Talking Crypto Policy and the Ripple Case; SEC Republican Warns on Mutual Fund Rules; Senator Blasts Gensler's Union Deal; Housing Advocates Worry About Bank Capital Plan
Capitol Account: Free Weekly Version
There was a lot to follow in financial regulation this week. House Republicans continued to enjoy their self-styled ESG month, hauling executives up for hearings and firing off letters to BlackRock and other asset management firms. GOP lawmakers in the House also introduced a new digital assets oversight bill. It already seems to be going nowhere fast. We covered a spirited talk by an SEC commissioner who warned that her agency may be trying to turn mutual funds into banks. We wrote about Chair Gary Gensler’s appropriations testimony where he was castigated for cutting a deal with the SEC union that brings employees into the office only four days a month. We also did a piece on the complicated bank capital plan coming from the Fed and other agencies. It’s suddenly (and surprisingly) causing concern in the fair housing community. Lastly, we spoke with a Duke crypto expert to get some clarity on the recent district court ruling in the SEC’s case against Ripple.
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Friday Q and A: Last week’s ruling in the SEC’s case against Ripple gave a big bounce to the crypto industry and delivered a comeuppance to its No. 1 government antagonist Gensler. Or did it? Not if you ask the SEC, which announced it was “pleased” with some aspects of the order.
The spin, frankly, has been a bit head spinning. One thing most people can agree on, however, is that the district court decision is murky – injecting a fair amount of uncertainty into the high-profile legal battle. In her decision, Judge Analisa Torres found that the XRP coins Ripple sold directly to institutional investors were securities, but when individual investors bought the tokens on exchanges they were not. So to some extent, the question of who gets to declare victory depends on who you ask.
In an effort to dig a little deeper into the ruling, we called up Lee Reiners, a lecturing fellow at Duke University’s Financial Economics Center. He’s been enmeshed in digital assets policy, closely watching – and participating in – the regulatory debate. Reiners testified on crypto oversight before both the House Financial Services and Senate Banking committees this year. He’s been a strong advocate for making the SEC the lead regulator.
A former supervisor for systemically important financial institutions at the Federal Reserve Bank of New York, Reiners joined Duke seven years ago. He now teaches classes on cryptocurrency law and policy and co-hosts a podcast called Coffee & Crypto. Read on to learn his thoughts about the Ripple and Coinbase enforcement actions, as well as why the CFTC should not be responsible for overseeing crypto. What follows is our (lightly edited and condensed) discussion.
Capitol Account: What’s your top-line view of Judge Torres’ decision?
Lee Reiners: It's definitely a loss for the SEC. Both sides are spinning it, which is to be expected. The crypto industry is spinning it more.
CA: Shocking.
LR: There's more of them. And they’re certainly more active on social media.
CA: Cut through some of the histrionics for us.
LR: They’re proclaiming this is a death blow to the SEC's quote-unquote regulation by enforcement agenda. Obviously that's not true. First, it's important to note that the Ripple case was initiated by [Trump SEC Chair] Jay Clayton. The industry is sort of spiking the football at Gensler's face. Gensler supported the enforcement action, but this was a Clayton-era case. Second, it's not precedent throughout the country. This is just applicable in the Southern District in New York…It's probably going to get appealed. The SEC’s reviewing it, and it very well could get overturned.
CA: So stay tuned?
LR: This is not the end of the saga, by any means. But certainly it's a chink in the SEC's armor, because up until this point the SEC had not lost a single crypto enforcement case. There's over 130 enforcement actions and they either won or they settled – which the crypto industry is fond of pointing out is not the same thing as winning…Nonetheless, that's a pretty impressive track record. And it reinforced the SEC's line, which I supported, that the law is pretty clear.
CA: And it's no longer?
LR: Now we have a federal district court judge who looked at the facts and circumstances and said, 'You know what? It's actually not clear, and I don't agree with the SEC's position’...It's the judiciary's opinion that matters here. That's important to keep in mind because I think you could have 10 different judges look at the same fact pattern in the XRP case and come to multiple different conclusions. If that's the case, then it's hard to continue to argue that it's clear.
