Recent Legislative and Agency Efforts to Enhance Regulation of Digital Assets
The recent bankruptcies in the digital assets industry have prompted a renewed commitment among lawmakers and agencies to create a federal legislative and regulatory framework for digital assets. The industry currently faces both legal uncertainty and increased enforcement activity by the SEC, whose chairman, Gary Gensler, has asserted that most digital assets qualify as securities rather than commodities. Under consideration by Congress are two bills attempting to clarify the jurisdictions of the Commodities Futures Trading Commission (“CFTC”) and the U.S. Securities and Exchange Commission (“SEC”) over digital assets while enhancing consumer protections. Meanwhile, the Biden Administration has directed agencies to increase cross-agency cooperation and implement specific proposals to enhance federal oversight of the digital assets industry.
The bipartisan Responsible Financial Innovation Act (the “Lummis-Gillibrand Bill”), released in June 2022, proposed bright line rules for categorizing digital assets as commodities or securities. Notably, the Lummis-Gillibrand Bill proposes a narrower definition of digital assets as securities than under the traditional Howey test. Under Howey, assets qualify as securities when their purchases involve 1) an investment of money 2) in a common enterprise 3) with expectations of a profit 4) to be derived from the efforts of others. By contrast, under the Lummis-Gillibrand Bill, digital assets do not qualify as securities unless they grant purchasers rights in the business entity issuing the asset, such as a debt or equity interest, an entitlement to interest or dividend payments, or a share of the profit or revenue in that entity.
For digital assets that might be considered securities under the Howey test but not under this restrictive definition, the bill creates a novel class of “ancillary assets” as commodities. Ancillary assets are defined as digital assets, like Bitcoin and Ethereum, which are provided to purchasers under investment contracts but which do not grant purchasers rights in the business entities issuing the assets. In a move that has been criticized as favoring the digital assets sector, the Lummis-Gillibrand Bill grants exclusive jurisdiction over all non-security digital assets to the CFTC, an agency with a substantially smaller staff and enforcement budget as compared to the SEC.
At the same time, the Lummis-Gillibrand Bill would seek to enhance consumer protections by imposing disclosure requirements on ancillary asset issuers. Although less stringent than current securities disclosure requirements, these requirements impose 38 categories of issuer disclosures to be provided to the SEC semi-annually. The disclosure requirements apply if, over the preceding fiscal year, the daily average aggregate value of all trading in a given ancillary asset across the United States exceeded $5 million and the issuer, or a shareholder owning 10% or more of any class of equity shares in the issuer, engaged in entrepreneurial or managerial efforts that determined the value of the asset. The Lummis-Gillibrand bill thusly aims to enable consumers to make informed decisions with regard to the purchase of digital assets.
The Digital Commodities Consumer Protection Act (the “Stabenow-Boozman Bill”), made public in August 2022, assumes a similar approach to digital asset regulation albeit with less definitional clarity. Like the Lummis-Gillibrand Bill, the Stabenow-Boozman Bill provides a broad definition of digital commodities that includes cryptocurrencies such as Bitcoin and Ether, and grants the CFTC exclusive jurisdiction over digital commodities. However, in contrast to the Lummis-Gillibrand Bill, the Stabenow-Boozman Bill provides no guidance regarding whether digital assets qualify as securities. Accordingly, the passage of the Stabenow-Boozman Bill provides leverage to the SEC to continue to argue that many digital assets quality as securities.
The Stabenow-Boozman Bill arguably assumes a less robust approach to consumer protection than the Lummis-Gillibrand Bill. The only disclosure requirement for digital commodities in the Stabenow-Boozman Bill is registration with the CFTC. More specifically, rather than specifying required categories of disclosures for digital asset issuers, the Stabenow-Boozman Bill directs the CFTC to engage in rulemaking to develop disclosure requirements.
While Congress has delayed consideration of the Lummis-Gillibrand Bill and the Stabenow-Boozman Bill, the Biden Administration released a proposed framework for agency activity to address digital asset regulation. On March 9, 2022, President Biden released an Executive Order directing the U.S. Department of the Treasury (“Treasury”) to work with other agencies to issue reports identifying financial stability risks, regulatory gaps, and policy recommendations.
Treasury subsequently published three reports in September 2022 outlining recommendations to enhance federal oversight over the digital assets sector. These recommendations included greater cross-agency coordination between among the U.S. Department of Justice, the SEC, and the CFTC to combat fraud and market manipulation involving digital assets; increased collaboration of interagency bodies such as the President’s Working Group’s Financial and Banking Information Infrastructure Committee, to identify and assess key risks related to digital assets, and an interagency working group, led by Treasury, that would consider the potential and risks of adopting a U.S. Central Bank Digital Currency.
Based on Treasury’s recommendations, on September 16, 2022, the White House released a report entitles “Comprehensive Framework for Responsible Development of Digital Assets.” The framework directs agencies to implement a series of specific measures to enhance federal oversight of the digital assets industry. Notably, the framework calls on both the SEC and the CFTC to redouble their pursuits of enforcement actions. Among other directives, the framework tasks the Department of Commerce with establishing a standing forum to bring together federal agencies, business, academia, and the public at large to inform federal regulation of digital assets. In addition to identifying gaps in the United States’ legal, regulatory, and supervisory regime governing over digital assets, Treasury is working to complete an illicit finance risk assessment on decentralized finance (DeFi) and will complete an assessment on non-fungible tokens (NFTs) by July 2023.
While the executive branch works to implement the September 2022 federal framework, legislators in both houses of Congress have called for additional legislation to address digital assets. In January 2023, House Republicans established the Subcommittee on Digital Assets, Financial Technology, and Inclusion. Overseen by the House Financial Services Committee, this subcommittee will work to provide regulatory clarity to the digital asset ecosystem. In particular, the subcommittee plans to construct a federal regulatory framework for stablecoins backed by the U.S. dollar.
More recently, in February 2023 the Senate Banking Committee held a hearing to discuss the recent crypto bankruptcies. The Committee heard testimony from law professors who shared varying proposals for digital asset regulation, ranging from a laissez-faire approach permitting industry self-regulation to an explicit grant of jurisdiction to the SEC as the primary enforcement of digital assets. During the hearing, Committee Chairman Sherrod Brown also proposed separating consumer funds from company assets, requiring clearer disclosures and transparency from digital assets issuers, and strengthening oversight and accountability. The Senate Banking Committee intends to develop new legislation related to digital assets over the coming year.
Numerous lawmakers have attempted to strike a balance between encouraging the growth of the digital assets sector and protecting consumers. Both the Lummis-Gillibrand Bill and the Stabenow-Boozman Bill err on the side of promoting industry growth by granting the CFTC, rather than the SEC, exclusive jurisdiction to regulate most digital assets. In contrast, the Biden Administration has called for greater cross-agency cooperation to establish a comprehensive regulatory framework for digital assets. These two approaches are, however, complementary in that both seek to provide greater clarity through legislation to pave the way for agencies to develop more specific expertise. Although Congress and the Biden Administration may not move in lockstep, the year ahead will certainly see a concerted effort by both branches of the federal government to establish a federal legal and regulatory framework for digital assets.