Is SEC “Regulation by Enforcement” for the Digital Asset Industry Next Up?

Faegre Drinker Biddle & Reath LLP

Cryptocurrencies are one of the fastest growing asset types worldwide. Cryptocurrencies, as an asset class, total over $1.5 trillion in market capitalization. With the rapid growth of this asset type, SEC Chair Gary Gensler shared his views for the SEC in this area. At a recent conference, Chair Gensler continued to broadly characterize most digital assets as “investment contracts,” placing cryptocurrencies within the scope of the SEC’s enforcement powers. During his remarks at the Aspen Security Forum on August 3, Chair Gensler stated, “many of these tokens are offered and sold as securities” because they meet the definition of an “investment contract.” As established by the U.S. Supreme Court under the “Howey Test”, investment contracts are defined as agreements in which a person invests money in a common enterprise, expecting profits based on the efforts of others. Investment vehicles that satisfy the “Howey Test” definition for investment contracts are securities that fall within the jurisdiction of the SEC.

Chair Gensler further stated that the cryptocurrency area currently “lacks the typical investor protection guardrails” and that he has asked Congress for additional authority to “prevent transactions, products and platforms from falling between regulatory cracks.” Chair Gensler’s views appear supported by the SEC’s Division of Enforcement having brought 75 enforcement actions over the last decade. However, others are not convinced that the SEC has clearly defined jurisdiction.

Tension Points: Should Securities Laws Apply to Digital Assets?

Some commentators in the field have criticized the SEC’s lack of clarity about the application of securities laws to the universe of digital assets. Commissioner Hester Peirce has stated that she and Chair Gensler “have a disagreement on the clarity point” as to when offerings of digital assets will be deemed securities offerings. Others, including Commissioner Brian Quintenz of the Commodity Futures Trading Commission (CFTC), have pushed back against Chair Gensler’s claims regarding the SEC’s enforcement powers. In a tweet following Chair Gensler’s remarks, Commissioner Quintenz wrote, “[j]ust so we are all clear here, the SEC has no authority over pure commodities or their trading venues, whether those commodities are wheat, gold, oil, … or #crypto assets.” Most notably, Bitcoin, currently the largest cryptocurrency by market capitalization, has already been deemed subject to the CFTC’s oversight as a commodity for purposes of fraudulent activity.

Moving Forward: To Be or Not to Be [A Commodity That Is].

Moving forward, the question will be which characteristics will determine whether a digital asset is regulated as a security or as a commodity. Chair Gensler’s comment that “no single crypto asset … broadly fulfills all the functions of money” increases the uncertainties regarding what it takes, from the SEC’s perspective, for a token to fall outside of the SEC’s oversight authority. Chair Gensler’s further declaration that the SEC “[has] taken and will continue to take our authorities as far as they go,” makes clear the SEC’s intention to act as a “watchdog” over the digital asset space. With the SEC’s recent acknowledged use of regulation by enforcement in other areas, we may start to see additional efforts by SEC Enforcement to further expand its efforts in this area.

Practice Points:

  • Watch for the upcoming result of SEC v. Ripple Labs, INC.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Faegre Drinker Biddle & Reath LLP

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