[Senate Hearing 115-176]
[From the U.S. Government Publishing Office]
S. Hrg. 115-176
VIRTUAL CURRENCIES: THE OVERSIGHT ROLE OF THE U.S. SECURITIES AND
EXCHANGE COMMISSION AND THE U.S. COMMODITY FUTURES TRADING COMMISSION
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE GROWING WORLD OF VIRTUAL CURRENCIES AND THE OVERSIGHT
CONDUCTED BY THE U.S. SECURITIES AND EXCHANGE COMMISSION AND THE U.S.
COMMODITY FUTURES TRADING COMMISSION
__________
FEBRUARY 6, 2018
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available at: http://www.govinfo.gov/
______
U.S. GOVERNMENT PUBLISHING OFFICE
28-854 PDF WASHINGTON : 2018
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada JON TESTER, Montana
TIM SCOTT, South Carolina MARK R. WARNER, Virginia
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
JERRY MORAN, Kansas DOUG JONES, Alabama
Gregg Richard, Staff Director
Mark Powden, Democratic Staff Director
Elad Roisman, Chief Counsel
John O'Hara, Chief Counsel for National Security Policy
Kristine Johnson, Economist
Elisha Tuku, Democratic Chief Counsel
Dawn Ratliff, Chief Clerk
Cameron Ricker, Deputy Clerk
James Guiliano, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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TUESDAY, FEBRUARY 6, 2018
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 36
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
WITNESSES
Jay Clayton, Chairman, U.S. Securities and Exchange Commission... 4
Prepared statement........................................... 36
Responses to written questions of:
Senator Brown............................................ 138
Senator Sasse............................................ 143
Senator Reed............................................. 146
Senator Schatz........................................... 151
J. Christopher Giancarlo, Chairman, U.S. Commodity Futures
Trading
Commission..................................................... 6
Prepared statement........................................... 101
Responses to written questions of:
Senator Brown............................................ 156
Senator Sasse............................................ 160
Senator Schatz........................................... 161
(iii)
VIRTUAL CURRENCIES: THE OVERSIGHT ROLE OF THE U.S. SECURITIES AND
EXCHANGE COMMISSION AND THE U.S. COMMODITY FUTURES TRADING COMMISSION
----------
TUESDAY, FEBRUARY 6, 2018
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:04 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. The Committee will come to order.
This morning we will receive testimony from SEC Chairman
Jay Clayton and CFTC Chairman Chris Giancarlo on the growing
world of virtual currencies and the oversight conducted by
their two agencies. And welcome, gentlemen.
Virtual currencies are meant to act as a type of money that
can be traded on online exchanges for conventional currencies,
such as dollars, or used to purchase goods or services,
predominantly online.
Additionally, developers, businesses, and individuals are
selling virtual coins or tokens through initial coin offerings,
also known as ICOs, to raise capital.
Over the last year, many Americans have become increasingly
interested in virtual currencies, especially given the meteoric
rise in valuation and recent fall of Bitcoin.
Just for perspective, on January 2 of last year, Bitcoin
broke the $1,000 barrier, then peaked in December of 2017 at
almost $20,000, and as of this morning is trading at roughly
$6,900.
Today the market capitalization of Bitcoin is roughly $115
billion. This is an incredible rise given that in 2013, when
this Committee had subcommittee hearings on the topic, the
total value of Bitcoin in circulation was approximately $5
billion.
As virtual currencies have become more widespread,
financial regulators and heads of financial institutions have
noticed and voiced their opinions.
Regulators and heads of industry have tried to educate
investors so that they make informed decisions and ensure that
the markets they oversee and participate in are working
appropriately.
For its part, the SEC has put forth many statements and
guideposts to help the markets and investors. Namely, the SEC
has issued investor bulletins on initial coin offerings; issued
an investigative report on what characteristics make an ICO a
security offering; issued several statements by Chairman
Clayton on the issue; brought enforcement actions against
fraudsters; and issued joint statements with the CFTC about
enforcement of virtual currency-related products.
The CFTC has also been helping inform the markets by
launching a dedicated website on virtual currencies to educate
investors; bringing enforcement actions against individuals
involved in cryptocurrency-related scams; issuing several
statements by Chairman Giancarlo and other Commissioners on the
issue; and scheduling hearings on the topic.
