000. To be fair, respondents this time had a broader menu of options to choose from than were available in the previous survey.
“Our investors recognized and the market recognized that the decentralized protocols have unique advantages that not only can benefit crypto markets, but also traditional markets more broadly,” Mary-Catherine Lader, Uniswap Labs COO, said in a Bloomberg TV interview.
While Bitcoin has been down about 60% this year, its price has been stuck between $18,171 and $25,203 since the previous survey was conducted, unable to meaningfully break out of that band.
Volatility has also largely subsided, with the T3 Bitcoin Volatility Index down 33% since the token hit its all-time high of almost $69,000 on Nov. 10. Bitcoin was trading above 19,400 Monday as of 8 a.m. New York time.
Bitcoin has held a strong correlation to risk-on assets as well as the S&P 500 since March, barely changing its position in the last three months as investors tarred crypto with the same brush as everything else in an environment of rising interest rates.
Some 42% of respondents said they think crypto’s correlation to tech stocks will stay the same over the next 12 months, while only 43% said they would increase their exposure to digital assets over the same period.
It’s been a tale of two halves for crypto in 2022, with the first half of this year dominated by chaos. There were bankruptcies, like Voyager Digital Ltd.’s, and the $40 billion wipeout of the Terra blockchain ecosystem.
Roughly $2 trillion in overall value was erased from the industry’s late-2021 record. In June, things began to shift with crypto starting to plateau to its current range-bound level as the broader macroeconomic environment soured and traders turned to more traditional assets like bonds and FX for profit.
The lower volatility is “likely regarding the indecisiveness out there,” said Katie Stockton, managing partner at Fairlead Strategies.
In September, the Ethereum network completed a major network upgrade known as the Merge, which by one estimate will reduce the blockchain’s energy consumption by about 99%.
Still, only around one-third of investors said they believe that the so-called Flippening, where Ether’s market value eclipses that of Bitcoin, could happen in the next two years — a number that’s largely stagnant from July.
Survey respondents also displayed a very broad church of opinions on crypto, emblematic of how despite the sector’s relative infamy among traders, it’s still a divisive topic.
When asked to choose one word that describes the space, the two most popular answers were almost evenly split between “Ponzi” and “future.”
“It’s almost like a religion — if you believe, you will always believe no matter the price or the headwinds,” said Victoria Greene of G Squared Private Wealth.
“The dichotomy between boom and bust perfectly describes crypto and the vast range of potential outcomes. There are so many unknowns, including regulation and platforms as well as what the hell it actually is and what it will be used for,” she said. “So, if you are a true believer, you say it’s the future.” People with more of a traditional view may say it’s a Ponzi, she said.
Republican Lawmaker Claims SEC Chair Was Coordinating With FTX ‘To Obtain Regulatory Monopoly’
Minnesota Representative Tom Emmer did not provide any evidence to his claim that Gary Gensler was “helping SBF and FTX work on legal loopholes” but said he was looking into the matter.
Tom Emmer, the recently reelected Republican lawmaker representing Minnesota’s 6th district in the United States House of Representatives, has alleged Securities and Exchange Commission Chair Gary Gensler had been helping FTX CEO Sam Bankman-Fried to gain a “regulatory monopoly” through the crypto firm.
In a Nov. 10 tweet, Emmer criticized Gensler for “run[ning] to the media” amid FTX’s liquidity issues causing ripples throughout the crypto market.
According to the Republican lawmaker, his team was looking into the SEC chair’s alleged collaboration with Bankman-Fried and FTX, but only cited reports presented to his office as evidence without providing details.
Interesting. @GaryGensler runs to the media while reports to my office allege he was helping SBF and FTX work on legal loopholes to obtain a regulatory monopoly. We’re looking into this. https://t.co/SznowgcP6V
— Tom Emmer (@RepTomEmmer) November 10, 2022
Gensler spoke on CNBC’s Squawk Box shortly before Emmer’s statement, not disputing records that SBF met with SEC officials on March 29.
The SEC chair said many similar meetings led to the same message to crypto industry leaders — “non-compliance is not gonna work” — but did not confirm reports that the regulatory body was investigating the FTX US exchange.
“When you mix together a bunch of customer money, non-disclosure, and leverage, borrowing against it — and inside these companies trading — investors get hurt,” said Gensler, also citing the collapse of Terra. “This is a very interconnected world in crypto with a few concentrated players at the middle. […] When markets turned on them, it appears that a lot of customers lost money.”
Bankman-Fried is no stranger to Capitol Hill, having testified in December 2021 before the House Committee on Financial Services on the challenges crypto firms faced with regard to regulatory clarity.
Committee Chair Maxine Waters issued a statement on Nov. 10 pushing for federal oversight of crypto trading platforms and consumer protection amid FTX facing liquidity issues but did not suggest the sort of coordination between the exchange and SEC that Emmer claimed.
The ongoing saga with FTX and SBF has resulted in extreme volatility across the crypto market and uneasiness from many users looking for the status of their funds. Bankman-Fried issued a public apology via Twitter on Nov. 10, claiming responsibility for not providing enough transparency during FTX’s “liquidity crunch.”
SEC Proposes Rules That Would Squeeze Stock-Market Middlemen
Agency is formally considering biggest overhaul of stock-market structure since mid-2000s.
WASHINGTON—The Securities and Exchange Commission voted Wednesday to advance the biggest changes to U.S. stock-market rules since the mid-2000s, aiming to give small investors better prices on their trades and reduce some advantages enjoyed by high-speed trading firms.
Democratic commissioners, who hold three of the SEC’s five seats, supported moving forward on each of the four proposals. Republican commissioners voiced objection to two of the measures. Voting to advance the rules opens them to public comment until at least March 31 before the agency can decide whether to finalize them.
The proposals grew out of a review prompted by last year’s frenzied trading in GameStop Corp. They would fundamentally alter the relationships between brokerages that take investors’ orders to buy or sell securities, the high-speed traders that often handle those orders, and stock exchanges.
The broad idea motivating the proposals is to use greater competition for investors’ orders to deliver better prices, while stepping up regulations of the firms that profit from handling retail stock trades.
“Today’s markets are not as fair and competitive as possible for individual investors,” SEC Chair Gary Gensler said.
The SEC’s proposals are expected to face opposition from brokerages and so-called wholesalers—trading firms such as Citadel Securities and Virtu Financial Inc.,
which handle many of the orders placed by individual investors.
Such middlemen, who trade billions of shares a year and profit by selling them at slightly higher prices than they bought them, would face new regulatory requirements that could compress their earnings.
They have argued that individual investors get a good deal under the current system and warned that the SEC’s overhaul could backfire and end up hurting investors.
“Some of the SEC’s proposed changes stand to resurrect discriminatory barriers to entry and hurt millions of retail investors,” Robinhood Markets Inc. deputy general counsel Lucas Moskowitz said. “The SEC should not be playing politics with individual Americans’ ability to improve their financial lives.”
A Virtu spokesman said the firm wasn’t immediately able to comment. The firm’s stock fell more than 6% Wednesday. A Citadel spokeswoman said, “any proposed changes must provide demonstrable solutions to real problems while avoiding unintended consequences that will hurt American investors.”
Republican SEC Commissioner Hester Peirce voiced concern that the proposed rules would have unpredictable effects. “There is no emergency in our markets that demands a comprehensive revamping of how broker-dealers and market-makers handle customer order flows,” Ms. Peirce said in a statement.
SEC economists estimated that more competition in the business of filling stock orders could save individual investors $1.5 billion a year, according to a fact sheet released by the agency.
The centerpiece of the SEC’s plans is a proposal for brokers to send many small-investor stock orders into auctions. This would enable a mix of high-speed traders and institutional investors such as hedge funds or pension funds to compete to fill the orders, with the idea that investors would get better prices as a result—higher prices if they are selling shares, or lower prices if they are buying.
The auctions would apply to so-called marketable orders—in which investors buy or sell stocks at the currently available price—less than $200,000 in size and placed by investors who average fewer than 40 trades a day.
They would be required to last between one-tenth and three-tenths of a second, roughly the duration of a blink of an eye, and would likely be run by exchanges.
Requiring such auctions would be a big change. The SEC says brokers send more than 90% of marketable orders to wholesalers. Unlike exchanges, which display price quotes publicly and allow a variety of market players to attempt to fill orders, wholesalers trade directly against the incoming retail flow, an arrangement that effectively prevents other market players such as institutional investors from interacting with individual investors’ orders.
Under the proposal, auctions could be skipped if wholesalers can beat a key price metric for filling an order. Wholesalers could also scoop up orders for which auctions fail to produce good bids.
SEC commissioners voted 3-2 along party lines to propose the auction rule.
A second proposal, advanced with a 5-0 vote, seeks to level the playing field between exchanges and wholesalers, according to the SEC.
It reflects longstanding complaints by executives from the New York Stock Exchange and other exchanges that they are handicapped in their ability to attract individuals’ orders.
The proposal centers on the price increments in which stocks are quoted and traded, called “tick sizes.” Currently, for most stocks, exchanges can only quote prices in increments of one penny.
The proposal would allow exchanges to quote prices in tighter increments, ranging from one-tenth of a penny to a whole penny, with the most actively traded stocks generally getting the tightest increments.
Meanwhile, the proposal would force wholesalers to trade stocks in the same increments, reducing the flexibility they currently enjoy to execute orders at prices in hundredths of a cent.
If the proposal is implemented, investors accustomed to seeing stocks quoted in dollars and cents would start seeing prices such as $13.567 on their screens.
The proposal could also push more trading to exchanges. Currently about 40% of daily U.S. equities trading volume takes place off exchanges, much of it in the private retail-trading platforms run by Citadel and Virtu.
“We are encouraged that the SEC’s proposals aim to level the playing field between on- and off-exchange trading,” NYSE Chief Operating Officer Michael Blaugrund said.
Wall Street lobbying groups voiced wariness about the proposals. “The SEC needs to be extremely careful in its approach,” Kenneth Bentsen, president of securities-industry trade group Sifma, said in a statement.
SEC commissioners voted 3-2 on a rule requiring brokers to seek out the markets where their customers’ securities trades can be executed on the most favorable terms available.
Brokers are already subject to a similar rule from Wall Street’s self-regulator, the Financial Industry Regulatory Authority, dubbed the “best execution” rule, but the SEC’s version is designed to be tougher.
This proposal would address a controversial practice called payment for order flow, in which some brokers collect rebates for sending customers’ orders to wholesalers.
Mr. Gensler has called the practice a conflict of interest and, in past statements, left open the possibility of banning it. The SEC’s best-execution proposal doesn’t go that far. But it imposes additional obligations on brokers that engage in payment for order flow to help ensure that customers are getting a good deal.
In a fourth action, the SEC voted 5-0 on a proposal to update and expand a more than 20-year-old rule that requires wholesalers and exchanges to publish monthly data about the quality of stock pricing they provide for investors.
The rule would be expanded to apply to brokerages with more than 100,000 customers, which includes Robinhood and Charles Schwab Corp.
