With the constant flow of news in the crypto world, it can be difficult to keep up with the latest enforcement news. There is no shortage of federal and state regulators investigating the industry and there are regular enforcement actions and statements from regulators to take note of. We have included below the most significant and interesting enforcement-related news from the past week.
SEC Names Crypto Czar. On Monday, June 4, the SEC announced that Valerie Szczepanik has been named Associate Director of the Division of Corporation Finance and Senior Advisor for Digital Assets and Innovation, or as many in the industry have described the position, the SEC’s new “Crypto Czar.” Szczepanik described her position, which the SEC just created, as involving the coordination of efforts across all SEC divisions and offices regarding the application of U.S. securities laws to emerging digital asset technologies and innovations, including initial coin offerings and cryptocurrencies. Szczepanik is no newcomer to the SEC or to the world of cryptocurrencies and blockchain. She joined the SEC in 1997, after working as an AUSA in the U.S. Attorney’s Office for the Eastern District of New York, and most recently served as the Assistant Director in the Enforcement Division’s Cyber Unit. She also is the Head of the SEC’s Distributed Ledger Technology Working Group, Co-Head of its Dark Web Working Group, and a member of its FinTech Working Group. Szczepanik has discussed publicly in the past her views on the need for cryptocurrency companies to protect investors and that whether a particular ICO is a security or not requires a facts and circumstances based analysis.
For those in the industry that have been pushing for regulation of the industry to root out fraudulent companies giving legitimate companies a bad name, it seems that Szczepanik’s appointment to this newly created position should be received as a welcome development.
SEC Crypto Czar Advocates Use of Smart Contracts to Address Regulatory Requirements. On Thursday, June 7, Szczepanik wasted no time in diving into the issues confronting the crypto industry when she appeared at the SINET Innovation Summit in New York. Szczepanik, who was a member of one of the panels there, shared some of her thoughts on how the SEC plans to oversee cryptocurrencies and ICOs. She noted that most companies running ICOs do little to protect investors from fraud or cyber attacks. Not surprisingly, Szczepanik did not commit to the SEC offering additional guidance regarding token sales or a time when they would do so, but she stressed that the SEC was happy to talk to those in the industry. Szczepanik stated the SEC has never turned down a request for a meeting and has met with dozens of entrepreneurs and attorneys. Notably, Szczepanik suggested that the regulatory challenges that ICOs face can in part be solved by using smart contracts, which can incorporate rules directly into the tokens about who can exchange them. “It will be relatively easy to program these rules into smart contracts and DLT [distributed ledger] technology – but technologists need to talk to regulatory attorneys,” Szczepanik noted.
Those who are planning ICOs should take note of these statements by Szczepanik. For those relying on exemptions that involve restricting the resale of securities, it likely is not going to be enough to sell into the market with no protections in place to restrict resale and then claim ignorance when a resale occurs. It seems likely that the SEC will expect that companies will attempt to use smart contracts to try to prevent scenarios like that.
SEC Chairman Clayton – the Definition of “Security” Is Not Changing. On Wednesday, June 6, at the Sandler O’Neill Global Exchange and Brokerage Conference, SEC Chairman Jay Clayton stated that the SEC is not going to be changing the definition of a “security” to address the rise in cryptocurrencies and ICOs. Clayton told CNBC “we’ve been doing this a long time, there’s no need to change the definition.” Addressing ICOs specifically, Clayton stated “if you have an ICO or a stock, and you want to sell it in a private placement, follow the private placement rules. If you want to do any IPO with a token, come see us.” Clayton noted that the SEC is “happy to help you do that public offering” if issuers take the responsibility SEC laws require. Clayton also addressed the recent debate over whether cryptocurrencies are securities. “Cryptocurrencies: These are replacements for sovereign currencies, replace the dollar, the euro, the yen with bitcoin,” Clayton said. “That type of currency is not a security.” However, “[a] token, a digital asset, where I give you my money and you go off and make a venture, and in return for giving you my money I say ‘you can get a return’ that is a security and we regulate that,” Clayton said. “We regulate the offering of that security and regulate the trading of that security.”
For those in the cryptocurrency industry holding out hope that the SEC and other regulators are going to make an exception under the securities laws for ICOs, that seems unlikely at this point. However, that does not rule out the possibility that the SEC may put rules and regulations in place that govern the cryptocurrency industry and ICOs that protect investors while also not destroying the concept of ICOs.
SEC Surprised at Underreporting of ICOs. Also on Wednesday, at the Sandler O’Neill Global Exchange and Brokerage Conference, one of the SEC’s directors noted that he is surprised by the underreporting of ICOs. “We’re underwhelmed by the enthusiasm for coming within the regulatory structure right now,” Brett Redfearn, SEC Director of Division of Trading and Markets, told CNBC. Redfearn noted that “there are a number of exchanges that are trading ICOs that I would think that we would see more registrations.” Redfearn noted that whether a particular offering is a security is determined by reference to the Howey test, but that not all offerings “are obvious on its face what exactly it is.” Redfearn told CNBC that there would be more statements coming from the SEC on the topic, but did not specify when. With respect to the recently popular question whether ethereum or XRP are securities, Redfearn declined to comment on that, but did say there will be statements on “at least one of those products forthcoming in the future.”
Based on the SEC’s statements, it appears likely that the wave of SEC investigations and subpoenas will continue. Although the issue of whether a company is engaging in fraud may be more difficult to determine, whether a company has registered their ICO after being listed on an exchange is likely not as difficult for the SEC to determine.