SEC's regulatory approach chills innovation and may send crypto overseas

"Come in and talk to us."

Gary Gensler, chair of the Securities and Exchange Commission, invites crypto companies to stop by, sit down and be proactive about understanding the application of securities laws to their entities' business.

However, rather than provide useful guidance to entities who try to "come in and talk," the SEC begins to investigate, serve subpoenas, and, in the case of Coinbase, threaten a lawsuit after Coinbase attempted to proactively engage with the commission. In recent months, the SEC has ramped up its "regulation by enforcement" strategy — despite publicly denying the practice — posing a threat to the United States' lead in the global race to capitalize on the digital assets economy. 

Two recent actions illustrate the SEC's hostile approach. In July, the SEC filed an enforcement action against a former Coinbase employee and two other individuals for alleged insider trading. And in a more recent move, the SEC is now apparently investigating whether Coinbase allows unregistered securities to be traded on its platform.

Other than the focus on Coinbase in particular, both actions illustrate the SEC's approach to regulating digital assets through enforcement rather than through well-informed rulemaking or guidance where the American people have a say. Indeed, industry is forced to manage compliance by reading between the lines of SEC enforcement filings, whether these are complaints filed in court or settlement agreements posted on its website. These are not the actions of a pro-innovation agency cultivating good relationships with an industry that it supposedly wants to have "come in and talk."  

As cryptocurrencies' widespread adoption and prominence continue to grow, there is broad consensus among policymakers and industry stakeholders alike that clear, fit-for-purpose regulations are long overdue. Leading figures in the crypto ecosystem have long asked for a better-defined regulatory framework to guide their work, but the recent approach by SEC leadership poses a serious threat to domestic innovation in this space.

Rather than working alongside Congress and other agencies like the Commodity Futures Trading Commission to coalesce around a unified approach to crypto regulation, the SEC has taken an opposite approach: working to slow down the industry and stifle innovation. Even SEC Commissioner Hester Peirce voiced her opposition to the SEC increasing resources and staff to focus on enforcement.

Unlike Congress, the CFTC and the millions of people who own and use cryptocurrencies, the SEC seems to inflexibly view these assets as securities rather than commodities, while failing to provide clarity as to why. Naturally, the SEC would be forced to relinquish its oversight of crypto if the assets are deemed commodities, suggesting a rigid bias behind its beliefs that is not rooted in any legitimate legal basis, but rather a tortured interpretation of a more than 70-year-old Supreme Court precedent. 

What could the SEC do if it truly wanted to work in cohesion with rather than punish the industry? For starters, it could provide updated guidance on the application of the Howey test, the standard for determining whether an asset constitutes an investment contract, and therefore a security. Rather than leading the conversation on acceptable standards for securities classification designed for the digital asset age, the SEC has stayed silent since its latest guidance in April 2019 and left entrepreneurs and developers to swim in murky waters.

This much is clear: Crypto market participants want to comply, but the SEC has failed in its responsibility to explain how they can do so. The SEC was established to protect investors, support efficient markets, and facilitate capital formation. The agency's approach to crypto runs counter to this mission.

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Simply stating that the "vast majority" of tokens in the crypto market are securities is nowhere near enough. The agency's lack of clarity has made it nearly impossible to assess compliance with the federal securities laws, both harming investors and creating persistent confusion and uncertainty in the markets. The SEC's regulation-by-enforcement approach also stifles capital formation by inhibiting innovation through the fear of enforcement.

If regulatory clarity and certainty would not support fair, orderly and efficient markets and facilitate capital formation, I don't know what would.

And I'm not alone in that view. As CFTC Commissioner Pham wrote in response to the SEC's recent insider trading enforcement action, "[m]ajor questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input. ... Regulatory clarity comes from being out in the open, not in the dark." If the SEC continues down this counterproductive path, the United States risks ceding our edge in technological innovation and sending this burgeoning industry overseas.

Regulation should be spurred by congressional debate and legislation — not through the enforcement decisions of a lone independent agency. Fortunately, members of Congress and other policymakers have realized the opportunity that crypto offers the United States and are working hard to craft sensible legislation that will move the technology forward. The SEC is the outlier, wedded to an outdated perspective on enforcement, which, if it continues, will ensure that the crypto's future will develop somewhere other than the United States.