The plan directs the agency to develop a robust regulatory framework to prevent market misconduct, as SEC officials’ public comments keep advancements in technology high on the agenda.
By Marlon Q. Paz, Stephen P. Wink, Donald Thompson, and Deric Behar
On August 25, 2022, the Securities and Exchange Commission (SEC) published a draft Strategic Plan (the Plan) for fiscal years 2022–2026. The Plan focuses on three goals that, according to SEC Chairman Gary Gensler, advance the SEC’s mission to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The Plan is open for public comment for 30 days after publication in the Federal Register on August 30, 2022.
The goals of the Plan are:
- Protecting Retail Investors Against Fraud, Manipulation, and Misconduct
Investor protection remains a core value for the current SEC, while keeping technological innovation essential to the agency’s considerations:
- The SEC will treat all financial activities under consistent and efficient regulation and enforcement, “regardless of … the technology, or the business model.”
- The SEC will continue to focus on accountability and deterrence of bad actors through its enforcement program.
- The SEC will continue to develop and implement faster and more comprehensive methods to leverage and analyze data to better prevent, detect, and enforce against improper behavior.
- The SEC will continue to build out its systemic risk identification capabilities to ensure maintenance of orderly markets.
In a recent speech, Chairman Gensler echoed this framework when he said that investor protection remains relevant, “regardless of underlying technologies.”
- Implementing a Regulatory Framework That Evolves With Innovation
The SEC plans to focus on an agenda that develops a regulatory framework that keeps pace with continued innovation:
- The SEC will update existing rules and approaches to reflect evolving technologies, business models, and capital markets, to ensure that core regulatory principles apply in all appropriate contexts.
- The SEC will continue to appropriately supervise global entities and coordinate with regulators from other jurisdictions, while maintaining appropriate data protection policies.
- The SEC will examine strategies to better prepare for and address systemic and infrastructure risks in the capital markets.
- The SEC will continue to focus on investor education and outreach that addresses diverse and underserved communities as well as on emerging and popular investment topics.
- Supporting Diversity, Equity, and Inclusion in the Workforce
Advancements in technology also fared prominently as part of the SEC’s efforts to support diversity, equity, inclusion, accessibility, and equality of opportunity of its internal workforce, including the following:
- The SEC will promote collaboration within and across SEC offices to maintain maximum flexibility in responding to market trends and technological innovations, including through maximizing telework opportunities to harness the benefits of telework that were highlighted during the pandemic.
- The SEC will continue to build its internal control and risk management capabilities, with a focus on data and information security to optimize controls on systems and data, both internally and across the SEC’s vendors and supply chains.
- The SEC will continue to modernize key systems, innovate with new technologies such as machine learning, and enhance its workforce’s ability to manage and leverage technology to pursue its mission.
A Nod to Digital Assets
Regarding digital assets, the SEC notes in the Plan that the rapid growth in digital assets represents an evolutionary risk to the securities markets, and that the SEC must continue to enhance its expertise to “product markets beyond equities” — digital assets included.
The Plan asserts that in order to address emerging risks, “the SEC must pursue new authorities from Congress where needed, continue to effectively collaborate with other regulators, and engage more proactively on digitization initiatives.” The Plan, however, does not specify what powers the SEC intends pursue. Regardless, Chairman Gensler recently stated that “for the past five years…the Commission has spoken with a pretty clear voice [with respect to the applicability of the securities laws in the crypto space] … Not liking the message isn’t the same thing as not receiving it.”
Digital Assets and Financial Intermediaries Dealing in Digital Assets Remain a High Priority on the SEC Agenda
The SEC’s focus on reigning in digital assets was confirmed in a string of speeches and public comments at the SEC Speaks series (September 2022), by Chairman Gensler and SEC senior staff, such as Director of Enforcement Gurbir Grewal.
These comments are in line with recent proposals that may have significant impact on the digital assets industry. For instance, in June 2022, the SEC released its Agency Rule List (the Reg Flex Agenda), that includes two notable entries in the Final Rule Stage:
- Amendments to Exchange Act Rule 3b-16 re Definition of “Exchange”; Regulation ATS and Regulation SCI for ATSs That Trade U.S. Government Securities, NMS Stocks and Other Securities; and
- Further Definition of Dealers.
