Kennedy and Crypto
Sept. 8, 2022
Thank you. It is good to be back with SEC Speaks.
I’d like to thank the Practising Law Institute for working with our agency on this program, and my colleagues Gurbir Grewal and William Birdthistle for co-chairing this event. As is customary, I’d like to note my views are my own, and I’m not speaking on behalf of the Commission or SEC staff.
Joseph Kennedy, the first Chairman of the SEC, had a saying: “No honest business need fear the SEC.”
In the depths of the Great Depression, Congress and President Franklin Delano Roosevelt (known for a slightly more famous quotation about “fear”) enacted the first federal securities laws.
The Securities Act of 1933 was about companies raising money from the public. Investors could decide which risks to take; companies that issued securities to the public were required to provide full, fair, and truthful disclosures to the public. FDR called this law the “Truth in Securities Act.”
Congress knew, however, that their job wasn’t done. The following year, they passed the Securities Exchange Act of 1934. That statute covered intermediaries, such as the exchanges themselves and the broker-dealers. The basic idea was that the public deserves disclosure and protections not only when a security is initially issued, but also on an ongoing basis when the security is traded in the secondary markets.
Congress knew the job still wasn’t done. They understood that, when advisers manage someone else’s money, there may be additional opportunities for conflicts of interest between those advisers and clients. Thus, six years later, Congress said funds and advisers had to register, under the Investment Company Act and Investment Advisers Act of 1940.
Over the generations, Congress has refined and amended these key statutes, adding, amongst other things, oversight of clearing agencies and the over-the-counter market for securities.
The core principles from these statutes apply to all corners of the securities markets. That includes securities and intermediaries in the crypto market.
Nothing about the crypto markets is incompatible with the securities laws. Investor protection is just as relevant, regardless of underlying technologies.
In this context, I will first discuss crypto tokens and then crypto intermediaries.
Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities. Offers and sales of these thousands of crypto security tokens are covered under the securities laws.
Some tokens may not meet the definition of a security — what I’ll call crypto non-security tokens. These likely represent only a small number of tokens, even though they may represent a significant portion of the crypto market’s aggregate value.
Why do I think a majority of crypto tokens are securities?
As Justice Thurgood Marshall put it in describing the scope of the securities laws, Congress painted the definition of a security “with a broad brush.” He further stated, “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.”
In general, the investing public is buying or selling crypto security tokens because they’re expecting profits derived from the efforts of others in a common enterprise.
These are the core considerations under the Supreme Court’s 1946 Howey Test in determining what is an investment contract — one of the categories of a “security.” This test has been reaffirmed by the Supreme Court numerous times — the Court cited Howey as recently as 2019. As the Supreme Court noted in the Howey case, the securities laws were designed “to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”
My predecessor Jay Clayton said it, and I will reiterate it: Without prejudging any one token, most crypto tokens are investment contracts under the Howey Test.
Some in the crypto industry have called for greater “guidance” with respect to crypto tokens.
For the past five years, though, the Commission has spoken with a pretty clear voice here: through the DAO Report, the Munchee Order, and dozens of Enforcement actions, all voted on by the Commission. Chairman Clayton often spoke to the applicability of the securities laws in the crypto space.
Not liking the message isn’t the same thing as not receiving it.
Investors are following crypto projects on social media and scouring online posts about them. These tokens have promotional websites, featuring profiles of the entrepreneurs working on the projects.
It’s not about whether you set up a legal entity as a nonprofit and funded it with tokens. It’s not whether you rely on open-source software or can use a token within some smart contract. These are not laundromat tokens: Promoters are marketing and the investing public is buying most of these tokens, touting or anticipating profits based on the efforts of others.
Therefore, investors deserve disclosure to help them sort between the investments that they think will flourish and those that they think will flounder. Investors deserve to be protected against fraud and manipulation. The law requires these protections.
Thus, I’ve asked the SEC staff to work directly with entrepreneurs to get their tokens registered and regulated, where appropriate, as securities.
A handful of crypto security tokens have registered under the existing regime.
Given the nature of crypto investments, I recognize that it may be appropriate to be flexible in applying existing disclosure requirements. Tailored disclosures exist elsewhere — for example, asset-backed securities disclosure differs from that for equities.
Our fundamental goal is to provide investors with the protections and disclosures they deserve — and that are required by law.
By contrast, in the case of a small number of crypto non-security tokens, they might meet some parts of the Howey Test or other tests of a security, but not necessarily all of them, and may not be securities.
Bitcoin, the first crypto token, is referred to by some as “digital gold”: trading like a precious metal, a speculative, scarce — yet digital — store of value.
I have a question for the lawyers in this audience. Do you represent any clients regarding their token projects?
How exactly were you hired? Did you enter into an engagement letter?
I’m going to guess that you had a client. I’m going to guess that you did not take on the work on behalf of a dispersed, unidentified group of individuals in an “ecosystem.”
The public deserves the same protections from your clients that they get with other issuers of securities. Other issuers in our capital markets also deserve to compete on a fair playing field.
