For the crypto industry, last year was “terrible, horrible, no good, very bad,” SEC Commissioner Hester Peirce said in a long speech.
There were several spectacular failures and fraud, costing investors multi-billion dollars. But ever the free market champion, she said that regulators working together with the industry to come up with a workable regulatory framework is the best way forward.
“The first and most important lesson… for people who believe in crypto’s future is that they should not wait for regulators to fix the problems that bubbled to the surface in 2022,” Peirce said before Digital Assets at Duke Conference on Jan. 20, 2023.
In her view, crypto entrepreneurs themselves must root out harmful practices and encourage good behaviors. Regulatory solutions tend to be inflexible; thus, it should be a last resort, not a first resort.
“People working together voluntarily are much better at fixing things than regulators using their inherently coercive power to impose mandatory solutions,” said Peirce, also known as Crypto Mom for her advocacy of the industry.
“Privately designed and voluntarily implemented solutions can be both more effective and more tailored because the people driving them better understand the technology and what they are trying to achieve with it,” she explained. “Iterating and experimenting with private solutions is easier than it is with regulatory ones. Moreover, private solutions avoid the systemic risk that comes from an industry homogenizing because everyone has to fit into the same regulatory parameters.”
She believes that 2022 was a teachable moment not only for the crypto industry but also for regulators. The industry must listen to critics, but regulators must foster an environment where good things can flourish while bad things perish.
“What we should not learn from the events of 2022 is that the failures of centralized entities are failures of decentralized protocols,” Peirce said. “Many of the 2022 failures involved crypto market participants doing the same foolish and fraudulent things that participants in other markets have been doing for centuries.”
Peirce’s Suggestion for Path Forward
Coming out of a dismal year for the crypto industry, it is imperative, in Peirce’s view, for the SEC to do some kind of notice and comment process to resolve the trickiest crypto policy issues.
While providing some tepid praise of some of the SEC’s actions, she reiterated that the commission does not have clear rules of the crypto road. The agency is good at bringing enforcement actions to go after fraudsters in crypto land. But there are still regulatory uncertainties that deter would be innovators and entrepreneurs from fully engaging in crypto activities.
The SEC has the authority to waive or modify legal obligations when there are good reasons to do so. And the commission used exemptive orders to provide relief from following certain securities laws requirements for certain crypto assets.
Moreover, SEC Chair Gary Gensler in September last year said he has “asked staff to sort through how we might best allow investors to trade crypto security tokens versus or alongside crypto non-security tokens.” Peirce said this is an area in which experimentation through no-action letters and exemptions would be possible.
He has also said that given “the nature of crypto investments . . . it may be appropriate to be flexible in applying existing disclosure requirements.”
Peirce said she agrees with the sentiment.
But at the end of the day, “the SEC needs to conduct better, more precise, and more transparent legal analysis,” Peirce said.
She described the SEC’s approach to regulating cryptos as follows: ”We tell people to come down to the office to talk to us about their projects, plug the information they give us into our proprietary security-identifying algorithms, and then send the people home with a court date.”
“Hardly a reasonable way forward, and one that results in what one lawyer has dubbed ‘regulation by anxiety,’” she added.
The SEC uses the now well-known Howey Test to figure out whether a certain crypto asset is an investment contract that falls under the definition of a security. But in her view, the SEC has been imprecisely applying the law, creating arbitrary and destructive results for crypto projects and buyers.
Making regulatory decisions more difficult is the unanswered question about who regulate crypto in a fractured regulatory system. The Commodity Futures Trading Commission (CFTC) also has a regulatory role to play.
“Why not set forth a coherent legal framework in a rule?” Peirce said. “After all, if we continued with our regulation-by-enforcement approach at our current pace, we would approach 400 years before we got through the tokens that are allegedly securities.”
A better approach is to do a notice-and-comment process that will allow broad public participation in developing sound regulation, she said.
She said that such public conversations should include federal and state regulators, crypto developers and users, consumer advocates and crypto critics. She suggested roundtables that are conducted jointly with the CFTC.
Solomonic Solution?
In her speech, she also touched upon some regulatory solutions that experts have been discussing. She mentioned a solution floated by Steven Lofchie, a partner with Fried, Frank, Harris, Shriver & Jacobson LLP. He proposed a Solomonic approach, in which platforms and tokens could pick between the SEC and CFTC.
“This approach would allow for regulatory competition, which could improve regulatory quality,” Peirce said. “It would also provide regulatory clarity to market participants who might otherwise incur legal bills to evaluate if their product is a security or a commodity and defend their decision to a skeptical regulator.”
However, she again said that decisions about allocating regulatory authority belong to Congress. But regulators can lay the groundwork for Congress to write a workable legislation.
“The ideal framework would reduce regulatory anxiety for would-be innovators and increase the difficulty for would-be fraudsters, which would help to separate the wheat from the chaff,” she said. “A rational framework should facilitate the compliance of good faith crypto actors with our securities laws, which would free the SEC to focus more of its resources on the bad faith actors.”
This article originally appeared in the February 1, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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