A Schwab spokeswoman said the firm would closely review the proposals. “We strongly believe structural changes should be thoroughly vetted to ensure any benefits genuinely outweigh the risks of degrading individual investors’ experience,” she said.
Commissioners also voted unanimously to adopt a final rule to impose tighter rules on how and when corporate insiders can buy or sell their company’s stock.
Those changes apply to so-called 10b5-1 plans, which allow corporate officers to schedule future share purchases or sales to avoid running afoul of insider-trading claims.
The rule, likely to take effect next year, would impose new disclosure requirements and create cooling-off periods between when a plan is adopted or modified, and when trading can commence.
The Wall Street Journal, in an article about 10b5-1 trading plans published in June, found that corporate insiders who sold shares within 60 trading days after adopting such a plan in aggregate had unusually good timing, often selling ahead of a downturn in the stock price.
SEC’s $1.5 Billion Problem With Stock-Market Middlemen Has A Complex Solution
Regulator’s proposals, such as an auction system, could get small investors better trade executions—but who loses on the flipside?
The Securities and Exchange Commission believes small investors could pocket about $1.5 billion a year from better trade execution. The question is whether someone else’s wallet could lighten by that amount.
A new series of SEC rule proposals are meant to address problems with equity market structure for investors, particularly for small investors when it comes to the practice of payment for order flow, or PFOF.
That is when a brokerage such as Robinhood Markets or Charles Schwab sends retail orders to a wholesale market-maker such as Citadel Securities or Virtu Financial and collects payments.
SEC Chairman Gary Gensler has long voiced concerns that the practice is rife with conflicts of interest and doesn’t sufficiently compensate small investors.
These SEC measures stop short of banning PFOF. But the myriad proposals, if adopted, might alter the practice.
Perhaps most notably for many brokerage retail orders—those for relatively smaller marketable orders and less-frequent traders—there would be auctions to determine which bidder would pay the best price for an individual order.
The SEC estimated that with open competition, individual investors collectively could stand to capture some additional $1.5 billion annually in the form of better prices, fully reflecting the liquidity value of their orders.
That is a large number, though spread out among millions of small traders it isn’t going to radically change anyone’s investing life.
To put things in context: An example of an individual’s roughly $500 trade described in a Wall Street Journal story might have netted an additional 79 cents by moving from wholesale execution to a theoretical midpoint trade.
So then would this theoretical $1.5 billion all come out of the pocket of wholesalers and, in turn, the brokers that they pay for the orders? That is very hard to say.
For one, brokers can still earn revenue when routing orders directly to exchanges, depending on if they collect a rebate—though the proposals also include some changes to rebate practices and to how brokers evaluate best execution.
Brokers can also internalize orders themselves by matching customers’ bids and offers and earning the spread in the middle, though they would likely need to subject qualifying orders to auctions first.
Wholesalers, too, have offsets. Whereas they typically now might pay for all orders sent by brokers, under an auction system they likely wouldn’t bid for all orders, as some can be costly to trade out of. Virtu has said it might actually save hundreds of millions of dollars under a retail auction system.
There is enough complexity that investors should be cautious about jumping to conclusions on ultimate winners and losers. On Wednesday, Virtu shares were down by more than 6%, but that might reflect uncertainty more than anything definitive.
Interestingly, exchange operators Intercontinental Exchange, Nasdaq and Cboe Global Markets also fell. Robinhood Markets and Charles Schwab were down, too. One thing about middlemen is that there are a lot of them.
SEC Was ‘Asleep At The Wheel’ About FTX — US Rep. Sessions
The Texas Congressman urged lawmakers to examine the SEC’s efforts to prevent fraud at the crypto exchange.
The Securities and Exchange Commission (SEC) was “asleep at the wheel” regarding how FTX Group and its subsidiaries met financial and corporate control requirements, Representative Pete Sessions said in the Saturday Report on December 17.
“We need to look at what the Securities and Exchange Commission was doing,” stated the Texas Congressman, adding that “the SEC was asleep at the wheel for these billions of dollars that we now find out about a year later.”
The SEC filed charges against Sam Bankman-Fried (SBF), the former CEO of FTX, on Dec. 13, claiming that Bankman-Fried violated the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.
In the complaint, the SEC requests an injunction to prohibit Bankman-Fried from participating in the issuance, purchase, offer or sale of any securities except for his own account.
SEC Chair Gary Gensler said Bankman-Fried “built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto.” The charges came a day after his arrest by Bahamian authorities at the request of the United States.
Representative Sessions also noted that a year ago, Bankman-Fried testified at a congressional committee hearing, where he was asked about the need for regulatory oversight of cryptocurrencies. Bankman-Fried replied, “it’s just a matter of transparency,” according to Sessions.
The Congressman also noted that Bankman-Fried had “full access to members of Congress and the U.S. Senate.”
Session’s comments follow those of Senator Tom Emmer, who criticized Gensler for his flawed “crypto information-gathering efforts,” calling on him to appear before Congress to explain “regulatory failures.”
Emmer also outlined that Gensler hasn’t appeared before the House Committee on Financial Services since October 2021, leaving crypto media to fill the void for the SEC’s failures in investigating.
Crypto Offers A Road Map For Improved Stock Trading
The SEC’s proposal to overhaul how transactions are conducted reads like the invention of lawyers and economists who can’t see the easy fix that exists right before their eyes.
The dispiriting thing about the Securities and Exchange Commission’s 400-page proposal to re-engineer financial markets, and the response from outside the agency, is that lawyers and economists are arguing over questions that have easy technical solutions.
If we wouldn’t trust these people to design the electrical power system or build a spaceship to Mars, why should we listen to them on market rules?
One basic issue the SEC is trying to address is how best to match buyers and sellers. The goal is not controversial: The person willing to pay the most should buy from the person willing to sell for the least amount, and these transactions should continue until every holder of the asset values it more highly than anyone who doesn’t hold it.
The trouble is that not every potential buyer and seller watches the market continuously, ready to make instant decisions. Therefore, intermediaries arise to provide liquidity. Economists study different market systems, and argue about which one is best, using different definitions of best.
Regulators make rules to force the system to be better, cheaper or to favor certain groups. All of this leads to complex systems, prone to unintended consequences and unexpected crises, with lots of money syphoned by clever people and insiders.
Now consider crypto. To some, “crypto” means tokens with monetary value such as Bitcoin, and to others it means ledgers like blockchains. But I think of it more broadly as engineers applying rationality to problems non-technical people have squabbled over without resolution forever.
Instead of arguing about what money is, make better money and put it in the public domain. Instead of regulating how records are kept, build a record-keeping system that meets everyone’s desires.
In crypto, designers started from scratch, not to entrench themselves in a legally protected oligopoly but to build exchange systems preferred by voluntary users.
To date these have been used only for crypto assets, which has limited the attention they receive, especially when crypto assets are in decline.
But the basic ideas are better, simpler and cheaper than traditional financial markets and should eventually supplant them.
Automated market makers let buyers and sellers trade asynchronously on their own schedules, so there’s no need to keep everyone in continuous contact for instant decisions. Liquidity has an explicit cost, rather than getting bundled implicitly in complex and immeasurable ways into prices.
If you want to execute quickly or in large size, you get a worse price than if you are willing to be patient or are trading in small size. Each market participant can choose the amount of liquidity to buy with each transaction. The liquidity providers are paid explicitly in a simple way.
There are no complicated rules with unintended consequences, lawsuits or political squabbling. And no expensive overhead with colocation arms races, speed bumps, circuit breakers, manipulation rules or regulatory analyses are needed.
Frequent batch auctions do match up buyers and sellers, but without pointless and destabilizing races to be first in line. All orders for a time interval — which might be a few seconds for high-volume stocks but up to a day or more for less liquid assets — are matched to a single clearing price.
Intermediaries are still needed for those who want to trade more slowly than the batch interval, but the vast array of high-speed intermediary trading no longer exists.
Only two order types, limit buy or limit sell, are needed, not the hundreds that exist today. Market making becomes a simple business relying on economics, not a high-pressure race based on outsmarting other algorithms.
Of course, these ideas are still being tested and refined. Perhaps the technical solution to financial markets is something different. But I’m confident it’s something mathematicians and computer scientists will design rather than something lawyers and economists come up with, and that it will be simple, transparent, cheap and fair.
Another major issue in market is protecting information. Legitimate traders want to protect information about their trades, while illegitimate market manipulators want to put out false information about their trades.
Regulations are not suitable for protecting and filtering information — information always leaks despite the most rigorous procedures.
The technical solution here is zero-knowledge trading. With the magic of cryptography, it’s possible for an individual to encode a trade order before it leaves her computer, so that no one can tell who placed it or what the order is, yet an exchange can match it with a corresponding zero-knowledge order, without ever knowing what either order is (other than that one was an offsetting buy of something to the other order’s sell).
The two orders can execute immediately and without credit risk via smart contract. There’s no spoofing, no manipulation because no one can see the false orders. There’s no front-running either.
Today there is vibrant, unfettered competition in crypto for the best exchange mechanism. Most important, ideas are tested with real traders instead of economists and regulators guessing about how they’ll work, and the tests are simple, without all the complexities of embedding them in existing financial markets.
I don’t know if any of the ideas above will win out, but I predict whatever does win will make traditional financial markets look medieval in comparison.
What the internet did for retail shopping, research, music, communication with friends and dozens of other things, it can do for stock trading — as long as economists and lawyers get out of the way of people who understand information processing.
SEC Leaked Crypto Miners’ Personal Information During Investigation: Report
The financial regulator reportedly unintentionally included 650 names and email addresses in communications with blockchain firm Green as part of an investigation.
The United States Securities and Exchange Commission, or SEC, has reportedly leaked the names and email addresses of many crypto miners connected to the blockchain firm Green.
According to a Jan. 17 report from the Washington Examiner, the SEC unintentionally included 650 names and email addresses in an email communication with Green as part of an investigation, leaving the blockchain’s nodes vulnerable to hacks.
The financial regulator had reportedly been reaching out to Green users regarding their purchase of the firm’s products.
“The Privacy Act of 1974 […] prohibits the disclosure without consent of information about individuals that the federal government maintains in a system of records,” the SEC website says. “If we store information about you in a system of records from which we retrieve that information by personal identifier […] we will safeguard your information in accordance with the Privacy Act.”
Hackers have often targeted centralized crypto exchanges to obtain information about users, but alleged unintentional leaks by government officials are less common. In October, the U.S. Justice Department announced charges against two Chinese intelligence officers who allegedly bribed a double agent with Bitcoin.
The SEC has also executed several crackdowns on crypto firms in 2022 in what many critics have called the agency taking a “regulation by enforcement” approach. In December, the financial regulator added its name to the list of federal agencies charging former FTX CEO Sam Bankman-Fried, alleging violations of the anti-fraud provisions of securities laws.
SEC Comes For Gemini Too Late
Also GTX claims trading, Goldman golfing and Razzlekhan.
Well, of course:
* US regulators sued crypto brokerages Genesis Global Capital and Gemini Trust Co. for breaking securities rules.