Before I turn to intermediaries, let me briefly discuss so-called stablecoins. Stablecoins have features similar to, and potentially competing with, money market funds, other securities, and bank deposits, and raise important policy issues.
As discussed in the President’s Working Group Report on Stablecoins, it is important to ensure that we have appropriate safety and soundness protections, investor protections, and safeguards against illicit activity.
Some stablecoins purportedly are backed by reserves of U.S. dollars. Other stablecoins, so-called algorithmic stablecoins, are not backed fully by fiat moneys and bear heightened risks related to whatever mechanisms are used purportedly to maintain a stable value.
Currently, stablecoins primarily are used as means to participate in, or as so-called settlement tokens inside of, crypto platforms.
Depending on their attributes, such as whether these instruments pay interest, directly or indirectly, through affiliates or otherwise; what mechanisms are used to maintain value; or how the tokens are offered, sold, and used within the crypto ecosystem, they may be shares of a money market fund or another kind of security. If so, they would need to register and provide important investor protections.
This is by no means an exhaustive list. The point is, it is important to look at the facts and circumstances of a product, not its label, to determine whether it is a crypto security token, a crypto non-security token, or another instrument.
Given that many crypto tokens are securities, it follows that many crypto intermediaries are transacting in securities and have to register with the SEC in some capacity.
Crypto intermediaries — whether they call themselves centralized or decentralized (e.g., DeFi) — often are 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.
These platforms match orders in crypto security tokens of multiple buyers and sellers using established non-discretionary methods. If that sounds legalistic, that’s because it is — these are the regulatory criteria for being an exchange.
Crypto investors should benefit from exchange rulebooks that protect against fraud, manipulation, front-running, wash sales, and other misconduct.
Crypto intermediaries also engage in the business of effecting transactions in crypto security tokens for the account of others, which makes them brokers, or engage in the business of buying and selling crypto security tokens for their own account, which makes them dealers.
Crypto investors should get the protections they receive from regulated broker-dealers.
Finally, many crypto intermediaries provide lending functions for a return. Make no mistake: If a lending platform is offering and selling securities, it too comes under SEC jurisdiction.
If you fall into any of these buckets, come in, talk to us, and register.
The commingling of the various functions within crypto intermediaries creates inherent conflicts of interest and risks for investors. Thus, I’ve asked staff to work with intermediaries to ensure they register each of their functions — exchange, broker-dealer, custodial functions, and the like — which could result in disaggregating their functions into separate legal entities to mitigate conflicts of interest and enhance investor protection.
Further, the nature of the current crypto market is that investors often trade and invest in both crypto security tokens and crypto non-security tokens, with crypto intermediaries generally handling both. Thus, I’ve asked staff to sort through how we might best allow investors to trade crypto security tokens versus or alongside crypto non-security tokens.
To the extent the Commodity Futures Trading Commission (CFTC) needs greater authorities with which to oversee and regulate crypto non-security tokens and related intermediaries, I look forward to working with Congress to achieve that goal consistent with maintaining the regulation of crypto security tokens and related intermediaries at the SEC. Further, to the extent that crypto intermediaries may need to register with both the SEC and the CFTC, I would note we currently have dual registrants in the broker-dealer space and in the fund advisory space.
After the Exchange Act was passed, as Kennedy later wrote, “it was prophesied that the securities markets of the country would dry up within a few months.” Of course, the opposite happened. Instead, “every important stock exchange” in the U.S. registered with the SEC, and our markets thrived.
Investors, issuers, and our overall economy have benefited from those securities laws and the SEC’s engagement for nearly 90 years.
That oversight should not change just because the issuance and trading of certain securities is based on a new technology. The investing public benefits when they receive disclosures and related protections about a project’s prospects and business. The investing public benefits when intermediaries are registered and overseen.
I look forward to working with crypto projects and intermediaries looking to come into compliance with the laws. I also look forward to working with Congress on various legislative initiatives while maintaining the robust authorities we currently have. Let’s ensure that we don’t inadvertently undermine securities laws underlying $100 trillion capital markets. The securities laws have made our capital markets the envy of the world.
On all of these projects, I’ve asked staff to consider using our regulatory toolkit to possibly fine-tune compliance for crypto security tokens and intermediaries.
I can’t make promises. I can’t speak on behalf of my colleagues on the Commission. I can only say that true cooperation benefits everybody here. Meaningful engagement is always welcome.
For those who are starting up in this space now — either from traditional finance or as crypto-native companies — work with us on compliance from the beginning. It’s far less costly to do so from the outset.
As Joseph Kennedy put it, “No honest business need fear the SEC.”
 See TIME Magazine, “Reform & Realism” (July 22, 1935), available at https://content.time.com/time/subscriber/article/0,33009,754995-1,00.html.
 See CoinMarketCap.com.
 Reves v. Ernst & Young, 494 U.S. 56, 60-61 (1990).