Much of the recent news about virtual currencies has been
negative. Between the enforcement actions brought by your
agencies, the hack of the international Coincheck exchange, and
the concerns raised by various regulators and market
participants, there is no shortage of examples that increase
investor concerns.
It is also important to note that the technology,
innovation, and ideas underlying these markets present
significant positive potential.
These aspects underpinning virtual currencies have the
ability to transform for investors the composition of, and the
ability to access, the financial landscape, thus changing and
modernizing capital formation and transfer of risk.
Technology is forward-looking, and we look to our
regulators to continue carrying out their mandates, including
investor protection, as markets evolve.
I look forward to hearing more and learning more about
virtual currency oversight from our two witnesses today,
including what their agencies are doing to ensure appropriate
disclosures and safeguards for investors.
Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Chairman Crapo, and welcome to
Chair Clayton and Chair Giancarlo. Good to have you both here.
Virtual currencies, and Bitcoin specifically, have captured
the attention of investors and speculators and computer
programmers and regulators all over the world. I do not know
how many people imagined how quickly and broadly Bitcoin, and
the technology it is based on, would spread. To most of us, it
is nothing short of remarkable.
To be sure, it is critical for our regulators to understand
innovation and technology so that markets can grow and evolve
while investors and consumers are protected. Understanding the
risks of emerging technologies is no easy task, but we are
relying on you to maintain the integrity of these new markets
and minimize the risks to Americans who want to participate in
them.
The volatility of Bitcoin has also been remarkable, defying
attempts to think of it as a traditional currency. Bitcoin's
1,000-percent rise last year and 60-percent decline last month
makes yesterday's Dow Jones record point drop look almost like
a rounding error.
But that growth has shown us the intersection of ingenuity
and, too often, greed. Sometimes it appears that scam artists
and hackers may understand more about the technology than most
market participants. That should concern all of us.
I hope our witnesses today can help us understand the
evolution of the markets related to virtual currencies, raise
awareness of the many threats involved, and identify the
regulatory gaps.
Each of you has made several public statements recently
explaining the threats to investor protection and the potential
for abuses in virtual currency markets.
I understand that neither the SEC nor the CFTC has
sufficient authority to police all aspects of virtual
currencies, but you must make the most of the authority you
have.
As you both noted in the Wall Street Journal, Bitcoin mania
has some analogies to the dot-com bubble of the late 1990s. I
hope there are lessons from that era that you draw on to do
your job to protect investors.
In addition to the investment risk, virtual currency may be
used to fund illicit activity, especially outside the United
States. I know the regulatory framework in many other countries
is still in development. I am pleased that the U.S., and FinCEN
in particular, has been a leader. But we can do more.
I hope the Chairman agrees with me that the Committee needs
to look closely at the gaps in regulation in this area and to
review your agencies' ability to get ahead of the curve.
As you begin to adapt to the unique enforcement and
regulatory demands posed by virtual currencies, I call on both
of you not to forget your day jobs--as Chair Clayton and I
talked the other day--not to forget your day jobs: to pursue
and punish misconduct, more traditional misconduct but very
serious misconduct, wherever it might appear. That means Main
Street; it also means Wall Street.
I am concerned that it is business as usual when it comes
to violations by the big banks. Just last week the CFTC imposed
penalties on three big banks for market manipulation--good--but
then decided those firms deserved waivers from bad actor
provisions under the securities laws. That might make sense if
this were an isolated incident, but the banks in question have
something like 68 violations over the last 10 years. So it is
very, very serious.
Too often we see big banks pay fines and move right along,
with little contrition and, frankly, no serious punishment.
Recidivist violators will not stop breaking the law if your
agencies serve as sanctuaries. I have raised the issue of
waivers over the years. I am disappointed in your unwillingness
to pursue every avenue available. It is clear that virtual
currencies bring us into a new age, but that does not mean we
overlook the basic principles of going after the bad guys and
being tough when they are repeat offenders.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you. Senator Brown.
Now we will turn to the testimony of our witnesses, and
first today we will receive testimony from the Honorable Jay
Clayton, Chairman of the U.S. Securities and Exchange
Commission.
Following him, we will then hear from the Honorable Chris
Giancarlo, Chairman of the U.S. Commodity Futures Trading
Commission.
Gentlemen, again, we welcome both of you here, appreciate
you coming to share your knowledge and understanding on this
issue with us. And, Chairman Clayton, you may proceed.