* The Securities and Exchange Commission said on Thursday that the firms illegally raised billions of dollars from hundreds of thousands of investors through the so-called Gemini Earn program. That product, which let customers loan out their assets in exchange for interest payments, amounted to the offering of unregistered securities, the SEC said.
* Gemini launched Earn in February of 2021, with the idea of offering users passive returns on their coins in exchange for the right to lend the tokens out. By August of that year, the program, which offered rates that far exceeded those on traditional bank accounts, crossed $3 billion in assets.
We covered this in 2021, when Coinbase Global Inc.’s similar crypto lending program was shut down by the SEC before it started. I wrote:
* Is Lending Your Bitcoins A Security?
* Oh, sure, yes, absolutely. The rule in the U.S. is that an “investment contract,” meaning “the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others,” is a security, and generally can’t be sold to the public without registering it with the Securities and Exchange Commission, delivering a prospectus with audited financial statements, etc.
A Bitcoin lending program — in which (1) a bunch of people pool their Bitcoins, (2) some manager or smart contract lends those Bitcoins to borrowers who pay interest, and (3) some or all of the interest is paid back to the people in the pool — is pretty straightforwardly an investment contract and thus a security.
This is easy stuff. People in crypto don’t like it, but that’s because they are wrong. More specifically, they have an intuition like “if a crypto platform pays you interest on your crypto deposits and uses them to make loans, that is like a bank account, and a bank account is not a security.” But that’s because IT’S A BANK ACCOUNT. Like:
* Securities Regulator: Your Earn product is a security and needs to be registered with us.
* Crypto Platform Operator: That’s ridiculous, Earn is just like a bank account, that’s not a security.
* Banking Regulator: Hi! I couldn’t help overhearing. Did you just say that YOU WOULD LIKE US TO REGULATE YOU AS A BANK?
* Crypto Platform Operator: [screams, dives out window]
As I Wrote In 2021:
* Coinbase obviously does not want to be regulated as a bank; it does not want to be subject to bank capital requirements (which require essentially 100% equity capital backing Bitcoin positions) or prudential regulation by bank regulators who like crypto about as much as the SEC does but have even more tools to crack down.
You think the SEC is being annoying about not issuing formal guidance! A bank examiner could just call you up and say “we don’t think owning Bitcoin is a good idea, get rid of it,” and then where would Coinbase be?
So, right. Gemini has an Earn product where it gives its customers interest on their crypto; it gets that interest by lending their crypto to Genesis Global Capital LLC, a unit of Barry Silbert’s Digital Currency Group. Genesis, in turn, lends the crypto to, you know, Three Arrows Capital, Alameda Research, things of that nature. Oops!
Last year Genesis lost a bunch of the money and eventually shut down withdrawals, including for Gemini Earn customers; Cameron Winklevoss has been sending Silbert some nasty open letters about it. I don’t really disagree with the nasty letters, but they are kind of absurd coming from Winklevoss: Sure, it was bad for Genesis to lose Gemini’s customers’ money, but it was pretty much equally bad for Gemini to let them? Nobody made good decisions here.
The SEC seems to see it my way, and last week it sued Genesis and Gemini, together, for this mess. Specifically for doing unregistered securities offerings:
* The Securities and Exchange Commission today charged Genesis Global Capital, LLC and Gemini Trust Company, LLC for the unregistered offer and sale of securities to retail investors through the Gemini Earn crypto asset lending program.
Through this unregistered offering, Genesis and Gemini raised billions of dollars’ worth of crypto assets from hundreds of thousands of investors. Investigations into other securities law violations and into other entities and persons relating to the alleged misconduct are ongoing.
* According to the complaint, in December 2020, Genesis, part of a subsidiary of Digital Currency Group, entered into an agreement with Gemini to offer Gemini customers, including retail investors in the United States, an opportunity to loan their crypto assets to Genesis in exchange for Genesis’ promise to pay interest.
Beginning in February 2021, Genesis and Gemini began offering the Gemini Earn program to retail investors, whereby Gemini Earn investors tendered their crypto assets to Genesis, with Gemini acting as the agent to facilitate the transaction.
Gemini deducted an agent fee, sometimes as high as 4.29 percent, from the returns Genesis paid to Gemini Earn investors. As alleged in the complaint, Genesis then exercised its discretion in how to use investors’ crypto assets to generate revenue and pay interest to Gemini Earn investors.
* The complaint further alleges that, in November 2022, Genesis announced that it would not allow its Gemini Earn investors to withdraw their crypto assets because Genesis lacked sufficient liquid assets to meet withdrawal requests following volatility in the crypto asset market. At the time, Genesis held approximately $900 million in investor assets from 340,000 Gemini Earn investors.
Gemini terminated the Gemini Earn program earlier this month. As of today, the Gemini Earn retail investors have still not been able to withdraw their crypto assets.
* The SEC’s complaint alleges that the Gemini Earn program constitutes an offer and sale of securities under applicable law and should have been registered with the Commission.
Here is the SEC’s complaint, which comes to a brisk 22 pages. The main argument that this is a security is on pages 13 to 19. Under the Securities Act of 1933, the definition of “security” includes a bunch of different things, but the two that are relevant here are a “note” and an “investment contract.”
There are two Supreme Court cases — Reves v. Ernst & Young and SEC v. W.J. Howey & Co. — that decided what makes an investment a “note” or an “investment contract” under this law. The SEC summarizes Reves:
* A note is presumed to be a security unless it bears a strong resemblance to instruments that are not securities, which courts determine by examining four factors: (1) the motivation of the parties; (2) the plan of distribution; (3) the expectations of the investing public; and (4) the availability of an alternative regulatory regime that “significantly reduces the risk of the instrument” for investors other than the securities laws, “thereby rendering application of the Securities Acts unnecessary.”
Here, publicly marketing Gemini Earn as an investment to hundreds of thousands of retail investors probably makes it a security. The “alternative regulatory regime” stuff is basically the point that bank accounts are not securities: If Gemini Earn were subject to banking regulation, then it might not be a security, but that is not the case. The SEC says:
* Although Gemini is registered with [New York State Department of Financial Services] as a New York limited purpose trust company, NYSDFS did not have oversight over Genesis. Gemini publicly stated that Gemini Earn does not operate like a traditional bank account, is not protected by a governmental program, and is not backed by Gemini itself.
In a February 2021 press release launching Gemini Earn, Gemini stated that “Gemini Earn is not a depository account. . . . Loans are not insured by Gemini or any governmental program or institution.” Likewise, on its website, Gemini noted that “Gemini Earn is structured similarly to non-deposit services offered by financial institutions and not insured by FDIC, SIPC, any other governmental program, or Gemini.”
* Any capital reserve requirements applicable to Gemini did not apply to Genesis or to the crypto assets tendered to Genesis through Gemini Earn.
It’s not a bank account, which makes it probably a security.
Meanwhile the Howey test of what makes an “investment contract” a security is the one I quoted above; it’s “the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” Gemini’s Earn customers invested money (their crypto) in a common enterprise (Genesis’s lending business) with a reasonable (?) expectation of profits (their promised yield) that would be derived from the efforts of others (Genesis’s lending decisions). The SEC says:
* From its inception, Defendants have explicitly marketed the Gemini Earn program as an investment opportunity which led investors to reasonably expect to profit from their efforts. As detailed above, through their websites and social media channels, both Genesis and Gemini publicly touted the ability for investors to earn yield or returns via Gemini Earn.
Gemini repeatedly itself described Gemini Earn as an investment on its own website; repeatedly touted that the Gemini Earn interest rates were “among the highest rates on the market” and that Gemini Earn investors could “receive more than 100x the national interest rate”; and Gemini’s website illustrated how much interest Gemini Earn investors could potentially earn by investing their crypto assets for a period between one and four years.
* Genesis also described itself as the “premier institutional digital asset financial services firm,” and “the world’s largest digital asset lender” and that “[h]olders of digital currencies can earn yield on their assets by lending directly to Genesis, a regulated and trusted counterparty.” Accordingly, Gemini Earn investors were led to expect that Defendants’ efforts to generate the investment returns – i.e., the promised interest – would result in profit for investors.
It is probably helpful to the SEC, in making this case, that Genesis and Gemini seem to have lost the money, or at least, uh, rendered it inaccessible. The SEC’s essential argument here is that Gemini Earn is an investment of money in a risky profit-seeking venture whose success depends on the efforts of Cameron Winklevoss and Barry Silbert; Gemini’s and Genesis’s essential argument is “no it isn’t, shhh, it’s just a nice 8% return on your money.” The fact that the money is gone, or at least temporarily indisposed, strengthens the SEC’s position. Ex post, it was definitely risky.
Of course it would have been better if the SEC had shut down Gemini Earn — like it did Coinbase Lend — before it lost the money, but that is hardly a defense now.
The main remedy for doing an unregistered securities offering is that you have to give the money back: If you raise $900 million from investors for your product, and then the product loses money, you have to give them their money back anyway. Well, that and you probably have to pay a fine to the SEC.
Elsewhere, Bloomberg News reports on the Ripple case:
* In the wake of the implosion of cryptocurrency exchange FTX, one urgent question keeps resurfacing: Who should regulate the industry?
* An upcoming ruling in New York federal court could help determine the answer, along with the fates of numerous crypto investors and companies. The case hinges on whether a prominent digital token should be treated as a security, which would fall under the Securities & Exchange Commission’s jurisdiction.
* The dispute dates back to 2020, when the SEC accused San Francisco-based Ripple Labs Inc. of selling unregistered digital tokens without adequate disclosure.
The issues in Ripple are not quite the same as the issues in Gemini Earn, but they are related; the basic question is whether courts will read the “investment contract” rules as broadly as the SEC does.
I think they will, but if the SEC loses the Ripple case then what I wrote above will probably be wrong, or at least, like, too strongly stated. But as that Bloomberg story notes, the broad crypto collapse probably helps the SEC’s position:
* The recent turmoil in crypto markets could taint the court’s view, said Joseph Hall, a partner at Davis Polk & Wardwell who worked at the SEC from 2003 to 2005.
* “You just have to imagine that the judges will be influenced by the investor losses they’ve seen,” Hall said. “And the SEC will make clear to them that if you rule the other way, we will not have the tools that we need to fight this kind of activity.”
Right. Ripple’s XRP token has lost a lot of value in the last couple of years, though it’s actually up a bit from where it was when the SEC sued; in any case Ripple does have the vague moral defense of “you say we did an unregistered securities offering, but it’s not like we took a bunch of investor money and lost it.” Lots of other crypto projects, including Gemini Earn, do not have that defense.
My basic view is that the crypto financial system was built by a bunch of young people who left traditional finance because they really love building new toy financial systems and crypto offers them a fun sandbox in which to do it.
If you went to those people and said “hey, can you design a system for trading claims on bankrupt crypto firms?” they would be like “sure that sounds really fun.” And a lot of them have a lot of time on their hands right now, what with their crypto firms having gone bankrupt. So, so, so:
* The founders of a bankrupt crypto hedge-fund firm are seeking to launch an exchange where creditors to insolvent digital-assets firms, including their own, would be able to buy and sell claims.