While neither of these potential rulemakings explicitly targets digital assets, Chairman Gensler’s messaging is that the SEC’s existing securities framework is sufficient to encompass securities and intermediaries in the crypto market. Furthermore, Chairman Gensler reiterated what he has said before, that “the vast majority” of digital tokens are investment contracts (i.e., securities) under the US Supreme Court’s 1946 Howey Test.
For example, the amendments to the definition of Exchange in the current version of Exchange Act Rule 3b-16(a) would replace the phrase “uses established non-discretionary methods” with “makes available established non-discretionary methods.” This amended definition would significantly expand the scope of the rules to capture systems that passively provide a protocol or merely provide access to such protocol to “interact, negotiate, and come to an agreement” regarding a securities transaction. While the Exchange proposal did not expressly make any references to crypto or digital assets, the expansion of Rule 3b-16’s definitions could be viewed to bring within scope online portals that provide access to decentralized exchanges that trade digital assets and DeFi protocols, including aggregation-type services. (for further information, see Latham’s previous post here and here.)
The amendments to the definition of Dealer, if finalized as proposed, would include persons and entities that use automated and algorithmic trading technology to execute trades and provide market liquidity, which could encompass persons acting as liquidity providers on digital asset exchanges and DeFi platforms to the extent they are dealing with securities. The original proposal states that the “Rule[s] … would apply to securities … including any digital asset that is a security or a government security within the meaning of the Exchange Act.” (for further information, see this previous Latham post). “Given that many crypto tokens are securities,” according to Chairman Gensler, “it follows that many crypto intermediaries are transacting in securities and have to register with the SEC in some capacity.” This scope would include centralized or decentralized (DeFi) exchanges, as well as crypto lending platforms that transact in securities.
Chairman Gensler further noted that to mitigate conflicts of interest and investor risks, disaggregating the exchange, broker-dealer, lending, and custodial functions of digital asset intermediaries is not off the table. Dual registration with the SEC and the Commodity Futures Trading Commission (CFTC) may also be appropriate depending on the intermediary’s offerings.
Enforcement and Disclosures
Regarding enforcement, Director Grewal stated that the SEC continues to remain technology agnostic when pursuing enforcement actions, and will “impartially enforce the laws and rules on the books for the benefit of investors and our markets.” He also echoed the views of Chairman Gensler by repeating that “the Howey and Reves tests remain vital and accurate means of identifying instruments that fall within the jurisdiction of the securities laws.” To the extent that the securities laws are violated, and essential disclosures and protections are not provided to investors, the SEC will take action.
Focusing on investor protection, Chairman Gensler also noted in his speech that the SEC’s “fundamental goal is to provide investors with the protections and disclosures they deserve — and that are required by law.” To that end, the SEC is committed to preventing fraud, manipulation, front-running, wash sales, and other misconduct in the digital assets market. At a September 15, 2022, hearing before the Senate Committee on Banking, Housing, and Urban Affairs, Chairman Gensler repeated that the SEC considers compliance with investor protection rules essential for crypto securities and their intermediaries.
On the other side of the aisle, SEC Commissioner Mark Uyeda commented on what many in the industry view as the SEC’s “regulation through enforcement” approach in the digital asset space. Contrary to Chairman Gensler’s and Director Grewal’s staunch stance that most digital tokens constitute securities under clear and existing precedent, Commissioner Uyeda highlighted the concerns expressed by market participants “regarding the lack of regulatory guidance in this space” and the fear that this “lack of predictability with regard to our regulation may encourage crypto firms to relocate to other jurisdictions.” To alleviate these concerns, Commissioner Uyeda urged the Commission to consider proposing rules and issuing further interpretive releases to address the unique issues raised by digital assets in order to take advantage of the benefits of public comment and to reduce any uncertainty with regard to which digital assets constitute securities and how market participants dealing in such securities can meet their compliance obligations.
Finally, pursuant to the SEC’s keen interest in digital assets, Cicely LaMothe, the acting deputy director of the Division of Corporation Finance’s disclosure operations, noted at the SEC Speaks event that the SEC plans to open an office within the Division of Corporation Finance dedicated to reviewing public filings related to digital assets. The SEC decided to establish this new office with both legal and accounting branches to “address the unique and evolving filing review issues related to crypto assets,” she said. Chairman Gensler briefly mentioned disclosures in his speech, and hinted that given the nature of digital asset investments, “it may be appropriate to be flexible in applying existing disclosure requirements.”