STATEMENT OF JAY CLAYTON, CHAIRMAN, U.S. SECURITIES AND
EXCHANGE COMMISSION
Mr. Clayton. Thank you. Chairman Crapo, Ranking Member
Brown, distinguished Senators of the Committee, thank you for
the opportunity to testify before you today on the important
topic of cryptocurrencies, initial coin offerings, and related
trading activities.
The total market capitalization of all cryptocurrencies was
estimated at $700 billion earlier this year. In 2017, ICOs--
initial coin offerings--raised nearly $4 billion. These markets
are local, national, and international.
Today I will attempt to level-set where we stand from a
market regulatory perspective. My remarks may be viewed by some
as overly simplistic, but they reflect how I present these
issues to Main Street investors.
For ease of analysis, I break this space into three
categories:
First, a promising new technology referred to as
distributed ledger technology or blockchain. Proponents of this
technology assert that it will bring great efficiencies to our
national and global economies, including our capital markets. I
hope that it does. And the Commission looks forward to working
with market participants who seek to bring efficiencies,
including more effective oversight, to our markets.
The second and third categories are cryptocurrencies and
ICOs, which are subsets of the products seeking to take
advantage of the commercial opportunities presented by
blockchain technology. One is promoted to be a replacement for
dollars. The other is like a stock offering.
Cryptocurrencies: Some of the more widely known
cryptocurrencies were introduced as substitutes for traditional
currencies, such as the U.S. dollar or the euro. Those who
promote these so-called virtual currencies have asserted that
they will make it easier and cheaper to buy and sell goods,
particularly across borders. They have asserted that
transaction and verification fees and costs will be eliminated
or reduced. To date, these assertions have proved elusive in
many areas.
ICOs: From what I have seen, initial coin offerings are
securities offerings. They are interests in companies, much
like stocks and bonds, under a new label. Promoters use the
term ``coin'' based on the fact that the security being offered
is represented by a digital entry or ``coin'' on an electronic
ledger, as compared with a stock certificate and a related
entry in a company's records. You can call it a coin, but if it
functions as a security, it is a security.
Also, importantly, an ICO may have nothing to do with
distributed ledger technology beyond the coin itself. Buying an
ICO does not mean you are investing in blockchain-related
ventures.
There are many problems with the way cryptocurrency and ICO
markets are operating, but two are worth particular attention.
First, the markets for these products have substantially
less oversight than our traditional securities markets. To be
blunt, if you are trading cryptocurrencies on a platform that
looks like a stock exchange, do not take any comfort from that
look. Our stock exchanges have extensive rule sets, and they
are required to conduct surveillance. Also, broker-dealers who
facilitate securities trading have capital and conduct
requirements. These requirements, and others, without a doubt
are necessary to protect those markets and our investors.
Second, many ICOs are being conducted illegally. Their
promoters and other participants are not following our
securities laws. Some say this is because the law is not clear.
I do not buy that for a moment. The analysis is simple. Are you
offering a security? If so, you have a choice: follow our
private placement rules or conduct a public offering registered
with the SEC.
A note for professionals in these markets: Those who engage
in semantic gymnastics or elaborate structuring exercises in an
effort to avoid having a coin be a security are squarely within
the crosshairs of our Enforcement Division.
So what are we doing about these problems? I look forward
to discussing with you that question in more detail, but will
start with a comment on jurisdiction and a comment on
enforcement.
We--the SEC and the CFTC--do not have direct jurisdiction
over the popular markets that trade true cryptocurrencies. This
is not an oversight. It is the result of a new product and
market. The traditional currency markets did not need direct
regulation by market regulators such as the SEC or the CFTC.
They are sovereign- backed and regulated with a long history.
Cryptocurrencies, on the other hand, have no sovereign
backing or oversight and, again, to be blunt, are currently
functioning as assets for trading and investment much more than
as mediums for exchange.
Please do not view this description as a request for
expanded SEC jurisdiction. If asked, we will work with other
regulators to evaluate and address this issue, including our
friends at the Fed, our friends at the CFTC, and the State
regulators. They all have a keen interest in this market.
I will close. I know my time is short. To the extent that
digital assets like ICOs are securities--and I believe every
ICO I have seen is a security--we have jurisdiction and our
Federal securities laws apply. We will enforce these laws. Many
of these laws also include private rights of action. We are
working with the DOJ and other regulators to enforce these
laws.
