On May 9, 2019, SEC Commissioner Hester Peirce delivered a speech at the Securities Enforcement Forum in East Palo Alto, California, discussing the SEC’s impact on the FinTech space and growth of the digital asset industry. Commissioner Peirce admitted her prior prediction, that the SEC would discourage the industry’s growth through hurried regulation and overenthusiastic enforcement action, was very wrong. While the SEC has stifled its growth, she remarked, this is not due to hasty regulation, but rather “its unwillingness to take meaningful action at all.”
Commissioner Peirce expressed that while “forbearance on the part of a regulator is often appropriate, . . . rather than knee-jerk regulatory impulses, to shape a developing industry,” the innovators still are required to comply with the securities laws. It is the regulators’ job to provide clear and concise guidance on how individuals and companies can comply with such laws, but she feels that the SEC has yet to fulfill such duty.
Despite such critiques, Commissioner Peirce did highlight key guidance and commentary the SEC has provided in the past two years: the 2017 SEC DAO Report, the February 2018 testimony of SEC Chairman Jay Clayton and the SEC June 2018 speech Director of Corporation Finance William Hinman.
She also mentioned enforcement actions that have been brought in the last few years. We have discussed numerous examples of SEC enforcement actions in the FinTech area in our posts from December 2017, October 2018 and November 2018.
Commissioner Peirce also discussed the SEC’s April 2019 digital asset framework and the TurnKey Jet, Inc. (“Turnkey”) no-action letter, both of which she criticized as confusing and unnecessary. The framework, which was intended to provide guidance as to whether a digital asset falls under the definition of a “security,” contained 38 separate items for consideration based on the four-factor Howey test. Commissioner Peirce fears that even a “seasoned securities lawyer” may have trouble applying such factors in the space, and expressed the concern that the lack of clear guidance in the framework could lead companies to abandon their US token projects, or move them outside the United States to a more crypto-friendly jurisdiction.
That same day, the TurnKey no-action letter was released. Commissioner Peirce argued the transaction described in the letter was “so clearly not an offer of securities” that she feared the letter may instead have the effect of expanding the reach of the securities laws as the letter “effectively imposed conditions on a non-security.” She questioned that if the TurnKey tokens were in fact securities, what would distinguish them from a mere Starbucks gift card? For more background on the framework and the no-action letter, please see our post from April 2019.
While a main focus of the SEC’s guidance to date has been on characterizing whether or not a token is a security, Commissioner Peirce argued that there are also more pressing questions in the crypto space, highlighting the following key topics that have lacked any real guidance at all:
- Brokers and investment advisers who hold client assets are subject to regulations regarding the custody of those assets. How can they satisfy the custody rules if the item being custodied is a digital security?
- How can auditors fulfill their obligations in connection with digital securities?
- If a broker is selling a digital security, how can the broker prove that it has control over the security such that no one else can sell the same asset?
- May a broker-dealer’s business include a mix of digital assets, only some of which are securities?
- If a trading platform wants to allow trading in digital assets, what are its obligations?
- Is a trading platform permitted to trade both securities and non-securities?
Commissioner Peirce worried these unanswered questions may ultimately cripple the FinTech space in the United States. The regulations and guidance regarding custody, ownership, storage and exchange of securities is critical – these are “exactly the aspects of digital assets that the crypto industry seeks to transform.” Further questions arise for investment advisers and funds that wish to include digital assets in their portfolios. Commissioner Peirce noted the need for a properly functioning secondary market in which broker-dealers and trading platforms have the ability and clear understanding how to legally trade digital securities.
Participating in a discussion at the Consensus 2019 crypto conference in New York on May 13, 2019, Commissioner Peirce reiterated her fears and disappointment with the lack of meaningful regulation, and that regulators should not mingle in the creative process, but instead embrace the potential and allow a space for such creativity to thrive. Otherwise, as Peirce acknowledged, the innovation and further growth in this space may end up overseas in a jurisdiction that has provided clear and consistent guidance in the space.