The Securities and Exchange Commission and other state and federal regulators have increasingly focused their attention on cryptocurrencies and the exchange platforms on which such digital assets trade.
While such attention may be warranted in light of the strong growth characterizing this still nascent industry, the SEC’s efforts may have begun to run counter to the SEC chairman’s priority to foster greater innovation and capital formation in the U.S.
A central question for the digital assets industry has long been the circumstances in which the SEC would consider a particular token or coin to be a security. If such an asset is a security, the securities laws require that it be registered with the SEC unless a statutory exemption applies. In addition, exchanges or other platforms where unregistered securities may be trading risk their own exposure to SEC scrutiny.
Whether the courts, and by extension the SEC, will deem a particular asset, including cryptocurrencies, to be a “security” for purposes of the U.S. securities laws is governed by the 1946 case S.E.C. v. Howey. In that case, Howey had leased citrus farmland to speculators in order to finance certain development. The question presented was whether those lease contracts were securities. The court held that they were securities because the lease contracts required “a person [to] invest his money in a common enterprise and [to be] led to expect profits solely from the efforts of the promoter or a third party.”
The SEC has applied Howey to cryptocurrencies. In June 2018, William Hinman, the director of the SEC’s division of corporation finance, expressed his view that, like the landowner in Howey, promoters of ICOs “overwhelmingly” tout their ability to create an innovative application of blockchain technology, while the passive investors in ICOs rely on promoters to build networks to make the enterprises successful. And in early April of this year, the SEC provided “Staff Guidance” to detail those factors under Howey the staff will likely consider relevant to a determination of whether a particular digital asset is a security. Finally, among other actions, the SEC recently sued a company for conducting a $100 million unregistered securities offering of digital tokens.
The SEC has sought to ensure that cryptocurrency purchasers are protected by the U.S. securities laws, but its efforts to do so have led industry participants to shift their operations overseas. For example, the crypto startup Circle, which operates an over-the-counter trading desk for cryptocurrencies directed largely at institutional investors, announced on May 22, 2019, that it was laying off 10% of its workforce in response to regulatory uncertainty in the U.S. In addition, Circle’s crypto exchange Poloniex announced on May 16, 2019, that it was restricting trading in nine of its cryptocurrencies to non-U.S. markets.
Perhaps surprisingly, this trend of an industry leaving the U.S. market to pursue opportunities abroad due—at least in part—to an uncertain or expensive regulatory framework was expressly identified by SEC Chairman Jay Clayton during his nomination hearings a little more than two years ago. Indeed, Chairman Clayton noted the number of U.S.-listed public companies had declined 35% since 1997 and that the number of U.S. initial public offerings were only 128 in 2016, compared with 845 in 1996.
While some of this decline in IPO activity may result from the growth in private capital available for funding businesses, Chairman Clayton has identified the higher regulatory and legal costs associated with filing an IPO in the U.S. as another important factor as potential IPO filers increasingly look to other markets. In his testimony, Chairman Clayton testified that he saw “meaningful room for improvement” in this area and that he looked forward to working with Congress to pursue such improvements. Chairman Clayton later noted concerns that the IPO process required companies to make disclosures that discouraged executives from taking their businesses public.
Since taking the helm of the SEC, Chairman Clayton appears to have made progress in reversing the trend of declining IPOs in the U.S. by easing regulatory requirements. In the first two months of Chairman Clayton’s tenure, the SEC began allowing all companies to confidentially file draft IPO registration statements, simplifying the regulatory requirements for going public. In May 2018, the SEC announced that it was considering expanding its “testing the waters” program to larger companies, which would allow those companies to hold talks with institutional buyers and accredited before filing registration statements with the SEC.
These and other efforts by the SEC appear to have had an impact. In Chairman Clayton’s first year, the number of IPOs filed in the U.S. increased 24%. While Chairman Clayton has apparently made progress in his goal to address IPO filers leaving the U.S. for less costly markets, it remains to be seen whether the SEC’s efforts concerning digital assets leads to similarly diminished creation, innovation and trading activity in those assets in the U.S.