Thank you for the opportunity to testify before you today.
I stand ready to work with Congress on these issues and look
forward to your questions.
Chairman Crapo. Thank you, Chairman Clayton.
Chairman Giancarlo.
STATEMENT OF J. CHRISTOPHER GIANCARLO, CHAIRMAN, U.S.
COMMODITY FUTURES TRADING COMMISSION
Mr. Giancarlo. Thank you, Chairman Crapo, Ranking Member
Brown, and distinguished Members of the Committee. I have
submitted a written statement for the record that details the
CFTC's work and authority over virtual currencies, but with
your permission, I would like to begin briefly with a slightly
different perspective, and that is as a Dad.
I am the father of three college-age children: a senior, a
junior, and a freshman. During their high school years, we
tried to interest them in financial markets. My wife and I set
up small brokerage accounts with a few hundred dollars that
they could use to buy stocks. Yet other than my youngest son,
who owns shares in a video game company, we have not been able
to pique their interest in the stock market. I guess they are
not much different than most kids their age.
Well, something changed in the last year. Suddenly they
were all talking about Bitcoin. They were asking me what I
thought and should they buy it. One of their older cousins, who
owns Bitcoin, was telling them about it, and they got all
excited. And I imagine that maybe Members of this Committee may
have had some similar experiences in your own families of late.
It strikes me that we owe it to this new generation to
respect their enthusiasm about virtual currencies with a
thoughtful and balanced response, not a dismissive one. And yet
we must crack down hard on those who try to abuse their
enthusiasm with fraud and manipulation.
We must thoroughly educate ourselves and the public about
this new innovation, and we must make good policy choices and
put in place sound regulatory frameworks to reduce risks for
consumers.
Putting my CFTC hat back on, I suggest that the right
regulatory response to virtual currencies has at least several
elements, and the first is to learn everything we can. At the
CFTC we have launched a new initiative called ``LabCFTC'' to
engage with these innovators and inform the agency about
virtual currencies and other financial technology.
Next is to put things in perspective. As of 8 a.m. this
morning, the total value of all outstanding Bitcoin is about
$113 billion. We have a slightly different figure than you
have, Chairman, but close. But the point is that that is less
than the market cap of one large publicly traded company--
McDonald's.
The total value of all virtual currency in the world is
around $313 billion. In comparison, global money supply is
around $7.6 trillion. And because Bitcoin is sometimes compared
to gold as an investment asset, the value of all the gold in
the world is around $8 trillion, which dwarfs the size of the
virtual currency market.
The next task is to tell the public what we learn and
educate consumers. There is a lot of noise around virtual
currency, and regulators must help set the record straight. The
CFTC has produced a large amount of consumer education
materials on virtual currencies, including written statements,
podcasts, webinars, and a dedicated Bitcoin website. We have
even scheduled visits to libraries and briefings for seniors.
We have never conducted this much outreach for any other
financial product.
Another element is regulatory coordination. Because no one
agency has direct authority over virtual currencies, we have to
work together. That includes us, the SEC, the Fed, the IRS, the
Treasury's FinCEN network, and even State banking officials.
And the next element is to exercise our legal authority
over derivatives on virtual currencies while clarifying our
statutory limitations. To be clear, the CFTC does not regulate
the dozens of virtual currency trading platforms here and
abroad. We cannot require them to meet requirements like trade
reporting and market surveillance, standards for conduct,
capital requirements, or even cyberprotections or platform
safeguards. But these are all standard regulations in the
futures markets we oversee. Yet through our authority over
commodity derivative markets, we do have enforcement power over
spot coin markets. And with newly launched Bitcoin futures, the
CFTC can now obtain trading data and analyze it for fraud and
manipulation in five underlying spot markets.
And that leads to the final element, and that is tough
enforcement. Led by the CFTC's Virtual Currency Enforcement
Task Force, we have launched several civil actions over the
past few weeks cracking down on fraudsters and manipulators,
and more will follow.
In closing, I want to quote something that Chairman Clayton
and I wrote recently in the Wall Street Journal: ``These
markets are new, evolving, and international. They require us
to be nimble and forward-looking, and coordinated with State,
Federal, and international colleagues, and engaged with
important stakeholders, including Congress.''
I am glad to be with you today, and I hope my kids are
listening. Thank you very much.
Chairman Crapo. Thank you, Chairman Giancarlo.