* Su Zhu, a co-founder of the bankrupt crypto hedge-fund manager Three Arrows Capital Ltd., said that he and others are seeking to raise $25 million in seed money for the new platform. A pitch deck to potential investors, seen by The Wall Street Journal, referred to the company as GTX, a poke at the fallen crypto exchange FTX.
* Mr. Zhu said that GTX isn’t the final name of the company. The other founders include Kyle Davies, who co-founded Three Arrows, and Mark Lamb and Sudhu Arumugam, the co-founders of crypto exchange CoinFLEX. They are likely to finalize a name for the company next week.
* Mr. Zhu said some Three Arrows creditors would have the option to convert their claims into equity in the new claim-trading company.
I just! Absolutely magnificent stuff. “We were too good at taking your money, sorry about that, but to make up for our losses we’ll let you bet on our ability to take your money again.”
The biggest problem 4 with the crypto financial system is that it is relatively bad at trading real stuff: Crypto exchanges are for trading crypto tokens, and without underlying cash flows or real-world businesses those have a distressing tendency to go to zero and bankrupt everybody.
But if you build a crypto exchange whose central product is all the money people lost on the last crypto exchange, you are solving that problem.
The net amount of money made in crypto fluctuates wildly, but the total supply of (1) money made in crypto plus (2) money lost in crypto can only really go up. If you build an exchange to let people trade their crypto losses, you will have a durable business.
SEC Scrutiny Blocks Some Crypto Firms From Going Public
Companies including Circle Internet Financial and eToro have failed to secure the regulator’s approval.
Increased scrutiny from the Securities and Exchange Commission has derailed crypto companies’ efforts to go public this past year, as financial distress and failures spread across the volatile industry.
Crypto-focused companies including Bullish Global, Circle Internet Financial and eToro Group Ltd. have failed to secure the SEC approvals that are required of companies going public.
The firms were seeking stock-exchange listings through mergers with special-purpose acquisition companies, an alternative path to going public that thrived in 2020 and 2021 before heightened regulatory checks and market turbulence ended the SPAC boom.
Another crypto broker, Galaxy Digital Holdings Ltd., has faced repeated rounds of questions from SEC staff about its business since filing paperwork to go public on the Nasdaq Stock Market, according to people familiar with the questioning.
Galaxy, which isn’t using a SPAC structure, announced in March 2021 that it wanted to become a U.S.-listed public company and hoped to clear SEC review by the end of that year.
The SEC didn’t set out to stop the companies from going public, according to a person familiar with the matter, but crypto firms believe the pace of the agency’s review hurt their efforts, particularly after the crash of a well-known cryptocurrency and the failure of a large crypto hedge fund that hit many exchanges and lenders.
The bankruptcy of crypto exchange FTX and a bear market in digital asset prices may keep the door closed.
Most crypto firms say their digital assets aren’t securities, and therefore they don’t need to comply with investor-protection rules. SEC Chair Gary Gensler disagrees and contends that much of the industry is noncompliant.
“Anyone bringing a crypto deal to the SEC should realize there is going to be a lot of friction,” said Scott Kimpel, a partner at law firm Hunton Andrews Kurth LLP.
The agency still holds clout when companies want to access the public markets. SEC accountants and lawyers ask potential securities issuers questions about financial disclosures, legal risks, the impact of market disruption and other subjects.
The SEC says it checks disclosures only to make sure they provide investors with the information required by law.
Potential issuers want the process to end with regulators deeming the company’s disclosures “effective,” making its shares good to be sold to the public. Bullish, Circle and eToro haven’t gotten there. The SEC reviewed their going-public filings for nearly a year or more, according to regulatory records, and didn’t declare them effective.
When Coinbase Global Inc. went public in 2021, the SEC sent three letters to the company with questions. Bullish, by contrast, responded to more than 10 letters over more than a year, according to people familiar with the letters.
Galaxy, which first filed paperwork to go public in the U.S. with the SEC in October 2021, received one letter from the SEC with more than 90 questions, according to a person familiar with the matter.
Galaxy, whose shares on the Toronto Stock Exchange are down about 80% from their peak over the past year, expects it will be able to eventually clear the SEC’s hurdles, a person familiar with the company said.
Galaxy Digital Chief Executive Mike Novogratz said on an August 2022 conference call that it has “been frustrating that it’s taken as long as it has.” A Galaxy spokesman declined to comment further.
Many of the crypto firms that went public after Coinbase had another challenge: their partnership with a SPAC imposed a strict deadline to close the deal.
A SPAC is a shell company that raises money from the public and plans to use the funds to combine with a private company. A SPAC typically has as long as two years to find its merger partner and complete the deal.
If the deal can’t clear the SEC’s review process in time, or other problems cause it to stall, the SPAC must return the money.
Last February, Circle pushed back the timetable for its merger with SPAC Concord Acquisition Corp., setting a new deadline of December 2022.
Circle spent much of last year working to address questions the SEC raised with its disclosures, which at one point numbered more than 100, according to people familiar with the discussions.
By early November, the company had only a handful of minor comments left, and it looked as if the deal could meet its deadline, the people said.
Then crypto exchange FTX filed for bankruptcy on Nov. 11. Circle said it didn’t have major ties to FTX. Afterward the SEC proceeded more cautiously with Circle’s review, the people said.
The SEC issued a list of 16 questions after FTX’s implosion that it wanted crypto companies to address in public filings, some of which were relevant to the firms under review, according to a person familiar with the review.
Several factors made the filings challenging to review, including changes to businesses during the review period, the person said.
Circle and Concord called off their deal in early December. “I think that it’s been a thorough process,” Circle Chief Executive Jeremy Allaire said at the time about dealing with the SEC. “Unfortunately it was a longer process than we had hoped.” A Circle spokesman declined to comment further.
EToro also gives users access to stocks, but the SEC’s questions for eToro focused on its crypto business, a person familiar with the questions said. Crypto trading at the company accounted for 63% of commissions and interest income in the first half of 2021, according to filings.
The SEC was especially focused on the accounting treatment eToro applied to digital assets it held for users, and at times took months to respond to eToro’s letters, the person said.
EToro said in a statement that it believes it will become a public company in the future but it “will wait for the right opportunity to take this step.”
Over-The-Counter Stock Reporting System Snarled By Tech Problem
* Finra Says Issue With Its ORF System Caused By Trade Processor
* All Affected Trade Messages Have Now Been Handled: Regulator
A technical issue in a key reporting system that snarled over-the-counter stock transactions on Monday has been resolved.
The Financial Industry Regulatory Authority blamed “a trade processor experiencing systemic disruption” for issues with transaction reports for certain stocks. The industry-backed regulator said in a statement that “all queued messages have been processed, and no further action is needed from firms.”
Finra hasn’t disclosed how many equities were impacted by the disruption, or what caused it in the first place.
Finra’s so-called Over-the-Counter Reporting Facility is a critical piece of market plumbing and is used to report stock trades that don’t occur on centralized exchanges like the New York Stock Exchange or Nasdaq. OTC trading is generally subject to lighter disclosure rules and regulation than transactions in stocks via major exchanges.
Cromwell Coulson, chief executive of OTC Markets Group Inc., said in an interview that the system was functioning normally after disruptions earlier in the day. “It’s been resolved. We are reporting trades,” he said.
Monday’s disruptions follow other recent incidents that have affected trading in equities and derivatives. Over the past few weeks, a cyber attack on software firm ION Trading UK disrupted global derivatives trading, while a New York Stock Exchange malfunction may have impacted thousands of retail trades.
Crypto And Securities: New Interpretation Of US Howey Test Gaining Ground
Lewis Cohen headed a team researching Howey-related case law to propose an application that differentiates between primary and secondary transactions.
The crypto community celebrated a victory in court on Jan. 30 when the United States Securities and Exchange Commission (SEC) admitted in the remedies hearing of the LBRY case that secondary sales of its LBC coin were not securities sales.
John Deaton, a friend of the court, or amicus curiae, in the case, was so excited that he created a video for his Twitter-hosted CryptoLawTV channel that evening.
Deaton, an amicus curiae in the Ripple case as well, recounted a conversation he had with the judge that day. “Look, let’s not pretend. Secondary market sales are a problem,” then “I brought up to him that Lewis Cohen article,” Deaton recalled.
Deaton was referring to the paper “The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securities” by Lewis Cohen, Gregory Strong, Freeman Lewin and Sarah Chen of the DLx Law firm, which Cohen co-founded. Deaton had praised the paper before, in November 2022, when it was submitted in the Ripple case, in which Cohen is also an amicus curiae.
There is a growing buzz around the paper. It appeared on the preprint repository Social Science Research Network on Dec. 13. When Cointelegraph spoke to Cohen in mid-January, he said the paper was the most downloaded in the website’s securities law category, with 353 downloads after about a month.
That number more than doubled in the following two weeks. The paper has also garnered attention in mainstream and legal media and crypto-related podcasts. Its unusual title is a nod to James Joyce’s Ulysses.
The Cohen paper looks closely at one of the timeless adages of crypto securities law: Securities are not oranges. This refers to the Howey test, established by the U.S. Supreme Court in 1946 to identify a security.
The paper makes an exhaustive examination of the Howey test and proposes an alternative to how the test is currently applied.
When Howey Met Cohen
Not everyone favors applying the Howey test to crypto assets, often arguing the test works better for prosecuting fraud cases than as an aid for registration. Cohen himself agreed with this position in a Feb. 3 podcast.
Nonetheless, the paper’s authors do not challenge the use of the Howey test — which arose from a case concerning orange groves — on crypto assets.
A short summary cannot come close to capturing the breadth of the paper’s analyses. The authors discuss SEC policy and cases involving crypto, relevant precedents, the Securities and Exchange Acts and blockchain technology in just over 100 pages, plus annexes.
They reviewed 266 federal appellate and Supreme Court decisions — every relevant case they could find — to reach their conclusions. They invite the public to add any other relevant cases to their list on LexHub GitHub.
The Howey test consists of four elements often referred to as prongs. According to the test, a transaction is a security if it is (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit, or (4) to be derived from the efforts of others. All four test conditions must be met, and the test can only be applied retrospectively.
1/ For almost three years, the @DLxLawLLP team has pondered the most consequential of question in all of crypto law: When and how do the US federal securities laws apply to crypto assets?
— Lewis Cohen (@NYcryptolawyer) November 10, 2022
Cohen and coauthors argue, in extremely basic outlines, that “fungible crypto assets” do not meet the definition of a security, with the rare exception of those that are securities by design. This is the insight captured in the adage about oranges.
The paper’s authors continue that a crypto asset offering on the primary market may be a security under Howey. However, they note, “To date, Telegram, Kik, and LBRY are the only thoroughly briefed and decided cases relating to fundraising sales of crypto.”
They were referring to the SEC suit against messaging service Telegram, claiming its $1.7 billion initial coin offering was an unregistered securities offering, which was decided in favor of the SEC in 2020.
The SEC case against Kik Interactive also concerned token sales and was decided in favor of the SEC in 2020. The SEC also won its unregistered securities sales case against LBRY in 2022.
