SEC Chairman Gary Gensler's latest speech: Why take a tough stance on the crypto market?

Original: "We've Seen This Story Before" Remarks before the Piper Sandler Global Exchange \& Fintech Conference

Compiled by: Joy, PANews

On June 8, SEC Chairman Gary Gensler delivered a speech at the Piper Sandler Global Exchange and Fintech Conference, reiterating the importance of regulation, from the signing of the Securities Act to the Howey Test, and listing a series of enforcement actions by the SEC against the crypto market, emphasizing that the crypto securities market should not undermine public trust in capital markets. The cryptocurrency market should not harm investors. He also pointed out that the current regulations are clear, and issuers, broker-dealers, and exchanges should know exactly how to comply. This is not a matter of insufficient guidance; exchanges simply do not want to act according to what they have been told by regulators.

Well-Regulated Markets

I want to focus on an area that I believe sits at the intersection of the two things highlighted in the title of this conference—exchanges and fintech—and that is cryptocurrency.

The U.S. capital markets have thrived because, since the signing of the Securities Act in 1933, we have established road rules over the past 90 years that help ensure investor protection, transparency, and competition. A year after the signing of that law, President Roosevelt, along with Congress, passed the Securities Exchange Act of 1934 to regulate securities intermediaries, such as exchanges and broker-dealers. This law also established the U.S. Securities and Exchange Commission, which celebrated its 89th birthday last Tuesday.

Crypto Securities

There is no indication that investors and issuers in the crypto securities market should not be protected by our securities laws.

Congress could have said in 1933 or 1934 that the securities laws only apply to stocks and bonds.

"The purpose of Congress in enacting the securities laws is to regulate investment, regardless of the form it takes or the name it is given." This is not just a talking point. As Justice Thurgood Marshall wrote in the Supreme Court's famous Reves decision, this is the law of the land.

Congress listed a long list of over 30 items in the definition of securities, including the term "investment contract."

As clarified in another famous Supreme Court case, SEC v. WJ Howey Co., an investment contract exists when funds are invested in a common enterprise with a reasonable expectation of profits derived from the efforts of others. This test has been reaffirmed by the Supreme Court multiple times—the most recent citation of the Howey test was in 2019.

In the Howey decision, the court stated that the definition of an investment contract "embodies a flexible rather than a static principle that is capable of adapting to the countless and variable schemes devised by those seeking to use the money of investors." Others promise profits.

As I have said many times, the vast majority of crypto tokens meet the test for investment contracts. Disliking this message and not receiving it are two different things.

These tokens have teams promoting them through websites and Twitter accounts. Investors may even meet the founders. These tokens do not come from nowhere. They do not grow in the ground like corn or wheat. While they are digital, that does not distinguish them from a large number of capital markets where securities and currencies have also been digitized.

Satoshi Nakamoto's innovation drove the development of crypto assets and the underlying blockchain ledger technology. However, regardless of the ledger used, whether it is a spreadsheet, database, or blockchain technology, the economic reality of the investment is what matters when investors put their funds at risk.

Therefore, crypto securities issuers need to register their offers and sales of investment contracts with the SEC or meet exemption requirements. For decades, we have had regulations on how issuers must do this. We have flexible rules for the disclosures required in registration statements—Regulation S-K and Regulation S-X—and registration exemptions, including Regulation A or Regulation D.

We have also provided market participants with years of guidance on what constitutes or does not constitute crypto asset securities, including the 2017 DAO Report and the staff's 2019 "Framework for 'Investment Contracts' Analysis of Digital Assets." Over 100 Commission orders, settlement actions, and court rulings have also clarified when the offering and sale of tokens is a security, including our actions against Telegram, LBRY, and Kik.

In fact, just this week, we alleged that Binance's CFO and Chief Compliance Officer knew about the relevance of the Kik case to their own business. According to our lawsuit against Binance, insiders at Binance were already aware that they needed to "start preparing everything" in response to subpoenas and Wells notices related to their exchange token BNB, including a "war fund" to prepare for this "battle."