I will begin the questioning. First I will say I have had
those dinner conversations with my own children, and you are
right, this is an incredibly interesting but growing new area
of financial challenge, particularly among our--at least my
children and yours.
Both of you have said in one way or another that neither of
you, neither of your agencies have complete jurisdiction over
cryptocurrencies. The question I have is whether you have
sufficient jurisdiction, and I would like both of you to
address that question. Should Congress address revising and
refining our financial law so that one agency or a group of
agencies have complete jurisdiction? Or if you look at the
jurisdiction of all agencies today, do we have sufficient
jurisdiction in place today? Chairman Clayton?
Mr. Clayton. Well, thank you, and in my position you are
always cautious about speaking for other agencies, so I thank
you----
Chairman Crapo. Understood.
Mr. Clayton. --for saying that we should all come to--to be
very direct, we should all come together, the Federal banking
regulators, the CFTC, the SEC--there are States involved as
well--and have a coordinated plan for dealing with the virtual
currency trading market. I think our Main Street investors look
at these virtual currency trading platforms and assume that
they are regulated in the same way that a stock exchange is
regulated. And as I said, it is far from that. And I think we
should address that issue.
Chairman Crapo. So am I hearing you say that you do not
think we need to have additional legislative authorities?
Mr. Clayton. I think we may. I think we may.
Chairman Crapo. So first you should get together and tell
us what you can and cannot do and then advise us.
Mr. Clayton. I think that is a very good way to put it,
Senator.
Chairman Crapo. Chairman Giancarlo.
Mr. Giancarlo. I think that is exactly right. I think the
first step is to recognize where the gap is. So as we both said
in different ways, what we call the spot market for Bitcoin is
not a regulated marketplace.
For us at the CFTC, we are familiar with that because we
generally do not have regulatory supervision over the spot
markets for which derivatives apply. That is a longstanding
basis. We regulated derivative markets. The underlying markets
we surveil, and we will take enforcement action for fraud and
manipulation. But we do not have the ability to set the
standards on those markets, and that is what we have today in
Bitcoin. And unless it is an ICO, then, as Chairman Clayton
described, he also does not have the jurisdiction. So there is
that gap, and I think the starting point for an informed
conversation is there is that.
Now, there are other elements to it. There are other
agencies that come to bear on this. So State regulators, there
is a patchwork of State regulation across the Nation. Some
States have been very assertive in this area, other States less
so, and some States have nothing.
FinCEN, as you referenced, has also been active in the area
in terms of anti-money laundering and Know Your Customer
requirements. So there is a patchwork here, but there is not a
comprehensive structure, and that is something that I think is
a policy discussion and an important one to be had.
Chairman Crapo. All right. Thank you. And you have led to
my next question. Much of the activity in the virtual currency
markets is cross-border and international, so that raises
obviously the question of what challenges does that present and
what is the appropriate role for FinCEN. I would like both of
you to respond. I only have about a minute left so take about
30 seconds each, if you would.
Mr. Clayton. I will try to be quick. The international
nature of this market is why a patchwork is probably not
sufficient if it is going to continue to develop as a
significant market and one that our Main Street investors
access.
From FinCEN's perspective, there are reports that we all
have heard that these cryptocurrencies are used for illicit
activity. I think FinCEN has been stepping up in that regard,
and I encourage them to continue to do so. And this challenge
of global markets is a challenge that I think we face now in
many regards. In the 21st century with the dawn of the
Internet, markets have become truly global and not just in
virtual currencies but so many things. And it does become a
challenge as we think about regulation. We certainly have had
that challenge working with overseas regulators in the area of
derivatives regulation as a result of the Dodd-Frank Act. The
challenge of bringing these regulations together in a
comprehensive whole is really a tremendous challenge for all of
us. So in this area, it requires a lot of new thinking.
Chairman Crapo. Well, thank you. I appreciate your remarks
from both of you on these issues, and I would encourage you to
form that work group, get together between yourselves, State
regulators, other appropriate Federal regulators, and evaluate
exactly what our regulatory structure should like in America to
deal with this and let us know your thoughts, your further
thoughts on that. I would appreciate that.
Mr. Clayton. Thank you.
Chairman Crapo. Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Chair Clayton, again, nice to see you. Last year initial
coin offerings raised about $4 billion globally. You have
testified that the SEC is focused on policing these
transactions to protect investors. How much of that $4 billion
was raised in the U.S.?
