A few questions about regulation of cryptoassets for SEC Chairman Gensler

This post is an expanded version of comments delivered by the author during a webinar titled “Is Crypto Legislation Coming?” which you can see in full here. The author writes in his private capacity and not on behalf of any company, institution or group.

Critics on the left typically portray the Federalist Society as if its members were all in agreement. But those of us who belong to FedSoc know that’s just not the case. Some of us are libertarians. Others are conservative. We often disagree with each other. And we are open to a lively engagement with the left – also with moderates – who believe as we do in the virtues of freedom of expression. Fundamentally, our federalist society is a debating society.

Public policy on cryptoassets – and the broader category of digital assets – is fodder for lively and healthy debate. Debate about public policy is a core feature of the representative democracy that we cherish. Debate with and about administrative agency management is part of our constitutional system.

In that regard, the SEC is part of a vast and ever-growing administrative state whose legitimacy in our system of government depends largely on its accountability to Congress.

No federal agency has been more dismissive of digital asset innovation—no agency has been less helpful in providing practical guidance to blockchain technology entrepreneurs—than the SEC. I hasten to add that the SEC staff attorneys are not to blame for this. Policy is not set by the staff, but by the commission, and rightly so, as only the commissioners are nominated by the president and confirmed by the Senate.

SEC leadership had little need to explain itself in the last Congress, when Democrats held all clubs on Capitol Hill. But today the Republicans also hold clubs. So SEC leadership can be held accountable again by all elected representatives – left, center and right. Questions that need to be answered can be asked.

Some on the left see this as a threat, but there is no malice in it. Just because agency heads can be called to Capitol Hill—just because Chairmen McHenry and Hill, Representatives Emmer and Huizenga, and our other elected representatives—can ask probing questions in public and insist on answers—just because of this, is the exercise. of power from SEC legitimate.

With that in mind, I’d like to suggest a few lines of inquiry for questioning SEC Chairman Gensler in appearances before the House Committee on Financial Services and its newly formed Subcommittee on Digital Assets, Financial Technology and Inclusion.

I want to start with a few questions about the SEC’s securities offering disclosure program.

Back in 2017, when the industry and the bar first started asking the SEC for guidance on cryptoassets, CFO Bill Hinman gave a speech titled “When Howey Met Gary (Plastic).” The bar relies on Hinman’s speech and the so-called “FinHub Framework” that accompanied it.

I will ask this binary question and press for an answer:

Do you agree, or disagree, Chairman Gensler, with Hinman’s assessment (agree with his Chairman) that Ether is not a security? That question, which you repeatedly dodge when asked, is more pressing now that the New York State Attorney is arguing in court that Ether is a security. The CFTC and NFA both state unequivocally that Ether is not a security. Is the New York AG right, the CFTC wrong? (They can’t both be right.)

Ether’s status is important not only because it is the second largest crypto-asset by market capitalization, but also because Chair Gensler’s predecessors made it clear that Ether is not a security, and the industry has depended on this understanding in rolling out Ether-like products.

If I were a member of the committee or subcommittee addressing Chairman Gensler in sworn testimony, this is what I would say next:

You testified in the Senate, and you’ve repeated, that you believe the “vast majority” of crypto assets are securities. In a recent op-ed, you went back to “most” crypto assets. OK. Maybe you’re right. Maybe you are wrong. But even if you’re right, you’re not telling us anything useful about any particular asset. The wind may blow along the lake in Chicago “most” days, or even “the vast majority” of days, but that doesn’t mean it’s windy in Chicago today.

Chairman Gensler, why don’t you take the top 25 cryptoassets and software protocols by market cap and publicly identify which ones you think are securities (and why)? Better yet, why don’t you ask your dedicated staff to publish a list of cryptoassets and protocols that are not securities, so that the public and exchanges will know that securities laws do not apply to these assets?

That would not mean “no protection for the public.” Investors in commodities are protected by the CFTC. Depositors in banks are protected by banking regulators. Not all investments are a security. Do you recognize that SEC jurisdiction is limited to investments in securities?