The paper’s biggest innovation is its views on transactions with crypto assets on secondary markets. The authors argue that the Howey test should be applied anew to sales of crypto assets on secondary markets, such as Coinbase or Uniswap. The authors write:
“Securities regulators in the U.S. have attempted to address the many issues raised from the advent of crypto assets […] generally through an application of the Howey test to transactions in these assets. However, […] regulators have gone beyond current jurisprudence to suggest that most fungible crypto assets are themselves ‘securities,’ a position that would provide them with jurisdiction over nearly all activity taking place with these assets.”
The authors claim crypto assets will not, for the most part, meet the Howey definition on the secondary market. The mere ownership of an asset does not create a “legal relationship between the token owner and the entity that deployed the smart contract creating the token or that raised funds from other parties through sales of the tokens.”
hus, secondary transactions do not meet the second Howey prong, which requires a third party.
The authors conclude, based on their comprehensive survey of Howey-related decisions:
“There is no current basis in the law relating to ‘investment contracts’ to classify most fungible crypto assets as ‘securities’ when transferred in secondary transactions because an investment contract transaction is generally not present.”
What It All Means
The effect of the paper’s argument is to separate the issuance of a token from a transaction with it on the secondary market. The paper says that the creation of a token may be a securities transaction, but subsequent trades will not necessarily be securities trades.
Sean Coughlin, principal at law firm Bressler, Amery & Ross, told Cointelegraph, “I think he’s [Cohen’s] taking ownership of the fact that the issuings [of tokens] are going to be regulated and he’s trying to suggest a way to then have it [a token] trade in an unregulated manner.”
Coughlin’s colleague, Christopher Vaughan, had reservations that the paper was in places “disingenuous.”
He said, “It disregards the realities everyone who’s ever traded in crypto knows, which is that these liquidity pools and these decentralized exchange transactions don’t happen unless the issuer of the token facilitates them.”
Nonetheless, Vaughan praised the paper, saying, “I would love for this to be the be-all and end-all of crypto.”
John Montague, attorney at digital asset-focused Montague Law, told Cointelegraph that custody issues might complicate Cohen’s argument, particularly how self-custody of crypto assets affects the investment prong of Howey.
Montague acknowledged the high quality of the paper’s scholarship, calling it:
“The most monumental thought piece in the industry with respect to securities law perhaps ever, […] definitely since Hester Peirce’s safe harbor proposal.”
In her final version of the proposal, SEC commissioner Peirce suggested network developers receive a three-year exemption from federal securities law registration provisions to “facilitate participation in and the development of a functional or decentralized network.”
“One thing I like about the world of crypto is that it’s adversarial,” Cohen told Cointelegraph. He said he hoped to “lift the level of discussion” with the paper. It did not find a lot of resistance in public responses. There have been expressions of cynicism, though.
“You are a novelist. You found in crypto a character best explained by law,” one network developer commented on Twitter.
“Intelligent legal opinions rarely move the needle on SEC opinions or enforcement cases,” a financial services executive said on LinkedIn.
Coinbase Will ‘Happily Defend’ Staking In US Courts, Says CEO
Coinbase executives claim that staking is not a security under the US Securities Act or Howey test.
Crypto exchange Coinbase’s executives are standing up for its crypto staking services, claiming they cannot be classified as a security and threatening to bring the matter to the courts in the United States.
Coinbase CEO Brian Armstrong posted on Twitter that the company will “defend this in court if needed.” The move follows the agreement reached by crypto exchange Kraken with the Securities and Exchange Commission on Feb. 10 to stop offering staking services or programs to clients in the country.
According to the SEC, Kraken failed “to register the offer and sale of their crypto asset staking-as-a-service program,” which the commission now qualified as securities. Aside from the service’s halt, Kraken agreed to pay $30 million in disgorgement, prejudgment interest and civil penalties.
Coinbase’s staking services are not securities. We will happily defend this in court if needed.https://t.co/GtTOz77YV3
— Brian Armstrong (@brian_armstrong) February 12, 2023
Coinbase’s chief legal officer, Paul Grewal, weighed in on the issue in a blog post, claiming that “staking is not a security under the US Securities Act, nor under the Howey test.” Grewal added:
“Trying to superimpose securities law onto a process like staking doesn’t help consumers at all and instead imposes unnecessarily aggressive mandates that will prevent US consumers from accessing basic crypto services and push users to offshore, unregulated platforms.”
Grewal argues that staking fails to meet the four elements of the Howey test: investment of money, common enterprise, reasonable expectation of profits and the efforts of others. “The Howey test comes from a 1946 Supreme Court case – and there is a separate discussion to be had about whether that test makes sense for modern assets like crypto,” he wrote.
“The purpose of securities law is to correct for imbalances in information. But there is no imbalance of information in staking, as all participants are connected on the blockchain and are able to validate transactions through a community of users with equal access to the same information.” Further, the executive wrote:
“Blockchain technology can spur significant economic growth in the US and staking is a safe and critical aspect of that technology. […] But regulation by enforcement that does nothing to help consumers and drives innovation offshore is not the answer. Getting it right on staking matters.”
The SEC decision on crypto staking sparked criticism. In a statement titled “Kraken Down,” Commissioner Hester Peirce publicly rebuked her own agency over the shutdown of Kraken’s staking service. Peirce argued that regulation by enforcement “is not an efficient or fair way of regulating” an emerging industry.
SEC Lawsuit Against Paxos Over BUSD Baffles Crypto Community
Members of the community were confused and argued that people buying the stablecoin were not expecting it to go up in value.
Paxos Trust Company-issued stablecoin Binance USD being in the sights of United States regulators sparked various reactions from the crypto community.
On Feb. 13, the United States Securities and Exchange Commission (SEC) issued a wells notice to Paxos, alleging that BUSD is unregistered security. On the same day, the New York Department of Financial Services (NYDFS) ordered Paxos to halt the issuance of BUSD.
As Paxos faces regulatory scrutiny on several fronts, various members of the crypto community took to Twitter to give their takes on the situation.
From disregarding the issue as “FUD” to calling it an attack against the Binance exchange, crypto community members laid down various theories on the allegations that BUSD is an unregistered security.
Crypto analyst Miles Deutscher expressed his thoughts in a tweet, arguing that nobody expects profit when purchasing a stablecoin. He tweeted:
The SEC has labelled BUSD as an “unregistered security”, and is suing its issuer, Paxos.
But how on earth is a STABLECOIN considered a security, when it clearly doesn’t meet the Howey Test criteria.
— Miles Deutscher (@milesdeutscher) February 13, 2023
Similarly, the pseudonymous trader Tree of Alpha was baffled by the new development. The community member questioned how it was considered a security and asked their followers if they were buying BUSD with the expectation that it would go to $2.
The trader also called out the SEC chairperson Gary Gensler and said that the government official is on an “unhinged, unchecked crusade against crypto.”
Meanwhile, iTrader AshWSB also commented on the matter and dismissed the issue as “FUD.” The trader argued that BUSD is fully backed, and Paxos not issuing any more tokens will not affect the existing tokens. “It’s good to stay informed but don’t make emotional moves,” they warned.
Don’t worry about the BUSD Fud
BUSD not a scam token,
it’s backed by USD 1:1
Paxos not issuing any more BUSD
will not effect the existing BUSD
It’s good to stay informed but don’t
make emotional moves.
— Ash WSB (@Ashcryptoreal) February 13, 2023
Bitcoin analyst Tedtalksmacro also echoed the sentiments that BUSD might not be meeting the criteria for a security. The analyst suggested that the event may simply be “a shot at Binance.”
Amid the news, Cointelegraph spoke with several blockchain lawyers to determine if stablecoins can be securities. One lawyer pointed out that while stablecoins are created to have a fixed value, holders can profit through various means like arbitrage, hedging and staking.
Blockchain Association Files Amicus Brief In Wahi Case, Says SEC Exceeded Authority
The industry group cited the Supreme Court’s recently reaffirmed “major questions” doctrine and listed the ways the Securities and Exchange Commission’s alleged regulation by enforcement causes harm.
The Blockchain Association filed an amicus brief on Feb. 13 in the United States Securities and Exchange Commission case against former Coinbase Global product manager Ishan Wahi and his associates.
The advocacy group expressed its support for the defendants’ argument for dismissal, claiming that the SEC had exceeded its authority in the case. The U.S. District Court of Western Washington is hearing the trial, which involves the alleged insider trading of nine tokens that the SEC claims are unregistered securities.
Calling the case “the latest salvo in the SEC’s apparent ongoing strategy of regulation by enforcement in the digital assets space,” the amicus curiae, or “friend of the court,” brief noted that the SEC declared nine tokens to be securities with no prior findings. The brief stated:
“The SEC conflates the tokens themselves, which are, after all, merely software, with any alleged investment contract pursuant to which those tokens were allegedly sold.”
The brief does not discuss the defendants’ “major questions” argument, but only reminds the court of the 2022 Supreme Court case of West Virginia v. the Environmental Protection Agency, which found that the “major questions” doctrine applies when federal agencies assert “highly consequential power beyond what Congress could reasonably be understood to have granted.”
The brief highlighted three ways in which the case could harm the blockchain industry and the broader public. First, the brief stated, token creators for those particular tokens, holders and users “are not defendants in this action, and have no meaningful way to counter the SEC’s pronouncements.”
Today we filed an amicus brief in SEC v. Wahi. While the SEC’s strategy of advancing its digital asset regulatory agenda through enforcement actions is well-documented, this case expands that effort by attempting to punish absent third parties.https://t.co/erHQvzucZZ https://t.co/jKHAI0EguF pic.twitter.com/AnBD75eSsJ
— Blockchain Association (@BlockchainAssn) February 14, 2023
The case is likely to be settled rather than being adjudicated on its merits, the brief noted, in line with historical trends. Thus the SEC “maximized its chances of being able to allege whatever it wants, with a minimal risk of being held to account for it.”
Second, the SEC’s case may cause exchanges to reconsider listing the tokens at issue, the brief stated, and it may have “a chilling effect” on the blockchain industry. The brief stated:
“Merely by proclaiming that a token is a security, the SEC gives certain tokens a ‘scarlet letter,’ impairing their value, hampering any secondary market trading of the token, and interfering with technological development.”
Finally, the brief claimed that market participants are unable to determine what is or is not a security, and “The SEC has shown little willingness to answer those questions.”
Ishan Wahi and his brother Nikhil pleaded guilty the criminal case brought against them for insider trading by the Justice Department in the Southern District of New York. Their codefendant Sameer Ramani remains at large.
The Blockchain Association is a nonprofit advocacy group with almost 100 members that promotes “a pro-innovation policy environment for the digital asset economy.”
Former SEC Chief Counsel Says Agency Needs To Make Clear Its Crypto Compliance Rules
“When the SEC tells us that something is not compliant, it’s not necessarily the same thing as telling us what they would consider compliant,” said TuongVy Le, a partner and head of regulatory and policy at investment firm Bain Capital.
