Blockchain Association's Smith Talks Crypto; a New Idea for Regulating Digital Tokens; Bond Traders Are Very Worried About a Pending SEC Rule
Capitol Account: Free Weekly Version
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Lawmakers trickled out of own and Washington got quieter. Our Friday Q and A with Blockchain Association Executive Director Kristin Smith features her bullish assessment of Congress finally taking action on digital tokens — and her take on the crypto industry’s endless frustrations with the SEC. Continuing the focus on virtual currencies, the head of OTC Markets wrote an op-ed recommending that securities regulations be applied to the space. And we exclusively report on the SEC’s plans (for now) to make brokers comply with a rule that could lead to debt-market disruptions. Thanks for your interest in our publication. If you’d like to see the full versions of these stories, or read our newsletter in real time, you can subscribe by hitting the button below:
Friday Q and A: We headed over to the Dupont Circle WeWork where (of course) the Blockchain Association has its offices and sat down with Smith. One of the early crypto advocates in D.C., she has been an ubiquitous presence in the congressional and regulatory battles over how to oversee the industry. The trade group’s members range from big to small companies and include many well known firms like Digital Currency Group, BlockFi, Genesis and Ripple. Here’s our (lightly edited) discussion:
Capitol Account: How did you get here?
Kristin Smith: I started my career on Capitol Hill where I worked as a staffer for about 10 years. I then tried to leave Washington, but learned I had no valuable skills. So I came back to Washington to be a lobbyist. I stumbled into crypto and blockchain and realized nobody was really doing anything in this space. One thing led to the other, and they needed somebody to come and be employee Number One at the Blockchain Association. I was willing to do it for not a lot of money.
CA: You’ve grown the association pretty quickly.
KS: We have 18 people, including one in Albany [New York]. We’re starting to get into the states. We have a full communications team. We have a full team that works with our outside lawyers and our members to figure out [policy] positions. We have a full government relations team and a bunch of outside lobbyists, and an industry affairs team that does all of the conferences and membership development.
CA: Who are your members?
KS: We are up to 96 or 97 member companies. It's a mix of investors, teams of software developers that are building blockchains or building on top of blockchains, different infrastructure providers, custodians, exchanges, a couple of Bitcoin mining companies. It's a really good mix of the crypto space… Everybody more or less realizes they're not competing against one another. The competition is the policy environment – and making sure that it works well for everybody. It's a surprisingly cooperative group. It’s a very passionate group, an occasionally very feisty group.
CA: Has it been tough convincing firms they need to engage in the political and policy process?
KS: It wasn't until last summer with the infrastructure bill that a lot of companies in the crypto space realized they needed to invest in Washington – and they’ve followed through. There are a bunch of companies opening up Washington offices or hiring policy people full time, hiring lobbyists. There's a lot of new people now, and there's a learning curve. It takes a while for all those people to become fully effective.
CA: How are your efforts going so far?
KS: [Members] are very engaged with what's going on on the regulatory front, and they're not afraid to call their congressman or senator when asked. We have the Washington infrastructure, the grassroots infrastructure – and the political giving infrastructure is starting to build out. It's not quite as robust as other industries, but people will open up their checkbooks… We had a problem with not having a group of bipartisan champions, and that's changed. We have some really strong Democrats who have stepped in, who want to get the regulation done in a constructive way. That is the biggest thing we have going for us right now.
CA: Where are your Democratic supporters? In Congress?
KS: I'm talking the Hill and the White House. I'm not talking the SEC.
CA: What's your problem with the SEC?
KS: The SEC thinks all of my member companies are either unregistered securities or facilitating the sale of unregistered securities. Our biggest challenge has been the ability to have a productive dialogue that would really get to the issues. We continuously hear, ‘just come in and register,’ and that doesn't really work. Coinbase can't just go in and register – because then they have nothing to trade [since the SEC is also arguing] that everything you're trading is a security… (Friday)
It’s Time to Dot the ‘I’s’ and Create Regulatory Clarity for Crypto Investors
By Cromwell Coulson
We had the boom. Now comes the bust. Major U.S.-based crypto investing platforms are freezing customer assets and filing for bankruptcy. Whether you call it Crypto Winter or a crisis of confidence, it’s time to bring in crypto from the wild. Washington must define the rules of the road, protect the public’s interests, and establish baseline operational standards for continued digital investment and innovation.
At OTC Markets Group, we have seen the growing investor demand for crypto investment products. We operate the public markets for some of the world’s largest digital asset trusts. These securitized products help investors gain exposure through broker-dealers and investment advisors that operate within a robust framework of state and federal securities laws. At the same time, issuers provide current disclosure, and their insiders are subject to anti-fraud rules.
Most crypto investing takes place outside any federal regulatory framework. Congress has not determined what makes digital assets a security or a commodity. This inaction has created a lack of clarity on what rules will apply and whether the CFTC or the SEC should lead oversight of market participants.
We sit at the intersection of crypto and the traditional capital markets. In our experience, the SEC’s broad anti-fraud, investor protection and market integrity rules are particularly well-suited to provide a robust and trusted regulatory framework. Here’s why:
Unlike commodities futures trading, crypto is decentralized. Investors use competing intermediaries offering fractional interests in the same fungible product. This is akin to securities trading, where investors trade at competitive prices through any registered broker-dealer.