Instead of observing that limit and rather than providing guidance (which is the ancient role of the SEC), you routinely suggest that blockchain entrepreneurs should “come in and register” with the SEC. But only two companies have ever managed to do so, and one of them quickly deregistered.

I ask you: How is it even possible for a software protocol to register when it is not a legal entity? What “business” will be described in the registration statement? What accounts will it contain? Who is “management” who will prepare “management’s discussion and analysis of financial condition and results of operations”?

It is an impossible situation you have backed into by refusing to propose rules and forms that suit the token industry. When you say “come in and sign up”, don’t you really mean “close up shop and walk away”?

Please note this: The SEC has the legal authority to create new types of registration forms for non-traditional registrants, and has done just that for securities securities. The SEC announced Regulation AB and tailored registration forms for asset-backed securities in 2004. It did so because the proliferation of ABS as a non-traditional asset class required a non-traditional approach to disclosure. The SEC proposed and adopted new rules “to clarify the regulatory requirements for asset-backed securities to increase market efficiency and transparency and provide more certainty for the overall ABS market and its investors and other participants.”

Chairman Gensler, you can do the same for crypto assets. Why not you?

Next, I want to ask a few questions about the SEC’s current securities trading and marketing program:

How is it that the SEC can purport to require cryptoasset exchanges to register as securities exchanges when…

· The existing rules require exchanges to list only registered securities, but the SEC has not registered any securities in cryptoassets? and

· The existing rules would require exchange members to be registered broker-dealers authorized to trade cryptoassets, but the SEC has not authorized any broker-dealers to trade cryptoassets if they also trade stocks?

SEC rules also impose exchange obligations related to record keeping, order book management, order tracking, trade reporting, linkage to clearing, SRO responsibilities, compliance, reporting and disclosure. But there are no interpretations of these rules related to the trading of crypto-assets, and there are no models for them.

Wouldn’t it be more accurate to say that, instead of requiring registration, your position, Chairman Gensler, is that crypto exchanges should either shut down or stop serving US customers? Again, it doesn’t have to be this way. You can use the SEC’s broad rulemaking authority to promulgate rules on every topic I’ve mentioned so that exchanges and broker-dealers can register to facilitate trading of cryptoassets under SEC oversight. It would be challenging work, but I know from my time at the SEC that your excellent staff is up to the challenge.

Finally, I would suggest some questions about how the Gensler Commission makes rules and decisions and its ever-expanding enforcement program:

Why do you usually give the public the shortest possible time allowed by the Public Administration Act to respond to your proposed regulations? Put another way, why is minimal time for public review and input OK with you? Shouldn’t you want more, rather than less, public awareness and input?

Likewise, why did you issue more than 1,000 pages of proposed regulations and analysis that would redefine core concepts like “securities dealer” and “securities exchange” in ways that are obviously intended to apply to the digital asset industry – without using more than ten words about digital assets?

You came to Congress for more money, claiming you were under-resourced in the fight against the crypto industry. But the pleadings and briefs in your existing crypto cases are signed by as many as 12 or 15 lawyers. Who is “under-resourced” – your SEC, with 15 lawyers on one case, or the recently arrived migrants that you chose to sue in Seattle recently?

I can end with this question:

Are you worried about what might happen when the Supreme Court reviews your overzealous enforcement program? You have one case there now and another on the way. In both cases, the appeals court held that the SEC’s internal courts violate the constitutional rights of your targets. Shouldn’t you exercise restraint in the pursuit of your agenda before being restrained by the Supreme Court?

I will ask these questions respectfully, knowing that Chairman Gensler has taken an oath to uphold the Constitution, and I will ask them in furtherance of the SEC’s rightful mission to protect securities investors.

Editor’s note: The Federalist Society takes no position on particular legal and public matters. Any opinions expressed are those of the author. To join the debate, please email us at [email protected].