The U.S. Securities and Exchange Commission (SEC) is falling short when it comes to addressing how it deals with the digital asset industry, said TuongVy Le, partner and head of regulatory and policy at investment firm Bain Capital.
What the federal agency is doing is regulating “almost entirely through enforcement actions,” Le, a former chief counsel for the SEC’s Office of Legislative and Intergovernmental Affairs, said on CoinDesk TV’s “First Mover” Tuesday.
“When the SEC tells us that something is not compliant, it’s not necessarily the same thing as telling us what they would consider compliant,” Le said in reference to the $30 million settlement the agency reached with Kraken, under which the centralized exchange will shutter its staking service platform to U.S. customers.
In Kraken’s case, Le said, there are still questions about the agency’s stance on staking services, such as whether other forms of staking services, including self-staking and decentralized staking, would fall within the agency’s guidelines.
“We don’t necessarily know just from a single enforcement action or even through multiple enforcement actions,” Le said. “Any single action, like the one against Kraken, can be limited in terms of what we can learn from it and what it means for other staking service providers.”
The Paxos Case
The SEC issued a Wells Notice that it would be filing suit against stablecoin issuer Paxos for its alleged sale of an unregistered security, stablecoin token Binance USD (BUSD). Paxos, however, has said it “categorically disagrees” with the agency, claiming that its Binance-branded token is backed one-to-one.
Le said in the case of Paxos, the SEC may not be applying the securities definition of the Howey Test to the BUSD stablecoin but a different set of criteria through the Reves test.
“Enforcement actions are very facts- and circumstances-specific, so it can be difficult to know how broadly to read any single action,” she said. “For instance, it can be hard to discern how heavily the SEC weighs particular facts when applying Howey, it can even be hard to discern – if the complaint doesn’t contain a fulsome analysis – which facts even apply to which Howey factors.”
By “blindly and mechanically applying the existing securities laws” without considering the potential of digital assets and blockchain technology, the SEC “could potentially just kill something like staking.”
As for trying to comply with the SEC, “it’s actually not as simple as going onto the SEC’s website and filling out a form and then you’re good to go. Applying the federal securities laws to something like staking services, where a provider takes your crypto and does things with it, that actually raises really novel and complex questions around custody.”
US Lawmakers And Experts Debate SEC’s Role In Crypto Regulation
Senator Tim Scott questioned whether the Securities and Exchange Commission had been “asleep at the wheel” amid major bankruptcies in the crypto space causing the loss of millions in user funds.
The United States Securities and Exchange Commission and its chair Gary Gensler were the targets of many lawmakers and witnesses at a hearing exploring the crash of the crypto market.
In a Feb. 14 hearing at the Senate Banking Committee titled “Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets,“ ranking member Tim Scott said Gensler should appear before Congress before September to address additional enforcement actions in the crypto space, calling out the SEC chair for doing “rounds on the morning talk shows” rather than testifying.
According to the South Carolina senator, the SEC had not provided “the slightest bit of guidance,” potentially leading to the lack of investor protection at bankrupt firms including FTX, Terra, BlockFi, Voyager, and Celsius.
“To think the SEC has failed to take any meaningful preemptive action to ensure this type of catastrophic failure does not happen again,” said Scott. “If they have the tools they need, were they just asleep at the wheel? […] We’d be happy to have chairman Gensler testify sooner — much sooner — than later.”
Witnesses testifying at the hearing proposed different approaches for lawmakers seeking to regulate crypto. Duke Financial Economics Center policy director Lee Reiners suggested Congress pursue legislation to “carve out cryptocurrency” from the Commodity Futures Trading Commission’s authority and label it as a security under the SEC’s exclusive purview.
Crypto Council for Innovation chief global regulatory officer and general counsel Linda Jeng testified that the lack of a consistent federal regulatory framework on crypto contributed to a lack of investor protection and uncertainty among firms, saying:
“The SEC has not initiated any formal rulemaking process to update securities laws that are decades old to account for the unique attributes of digital assets that are determined to be securities.”
Vanderbilt University law professor Yesha Yadav echoed some of Jeng’s concerns on developing a federal framework for crypto, but also proposed a self-regulatory regime in which exchanges could oversee themselves as a complement to public regulation. Firms that failed to comply with the rules could be forced to pay financial penalties.
In the United States, there is seemingly a regulatory tug-of-war between many government agencies looking to establish rules on crypto companies.
Gensler has claimed most token projects qualify as securities under SEC guidelines and repeatedly called on firms to “come in and talk to us”. The agency has already taken enforcement actions against Kraken and Paxos in 2023.
SEC Proposes Tougher Rules As Part Of Its Crypto Custody Crackdown
The new proposals set forth by the Gensler-led Securities and Exchange Commission seek to “expand the scope” of rules set out by the 2009 Custody Rules.
A five-member panel of the United States Securities Exchange Commission (SEC) has voted 4-1 in favor of a proposal that may make it more difficult for cryptocurrency firms to serve as digital asset custodians in the future.
The proposal, which is yet to be officially approved by the SEC, recommends amendments to the “2009 Custody Rule” will apply to custodians of “all assets” including cryptocurrencies, according to a Feb. 15 statement from SEC Chairman Gary Gensler.
Gensler stated that currently, some crypto trading platforms that are offering custody services are not actual “qualified custodians.”
According to the SEC, a qualified custodian is generally a federal or state-chartered bank or savings association, trust company, a registered broker-dealer, a registered futures commission merchant or a foreign financial institution.
In order to become a “qualified custodian” under the newly proposed rules, U.S. and offshore firms would additionally need to ensure that all custodied assets — including cryptocurrencies — are properly segregated, while these custodians will be required to jump through additional hoops such as annual audits from public accountants, among other transparency measures.
We @SECGov just proposed to expand & enhance the role of qualified custodians when registered investment advisers custody assets on behalf of investors.
Thru our rule, investors would get the time-tested protections—and qualified custodians—they deserve.
What does this mean? ⬇️ pic.twitter.com/RerUGnpArI
— Gary Gensler (@GaryGensler) February 15, 2023
While Gensler said these amendments would “expand the scope” to all asset classes, he specifically took a shot at the crypto industry:
“Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets. […] Further, though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians. Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto.”
“When these platforms go bankrupt—something we’ve seen time and again recently—investors’ assets often have become property of the failed company, leaving investors in line at the bankruptcy court,” the SEC chairman added.
Gensler also pointed to the industry’s track record to suggest that few crypto firms would be reliable enough to serve as qualified custodians:
“Make no mistake: Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians.”
However, not every SEC member is on board with Gensler’s plans.
While the proposal isn’t “regulation by enforcement” per se, Commissioner Hester Peirce said “the latest SEC statement seems designed for immediate effect” to take down the crypto industry:
“Such sweeping statements in a rule proposal seem designed for immediate effect, a function proposing releases should not play. These statements encourage investment advisers to back away immediately from advising their clients with respect to crypto.”
As for the proposal itself, Peirce believes it would do more harm than good.
She said that such stringent measures will force investors to remove their assets from entities that have developed sufficient safeguarding procedures to mitigate and prevent fraud and theft:
“The proposal would expand the reach of the custody requirements to crypto assets while likely shrinking the ranks of qualified crypto custodians. By insisting on an asset neutral approach to custody we could leave investors in crypto assets more vulnerable to theft or fraud, not less.”
As for the next steps, Peirce noted the agency will soon schedule in a 60-day comment period once the proposal has been published in the Federal Register.
However, the commissioner is concerned that this timeframe isn’t sufficient to allow the public to analyze all aspects of the proposal.
Those who voted in favor of the proposal hope to implement the new rules within 12 to 18 months, according to Peirce, who added that it was an “aggressive timeline” given the changes being proposed.
SEC’s Gensler Called ALGO ‘Great Technology’ In 2019: SEC Now Deems It A Security
Members of the crypto community have called out the SEC Chairman for “shilling” Algorand.
A four-year-old video of United States Securities and Exchange Commission Chair Gary Genser giving praise to smart contract platform Algorand is circulating on Twitter following the SEC declaring that ALGO is an unregistered security.
In the video, Gensler referred to Algorand as a “great technology” while he was contemplating whether a “high performance” smart contract network would be capable of integrating an Uber or Lyft-like application on its platform.
ALGO is one of six tokens that Gensler claimed was an unregistered security in the SEC’s lawsuit against crypto trading platform Bittrex on April 17 that took issue with the Algorand Foundation’s initial coin offering (ICO) of ALGO in June 2019.
Cryptocurrency researcher Mason Versluis was one of the first to highlight the video in an April 17 tweet criticizing Gensler for “shilling” ALGO, with others calling out the SEC chair for his apparent hypocrisy.
Gary Gensler was SHILLING $ALGO and now he’s trying to call it a security.
This dude is all over the place, and he’s gotta go ➡️ pic.twitter.com/JmpL9xAZhq
— MASON VERSLUIS (@MasonVersluis) April 17, 2023
Gensler’s praise of Algorand was heard by an audience at a Massachusetts Institute of Technology () “Fintech Beyond Crisis” conference held on April 25, 2019.
Gensler worked as a professor of global economics and management at MIT prior to becoming the SEC’s chair, and he acknowledged former MIT colleague and Algorand founder Silvio Micali in the speech — who appeared to be in the crowd.
The video sparked Cinneamhain Ventures partner Adam Cochran to question the long-standing advice from Gensler for crypto firms to register with the regulator.
Surely if there is a path to register, a world renown MIT professor who personally knows the Chairman of the SEC can figure it out, or pick up the phone and call the Chairman…
— Adam Cochran (adamscochran.eth) (@adamscochran) April 17, 2023
“Surely if there is a path to register, a world renown MIT professor who personally knows the Chairman of the SEC can figure it out,” Cochran tweeted on April 17.
Fox Business reporter Eleanor Terrett expects Gensler to be questioned over his Algorand comments in his upcoming testimony before the U.S. House Committee on Financial Services on April 18.
Other critics choose to mock the situation at hand, highlighting the price decline of ALGO, which has seen a 93.8% decline since its launch, according to CoinGecko data.
If you bought $100 of Algorand when Gensler told you they could build Uber on it you would now have $5
— db (@tier10k) April 17, 2023
It should be noted that ALGO didn’t hit the market until late June 2019, two months after Gensler’s speech.
Gensler stated in an April 17 tweet that it had been an “honor” to work at the SEC over the last two years and chose to highlight the 1,500 enforcement actions the regulator has undertaken since he’s been at the helm.
Serving at the @SECGov for two years has been an honor.
We’ve filed 1,500 enforcement actions & overseen tens of thousands of registrants.
We’ve proposed rules to make our markets more efficient, competitive, transparent, resilient—and worthy of the public’s trust.
— Gary Gensler (@GaryGensler) April 17, 2023
Gensler was sworn into office as SEC chair on April 17, 2021, after U.S. President Joe Biden’s nomination of Gensler was confirmed by the Senate on April 14, 2021.
