3 - 5 minute read
A new draft bill by House Financial Services Committee Chair Patrick McHenry and Agriculture Committee Chair Glenn “GT” Thompson has caused a stir in the crypto industry. The bill attempts to create a new asset class called “digital assets,” which would exempt crypto tokens from traditional securities laws. However, this approach has created new regulatory uncertainty instead of providing clarity for the industry.
The Howey Test, which determines if an asset is a security based on whether it is an investment of money in a common enterprise with the expectation of profit to be derived from the efforts of others, is the basis for the Securities and Exchange Commission’s (SEC) lawsuits against Coinbase and Binance. McHenry and Thompson’s bill attempts to sidestep the Howey Test entirely by creating a new asset class called “digital assets.”
The bill proposes two types of digital assets: “digital commodities” and “restricted digital assets.” Restricted digital assets are still securities under the Howey Test but would be exempted from significant parts of the securities laws.
One of the qualifications for a token issuance to qualify as a restricted digital asset is that it cannot “involve the offer or sale of equity securities, debt securities, or debt securities convertible or exchangeable to equity interests.” The purpose of this provision appears to be to prevent regulatory arbitrage.
However, the bill does not define these terms, leaving the SEC to decide which of those tokens are equity or debt securities. Given that the code governing many decentralized apps and DAOs give token holders similar rights as stockholders in corporations, the SEC would deem most, if not all, crypto tokens that meet the Howey Test to be equities subject to traditional securities law disclosures.
Other options to remove SEC discretion while preventing regulatory arbitrage would similarly fail. A bill that carves crypto out of the Howey Test would turn the securities laws from being technologically neutral to one that benefits blockchains over everything else. A bill that defines equity securities as just “stocks” leaves it up to the courts to figure out what is a stock, resulting in a new judge-made test that requires litigation before legal certainty.
The bill also grants significant new jurisdiction to the CFTC without providing it with new funding. Additionally, the bill appears to exempt DeFi exchanges from complying with the same investor protection provisions as CeFi exchanges. The CFTC would also be permitted to retroactively or prospectively exempt large swaths of the digital commodity markets from McHenry and Thompson’s customer protection provisions, making the bill’s regulation of exchanges and brokers optional.
The Bottom Line
While Chairs McHenry and Thompson have endeavored to craft a bill that gives crypto assets a way out of the securities laws, their legislation – like others before it – shows just how impossible it is to do without giving issues of traditional securities a new way to opt-out of those laws as well. The bill has created more confusion than clarity, leaving traders with more questions than answers. It is important to keep an eye on the progress of this bill and any future developments in the crypto industry to make informed trading decisions.
