Why SEC Chairman Gary Gensler is cracking down on the crypto market: Latest Speech
SEC Chairman Gary Gensler's latest speech explains why he is tightening regulations on the cryptocurrency market.
SEC Chairman Gary Gensler gave a speech at the Piper Sandler Global Exchange and FinTech Conference on June 8, reiterating the importance of regulation, from signing securities laws to Howey testing, and citing a series of SEC enforcement actions against the crypto market, emphasizing that the crypto securities market should not be allowed to undermine the public’s confidence in the capital market. Cryptocurrency markets should not harm investors. He also pointed out that the current regulations are clear and that issuers, broker-dealers, and exchanges should know exactly how to comply. It is not a problem of insufficient guidance, but rather exchanges do not want to do what they are told by regulatory agencies.
Below is the full text of the speech, translated by BlockingNews:
Well-regulated market
I want to focus on an area that I think is at the intersection of the two things emphasized in the title of this conference–exchanges and FinTech–and that is cryptocurrency.
The reason why the US capital market has flourished is that since the signing of the Securities Act in 1933, we have developed rules of the road that help ensure investor protection, transparency, and competition for 90 years. A year after the law was signed, President Roosevelt and Congress passed the Securities Exchange Act of 1934 to regulate securities intermediaries such as exchanges and broker-dealers. The law also established the Securities and Exchange Commission, which turned 89 last Tuesday.
Crypto securities
There is no indication that investors and issuers in the crypto securities market should not be protected by our securities laws.
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Congress could have said in 1933 or 1934 that securities laws only apply to stocks and bonds.
“Congress enacted the securities laws to regulate investments, regardless of how they are offered or what they are called.” This is not just a talking point. As Justice Thurgood Marshall wrote in the Supreme Court’s famous Reves decision, it is the law of this land.
Congress listed more than 30 items in the definition of securities, including the term “investment contract.”
As the Supreme Court explained in another famous decision, SEC v. WJ Howey Co., an investment contract exists when funds are invested in a common enterprise with a reasonable expectation of profit derived from the efforts of others. This test has been reiterated by the Supreme Court many times–most recently in 2019 citing the Howey test.
In the Howey case, the court stated that the definition of an investment contract “embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” As I’ve said many times, the vast majority of crypto tokens meet the test of an investment contract. Disliking this fact and not receiving it are two different things.
These tokens are promoted by teams through websites and Twitter accounts. Investors may even meet the founders. These tokens don’t come out of thin air. They don’t grow out of the ground like corn or wheat. Although they are digitized, they cannot be distinguished from the mass of capital markets, in which securities and currencies are already digitized.
Satoshi Nakamoto’s innovation has driven the development of crypto assets and underlying blockchain ledger technology. However, regardless of which ledger is used, whether it is a spreadsheet, a database, or a blockchain, the economic reality of the investment is the most important when investors put their funds at risk.
Therefore, issuers of crypto securities need to register their investment contract offerings and sales with the U.S. Securities and Exchange Commission or satisfy exemption requirements. We’ve had rules for decades on how issuers must do this. We’ve developed flexible rules for the disclosures required in registration statements – Regulation S-K and Regulation S-X – as well as registration exemptions, including Regulation A or Regulation D.
We’ve also provided market participants with years of guidance on what does or does not constitute a crypto asset security, including the 2017 DAO report and the staff’s “Framework for ‘Investment Contract’ Analysis of Digital Assets” in 2019. Over 100 Commission orders, settlement agreements, and court decisions have also made clear when the offer and sale of tokens constitutes a security, including our actions against Telegram, LBRY, and Kik.
In fact, just this week, we alleged that Binance’s CFO and Chief Compliance Officer knew of the relevance of the Kik case to their own business. According to our lawsuit against Binance, internal Binance communications showed that the company was well aware that it needed to “begin preparing for the worst” in response to subpoenas and Wells notices related to its exchange token, BNB, including (to prepare for this “battle”) a “war chest.”