Mr. Clayton. It is not clear. It is hard to get a number on
that because this has been conducted on largely an unregulated
basis, but I imagine, Senator, a significant enough portion
where we should be paying attention.
Senator Brown. And my understanding is that during the last
few months the SEC has taken four enforcement actions targeting
coin offers for serious violations of law. That speaks volumes
about the work that--the challenges in front of you.
In response to the Chair's question, you both talked,
leading with you, Chair Clayton, about agencies working
together and the importance of that on this and other issues.
Your testimony highlights cooperation between the SEC and CFTC,
Chair Clayton, regulating Bitcoin and other virtual currencies.
It does not mention any cooperation with the Consumer Financial
Protection Bureau. Hundreds of consumers have filed complaints
with the Bureau about virtual currencies. How have you been
coordinating your work specifically on this but in other areas,
too, with CFPB?
Mr. Clayton. On this area, largely through the FSOC. At the
FSOC I believe I have made very clear my views in this area and
that this is an area that we should all be on the lookout for,
on the lookout from each of our perspectives. The CFPB is a
member of FSOC, and they have heard my comments there.
From an enforcement perspective, we are in the securities
area. We do not see the CFPB on the securities side of this. I
am not aware of any direct coordination on a particular
enforcement action, but I could check on that.
Senator Brown. OK. In the past few months, Deutsche Bank,
Credit Suisse, UBS, and HSBC have been fined over $300 million
by other regulators for various forms of market manipulation.
But SEC has been quiet under your watch. One study by a
Georgetown law professor found that SEC has ``virtually stopped
enforcement actions against large entities, often referred to
as `Wall Street firms'. ''
How do we have confidence, Mr. Chairman, that the SEC is
willing to hold Wall Street accountable when the trend in
penalties and actions is going the wrong way?
Mr. Clayton. I actually saw that report. That probably does
not come as a surprise to you that someone sent it to me. I
found it annoying, to be honest, because it did not reflect the
fact that the gestation period for the cases we bring is
roughly 22 to 24 months. So any type of statistics necessarily
have a latency period to them.
Our Enforcement Division put out a report that talks about
the numbers in a comprehensive way. I am happy with that
report. I am also confident that the people who are in our
Enforcement Division and leading it, many of them former
Federal prosecutors, two of them former heads of the Securities
Task Force in the Southern District of New York, are pursuing
our securities laws vigorously. I have no doubt. They come to
work every day and they have my full confidence.
Senator Brown. I hear you say that, and I believe you when
you say that. I remember the last SEC--and it was not you--the
last SEC under a Republican President, how they were asleep at
the switch. So as the Governor of the Richmond Federal Reserve
used to tell me, ``Watch us, and let us know you are watching
us.''
But I am further troubled by a statement by one of the
SEC's enforcement codirectors last fall that SEC might lose 100
of its enforcement staff by not replacing those who leave.
Compared to 2016 figures, this would reflect a 7-percent
reduction in enforcement head count. So how are you going to
stay on top of developments in virtual currencies and the other
enforcement in all the other areas that we just talked about to
be able to fight traditional misconduct? How are you going to
do that when you are not replacing them, if, in fact, that is
the case?
Mr. Clayton. Senator Brown, personnel is my biggest
challenge at the moment. We have a hiring freeze as a result of
natural increases in costs and people retiring or taking other
jobs has reduced the size of the workforce at the SEC. I could
use more people in Enforcement. I could use more people in
Trading and Markets. Those are the two areas where I think the
American people would get the greatest return for additional
bodies.
Senator Brown. So when you come in front of us--and I
appreciate your candor. When you come in front of us and tell
us that you are having trouble filling those jobs and----
Mr. Clayton. No trouble. I just cannot.
Senator Brown. OK, I guess trouble that way, all right,
because of the freeze. Isn't that message to those who want to
game the system and those who want to defraud the system, isn't
the message that the SEC is not the cop on the beat that even
the new Chair wants it to be?
Mr. Clayton. Do I want more bodies to do more? Yes. Is the
message that somehow we are asleep at the switch? Absolutely
not.
Senator Brown. And with your budget that is coming out, our
understanding is the budget--I hope the freeze is lifted. I
hope the budget is enough. And I hope that you will speak to us
and ask particularly people on the other side of the aisle for
the dollars you need and the flexibility you need to put those
cops on the beat.