CA: It sounds like the matter will ultimately need to be settled by a higher court.
LR: Absent federal legislation…This question of whether or not any given token is a security, I think, will ultimately have to be decided by the Supreme Court…The regulatory clarity can only be provided by the appellate courts. I've always rejected that argument, but I've come around to it more in light of Judge Torres' ruling.
CA: You wrote a piece that pointed out some flaws with the decision. What are the problems you see?
LR: The decision flips the purpose and intent of securities law on its head. Securities laws were passed, and are enforced, to protect retail investors. What Judge Torres found is that the institutional sales were investment contracts, and therefore should have been subject to the protections afforded by the securities laws. Whereas the programmatic sales, which were made to retail investors on secondary exchanges, were not investment contracts. Therefore the securities laws did not apply. That's just a bizarre outcome.
CA: What does this mean for Coinbase, which is also being sued by the SEC?
LR: The logic, if you applied it broadly to the Coinbase case, and just crypto exchanges in general, would clearly absolve them of listing unregistered securities and therefore operating as unregistered securities exchanges. You've already seen Paul Grewal, the Coinbase GC, and others affiliated with the company tout this ruling as a win, and vindication for them. Certainly if other courts adopt Judge Torres’ logic, then Coinbase will win.
CA: Could the decision be a fatal blow for that enforcement action? And maybe even Gensler’s broader crypto push?
LR: Absolutely. The most significant aspect of this ruling is how it applies to the Coinbase case. Whether or not any given token is a security is interesting, but it's not as relevant as cases involving these large intermediaries where hundreds of tokens are trading. That's where Chair Gensler has decided to focus his efforts, rather than play a game of whack-a-mole going after all these token issuers.
CA: But you don’t think it is necessarily going to be smooth sailing for Coinbase either.
LR: Even if Coinbase wins their case, I'm not entirely sure that being a standalone cryptocurrency exchange is a profitable business model. Certainly it hasn't been since the crypto winter set in last May. They're kind of fighting for their life – independent of whether or not they get favorable legislation or courts rule in their favor. That's why they're trying to diversify their business model – why they're partnering with, for instance, BlackRock on its ETF application. It’s why they're providing custodial services and working with institutional investors. Because they need to…(Friday)
Taking a Swing: One indication of the opposition to the SEC’s demand that mutual funds use swing pricing: The standing room only crowd for Hester Peirce’s 9:00 a.m. talk on the issue, hosted by the U.S. Chamber of Commerce. The Republican commissioner, of course, has made no secret of her disdain for the plan and neither has the business trade group. The event was (not so subtly) entitled “Swing and a Miss” and most of the audience seemed to agree with the sentiment.
Peirce, who voted against the plan when it was issued in November, said she was gratified by the turnout. “When we proposed this rule I really thought there would be some sort of cataclysmic response from people, that people would just be up in arms immediately,” she said. “I was sort of surprised that people were pretty calm about a rule that I thought was potentially so problematic.”
Objections to the mandate, however, have grown in the ensuing months and now a wide range of retirement plan administrators, Republican and Democratic lawmakers, and even consumer groups have joined the industry in expressing serious reservations. The SEC itself unexpectedly backed away last week from requiring money market funds to use swing pricing. But the regulator is still considering a separate plan that would apply the mechanism to a much larger universe of mutual funds.
In her remarks, Peirce said it is “too early to tell” if the commission will take a similar approach with the broader rule. She was also very dubious about the alternative method that the SEC adopted for money market funds, a “liquidity fee” to be charged to shareholders that sell in times of market volatility. “I really don’t like one-size-fits-all mandates like this,” Peirce noted, adding that “we designed it with no input.”
Being in the minority on the commission, Peirce can’t stop the SEC from moving ahead on the latest swing pricing rule. But she offered up a lot of fodder for critics – and any firm or trade group that may want to challenge the regulation in court. Peirce panned, for instance, the underlying cost-benefit analysis. She also questioned whether the agency has the authority to adopt the proposal, given its vast economic implications.