Bitcoin Scores Landmark US Legal Win Against SEC With Grayscale ETF Ruling
* Ruling By Appeals Court Overturns Decision By SEC To Block ETF
* Bitcoin Surges After Release Of Court Opinion On Tuesday
Grayscale Investments LLC won a key legal fight in its push to launch a Bitcoin exchange-traded fund, bringing the crypto industry to the precipice of tapping billions of dollars from everyday investors.
The firm’s court victory over the US Securities and Exchange Commission in a three-judge appeals panel in Washington represents a watershed moment for the largest cryptocurrency. Advocates say an ETF based on spot Bitcoin prices would result in a gush of retail cash.
The SEC, which has thus far only allowed crypto ETFs based on futures because it says they are safer, is reviewing the decision.
The agency could still fight the ruling, either by asking a full slate of judges on the DC Circuit Court of Appeals, or the US Supreme Court to review the decision.
Meanwhile, the decision injects significant momentum into Grayscale’s yearslong push. It’s also a stinging rebuke of Chair Gary Gensler’s bid to clamp down on the industry.
Investors welcomed the news. The Grayscale Bitcoin Trust rallied as much as 21% and Bitcoin surged by as much as 8.3%.
Grayscale has said converting to an ETF would help it unlock billions of dollars in value for investors in its $16.2 billion trust by making it easier to create and redeem shares.
The trust’s closed-end structure doesn’t allow for investors to redeem shares when prices fall, causing it to trade at steep discounts to its underlying Bitcoin. As an ETF, it could create and redeem shares to keep up with changing demand.
Tuesday’s ruling is the second recent high-profile court defeat for the SEC over its stance on crypto. The agency is fighting a federal judge’s ruling that offerings of Ripple Labs’ XRP token were not securities when sold to the general public.
Grayscale’s win may have the most sweeping impact yet. Some of the biggest and most established names in finance have recently filed applications with the SEC to launch Bitcoin ETFs.
In a statement, Grayscale called the decision “a monumental step forward for American investors.”
Owen Lau, analyst at Oppenheimer & Co, said in a phone interview that the ruling adds to momentum for the digital-asset industry following the Ripple case.
“There’s huge optimism baking into the market right now,” he said.
The SEC rejected Grayscale’s conversion proposal in 2022, arguing that an ETF based on Bitcoin lacked adequate oversight to detect fraud.
Grayscale sued to overturn the decision accusing the SEC of discriminating against its product, while approving similar Bitcoin futures ETFs.
‘Arbitrary And Capricious’
“The denial of Grayscale’s proposal was arbitrary and capricious because the Commission failed to explain its different treatment of similar products,” wrote Judge Neomi Rao.
In its opinion, the court said that Grayscale “advanced substantial evidence” that its product was similar to Bitcoin futures ETFs approved by the SEC, the opinion read.
The underlying assets of both types of products are closely correlated and the surveillance sharing agreements with the Chicago Mercantile Exchange are “identical.”
During a hearing on the case in March, the judges grilled the SEC about its decision and seemed to side with Grayscale’s argument that the underlying markets for spot Bitcoin and Bitcoin futures pose the same risk for fraud and manipulation.
The SEC has 45 days to ask a full sitting of the DC Circuit to reconsider what the three-judge panel decided on Tuesday. If the appeals court declines to take it up, the SEC would then have 90 days to petition the US Supreme Court to hear the case.
The case is Grayscale v. SEC, 22-1142, US Court of Appeals for the District of Columbia Circuit.
What Grayscale’s Court Victory Means For Crypto And A US Spot-Bitcoin ETF
Tuesday’s ruling isn’t the final word on approval of a spot Bitcoin ETF, but it still helped to boost spirits in a beaten-down sector.
In a year when it has seemed as if US officials were hell-bent on putting much of the cryptocurrency market out of commission, the beaten-down digital-asset industry has finally scored a big legal win.
A US appeals court’s ruling to overturn the Securities and Exchange Commission’s decision to block the first exchange-traded fund tied to the spot price of Bitcoin sent the original cryptocurrency soaring more than 7%, its biggest daily gain in months.
Perhaps just as important, it boosted spirits in a sector that’s been contending with a near-constant blast of high-profile regulatory enforcement actions, bankruptcies and lawsuits.
While it’s only one victory against the US in a multi-pronged campaign, the win by Grayscale Investments LLC shows that the SEC’s approach to policing the gray legal areas of crypto — what Coinbase Global Inc. has called “regulation by enforcement” — is far from foolproof.
Judge Neomi Rao wrote that the regulator’s denial of the ETF was “arbitrary and capricious” because the SEC had failed to explain its different treatment of similar products.
“This ruling is not just about Grayscale or Bitcoin, it sets a precedent for the broader crypto industry,” Ji Kim, general counsel and head of global policy for the Crypto Council for Innovation, said in an email.
“This is big, positive, and precedent-setting news. It provides the obvious reminder that it is critical for regulators to provide much needed clarity and rationale when making such critical determinations affecting such a significant industry.”
To be sure, the SEC is likely to fight the ruling. And the ultimate outcome of the case will have little bearing on other parts of the US crackdown on crypto, including the watchdog’s lawsuits against digital-asset exchanges Coinbase and Binance Holdings Ltd. for allowing trading of other tokens the regulator claims are unregistered securities, among other things. (Both companies dispute the SEC’s legal claims.)
Recall that a July ruling in another lawsuit between the SEC and Ripple Labs Inc. led to a similar market pop because it was widely viewed as crypto-friendly. But then the SEC moved to appeal and a judge in a separate case sent a conflicting signal, dousing the optimism and making the outcome much less clear.
Still, Tuesday’s court action does potentially move Bitcoin much closer to more widespread acceptance in the traditional investment industry.
Grayscale Can Be A Bitcoin ETF
There Are Two Ways To Run A Bitcoin Exchange-Traded Fund:
You could raise money from investors, park it in cash or Treasuries, and trade cash-settled Bitcoin futures listed on a US commodities exchange.
The futures would periodically expire, paying off whatever Bitcoin is worth at the time, and you would roll the proceeds into new futures to keep your Bitcoin bet active.
The ETF would roughly track the price of Bitcoin, because the futures pay off based on the price of Bitcoin, but there would be some frictional costs from rolling the futures and some tracking error.
You could raise money from investors, use it to buy Bitcoins, and keep the Bitcoins somewhere safe. Then you’d have Bitcoins, and the price of the ETF would track the price of Bitcoin.
If it didn’t, arbitrageurs could deliver Bitcoins and get back ETF shares, or deliver ETF shares and get back Bitcoins, just like any normal stock index ETF.
It seems to me that Approach 1 is, you know, fine and interesting, but Approach 2 is strictly better: It’s simpler for the ETF manager to do, simpler for investors to understand, and has less friction and tracking error.
My one quibble with Approach 2 is that you really do have to keep the Bitcoins somewhere safe, and there is a long, long, long history of people in crypto finding exciting new ways to lose their cryptocurrency, but I think that in 2023 “buy Bitcoins and don’t lose them” is the sort of thing that you can expect a regulated financial institution to manage.
But in fact the US Securities and Exchange Commission has approved Bitcoin futures ETFs (Approach 1) and repeatedly declined to approve spot Bitcoin ETFs (Approach 2), for reasons that have never really made much sense to me.
Essentially the SEC worries that the spot Bitcoin market is the Wild West, someone might manipulate it, and if they did then the price of the Bitcoin ETF would be manipulated.
Whereas Bitcoin futures trade on the Chicago Mercantile Exchange, a US commodities exchange regulated by the Commodity Futures Trading Commission; that market is presumably free of manipulation, so a Bitcoin futures ETF can rely on it.
This strikes me as a bit silly: The spot Bitcoin market is much bigger than the one for CME-listed Bitcoin futures,3 and the futures are obviously a derivative of spot Bitcoin prices, so if you managed to manipulate the price of Bitcoin you would also succeed in manipulating the price of Bitcoin futures.
As a matter of legal formalism, I can see why you might say “US-approved ETFs should only own things that trade on US-regulated exchanges,” but as a matter of economic reality I don’t think it really works.
My assumption is that (1) the SEC really dislikes crypto, (2) a spot Bitcoin ETF is a straightforward, easy-to-understand, appealing product that would make it easier for a lot of US investors to own Bitcoin, and so (3) the SEC wants to block spot Bitcoin ETFs just to protect US investors from crypto generally.
(Whereas a Bitcoin futures ETF is complicated and janky enough to turn off a lot of investors.) It can’t say that, but its stated reasons for blocking spot Bitcoin ETFs don’t make a ton of sense.
The biggest wannabe spot Bitcoin ETF is the Grayscale Bitcoin Trust, a $16 billion pot of Bitcoins that is organized as a closed-end investment trust; it trades under the ticker GBTC, and it has been trying to convert into an ETF for years.
In its current form, it can accept new investor money but can’t really redeem investors, which makes it not a great way to hold Bitcoin; it has over the years traded at large premiums or discounts to the actual price of Bitcoin, and as of yesterday it traded at about a 25% discount.
Converting to an ETF would make it easier for Grayscale to transform Bitcoins into GBTC shares and vice versa, which should more or less eliminate the discount and create billions of dollars of value for investors.
Grayscale kept asking the SEC to approve it as an ETF, the SEC kept saying no, so Grayscale sued in US federal courts. Today it won:
* A three-judge appeals panel in Washington on Tuesday overturned a decision by the US Securities and Exchange Commission to block the ETF, which would be tied to the spot Bitcoin price.
* The ruling marks a major legal win for the crypto industry and sent the price of Bitcoin surging by as much as 6%. The SEC could still fight the decision.
* Grayscale has said converting to an ETF would help it unlock about $5.7 billion in value from the $16.2 billion trust by making it easier to create and redeem shares. More broadly, the crypto industry has long viewed the launch of an ETF based on the cryptocurrency itself, rather than futures, as significant milestone.
* In June 2022, the SEC rejected Grayscale’s conversion proposal arguing that an ETF based on Bitcoin lacked adequate oversight to detect fraud. Grayscale sued to overturn the decision accusing the SEC of discriminating against its product, while approving similar Bitcoin futures ETFs.
* “The denial of Grayscale’s proposal was arbitrary and capricious because the Commission failed to explain its different treatment of similar products,” wrote Judge Neomi Rao.
Here Is The Opinion. The Court Says:
* Grayscale has demonstrated its proposed bitcoin ETP is materially similar, across relevant regulatory factors, to the approved bitcoin futures ETPs. First, the underlying assets—bitcoin and bitcoin futures—are closely correlated.
And second, the surveillance sharing agreements with the CME are identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin and bitcoin futures.
Basically Grayscale, like the Bitcoin futures ETFs, proposes to rely on the CME (which trades Bitcoin futures) to detect fraud and manipulation in the Bitcoin market.
The futures ETFs own futures traded on the CME, while Grayscale just owns actual Bitcoins, but any manipulation will probably affect both. From the opinion (citations omitted):
* While the Commission asserted that owning assets not traded on the surveilled exchange was a “significant difference” and proclaimed that there was “reason to question whether a surveillance-sharing agreement with the CME would, in fact, assist in detecting and deterring fraudulent and manipulative misconduct affecting the price of the spot bitcoin held by that ETP,” it provided no support for these claims.
