When compared to the rest of the world, the Securities and Exchanges Commission (SEC) appears to have a higher rate of intervention in blockchain related cases. In just the last 18 months, the U.S. regulator ordered Telegram to stop selling its cryptocurrency, fined Kik Interactive $5 million over issues with its Kin token and is currently suing Ripple.
Recent research by Yuliya Guseva of Rutgers Law School and her colleague Douglas S. Eakeley, co-director of the Rutgers Center for Corporate Law and Governance and Alan V. Lowenstein Professor of Corporate and Business Law, confirms that the SEC “brings more enforcement actions against digital-asset issuers, broker-dealers, exchanges, and other crypto-market participants than do regulators in most other major jurisdictions combined.”
Prof. Guseva acknowledges that the size of the U.S. cryptocurrency market is a contributing factor to the SEC’s high rate of intervention. However, she believes the other key factor may be the use of the Howey test for determining whether a transaction should be classified as an investment contract and therefore registered as a security. The broad scope of the test has allowed the SEC to extend its authority over the past 70 years to a wide range of financial instruments, which today also include digital assets.
Prof. Guseva cautions that, unfortunately, there may be enforcement inconsistencies that highlight how a Supreme Court ruling from 1946 may be unsuitable for judging 21st century innovations. In her recent paper, Guseva emphasizes that the SEC seems to have departed from its previously clear policy of prosecuting crypto-fraud and protecting investors. Kik, Telegram, and Ripple are important examples of this departure.
“I am worried about the dynamic inconsistencies in the recent SEC enforcement actions. Together with the broad reach of the Howey test, the inconsistencies in enforcement may exacerbate uncertainty and fail to provide market participants with a clear ex ante understanding of the securities laws.”
Market actors need to understand what is expected of them and how to effectively comply with regulations. In fact, markets prefer predictability and certainty, while inconsistencies and unclear rules risk forcing U.S. companies to relocate their businesses to other countries and may profoundly affect the direction of financial innovation.
In contrast to the U.S., the lack of regulatory clarity and the focus on enforcement are not the case in other countries. Some foreign regulatory bodies provide more guidance to digital-asset markets. The UK’s Financial Conduct Authority, for instance, classifies digital assets based on their functions and utility and relies more on upfront guidance and clear prospective rules than retrospective enforcement.
Of the 23 major financial market jurisdictions that Prof. Guseva researched for her paper, nine had yet to take any form of enforcement action against crypto-related companies, and the remaining jurisdictions in the sample resorted to more lenient enforcement actions compared with those initiated by the SEC. It is possible that some foreign jurisdictions adopted this approach as a deliberate strategy appealing to fintech startups looking for a more welcoming environment.
Another concern is that “[i]f the SEC can no longer provide clarity through strategic predictability of a transparent enforcement approach, and if the market finds substantial inconsistencies in the regulator’s moves and strategic commitments, the fabric of cooperation between the innovators and the regulator can be undermined.” Guseva suggests that when this happens, even bona fide firms may be less inclined to comprehensively comply with U.S. securities law or seek cooperation with the SEC.
Guseva also argues in her recent article that the SEC should be mindful of the cost-benefit analysis in its enforcement policies, particularly in cases not involving fraud or cases concerning opaque regulatory issues, such as classifications of assets as securities or as commodities. “Digital assets can have different utilities or a limited application,” Guseva explains. “That’s why a functional approach where one looks at the actual uses and applications of a digital asset may be more appropriate. Even then, however, regulatory analysis is not always that simple.”
Given the complexity of blockchain technology, Prof. Guseva believes that academia has an important role to play in helping to educate regulators and policymakers about the benefits and risks of innovative financial instruments. The current global pandemic and subsequent economic downturn has made statutory reform even more critical, as innovations can drive future growth and provide new ways to help people during a crisis.
With the help of Ripple’s University Blockchain Research Initiative (UBRI), the Rutgers Center for Corporate Law and Governance and Prof. Guseva recently launched the Fintech and Blockchain Collaboratory, a gathering of academics, regulators, and lawyers interested in regulatory and industry developments in fintech, defi and blockchain-based businesses. The purpose of the Collaboratory is to discuss the latest policy issues in fintech and crypto. Guseva is also teaching a new Financial Regulation and Innovations course with Prof. Ozair of Rutgers Business School. In addition, Prof. Guseva created a research group that has already attracted many students.
“Our recent initiatives would not be possible without the support that we received from UBRI,” Prof. Guseva concludes. “It has enabled us to do research and provide better education on technology, fintech, and crypto to our students. Given the need for reform in the crypto- and fintech-space, law schools have become crucial hubs for debating policies and suggesting doctrinal and regulatory solutions to the industry, the regulators, and other stakeholders.”