 See, e.g., Tcherepnin v. Knight, 389 U.S. 332, 336 (1967), United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 847-48 (1975), SEC v. Edwards, 540 U.S. 389, 395 (2004). The Supreme Court has articulated additional standards that may apply to other kinds of securities, such as notes.
 Lorenzo v. SEC, 139 S. Ct. 1094, 1103 (2019). SCOTUS, per Justice Breyer: “the basic purpose behind these laws: ‘to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.’ Capital Gains, 375 U.S. at 186, 84 S.Ct. 275.
 SEC v. W. J. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946).
 See, “SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities” (July 25, 2017), available at https://www.sec.gov/news/press-release/2017-131; “Company Halts ICO After SEC Raises Registration Concerns” (Dec. 17, 2017), available at https://www.sec.gov/news/press-release/2017-227; and “Crypto Assets and Cyber Enforcement Actions,” available at https://www.sec.gov/spotlight/cybersecurity-enforcement-actions. See also “Framework for ‘Investment Contract’ Analysis of Digital Assets,” available at https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets. This framework represents the views of the Strategic Hub for Innovation and Financial Technology of the Securities and Exchange Commission (the “Commission”). It is not a rule, regulation, or statement of the Commission, and the Commission has neither approved nor disapproved its content.
 See, e.g., Jay Clayton, “Hearing Before the Committee on Banking, Housing, and Urban Affairs, United States Senate” (Dec. 11, 2018), available at https://www.govinfo.gov/content/pkg/CHRG-115shrg34221/pdf/CHRG-115shrg34221.pdf. “The Federal securities laws provide important market and investor protections in connection with the offer and sale of securities—regardless of whether they are called shares of stock or digital assets or tokens. If you are offering digital asset or tokens that are securities to U.S. investors, you have two options: (1) comply with an exemption from registration; or (2) register the offering with the SEC. Secondary market activities in the digital asset markets also raise concerns. As currently operating, trading platforms in this space often permit the trading of securities but offer substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.”
 For circumstances in which a token may not be a security, see, e.g., Response of the Division of Corporation Finance, Pocketful of Quarters, Inc. (July 25, 2019), available at https://www.sec.gov/corpfin/pocketful-quarters-inc-072519-2a1.
 Issuers alternatively could comply with one of the existing exemptions from registration.
 The disclosure framework for asset-backed securities was developed by staff through the review program and was ultimately codified in Regulation AB, adopted about 10 years after the first asset-backed deal was registered.
 See Nathaniel Popper, Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money (Harper Paperbacks, 2016).
 The President’s Working Group on Financial Markets, the Federal Depository Insurance Corporation, and the Office of the Comptroller of the Currency, “Report on Stablecoins” (Nov. 2021), available at https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.
 See Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 756 F.2d 230 (2d Cir. 1985) (In finding that certificates of deposit were offered and sold as securities, the court stated: “Each transaction must be analyzed and evaluated on the basis of the content of the instruments in question, the purposes intended to be served, and the factual setting as a whole.”).
 Former SEC Chairman Jay Clayton: “A stablecoin that promises $1 back to you, in exchange for the coin, and is backed by cash is one item. Such a coin that is backed by commercial paper, whether it’s 30, 60 or 90 days, sure looks like a money market mutual fund to me. So the second element really looks like a security. We have decided that a pooled vehicle of commercial paper that you use for daily liquidity is a money market mutual fund and should be regulated as such.” See Steven Ehrlich, “Exclusive: Former SEC Chairman Jay Clayton On Stablecoins, DeFi, And Bitcoin ETFs” (Oct. 6, 2021), available at https://www.forbes.com/sites/stevenehrlich/2021/10/06/exclusive-former-sec-chairman-jay-clayton-on-stablecoins-defi-and-bitcoin-etfs/?sh=77b07b8661b1. Federal Reserve Chair Jerome Powell: “Stablecoins are like money market funds, are like bank deposits, but they're to some extent outside the regulatory perimeter and it's appropriate that they be regulated. Same activity, same regulation.” See Matthew Fox, “The Fed has 'no intention' to ban cryptocurrencies, Jerome Powell tells Congress” (Sept. 30, 2021), available at https://finance.yahoo.com/news/fed-no-intention-ban-cryptocurrencies-193120137.html.
 See supra note 11 and accompanying text.
 See Gary Gensler, Prepared Remarks On Crypto Markets at Penn Law Capital Markets Association Annual Conference (April 4, 2022), available at https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422.
 See Gary Gensler, “The SEC Treats Crypto Like the Rest of the Capital Markets” (Aug. 19, 2022), available at https://www.wsj.com/articles/the-sec-treats-crypto-like-the-rest-of-the-capital-markets-disclosure-compliance-security-investment-mutual-fund-protections-blockfi-bankruptcy-bitcoin-11660937246.
 See Joseph P. Kennedy, I’m for Roosevelt, (Reynal & Hitchcock, 1936), p. 94.
 See TIME, “Reform & Realism.”