When crypto asset market participants say on Twitter or television that they were not "reasonably notified" that their actions might be illegal, do not believe them. They may have made a calculated economic decision, treating enforcement risk as a cost of doing business.

Like other parts of the securities market, registration and compliance need to work—bond and stock issuers at this conference know this. However, this is appropriate because it is this work that ensures investors receive the comprehensive, fair, and truthful disclosures they deserve.

Some issuers of crypto asset securities argue that their tokens have functions beyond being investment vehicles. However, as courts have stated in the Telegram case and others, some additional utility does not remove crypto asset securities from the definition of investment contracts. The investing public typically buys these crypto assets, at least in part, based on the efforts of these token issuers to anticipate profits.

In fact, in the famous Howey decision, the Supreme Court wrote that if the investment contract test is met, "it does not matter whether the enterprise is speculative or non-speculative, or whether the property sold has or does not have intrinsic value." However, for tokens used exclusively within their blockchain ecosystems, staff has indicated a willingness to provide no-action letters.

Crypto Intermediaries

Given that most crypto tokens are subject to securities laws, most crypto intermediaries must also comply with securities laws.

Similarly, these laws have been in place for decades. Sections 5, 15(a), and 17A(b) of the Exchange Act require intermediaries acting as securities exchanges, brokers, and dealers, as well as clearing agencies, to comply with securities laws and to register or meet exemption requirements.

Likewise, these crypto entities know the rules. As Binance's Chief Compliance Officer candidly stated to a colleague in 2018, "We are an unlicensed securities exchange in the U.S."

Registration is not just a process issue. Failing to register is not just a foot fault in a tennis match. It is at the core of providing basic protections for the investing public and our markets.

This year, we have charged Beaxy, Bittrex, Binance, and Coinbase in separate lawsuits for mixing and illegally offering securities intermediary functions without registering with the SEC. The Commission took settlement actions against EtherDelta and Poloniex in 2018 and 2021.

These so-called failures deprive investors of critical protections, including the rulebook against fraud and manipulation, proper disclosures, the segregation of customer assets, safeguards against conflicts of interest, self-regulatory oversight, and routine inspections by the SEC. When intermediaries do not register, it is investors who suffer, and the U.S. financial markets may be affected.

In other parts of our securities markets, exchanges, broker-dealers, and clearing functions are separated. This separation of core functions helps mitigate conflicts that may arise from mixing such services.

I do not agree with the notion that "crypto intermediaries cannot comply," and recent history has proven this. I do recognize, however, that I believe this is a work in progress. It is not just a matter of "verbally committing to comply with applicable laws," nor is it merely seeking a series of meetings with the SEC during which you are unwilling to make the necessary changes to comply with securities laws.

Crypto intermediaries may need to separate business lines, establish rulebooks to prevent fraud and manipulation, properly segregate customer funds, mitigate conflicts, or change their clearing and custody methods. These are investor protection matters. In fact, not considering these matters when building their platforms should not be a free pass for exposing investors to risk.

Every registered securities exchange at this conference has done the hard work of registering and establishing appropriate rulebooks and oversight, and each is bound by all of our rules. We should not undermine 90 years of securities law.

As Gurbir Grewal, the SEC's enforcement director, said, "You cannot ignore these rules because you do not like them or because you prefer different rules: the consequences for the investing public are too great."

Moreover, just last month, a company limited to crypto asset securities was approved by the Financial Industry Regulatory Authority as a special purpose broker-dealer. This is achievable.

We have also addressed issues in the crypto security industry through rulemaking. Despite many industry calls for rulemaking expressing dissatisfaction with this rulemaking.

We issued a reopened version reaffirming the applicability of existing rules to platforms trading crypto asset securities, including so-called "DeFi" systems. This version also provided additional information for systems that would be included in the new proposed definition of exchanges.

While our current investment adviser custody rules have already applied to crypto funds and securities, our recent proposal to update them will cover all crypto assets and strengthen the protections provided by qualified custodians.

