On February 6, 2018, the chairmen of the US Securities Exchange Commission (“SEC”) and the US Commodity Futures Trading Commission (“CFTC”) testified before the Senate Committee on Banking, Housing, and Urban Affairs regarding virtual currencies and their respective agencies’ involvement in the oversight of these new markets.1
The two chairmen painted a broadly coherent picture of regulation of virtual currency markets, though they used distinctly different color palettes. CFTC Chairman Christopher Giancarlo sketched an optimistic and encouraging image of the potential for technological advancements and stressed the importance of ensuring that regulation does not squelch enthusiasm for new ideas. SEC Chairman Jay Clayton repeatedly expressed his concerns regarding securities fraud involving virtual currency promoters and initial coin offerings (“ICOs”). Differences aside, both chairmen reiterated well-known risks in virtual currency markets and expressed the need for more interagency cooperation, and potentially new laws, to protect consumers and reduce illegal activity.
The chairmen described the current US policy on virtual currencies as a patchwork of actions by agencies entering uncharted regulatory territory. This may be attributed to the chimera-like nature of Bitcoin and other virtual currencies. As Chairman Giancarlo explained:
One of the phrases that’s often used is that Bitcoin is a medium of exchange, a store of value or a means of account. Well those three things have different connotations….If it’s a medium of exchange, then it’s like a currency-like instrument….but yet it’s still spoken of as perhaps a means of account. And in that case, it has implications from the [Federal Reserve] and currency. From [the CFTC’s] point of view, when it’s used as a store of value, then it’s very much like an asset, like a commodity.
Because of these different aspects embodied in virtual currencies, regulatory agencies have struggled to determine where their jurisdiction begins and ends. The chairmen emphasized that agencies are attempting to establish their jurisdictional boundaries to determine how to properly exercise their oversight in a constructive manner.
In particular, Chairman Clayton highlighted the SEC’s working group for monitoring the dark web as one group involved in the effort and expressed his belief that “[w]e should all come together, the federal banking regulators, the CFTC and SEC — there are states involved as well — and have a coordinated plan for dealing with the virtual currency trading market.” Chairman Giancarlo disclosed that:
[W]e have begun discussions at [the Financial Stability Oversight Council (FSOC)]. In addition, there’s also been discussions lead by Chairman Clayton at the Financial Stability Board and also at [the International Organization of Security Commissioners (IOSCO)]….So these discussions are taking place at the right level of debate...
These dialogues among regulators reflect both the regulators’ concerns about the challenges posed by virtual currencies and their desire to understand this new financial technology and its uses before imposing regulation. Chairman Giancarlo emphasized that “we owe it to this new generation to respect their enthusiasm about virtual currencies with a thoughtful and balanced response, not a dismissive one.”
ICOs and securities laws
Chairman Clayton has repeatedly stated that ICOs may be securities offerings that should comply with the registration requirements of the federal securities laws or an exemption therefrom. At the Senate hearing, he stated that “[b]y and large, the structure of ICOs that I have seen involve the offer and sale of securities and directly implicate the securities registration requirements.” In response to Senator Elizabeth Warren’s (D-MA) inquiry “[i]n 2017, companies raised more than $4 billion in ICOs….[h]ow many of those companies registered their ICO with the SEC?” he replied, “[n]ot one.”
While some market participants believe token utility (e.g., using the token for the purchase of goods or services) to be a differentiating characteristic, Chairman Clayton stated that “merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security.” His warning was clear to professionals in the ICO market:
[T]hose who engage in semantic gymnastics or elaborate structuring exercises in an effort to avoid having a coin be a security are squarely in the crosshairs of our enforcement division.
Chairman Clayton was also cognizant of the lawful participants seeking to participate in ICOs to raise money for their companies. He stated:
We want people to raise capital. But we want them to do it right….What ICOs do is take the disclosure-light benefits of a private placement and then add to it the public general solicitation and retail investor promise of a secondary market without registering with us. And folks somehow got comfortable that this was new and it was OK and that it was not a security….I disagree with them.
Risks and warnings
Chairman Giancarlo noted that many consumers believe the exchanges on which they purchase virtual currency are regulated. However, he clarified that the CFTC cannot impose the protections and safeguards that consumers might expect from traditional exchanges because “the CFTC does not regulate the dozens of virtual currency trading platforms here and abroad.”
Senator Bob Menendez (D-NJ) questioned how consumers were being protected from the use of promoters or celebrity endorsers to increase sales.2 In response, Chairman Clayton warned that issuers and promoters take on “securities law liability” when they promote securities.
Both chairmen also emphasized the general risk of investing in virtual currencies, particularly for the elderly, who may be less familiar with the risks associated with new technology. The SEC has previously released several statements warning investors to take precautions to avoid becoming victims of theft or fraud.3 At the hearing, Chairman Clayton warned investors:
[W]hen you engage in investing online with an offshore entity, the chances that we can do anything practical to get your money back are very, very low.
Chairman Giancarlo echoed the advice, stating:
It’s the same advice I give my children. If it sounds too good to be true, it is. If they’re promising ridiculous returns, they’re ridiculous. If [you are] going to give them money, you’d better be prepared to lose it.
Chairman Clayton has previously spoken about the market professionals on whom the SEC relies to ensure compliance with securities laws.4 At the hearing, he called on accountants and lawyers to ensure that the advice they provide properly reflects the law. In the past, the chairman has urged gatekeepers to focus on the SEC’s motivation for the securities laws, rather than looking for loopholes to work around the spirit of the law. At the hearing, the chairman echoed his past criticisms of market professionals, chiding those who have given advice that ICOs operate in a regulation-free zone:
I don’t think the gatekeepers that we rely on to assist us in making sure our securities laws…are followed have done their job.
While both agencies have been increasing their enforcement against market professionals and others who have blatantly disregarded federal regulations,5 Chairman Clayton disclosed that a lack of enforcement personnel at his agency has constrained its efforts. His hope appears to be that gatekeepers will be motivated—by the government’s public statements and educational outreach, as well as enforcement actions— to reflect on the purpose of the investor protections of the federal securities laws and advise clients appropriately.
Senate Committee Chairman Mike Crapo (R-ID) recommended that the two agency chairmen work to determine what they can and cannot do and then advise the committee on what is needed to enhance their ability to protect US investors. Both chairmen acknowledged that the next steps were not clear but that additional coordination would occur. Chairman Clayton hinted at the next possible step by stating, “We may be back with our friends from Treasury and the Fed to ask for additional legislation.”
Virtual currency market participants should not only heed the warnings expressed at the hearing but also consider directly engaging with the regulatory agencies and Congress to help shape impending regulation and/or legislation in an evenhanded and efficient manner.