The SEC’s Exchange Act and associated FINRA SRO rules robustly regulate secondary markets. These regulations aim to ensure intermediaries, insiders, and issuers treat investors fairly. The core principles and procedures embedded within these rules could solve many of crypto’s current problems.
The SEC and FINRA ensure market integrity by regulating intermediaries. Retail brokers can only make investment recommendations in the customer’s best interest, must obtain best execution, and meet net capital requirements. Brokers acting as custodians have strict processes to safeguard and segregate customer funds. Markets in turn must provide fair and equitable access to all participants and adhere to security and system integrity requirements. The SEC has a proven track record, including robust inspection regimes that would benefit reputable crypto market participants.
Under the securities framework, digital asset intermediaries would register as broker-dealers. Regulators could then provide exemptions to fit digital assets into established brokerage, clearing and custody operations. In 2008, FINRA issued guidance reminding member firms that market regulation rules apply to “all of the business of a broker-dealer, not only to its securities and investment banking business.” Trading digital assets through regulated broker-dealers would immediately benefit crypto investors with these same protections.
Crypto markets have recently seen allegations of insider trading and secondary market distributions by insiders. Lack of regulatory clarity on crypto control person and affiliate responsibilities has allowed instances of insider trading. Accusations include undisclosed “whales” dumping their holdings and rampant promotional schemes occurring across messaging apps and social media platforms. These are not new problems. Over the past 90 years, the SEC has developed robust insider trading and disclosure rules. Regulators aim to ensure that insiders and paid promoters cannot fly under the radar and manipulate the public market. Clear definitions of who is an affiliate, dealer or statutory underwriter provide additional clarity. FINRA-regulated broker-dealers have established KYC and AML gatekeeper processes to detect affiliate trading and prevent unregistered distributions.
The securities law framework imposes enhanced requirements on those who have the power, influence, or control to manipulate the public market, including corporate officers, directors, large shareholders and paid promoters. Under SEC regulation, large stakeholders and insiders with informational advantages must limit buying and selling activity and disclose their transactions. These rules help protect investors from pump-and-dump schemes, insider trading and other fraudulent practices.
Comprehensive intermediary and insider rules would allow securities regulators to be flexible in establishing ongoing disclosure requirements for crypto issuers. The SEC can acknowledge where the disclosure requirements for digital assets and DeFi organizations should differ from those of a traditional corporate entity. Companies and funds offering investment opportunities to the public must be truthful and transparent about their businesses and the risks involved in investing. This framework reduces information asymmetries and provides investors with a standardized baseline of information.
Unlike static commodities and currencies, many crypto projects and DeFi organizations are dynamic. The importance of ongoing insider and issuer disclosure will become clearer as projects mature, new features emerge and/or governance moves from proof of work to proof of stake. The more complex entities become, the higher the requirements for ongoing disclosure. Crypto disclosure rules need the flexibility to handle digital enterprises at all stages.
The SEC and FINRA have an opportunity to demonstrate why their regulatory framework best serves investors. Success requires a pragmatic approach to bring market participants over the regulatory wall. SEC and FINRA staff must engage with industry participants to design workable frameworks and issue regulatory relief in the form of rulemaking and no-action letters.
It’s clear Americans will continue to invest in this innovative asset class. Congress can seize this opportunity to provide additional regulatory clarity to support SEC oversight for all digital investing. Dotting the regulatory “I’s” of intermediaries, insiders, and issuers will better protect investors today and ensure the U.S. capital markets remain the envy of the world… (Thursday)
New Crypto Bill: The Senate Agriculture Committee is out with its legislation that gives the CFTC power to regulate spot-market trading for Bitcoin, Ether and other digital commodities – just ahead of the August recess. The proposal also requires companies that handle commodity tokens, including trading platforms, brokerages and custodians, to register with the agency. And because the CFTC is chronically underfunded, the panel authorizes it to pay for its oversight by collecting user fees from crypto exchanges.
The committee, according to people familiar with the matter, is looking to hold a hearing in September on the bill. So at the very least the measure will get the discussion over digital asset regulation rolling again after the summer break. The talks are going to be messy, however. A lot of interested parties and federal agencies have different thoughts and agendas. Here’s a link to the full text.
We’ve checked in with our sources and some token experts to bring you a quick analysis. The top line takeaway: Consider this another marker in the ongoing debate. Few expect any crypto legislation to pass this year.
Strong support: This is a bipartisan bill that two Democrats (Debbie Stabenow and Cory Booker) and two Republicans (John Boozman and John Thune) put their names on. Stabenow and Boozman are the chair and ranking member of the agriculture panel. That carries some heft, and it is more backing than the comprehensive crypto legislation introduced earlier this year by Senators Cynthia Lummis, a Republican, and Kirsten Gillibrand, a Democrat.