These are just two rules we have proposed that involve the cryptocurrency market.

Additionally, recognizing the risks and uncertainties associated with crypto assets, staff has expressed views on the accounting for public companies related to crypto assets and disclosures regarding significant developments in the crypto asset market.

Lending and Staking as a Service

Another common feature of the crypto market is that intermediaries and issuers offer lending or staking as a service programs, promising returns in exchange for investors' crypto tokens. Their products and promised returns have many names, often used to attract users to their platforms.

However, in decades of case law, the Supreme Court has made it clear that the economic reality of a product—rather than its label—determines whether it falls under the provisions of the securities laws.

What assets investors put into lending or staking as a service platforms does not matter—cash, gold, Bitcoin, or anything else. What the intermediaries say they will do with the assets determines what legal protections are provided. Customers invest their assets through the platform, which then lends or pools and stakes them, promising returns in each case. These are classic securities, regardless of whether they involve cryptocurrency.

Similarly, the SEC has been clear on this for years. From BitConnect in 2021, BlockFi in 2022, to a series of actions this year, the SEC has consistently claimed that these lending and staking as a service products need to be registered and provide appropriate disclosures to investors.

Just this week, we, along with 10 states, charged Coinbase for offering and selling its staking program without ever properly registering.

Conduct: Fraud, Manipulation, and Bankruptcy

Frankly, it is not surprising that we see many issues in these markets due to widespread violations. We have seen this story before. It brings to mind the situation before the federal securities laws were enacted in the 1920s. Small-time operators. Fraudsters. Scam artists. Ponzi schemes. The public lining up outside bankruptcy courts.

Earlier this week, we alleged that certain Binance entities misled investors about the platform's risk controls and its damaged trading volume while actively concealing who was operating the platform, the manipulative trading of its affiliated market makers, and even concealing the location and identity of investor funds and cryptocurrencies being held.

We also charged that Sigma Chain, an affiliate controlled by Binance founder Changpeng Zhao, acted as the primary market maker for Binance.US, engaging in manipulative trading and wash trading to fraudulently inflate the trading volume on the platform, including around the time of Binance.US's launch, its subsequent round of financing, and the recent launch of certain new crypto securities tokens.

Additionally, it is alleged that billions of dollars in customer funds from both Binance platforms were mixed into accounts held by Zhao-controlled entity Merit Peak Limited through accounts owned and controlled by Zhao and Binance.

These allegations also describe how Zhao and Binance attempted to evade U.S. securities laws by announcing a false control that they ignored behind the scenes so they could keep high-value U.S. customers on their platform. Our complaint cites a statement from Binance's Chief Compliance Officer, who said, "On the surface, we do not have U.S. users, but in reality, we should find them through other creative means," the CCO further stated, "CZ would definitely agree with this… senior management introduced me to ways to always find ways to support the business."

We have also seen FTX deceive investors. With the collapse of Terra and LUNA, we saw deception. We allege that Do Kwon and Terraform repeated false and misleading statements to build trust before causing devastating losses to investors.

In the case against Justin Sun and his three companies, we charged a scheme to pay celebrities to promote tokens without disclosing the compensation.

I could go on, but in a market rife with fraud, abuse, and violations, there are too many to list.

We have also seen many companies implode before and after FTX, harming countless investors. Investors often line up in court due to the bankruptcies of BlockFi, Celsius, FTX, Genesis, and other crypto companies.

Let me be clear: these types of misconduct and bankruptcies are more likely to occur in markets where issuers and intermediaries fail to comply with basic laws. Even if we may not have discovered fraud or such blatant misconduct, investors need appropriate disclosures, the segregation of their hard-earned assets, and assurance that they are not trading against the company.

Conclusion

Markets ultimately are about trust. For 90 years, that trust has relied on compliance with securities laws.

The crypto securities market should not undermine public trust in capital markets.

The cryptocurrency market should not harm investors.