Do not believe it when participants in the cryptocurrency market claim on Twitter or on television that they were not “reasonably notified” that their actions may be illegal. They may have made an informed economic decision, taking enforcement risk as a cost of doing business.
Just like other parts of the securities markets, registration and compliance need to play a role – bond and stock issuers at this conference know that. But that is appropriate, because that work ensures that investors receive the full, fair, and accurate disclosure they are due.
Some sponsors of cryptoassets argue that their tokens have functionality beyond solely acting as investment vehicles. However, as courts have made clear in cases like Telegram, and in other cases, some of the additional functionality does not remove the digital asset from being a security under the investment contract analysis. Retail investors typically purchase these cryptoassets, at least in part, because they are counting on the efforts of others to create a return.
In fact, in the well-known Howey case, the Supreme Court wrote that it does not matter “whether the enterprise is speculative or non-speculative or whether there is a sale of property with or without intrinsic value.” For those tokens that are used specifically in an ecosystem, however, staff is willing to provide a no-action letter.
Cryptocurrency Intermediaries
Given that most crypto tokens are subject to securities laws, most crypto intermediaries must comply with securities laws as well.
Again, these laws have been on the books for decades. Sections 5, 15(a), and 17A(b) of the Exchange Act require intermediaries that act as securities exchanges, brokers and dealers, and clearing agencies to comply with securities laws and either register or meet exemptions.
Again, these crypto entities know the rules. As Binance’s Chief Compliance Officer candidly told a colleague in 2018, “We are a noncompliant securities exchange in the United States.”
Registration is not just a process issue. Failure to register is not just a foot fault in a tennis match. It goes to the core of providing basic protections to retail investors and our markets.
This year, we have separately charged Beaxy, Bittrex, Binance, and Coinbase with illegally offering unregistered securities in a mix of enforcement actions, including for not registering with the SEC. The Commission has also taken enforcement action against EtherDelta and Poloniex in 2018 and 2021 through settled orders.
These so-called failures deprived investors of crucial protections, including rulebooks to prevent fraud and manipulation, proper disclosures, segregation of customer assets, safeguards against conflicts of interest, oversight by self-regulatory organizations, and routine inspections by the SEC. When intermediaries fail to register, it is investors who are harmed, and U.S. financial markets may be affected.
In other parts of our securities markets, exchanges, broker-dealers, and clearing functions are separated. This separation of core functions helps mitigate conflicts that may arise from mixing such services.
I do not agree that “crypto intermediaries cannot comply,” and recent history has proved this. I do recognize, however, that it is and should be a work in progress. It’s not just a matter of “verbal promises to comply with applicable laws” or seeking a series of meetings with the SEC during which you are unwilling to make the necessary changes to comply with securities laws.
Crypto intermediaries may need to separate lines of business, create rulebooks to prevent fraud and manipulation, appropriately segregate customer funds, mitigate conflicts, or change their clearing and custody methods. These are things that protect investors. In fact, they didn’t think about these things to build their platforms, and this should not be a free pass for investors to take risks.
Every securities exchange registered at this meeting has worked hard to register and develop appropriate rulebooks and oversight, and each is bound by all of our rules. We should not undermine 90 years of securities law.
As SEC Enforcement Director Gurbir Grewal said, “You can’t ignore these rules because you don’t like them or because you prefer different ones: the consequences for the investing public are too great.”
Furthermore, just last month, a company that restricts its business to crypto asset securities was approved by the Financial Industry Regulatory Authority as a special purpose broker-dealer. This can be done.
We have also solved the problems of the crypto security industry through rulemaking. Although many industry insiders who called for rulemaking are dissatisfied with this rulemaking.
We have issued a reissued version reiterating the applicability of existing rules to platforms trading crypto asset securities, including so-called “DeFi” systems. This version also provides supplemental information for systems that would be included in the new proposed exchange definition.
While our current investment adviser custody rules already apply to crypto funds and securities, we recently updated our proposal to cover all crypto assets and enhance the protections provided by qualified custodians.
These are just two of the rules we have proposed involving the cryptocurrency market.