Swing pricing essentially penalizes investors that flee during market stress, and SEC Chair Gensler has argued that it protects a fund’s remaining shareholders from being forced to shoulder the costs. Peirce, however, said that is a “theoretical problem” that the commission’s economic review hasn’t proved. “It really has been sort of this theoretical exercise, an academic exercise – which is what a lot of our rulemakings are now.”
Peirce also called out the SEC for acting at the behest of bank regulators concerned about stability in the financial system. (The Fed was forced to step in and backstop money funds in March 2020 as the pandemic took hold and investors sought more cash. Mass withdrawals from corporate bond mutual funds also caused problems.)
“The Fed and FSOC, I think, have put pressure on the SEC to try to solve these problems,” she said. “I fear what that ends up doing is trying to turn money market funds into banks, and now trying to turn open-end funds into banks.”…(Thursday)
SEC Union Deal Blasted: Gensler spent about 90 minutes on Capitol Hill this afternoon, testifying before a Senate Appropriations subcommittee on the SEC’s budget. Our favorite exchange from the hearing came when Susan Collins raised her “deep concern and disappointment” about the deal the chair cut with the agency’s union that brings workers into the office only twice per two-week pay period.
“I will quickly concede that there are some jobs that can be done remotely, but when you’re serving the public, when you’re helping to protect consumers, when you’re dealing with large financial firms, you need people to be at work,” the Maine Republican told Gensler. “You need people to be in the office. You need people to benefit from the conversations that they have with their fellow staff members and regulators.”
In response, Gensler said that during the pandemic when offices were shut down “we actually found that the staff could be quite productive.” He added: “We did end up bargaining in good faith, and this is where we landed.”
Collins, however, stressed that the agreement “does not strike me as a good deal for the taxpayers, or for the consumers that you’re charged with protecting.”
The senator also pointed out that empty offices can be a problem for the firms that the SEC oversees. “The companies and financial advisers whom you’re regulating are going to find it difficult to get information,” she noted. “Many of them have brought their employees back to work – they’re certainly back to work more than four days per month.”…(Wednesday)
Housing Uproar: For months, banks have struggled to make headway in their battle with regulators seeking to impose a tougher capital regime. But the industry may soon gain some surprising (and valuable) allies: liberal housing advocates.
While few would expect the left to argue against new rules that handcuff big banks, one aspect of the impending capital proposal has caught the attention of housing groups because it could end up making mortgages more expensive for lower-income people. That could also stir up trouble with influential Democratic lawmakers who are strong proponents of boosting homeownership.
The provision, part of a plan being released next week by the Fed, OCC and FDIC, is expected to call for banks to hold more capital against mortgages that come with a low down payment – the types of loans typically used by minorities and first-time home buyers. That isn’t sitting well with some housing groups.
“What happens when you raise the capital costs? You make more affordable loans less economic for lenders, which means they will make fewer of them,” notes David Dworkin, the president and CEO of the National Housing Conference. “There may be no more effective way for regulators to undercut efforts to close the racial homeownership gap than by this capital proposal.”
Such critiques could cause some heartburn in the Biden administration, which has made it a priority to expand homeownership for people of color and other underserved communities. The White House’s progressive allies have also focused a lot of their attention on housing, especially as skyrocketing prices and rising interest rates have made it more and more difficult for average Americans to buy houses. (The U.S. median home price is now $436,800, making a 20 percent down payment more than $87,000.)
The Fed declined to comment on the expected mortgage capital change. Though it is a bit technical, the plan tinkers with the so-called risk weights (calculations that determine the amount of capital needed) for mortgages that banks hold. The risk weights for mortgages with a 20 percent to 40 percent down payment – loans that are typically marketed to middle-income borrowers – are likely to remain unchanged, sources said. But they will rise for loans with less than 20 percent down…(Wednesday)
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