Insights from Winston & Strawn
Balancing Investor Protection and Technological Innovation—Cryptocurrency Regulatory Developments in the U.S.
While industry participants remain hopeful that the Securities and Exchange Commission (“SEC”) and other U.S. regulatory bodies will provide more definitive guidance for regulating cryptocurrencies and distributed ledger technologies—particularly for “Initial Coin Offerings” (“ICOs”)—regulators have remained focused on protecting investors by enforcing current securities laws, and securities and commodities rules and regulations, and advising so-called “gatekeepers”(e.g., lawyers and accountants) to remain focused on regulatory compliance matters while advising industry participants.
As discussed below in the “Disruptive Technology Developments” section of this newsletter, recent weeks have seen continued regulatory developments focused on investor protection. These developments include SEC actions targeting allegedly fraudulent ICOs, and a large-scale coordinated regulatory action by the North American Securities Administrators Association (“NASAA”), which recently announced the results of its “Operation Cryptosweep.” This series of enforcement actions by U.S. state and Canadian provincial securities regulators focused on ICOs and cryptocurrency investment products, and has resulted in nearly 70 inquiries and investigations, and 35 pending or completed enforcement actions, since the beginning of May 2018. On May 31st, the Financial Industry Regulatory Authority (“FINRA”) issued a virtual-currency primer aimed at providing the retail investor base with some basic information on this developing technology sector, and urging caution for those retail investors considering making investments in the sector. The primer follows the SEC’s May 16th, HoweyCoins.com investor education initiative, which sought to provide the retail investor base with some common warning signs and considerations relating to ICOs.
Simultaneously with these actions, regulatory bodies and various working groups are engaging in a series of discussions aimed at achieving an effective regulatory regime for cryptocurrencies that seeks to provide adequate investor protection, while avoiding potentially adverse chilling effects on developing technologies. Some industry participants have requested that the SEC provide definitive guidance that is similar to the Swiss model of ICO regulation. Under that model, the Swiss Financial Market Supervisory Authority (“FINMA”) has issued guidelines for conducting ICO reviews under Swiss law. These guidelines have established a token taxonomy, which includes certain features that FINMA will utilize in classifying various ICO tokens within that taxonomy (e.g., features that would classify tokens as securities tokens, asset tokens, utility tokens, or hybrid tokens). Vocal critics of current U.S. regulations have stated that they fear that the current regulatory regime could harm healthy technological development if similar guidance is not provided. Others, such as Kathryn Haun, a board member of Coinbase and HackerOne, have stated that regulators must be careful in issuing any definitive cryptocurrency regulations for a sector that has seen such fast-paced developments, pointing out that regulations issued only a year ago would potentially already be outdated due to the rise of ICOs in 2017. Any such outdated regulations could curtail potential development and send innovators to other jurisdictions that have more favorable regulatory regimes.
While the SEC has yet to issue guidance that is similar to that of FINMA, the SEC and other U.S. regulatory bodies do appear to be taking steps to guide industry participants. For instance, as discussed below in the “Disruptive Technology Developments” section of this newsletter, SEC Chair Jay Clayton recently stated that ICO organizers should be proactive in reaching out to the SEC regarding their plans, and that the SEC will be receptive to working with these organizers to determine the extent to which federal securities laws could affect their projects. Additionally, the Commodity Futures Trading Commission (“CFTC”) recently released guidance for certain CFTC registrants relating to listing virtual currency derivative products.