Missing however: There is no clear definition about which products are securities and which are commodities. This is really the crux of the digital asset debate and there is little clarity for those eager to know whether the CFTC has oversight of certain tokens and exchanges, or the SEC does. The bill does call two of the biggest, Bitcoin and Ether, digital asset commodities (remember, the SEC under the Trump administration essentially ceded this point). But the legislation also notes that the term digital asset commodity does not include “a security” or a “digital form of currency backed by the full faith and credit of the United States.” For example, a Central Bank Digital Currency… (Wednesday)
Bond Market Jitters: For almost a year, Wall Street brokers have teamed up with corporate lobbyists to evade an SEC rule that may trigger massive headaches for both traders and companies that issue bonds. But now their luck appears to be running out – and debt markets could soon experience major disruptions if the doomsayers are correct.
At issue is a little noticed (and in the weeds) regulation the agency approved in September 2020, barring brokers from offering pricing information on any stock or bond that doesn’t have its underlying financial data publicly available. In other words, if a company isn’t routinely disclosing profit and revenue figures in regulatory filings, brokerage firms can’t publish price quotes. The rule’s impact is pretty clear: trading in those securities would likely dry up and valuations would quickly fall off a cliff.
The SEC had a good reason for approving the rule – at least when it came to stocks. Officials at the time pointed out that the over-the-counter markets were loaded with shares of companies that would go months, or even years, without filing earnings reports. And these penny stocks were a favorite of scammers who would buy tons of shares for almost nothing, hype them on social media and then sell once the dumb money poured in. This old pump-and-dump scenario became even more of a problem for the SEC’s market police during the pandemic when numerous inexperienced investors downloaded apps for their phones and started trading for the first time.
Here’s a comment from then SEC Chairman Jay Clayton at the 2020 meeting where the agency made the rule changes:
“There are thousands of issuers of quoted OTC securities that are currently dark, meaning that they do not disclose current information publicly. The commission expends substantial resources in addressing fraud related to the securities of OTC issuers. These cases have involved substantial harm to investors – particularly retail investors.”
But it turned out that banning brokers from offering price quotes was a blunt instrument, even to fix a fairly serious problem. And, as is often the case, the well-intentioned rule had some knock-on effects.
That became clear about a year ago when bond traders learned the SEC was determined to apply the revised regulation they assumed was meant for stocks to fixed income (except for municipal bonds), as well. On the surface, that may not seem a very big deal. After all, massive corporate bond issuers like Microsoft and Apple report their earnings every quarter.
Yet there’s an entire market worth trillions of dollars for debt that doesn’t have widely available financial data. This includes asset-backed securities, collateralized loan obligations, mortgage securities and bonds issued by private companies. A question began swirling around Wall Street trading desks: Were brokers – prompted by the SEC – about to shut down secondary-trading in these markets, effectively turning them into investing deserts? The answer was yes.
Not wanting to see this business disappear, brokerage firms started aggressively lobbying the SEC last August to cut them some slack and delay the rule’s application to fixed income. The agency ultimately listened. While the rule took effect for stocks in late 2021, it was postponed a few months for bonds. The SEC then extended the deadline again, until January 2023.
This brings us to news: Just last month, the SEC staff privately told at least two broker trade groups – the Securities Industry and Financial Markets Association and the American Securities Association – that they shouldn’t expect any further reprieves, according to people familiar with the matter. The likely result, according to a number of market participants, is that trading in some private debt may dry up dramatically. They add that it’s now on firms to figure out a way for all the issuers of complex debt to disclose the underlying financial data – an exceedingly tall order… (Tuesday)
GOP Assault on ESG: Republican Study Committee Chairman Jim Banks issued a pointed memo last month that is designed to educate his members on the Environmental Social and Governance investing movement. While it’s not surprising that the conservative House caucus leader is (to put it mildly) not a fan, the document underscores some of the talking points and strategy in the Republicans' fight against ESG. And though the arguments may be one-sided, the paper serves as a good reminder of what’s in store for big asset management firms, Wall Street banks, pro-climate CEOs and the Gary Gensler-led SEC if Republicans take control of the House next year.
Here’s a few pertinent points from the July 27 two-pager, which is not so subtly titled, “The War on American Energy: Ground Zero.” It was also signed by House Financial Services Committee members Blaine Luetkemeyer, French Hill, Andy Barr and Bill Huizenga.
The definition:
“ESG refers to the progressive scheme through which the Left pressures corporate America to take positions on social and political issues that have nothing to do with business. Wall Street likes to market and sell ESG or `socially responsible’ funds that invest in compan[ies] based on criteria like greenhouse gas emissions or executives’ compensation. But ESG funds often charge higher fees and underperform when compared to a low-fee index fund[s] - this ultimately hurts everyday investors.”
Who knows what this is? Not investors:
“Only 24% of retail investors can define ESG and only 21% know what the letters in ESG stand for. Yet the nation’s largest asset managers have made a fortune on ESG at the expense of everyday investors.”
Poor performance:
“[S]ay an ESG fund considers the oil and gas industry to be ‘bad’ and excludes all energy investments. The S&P 500 Ex-Energy fund fell 17.35% since January 2022, whereas the Dow Jones U.S. Oil & Gas Index gained 28.37% during the same time. Which would you have rather invested in?” (Monday)