On April 14, 2023, by a 3-2 party-line vote the US Securities and Exchange Commission (SEC) reopened the public comment period and provided supplemental information on amendments proposed in January 2022 to the definition of “exchange” under Rule 3b-16. The SEC previously reopened the comment period in May 2022. The April 2023 action provides supplemental information and economic analysis regarding trading systems that trade crypto asset securities that would be newly included in the definition of “exchange” under the proposed rules.
By way of background, the 2022 release proposed sweeping changes to the scope of SEC oversight over securities intermediaries including securities exchanges and alternative trading systems, or ATSs. Although the 2022 release never used the term “crypto” or “digital asset”, many commenters noted that the scope of the amendments could sweep in various decentralized and blockchain-based financial applications.
The 2023 reopening release reiterates the SEC’s views as to the applicability of existing rules to platforms that trade crypto asset securities, including DeFi platforms. For example, the release notes that the SEC “preliminarily believes that New Rule 3b-16(a) Systems, including some so-called “DeFi” systems, trade some amount of crypto asset securities, and would, under the proposed amendments to Exchange Act Rule 3b-16(a), be required to register as a national securities exchange or comply with the conditions of Regulation ATS.” The reopening release also requests information and public comment on crypto asset securities trading on such systems and certain aspects of the proposed amendments applicable to all securities.
The April 2023 proposal comes at a time when the SEC has stepped up its rhetoric and enforcement action surrounding unregistered cryptocurrency exchanges. In a series of recent actions that have received extensive media coverage, the SEC has sued (or threatened to sue) several prominent cryptocurrency exchanges for failure to register with the SEC as a broker-dealer or exchange under existing SEC rules. Further, in prepared remarks at a recent oversight hearing of the House Financial Services Committee, the SEC Chair was clear in his view that:
As I’ve said numerous times, the vast majority of crypto tokens are securities.
The investing public generally is buying crypto tokens because those investors are anticipating a profit and hoping for a better future. These thousands of tokens often are supported by websites and social media accounts, and generally there are entrepreneurs backing them. The public generally is counting on the efforts of other humans behind these tokens to generate profits on their investment.
Given that most crypto tokens are securities, it follows that many crypto intermediaries are transacting in securities and have to register with the SEC.
Crypto intermediaries—whether they call themselves centralized or decentralized—often provide an amalgam of services that typically are separated from each other in the rest of the securities markets: exchange functions, broker-dealer functions, custodial and clearing functions, and lending functions. The commingling of the various functions within crypto intermediaries creates inherent conflicts of interest and risks for investors—risks and conflicts the Commission does not allow in any other marketplace.
Crypto investors should benefit from compliance with the same laws that [Speaker of the House Sam] Rayburn and [President Franklin D.] Roosevelt laid out to protect against fraud, manipulation, front-running, wash sales, and other misconduct. As Justice Thurgood Marshall put it so well, “Congress’s purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.”
It’s the law; it’s not a choice. Calling yourself a DeFi platform, for instance, is not an excuse to defy the securities laws.
Right now, unfortunately, this market is rife with noncompliance. This noncompliance not only puts investors at risk, but also puts at risk the public’s trust in our capital markets.