TheCorporateCounsel.net

Yesterday, Chair Gensler issued a statement regarding the crypto legislation pending in the House of Representatives — the Financial Innovation and Technology for the 21st Century Act — which, according to this Better Markets Fact Sheet “claims to seek to modernize the regulation of investment contracts by creating a new category called ‘investment contract assets,'” which “are excluded from the definition of a ‘security,’ likely eliminating SEC oversight.”

Chair Gensler believes the bill would “create new regulatory gaps and undermine decades of precedent regarding the oversight of investment contracts, putting investors and capital markets at immeasurable risk.” He identifies seven concerns in detail. Here are two:

[T]he bill’s regulatory structure abandons the Supreme Court’s long-standing Howey test that considers the economic realities of an investment to determine whether it is subject to the securities laws. Instead, the bill makes that determination based on labels and the accounting ledger used to record transactions. It is akin to determining the level of investor protection based on whether a transaction is recorded in a notebook or a software database. But it’s the economic realities that should determine whether an asset is subject to the federal securities laws, not the type of recordkeeping ledger. The bill’s result would be weaker investor protection than currently exists for those assets that meet the Howey test.

[T]he bill specifically excludes crypto asset trading systems from the definition of an exchange and thus removes, for investors on crypto asset trading platforms, the protections that benefit investors on registered exchanges. These crypto trading platforms would be able to legally comingle their functions in a way that fosters conflicts of interest, may allow trading against their customers, and reduces custody protections for their customers.

He then warns that the bill could undermine the broader capital markets “by providing a path for those trying to escape robust disclosures, prohibitions preventing the loss and theft of customer funds, enforcement by the SEC, and private rights of action for investors in the federal courts.” For example, if “perpetrators of pump and dump schemes and penny stock pushers” were to “contend that they’re outside of the securities laws by labeling themselves as crypto investment contracts or self-certifying that they are decentralized systems [as permitted by the bill].” The bill only allows the SEC 60 days to contest any self-certification.

– Meredith Ervine