Grayscale, however, provided evidence that CME bitcoin futures prices are 99.9 percent correlated with spot market prices. Based on that data, fraud in the spot market would present identical problems for a bitcoin ETP and a bitcoin futures ETP.
Bitcoin futures are derivatives of bitcoin and, as long as the market is efficient, arbitrage will drive the prices together.
* The Commission neither disputed Grayscale’s evidence that the spot and futures markets for bitcoin are 99.9 percent correlated, nor suggested that market inefficiencies or other factors would undermine the correlation.
The Commission faults Grayscale for failing to provide other types of evidence. Without further explanation, however, the Commission’s assertion that “information in the record for this filing does not support [the] claim” that “any fraud or manipulation in the underlying [spot] market will affect both products in the same way” is unreasonable.
The Commission’s unexplained discounting of the obvious financial and mathematical relationship between the spot and futures markets falls short of the standard for reasoned decisionmaking.
And so the court reversed the SEC’s order for being “arbitrary and capricious.”
Substantively this seems correct and straightforward: It really is kind of arbitrary for the SEC to allow Bitcoin futures ETFs and not spot Bitcoin ETFs.
Still it is a potentially important decision. For most of my time watching financial markets, the courts and the financial industry have broadly deferred to the SEC as the expert financial regulator.
If the SEC says “well Bitcoin futures ETFs are a safe product but spot Bitcoin ETFs are not,” who is a federal judge to second-guess that?
The SEC’s decisions on a range of financial regulatory topics were, in effect, final; fighting the SEC often seemed to big repeat-player firms like a bad idea.
But that might be changing. The current SEC under Chair Gary Gensler has been aggressive about expanding its regulatory authority — in crypto, of course, but also in things like the regulation of private funds or environmental disclosure.
Meanwhile the financial industry — the crypto industry, but also more traditional financial firms — has gotten more aggressive about pushing back on the SEC, fighting enforcement cases in court or suing the SEC for “arbitrary and capricious” rulemaking.
And the post-Trump federal courts are far more willing to strike down regulatory decisions, and more skeptical of regulation generally.
One possible interpretation of this case is that the SEC’s decision to block spot Bitcoin ETFs was unusually egregious, and a court fixed that, and there are no broader implications for anything.
And that’s possible, because the spot Bitcoin ETF decision really was weird. But another possible interpretation is that the modern SEC has become more aggressive about regulating the crypto industry, and the broader financial industry, in a lot of different areas, while the crypto and financial industries have become more aggressive about fighting back and the modern US courts have become more aggressive about second-guessing the SEC.
The SEC has gotten used to its decisions being, for all practical purposes, the law, and that might not be right anymore.
Crypto’s Top Enemy Gensler Put On Defensive by Grayscale Ruling
* Industry Advocates Pounce On Ruling To Push Back On Agency
* SEC Says That A Range Of Cryptoassets Fall Under Its Remit
After two years of fines, threats and lawsuits, Gary Gensler had crypto reeling. But a pair of recent legal setbacks have Wall Street’s top cop on the defensive.
The most stinging defeat for the Securities and Exchange Commission came on Tuesday when an appeals court overturned its decision to block Grayscale Investments LLC’s proposed spot Bitcoin exchange-traded fund.
The ruling cracks open the door for a suite of products the regulator has deemed unsafe for retail investors.
The SEC may still appeal the decision. It’s already fighting another lower-court ruling over sales of Ripple’s XRP token, which risks undercutting some of the agency’s jurisdiction over crypto.
A representative for the SEC didn’t immediately respond to a request for comment.
Meanwhile, the regulator is still moving ahead with a series of high-profile enforcement actions, including against Coinbase Global Inc. and Binance Holdings Ltd. The recent losses, however, represent a dramatic turn and crypto advocates are pouncing.
“The rulings show the courts will not blindly accept the SEC’s conclusions on the application of securities laws to crypto,” said Coy Garrison, a former counsel to SEC Commissioner Hester Peirce, who is the most crypto-friendly member of the panel.
“The courts, not the SEC, have final say,” said Garrison, who now works at the law firm Steptoe & Johnson.
The SEC has said it’s reviewing the court’s decision on Grayscale. Agency lawyers have 45 days to ask a full slate of judges on the DC Circuit Court of Appeals to reconsider what the three-judge panel decided on Tuesday. It could also petition the US Supreme Court to take up the case.
Regardless of the path, the agency will have to justify its decisions in a way that it hasn’t previously.
In the court’s Tuesday decision, Judge Neomi Rao, said “the denial of Grayscale’s proposal was arbitrary and capricious because the commission failed to explain its different treatment of similar products.”
Under Gensler, the SEC has claimed many crypto products should be registered with the agency. On Monday, the regulator settled its first case over nonfungible tokens.
The SEC chief has consistently justified the stance as necessary to protect investors from an industry that he says is rife with fraud.
Critics, including lawyers who represent crypto clients, have argued that the SEC has overstepped under Gensler. Already some are casting Tuesday’s Grayscale ruling as supportive of that view.
“It sends a message to those in the digital-assets industry that for those who have the appetite and resources to challenge the SEC, there are opportunities for successful challenges,” said Daniel Tramel Stabile, partner at Winston & Strawn.
“It represents another check on the SEC which sends us a signal that its authority in the space is not unbridled.”
SEC’s Grayscale Court Rout Puts Agency In Will-They, Won’t-They Role Starring Gensler
A strong court win for the crypto spot-market ETF fight isn’t the end of the battle, because the next move belongs to the SEC, though it’s now significantly weakened.
* A slap-down from federal courts means the Securities and Exchange Commission must now rethink bitcoin spot ETFs, though its old objections won’t work and the clock is ticking.
* Crypto industry insiders argue the most logical course of action is just giving in.
The crypto industry’s campaign to set up exchange-traded funds (ETFs) has now pushed the U.S. Securities and Exchange Commission against a wall with Grayscale Investments’ consequential court win, but it’s still up to the agency to decide whether to retreat or keep fighting.
“It’s back in the SEC’s court,” said Dan Berkovitz, who was general counsel at the agency until early this year. If SEC officials wanted to deny Grayscale’s bitcoin ETF again, “they’d have to really think of some other reasons that they haven’t articulated yet. That would be a hurdle for them.”
The U.S. securities regulator, led by Chair Gary Gensler, now faces several options: appeal the decision; grant Grayscale’s application to list its bitcoin spot ETF; let it be automatically approved by doing nothing; or start up a new, second effort to reject the application based on fresh objections.
Much of the industry celebrated Tuesday, assuming this is the beginning of the end of this particular SEC roadblock for crypto, and bitcoin’s 6.5% price climb offered evidence of that optimism. But Gensler has been famously skeptical of crypto and the dangers he says it poses to investors.
“‘Arbitrary and capricious’ are not words that Gary Gensler should want to hear from federal courts, but that’s what this unanimous panel of judges called his agency’s judgment,” said Pat Daugherty, a former SEC lawyer who now represents crypto clients with Foley & Lardner.
“The SEC failed to explain why it could approve ETFs based on bitcoin futures but not an ETF based on bitcoin. Since like cases must be treated alike in America, the SEC lost.”
At stake is an investment product that could bring new investors to crypto but that the SEC has said is still too hazardous.
So far, the securities regulator said after the ruling that it’s “reviewing” the court action and will make a decision on its next steps.
With the original rejection of Grayscale’s application now vacated by the court, it remains unclear when the clock starts counting down again to an SEC deadline, but observers are assuming the agency will soon make that timeline clear.
“After losing this case, the smart play for the SEC will be to approve Grayscale’s application speedily,” said Daughtery, who also teaches crypto and ETF innovation courses at Cornell Law School. “Will Chair Gensler back off and shift course? Perhaps a few Democrats on Capitol Hill will persuade him.”
One former Republican SEC commissioner told CoinDesk – on the condition he not be named – that he wouldn’t be surprised if the agency works to come up with another rejection.
“One theory is that the SEC will just pick a different reason to deny Grayscale’s proposal and force more long and costly litigation,” Jake Chervinsky, chief policy officer for the Blockchain Association – a crypto lobbying group – said in a series of tweets on the decision.
“But another theory is that the SEC will take the DC Circuit’s decision as a (semi-)graceful exit from their anti-ETF position. I’m in this camp. It’s the right move.”
Grayscale is a unit of Digital Currency Group, which is also the parent of CoinDesk.
As with most federal agencies, the SEC has a long history of court defeats, including a tough loss on its 2010 “proxy access” rule and a couple of the specialized disclosure rules mandated by the Dodd-Frank Act.
It kept fighting for much of a decade after defeats on a rule that says resource-extraction businesses, such as oil companies, must disclose their payments to foreign governments, but that effort was actually required by law.
This time the court’s repudiation is different, targeting a position born inside the agency that the SEC ought to reject a specific financial project that would be automatically approved if the agency instead chose to sit on its hands.
Court battles aren’t getting any easier for the agency, Berkovitz said.
“The deference that the agency might have gotten in prior years is just not nearly as easily granted anymore,” he said. And the more the SEC loses, the harder it gets, he added.
Two of the judges in the decision – Chief Judge Sri Srinivasan and Senior Circuit Judge Harry Edwards – were Democratic appointees, from the same party as Gensler, so their view can’t be characterized as a conservative backlash against the administration.
“I’ve never before seen a financial regulator’s denial of an application get slapped down by a bipartisan judicial panel of a moderate, a conservative, and a progressive like just happened in Grayscale,” said Justin Slaughter, who has worked at the SEC and is now the policy director at Paradigm. “The SEC has restored bipartisanship in DC.”
Whether or not Grayscale wins in the end, the ruling may lift the other ETF efforts.
“While it doesn’t guarantee that the SEC will approve Grayscale’s bitcoin ETF, it is likely they will approve all of the ETF applications with what they deem as sufficient information sharing agreements, specifically from Blackrock and Fidelity,” predicted Dave Weisberger, co-founder and CEO of CoinRoutes, who called the ruling a “huge win” for crypto.
Weak surveillance of trading information marked a chief complaint of the SEC regarding these ETF efforts as it rejected one after another.
Weisberger suggested the SEC could now decide to approve the projects with good surveillance plans and call it a win for consumer protection.
Coinbase (COIN), the crypto exchange that would provide much of the required surveillance, noted Tuesday that “the courts are giving us regulatory clarity where the SEC has refused,” according to a statement from Paul Grewal, the publicly-traded company’s chief legal officer.
“While we still believe comprehensive federal crypto legislation is the best way forward, decisions like this are an important step toward the clarity the industry needs.”
Gensler’s SEC still has supporters, however, who encourage the agency to resist.
“The decision does not change the fact that the Bitcoin market is subject to fraud and manipulation or that an ETF would be a serious threat to investors, which is why the SEC did and should deny Grayscale,” said Dennis Kelleher, CEO of Better Markets, a Washington-based group that often seeks to counter financial industry lobbying. “The SEC should consider rescinding the prior unwarranted Bitcoin futures ETF approvals.”