Mr. Clayton. I think I have been very straight about an
incremental amount of money and where I think value can be
added.
Senator Brown. Thank you.
Chairman Crapo. Senator Shelby.
Senator Shelby. Thank you. Thank you, Mr. Chairman.
Chairman Clayton, you and Chairman Giancarlo, you are
Chairmen of two powerful regulatory bodies, but you have
different jurisdictions. Anything that smacks of security comes
somewhere in your range, does it not? Dealing with a commodity,
something that could be deemed a commodity clearly comes in
your range. The Federal Reserve is the biggest bank regulator
we have and also the--and Treasury is involved in this. How are
you going to put together a task force, can you do it on your
own through the Administration, to deal with the
cryptocurrencies--because you have got the Fed, you have got
the Treasury, you have got the commodities, you have got the
securities, perhaps some others that we have not thought
about--before this gets out of control somewhere in the world?
Mr. Clayton. Let me start, and then Chris can----
Senator Shelby. Yes, sir, go ahead.
Mr. Clayton. ----by recognizing the Treasury Secretary. He
has brought us together----
Senator Shelby. That is good.
Mr. Clayton. ----the CFTC, the SEC, and representatives of
the Federal Reserve to talk about this because, Senator, you
are exactly right. The funny thing about these cryptocurrencies
is they only work for their purported purpose if they are
integrated with the financial system. And so, therefore, it
necessarily touches on all of our regulation.
Senator Shelby. Chairman.
Mr. Giancarlo. I would just reinforce that. The Treasury
Secretary has been out front on this. He has formed a Virtual
Currency Working Group of ourselves, the SEC, the Fed, and
FinCEN. We have had a number of preliminary conversations and
work streams developed. I have had a number of bilateral
conversations with the Treasury Secretary on virtual
currencies, and we are going to be coordinating our various
responses.
It has begun with just some broad conversations
establishing our different jurisdictions so that we are all
clear as to what we are doing, but also what we are not doing,
where the gaps are.
Senator Shelby. Do you need additional legislation in this
area, to both of you, or do you think you can work a task force
together to get your arms around this without that?
Mr. Clayton. I cannot give you a definitive answer to that
question because we should work together, but, Senator, we may
be back with our friends from Treasury and the Fed to ask for
additional legislation.
Senator Shelby. You know, we live in a virtual world. We go
to the doctor, and they give you a virtual examination, you
know? We can go here and it is virtual, and this was not my
world. I started out with pencil and paper in school, as you
can imagine, in my day.
But at the same time, this currency, these
cryptocurrencies, they lack intrinsic value, it seems to me.
They lack liquidity. I am sure people have probably made a lot
of money going up, and a lot of them made money or lost money
going down. But I do not know where the bottom is, if the
bottom was ever reached, as opposed to a sovereign-issued
currency. Do you disagree?
Mr. Giancarlo. No, Senator. I do not know where the natural
equilibrium point is in this, but I will tell you there are
some economists who posit that there is a relationship between
Bitcoin value and the difficulty or the cost of mining, which
is a process of electronically producing these, and that there
are some charts I have seen that have plotted that correlation
that seemed to be readily correlated until last summer when the
price broke free of that correlation and that it came back into
correlation late at the end of the year last year.
Now, I am not an economist. I find those things
fascinating, but I am not an expert in it. But the point the
economists are making is that there is some sort of floor, that
the level set is not zero, that there is some floor there tied
into the cost of mining of Bitcoin. And I am not endorsing that
point of view. I am just sharing that with you.
Senator Shelby. Chairman Clayton, do you have any comment?
Mr. Clayton. Look, there are a lot of smart people who
think there is something to the value of the cryptocurrency in
the international exchange, and I am not seeing those benefits
manifesting themselves in the marketplace yet. And from the
perspective of--look, I look at this as protecting Main Street
investors. They should understand that.
Senator Shelby. How do you put a value on cryptocurrencies?
Does the market put a value on it, or does it go straight up,
then straight down, or what?
Mr. Clayton. Well, that is what is something worth? It is
worth what somebody is willing to pay you for it. But in our
world, the securities world, you know, there are rules that
dictate how much you have to tell somebody about what it is you
are selling them.
Senator Shelby. But part of your mandate, the Securities
and Exchange Commission, is to protect the investor. Is that
right?
Mr. Clayton. That is right.
