Conversation With Former SEC Commissioner: Why We Shouldn’t Expect Agency To Move Fast On Crypto
Earlier this year, the global cryptocurrency markets shuddered amid revelations that the U.S. Securities and Exchange Commission subpoenaed dozens of companies related to Initial Coin Offerings (ICOs), Blockchain, and Bitcoin trading.
The ensuing price volatility would likely continue, experts predict, until the SEC offered clear guidance to industry players, specifically on whether the agency would classify tokens as securities and thus subject to regulation.
In that case, expect the volatility to continue because the SEC will probably not give the industry the clarity it so desperately wants. At least not for foreseeable future.
“There’s only so much certainty that a regulator is able to provide at the outset because you can’t foresee all the facts and circumstances as they may unfold over time,” said Troy Paredes, a law professor and founder of Paredes Strategies consulting firm in New York.
“Regulators are often reluctant to give any sort of sweeping declaration too early from their vantage point,” he said, “because they realize that with further understanding or consideration, they may prefer to have decided things differently. They may be reluctant, for example, to say something is not a security, only to realize, as things play out, that wasn’t the right judgment as they see it.”
Paredes holds more insight on SEC thinking than most people. In 2008, just before the financial crisis and the onset of the Great Recession, President George W. Bush appointed Paredes to serve as one of the agency’s five commissioners. During his five-year tenure, Paredes helped oversee the roll out of the Dodd-Frank Act, a massive set of new regulations passed by Congress in response to the financial crisis, and the 2010 JOBS Act, a law designed to encourage more startups to go public.
It’s probably safe to say that Paredes’ approach to regulation leans more pro-market. Yet much of Paredes’ tenure at the SEC was marked by crisis, which prompted quick and extensive government efforts to stabilize the economy.
So Paredes certainly appreciates the delicate balancing act of responding to rapid change, while holding true to the SEC’s historic approach of careful, deliberate regulation, which has worked pretty well for the most part. There’s a reason why the U.S. capital markets remain the best in the world.
“Even as technology changes, we should consult first principles that underpin the marketplace and our legal and regulatory environment,” Paredes said. “First principles are just that because they are the foundation upon which we build, because they make good sense, because they have proven to be robust even as technology and other things have changed around us.”
The heart of U.S. financial regulation goes back to the Securities Act of 1933 and the Securities and Exchange Act of 1934, which created the agency to oversees the sales of securities, or “investment contracts,” across state lines. In 1946, the Supreme Court developed the “Howey Test,” that defined an investment contract as “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
With cryptocurrencies, the big question is whether the SEC, using the Howey Test, determines whether to classify a token as a utility, which grants the holder access to a service, or a security, in which the holder expects to earn a profit from the labors of others.
“If I acquire a token, what does it entitle me to?” Paredes said. “What do I get? What do I want to get? Going back to Howey, the SEC has essentially said that if you want a return on the money you put in, you want an interest in the company and its success and you hope to earn a profit, that’s the makings of an investment. That’s going to be a major consideration in the judgment as to whether or not something is a security.”
For example, a token might start as utility, in that it grants the user access to certain services on the Blockchain, but then becomes a security once it gets traded on the secondary market. In other words, a holder might initially buy a token to exchange for a service but then decided to sell it to another investor.