The SEC, Labor Department and Congress are gearing up to “protect investors” from the emerging cryptocurrency market.
Contending that large parts of the crypto market are not operating within regulatory frameworks that protect investors, SEC Chairman Gary Gensler has indicated that the Commission plans to take action. He also has called on Congress for more authority to regulate the field.
In an Aug. 5 letter to Sen. Elizabeth Warren (D-MA), Gensler suggested that the Commission needs additional authority to prevent transactions, products and platforms from falling between regulatory cracks, as well as more resources to protect investors in what he described as a “growing and volatile sector.”
“In my view, the legislative priority should center on crypto trading, lending, and DeFi platforms. Regulators would benefit from additional plenary authority to write rules for and attach guardrails to crypto trading and lending,” Gensler wrote in response to a July 7 letter from Warren inquiring about the sufficiency of the SEC’s authority to regulate crypto platforms. Warren urged the Commission to use its full authority to address risks that endanger consumers and investors, and undermine the safety of financial markets.
Gensler’s letter to Warren echoes remarks he made in early August at the Aspen Security Forum, where he outlined the need for greater investor protection and oversight of digital currencies. In both instances he said he believes that not only can these various platforms implicate the securities laws, but some platforms can also implicate commodities laws and banking laws. “This raises a number of issues related to protecting investors and consumers, guarding against illicit activity, and ensuring financial stability,” Gensler noted.
Existing Regime
In noting that a typical trading platform has 50 or even 100 tokens or more, he explained that while each token’s legal status depends on its own facts and circumstances, the probability is remote that any given platform has zero securities. “I believe we have a crypto market now where many tokens may be unregistered securities, without required disclosures or market oversight,” Gensler stated. To the extent there are securities on these trading platforms, they must register with the Commission unless they meet an exemption, Gensler said.
What’s more, if a lending platform is offering securities, it also falls into SEC jurisdiction, he noted, adding that there are initiatives by various platforms to offer crypto tokens or other products that are priced off the value of securities and operate like derivatives. “It doesn’t matter whether it’s a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These products are subject to the securities laws and must work within our securities regime,” Gensler emphasized.
At the Aspen Security Forum, the chairman also addressed the issue of custody of crypto assets, where he noted the SEC is seeking comment on crypto custody arrangements by broker-dealers and relating to investment advisers. In noting that custody protections are key to preventing theft of investor assets, the chairman advised that the Commission will be looking to maximize regulatory protections in this area.
Stablecoins
Gensler also addressed the issue of stable value coins, which he noted are crypto tokens pegged or linked to the value of fiat currencies. Pointing to Facebook’s efforts to stand up a stablecoin called Diem (formerly known as Libra), which received a lot of attention from central bankers and regulators, Gensler observed that what might be less well known is that there already is an existing stablecoin market worth $113 billion, including four large stablecoins—some of which have been around for seven years.
These stablecoins are embedded in crypto trading and lending platforms, he noted, adding that in July, nearly three-quarters of trading on all crypto trading platforms occurred between a stablecoin and some other token. “Thus, the use of stablecoins on these platforms may facilitate those seeking to sidestep a host of public policy goals connected to our traditional banking and financial system: anti-money laundering, tax compliance, sanctions, and the like. This affects our national security, too,” Gensler contended.
To the extent these stablecoins may be securities and investment companies, Gensler advised that the Commission will apply the “full investor protections” of the Investment Company Act and the other federal securities laws to these products.
DOL Guidance?
Speaking at the 2021 NAPA D.C. Fly-In Forum in July, the Acting Assistant Secretary for the Department of Labor’s Employee Benefits Security Administration intimated that the department is also considering issuing guidance in this area. While noting that he didn’t have much to share because the department is in the early stages of conversations, Acting Assistant Secretary Ali Khawar did suggest that reports about the use of cryptocurrency in 401(k) plan lineups is troubling and that he anticipates future guidance.
“When you look at cryptocurrency and the different forms of currency, there is a lot of volatility, there’s a lot of noise, there’s very little transparency, and I’m sure some of you have seen reports about cryptocurrency becoming an option in investment lineups, but it’s something that we find very troubling,” Khawar told the NAPA delegates.
Khawar said he anticipates that the DOL will issue some guidance in the near future, but didn’t give any other details, other than to say keep your eyes open. “I do think we will feel a need, ultimately, to say something on this, because it is a pretty troubling development for these investments to be held in tax-advantaged retirement accounts,” he added.
Digital Asset Reporting
One thing that does seem imminent is that information reporting requirements will soon include “digital assets.” The Infrastructure Investment and Jobs Act (H.R. 3684, as amended) passed by the Senate Aug. 10 expands current-law information reporting requirements to include “digital assets,” including cryptocurrency.
The infrastructure bill defines digital assets as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the [Treasury] Secretary.” The definition of “broker” would also be modified to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”
During debate over the bill in the Senate, Sens. Rob Portman (R-OH) and Mark Warner (D-VA) noted that concern has been expressed that some in the cryptocurrency industry who are not brokers would be caught up in this definition. Indicating that the Treasury Department and the congressional Joint Committee on Taxation believe that the current language is clear enough that the reporting requirements only cover brokers, they noted that their purpose was to clarify that that is the intent of the legislation.
The purpose of the provision is not to impose new reporting requirements on people who do not meet the definition of brokers, the senators explained. “We want to be sure that miners and stakers and others who play a key role in validating transactions now or in the future, or hardware and software sellers for digital wallets will not be subject to the rules for those activities. Again, you will need to provide the information reporting only if you are functioning as a broker,” Portman emphasized.
Apparently the two had been working on a compromise amendment to clarify the language, but it didn’t make it into the Senate bill before approval due to reasons not having to do with the policy arguments. It’s possible the legislation will be clarified before final congressional approval.
Under the Senate-passed bill, broker-to-broker reporting requirements would also be expanded to make clear that transfers of digital assets are included. The bill also adds digital assets to existing rules requiring businesses to report cash payments of more than $10,000.
Participant Interest?
And while plan sponsors, fiduciaries and most participants remain hesitant to include cryptocurrencies in their investment lineup, there is a small contingent of participants—primarily younger ones—who are interested in learning more about cryptocurrency investing.
A recent Morningstar report found that the two youngest generations—Gen Zers and Millennials—were about five times as likely to prefer cryptocurrency in their retirement plan as Baby Boomers, the oldest generation. In contrast, Baby Boomers were about twice as likely as any other generation to rank cryptocurrency last. Nonetheless, while younger investors find cryptocurrency more appealing than older investors do, there is a general hesitancy to add it to their retirement portfolios.
Similar findings were revealed in Vestwell’s 2020 Employee Retirement Trends Report, which found that while participants are hesitant about including Bitcoin or other cryptocurrencies in their 401(k) investment lineup, they are open to learning more. The firm’s survey of 1,000 plan participants found that 22% said they would be interested in considering these funds, while 38% said they might be.
