On February 6, 2018, the United States Senate Committee on Banking, Housing and Urban Affairs conducted a hearing entitled “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission.” Hearing. The Chairman of the U.S. Securities and Exchange Commission (SEC), Jay Clayton, and the Chairman of the U.S. Commodity Futures Trading Commission (CFTC), J. Christopher Giancarlo, provided testimony.
The hearing comes at a time when both agencies are increasingly active in the virtual currency space. Most notably, the SEC has provided extensive guidance and taken enforcement action against certain “initial coin offerings” for violations of the U.S. securities laws. Similarly, the CFTC has taken enforcement actions against fraudulent schemes, as well as overseeing the launch of Bitcoin futures contracts. For further information on these actions, please consult virtualcurrencyreport.com. The testimony from both agencies follows on public statements by both Chairmen, including most recently a joint op-ed published in the Wall Street Journal.
Key Takeaways from Written Statements
Below are some of the key takeaways from the written testimonies:
- A United Regulatory Front.
The SEC and the CFTC potentially share federal regulatory jurisdiction over certain aspects of virtual currency activity, and both statements made clear that the agencies are cooperating and working together to ensure effective oversight of potential misconduct. Both agencies have established virtual currency task forces within their enforcement divisions that cooperate and share information. The statements also made reference to cooperation with other federal and state agencies regarding enforcement, information sharing and public education initiatives.
- Fostering Innovation.
Both statements included language that acknowledged the promise of technology to transform the financial markets in alignment with the agencies’ regulatory goals. However, the statements did address such promise cautiously, noting the need for sensible and appropriate regulation. Consistent with this, the statements included references to some of the outstanding questions on which the agencies are consulting with industry participants, including custody, liquidity and valuation. See SEC Staff Letter. The CFTC also outlined some of the results of its consultation with clearing houses regarding Bitcoin futures. However, the tone remained generally positive, with Chairman Clayton stating “[t]hese warnings are not an effort to undermine the fostering of innovation through our capital markets—America was built on the ingenuity, vision and spirit of entrepreneurs who tackled old and new problems in new, innovative ways.”
- The More Things Change, the More They Stay the Same.
Both statements restated the application of existing laws to new technology. Chairman Clayton’s statement reiterated that the “Howey test” remains an appropriate metric for determining if a token is an “investment contract” under the U.S. securities laws. In addition, he noted that the SEC was examining potential violations of exchange or broker-dealer registration requirements, failures by “gatekeepers” to take appropriate action, as well as the extension of credit by some market participants. Chairman Giancarlo’s statement clarified that many of the recent actions within the CFTC’s jurisdiction, such as the self-certification process of Bitcoin futures contracts, were the result of existing legislation and the practices of clearing houses as self-regulatory organizations. Chairman Giancarlo’s statement also clarified the more limited scope of the CFTC’s regulatory jurisdiction over the spot exchange of virtual currency, while acknowledging its capability to take enforcement actions with respect to certain fraudulent and manipulative practices. Unsurprisingly, these points were consistent with prior statements of both agencies.
- Is Legislation Required?
The statements acknowledged that the existing regime governing virtual currency exchange activities were money transmission rules, which operate under a state-by-state licensing regime. The Chairmen recognized that the manner in which virtual currency markets operate is not particularly well suited to such a regime, and stated that they are “open to exploring with Congress, as well as with our federal and state colleagues, whether increased federal regulation of cryptocurrency trading platforms is necessary or appropriate. We also are supportive of regulatory and policy efforts to bring clarity and fairness to this space.” Chairman Giancarlo’s statement was particularly critical of the shortcomings of the existing state-by state approach, and suggested potential elements for federal oversight, including data reporting, capital requirements, cyber security standards, measures to prevent fraud, price manipulation and anti-money laundering, and “know your customer” protections.
- The Art of the Possible.
The overriding theme of both statements appeared to be consistency, with both the agencies’ prior positions and with each other’s approach. However, there were some significant acknowledgments.Chairman Clayton’s statement acknowledged the possibility of a compliant token offering through the use of available exemptions. He stated “[i]t is possible to conduct an offer and sales of securities, including an ICO, without triggering the SEC’s registration requirements. For example, just as with a Regulation D exempt offering to raise capital for the manufacturing of a physical product, an ICO that is a security can be structured so that it qualifies for an applicable exemption from the registration requirements.”While Chairman Clayton’s statement generally criticized failures by industry participants to consider securities law concerns, he did clearly acknowledge that certain cryptocurrencies were not securities. He stated “there are cryptocurrencies that, at least as currently designed, promoted and used, do not appear to be securities,” although he went on to clarify that simply calling a token a “currency” would not preclude it from being a security, and that form should not be elevated over substance.Consistent with the recent statement by the SEC’s Investment Management Division, Chairman Clayton confirmed that there were a number of potential issues with exchange traded-fund products, including liquidity, valuation and custody of holdings, as well as creation, redemption and arbitration, that must be resolved before approval could be considered.
The self-certification process for Bitcoin futures was affirmed as the appropriate method for the certification of virtual currency futures products, but the CFTC does intend to ensure that “interested parties, especially clearing members” should have the opportunity to raise concerns and engage in stakeholder input. This is now an additional element within the review and compliance checklist for virtual currency product self-certifications with which designated contracts markets and swap execution facilities will be required to comply.
Lastly, it is worth noting that Chairman Giancarlo gave clear criticism of the existing state-by-state money transmission regime as inadequate, stating that “[o]verall, a rationalized federal framework may be more effective and efficient in ensuring the integrity of the underlying market.” Whether Congress ultimately agrees with this view remains to be seen.
Testimony and Questions.
The Chairmen also addressed questions from members of the Committee following their testimonies. Some takeaways arising from those questions are as follows:
- While the SEC has formed a cryptocurrency working group, Chairman Clayton noted that the hiring freeze has not helped. In particular, the SEC could use more attorneys in their enforcement and trading and markets divisions.
- Chairman Clayton reiterated that he has not seen an ICO that is not a security, a position that he took in November 2017. It follows that ICOs that are securities offerings should be regulated as such or avail themselves of an appropriate exemption.
- In response to a question regarding potentially limiting the right of private investors to take class action lawsuits that had been reported in the press, Chairman Clayton confirmed that he is “not anxious to see a change in this area.”
- Chairman Clayton also reiterated the SEC’s intention to enforce existing laws and work with the Department of Justice to combat illegal conduct, although he noted that the SEC does not have jurisdiction over “true cryptocurrencies.” Chairman Giancarlo referenced the ability of the CFTC to take enforcement action in the spot markets of such cryptocurrencies. Both Chairmen acknowledged the potential gap of federal regulatory oversight.
- To that end, both Chairmen acknowledged the potential for new regulatory tools and the need for agencies (including the SEC, CFTC and other relevant regulators) to come to Congress with an overarching plan or framework to enable an informed policy decision to move forward. Regarding existing collaborations, Chairman Clayton referenced discussions with the Financial Stability Oversight Council (FSOC), and Chairman Giancarlo mentioned discussions with the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO).
- The risk of fraud in the market and its impact on systemic reputational effects were consistent themes of the hearing. Chairman Giancarlo also noted the generational difference in acceptance and understanding of cryptocurrency, and cited the risk to consumers as one of the reasons why the CFTC has focused on general educational initiatives with respect to the asset class.