Additionally, recognizing the risks and uncertainties associated with crypto assets, staff has issued views on accounting by public companies that hold crypto assets and on disclosure relating to significant market developments involving crypto assets.
Lending and Staking as a Service
Another common feature of the crypto market is intermediaries and issuers offering loan or staking as a service programs, promising returns in exchange for investors’ crypto tokens. Their products and the promised returns have many names, often used to attract users to their platforms.
However, for decades, the Supreme Court has been clear that the economic realities of a product – not labels – determine whether it meets the definition of a security under the securities laws.
It does not matter what asset investors put into a lending or staking as a service platform – whether it’s cash, gold, bitcoins, or any other thing. What matters is what the intermediary is doing with the assets and what legal protections are in place. Customers invest their assets through the platform, which then lends or pools and stakes them, in each case promising returns. These are classic securities, regardless of whether they are digital assets.
Similarly, the US Securities and Exchange Commission has been clear on this for years. From BitConnect in 2021 and BlockFi in 2022, to a series of actions this year, the SEC has consistently maintained that these lending and staking as a service products need to be registered and provide investment public with appropriate disclosures.
Just this week, we, along with 10 states, charged Coinbase with offering and selling its staking program without properly registering.
Behavior: Fraud, Manipulation, and Bankruptcy
Frankly, given the widespread violations, it’s not surprising that we see many problems in these markets. We’ve seen this story before. It’s reminiscent of the situation before the federal securities laws were enacted in the 1920s. Hucksters. Swindlers. Fraudsters. Ponzi schemes. The public lined up to leave in front of bankruptcy court.
Earlier this week, we alleged that certain Binance entities misled investors about the platform’s risk controls and its inflated trade volume, actively concealed who operates the platform and its affiliated market makers’ manipulative trading, and even concealed where investors’ funds and cryptocurrencies were being held and who was detained.
We also alleged that Sigma Chain, an affiliate controlled by Binance founder Changpeng Zhao, as a primary market maker for Binance.US, engaged in manipulative trading and wash trading to fraudulently inflate the platform’s trade volume, including during the period before and after Binance.US’s launch, its subsequent fundraising round, and the recent launch of certain new crypto securities tokens.
Additionally, it is alleged that billions of dollars in customer funds from both Binance platforms were mixed together and held in accounts controlled by Zhao’s entity Merit Peak Limited, through accounts owned and controlled by Zhao and Binance.
These allegations also describe Zhao and Binance’s attempt to evade U.S. securities laws by announcing false controls they ignored behind the scenes to keep high-value U.S. customers on their platform. Our complaint cites words from Binance’s chief compliance officer, who said, “On the surface, we’re like … we don’t have U.S. users … but, ummm … if you use a VPN or if you actually do KYC, etc. … you’re not going to be kicked off after you already have that account.” The CCO went on to say, “CZ definitely agrees too haha … the senior management team has already given me a lesson on how to always find a creative way to get around the problem of having U.S. users.”
We also saw deception from FTX towards investors. With the collapse of Terra and LUNA, we saw deception. We alleged that Do Kwon and Terraform made repeated false and misleading statements to build trust with investors before causing them devastating losses.
In the case against Justin Sun and his three companies, we alleged a scheme to pay celebrities for promoting tokens without disclosing compensation.
I could go on, but in a market rife with fraud, abuse, and misconduct, there are too many to list.
We’ve also seen many companies self-destruct before and after FTX, injuring countless investors. Due to the bankruptcy of BlockFi, Celsius, FTX, Genesis, and other crypto companies, investors are often lining up in court.
Let me be clear: these types of misconduct and bankruptcy are more likely to occur in markets where issuers and intermediaries fail to comply with basic laws. Even if we may not uncover fraud or such overt misconduct, investors need proper disclosure, segregation of their hard-earned assets, and confidence that they are not trading against the firm.
Conclusion
Ultimately, the market depends on trust. For 90 years, this trust has relied on compliance with securities laws.
The crypto securities market should not be allowed to undermine the public’s well-placed trust in the capital markets.
The cryptocurrency market should not be allowed to harm investors.