Senator Shelby. And the Chairman of the Commodity Futures
Trading Commission, he has seen obviously commodities just go
wild at times, and your mandate is to watch the commodities,
right?
Mr. Giancarlo. Market integrity is generally perceived to
be our core mandate.
Senator Shelby. You also mentioned personnel, you know, you
need personnel. There is a hiring freeze on. We talked the
other day about--this gets into the realm of appropriations and
so forth. I am hoping that we will give you every tool you need
to do your job and to hire the people that you need to execute
that.
Mr. Clayton. Thank you very much. Thank you.
Senator Brown [presiding]. Senator Reed.
Senator Reed. Thank you very much. Thank you, gentlemen,
for your testimony.
Following on the questions of Senator Brown and Senator
Shelby, you do need more personnel, but very specifically, do
you have the technologists, the computer experts that can begin
to understand how these cryptocurrencies work, the
cryptologists, and not just sort of on a day-to-day basis, you
know, to give you the Thompson, but look ahead and say this is
the direction it is going, which could have very significant
deleterious effects? Do you have anyone like that on the staff?
Mr. Clayton. The answer to your question is we formed a
Distributed Ledger Technology Working Group, a cybergroup. They
have done an exceptional job getting up to speed on this in a
short amount of time and identifying some of the very issues
you talk about.
You know, in an emerging area like this, could you use more
horsepower? Always. But you make a very good point, Senator, on
looking out across the international nature of this and trying
to understand where it is going to land and do the things that
people say add up. That is a very important----
Senator Reed. Where are the technologists located? If you
do not have them--and I presume you do not--is it----
Mr. Clayton. What we have, I would say it is a combination
of economists and technologists. It is a question of, you know,
here is what the technology is and does it make economic sense.
We have those people in our Division of Economic and Risk
Analysis, DERA, and we also have some of them in Enforcement,
and they work together.
Senator Reed. But you need more. I will take that as a yes.
Mr. Giancarlo, the same question. Do you have the
technologists? Are you working together?
Mr. Giancarlo. Thank you, Senator Reed. We have done a
couple of things in 2017, as Senator Brown said, to get ahead
of the curve. We hired the agency's first-ever Chief Innovation
Officer, someone who comes with a deep background in a lot of
these new financial technology innovations.
We also created something called ``LabCFTC'', which is our
innovation hub, and you asked where is it located. It is
actually located in New York City because so much of this
innovation is taking place there and we wanted to be close to
these innovators to learn from them.
But in terms of protecting consumers, we also formed a
Virtual Currency Enforcement Task Force. It was actually that
task force that recently brought three civil actions against
Bitcoin fraudsters. And as I said in my testimony, there is
more to come.
And as to the resource questions, we do need more
resources. I used our bypass authority last year to put forward
a budget request of 13 percent over our budget. We had been
flat-funded for 3 years, and we do need additional resources.
And built into those resources are additional resources for
FinTech generally and cyber and cryptocurrencies specifically.
Senator Reed. Let me just elaborate a bit. We continue to
refer to Bitcoin. That is just one cryptocurrency. They seem to
be proliferating, that every day there is a new variety of
cryptocurrency, some of them out-and-out fraudulent, some of
them based on the Bitcoin technology or processes. But just the
sheer expansion of these cryptocurrencies is an issue, one.
And, two--because my time is short and I have one other
slightly unrelated question to Chairman Clayton--are you
tracking all these different daily emerging currencies, one?
And, two--again, it goes back to my sort of step-back
question--is someone looking long term at the systemic effects?
You know, where are we going to be? This is eerily reminiscent
of the late 1990s in derivatives which were nominally small
parts of the market that were esoteric, et cetera, and then, of
course, 10 years later, exploded. So why don't you start, Mr.
Giancarlo? And I will finish up with the Chairman.
Mr. Giancarlo. Thank you very much. So you are absolutely
right. Bitcoin is one of many. However, of the many, there is
really a handful that have gotten significant traction.
Senator Reed. Right.
Mr. Giancarlo. And so that is important, though, for
listeners to know because so many of these are fraudulent, as
you said. We went after one--and I just mention it because I
think it is interesting--called ``My Big Coin'', which became
known as ``My Big Con'' by people that were defrauded by it. It
was people that really were taking--it was a Ponzi scheme. They
were taking consumers' money and using it to buy houses and
furniture and jewelry. And we went after them and went after
them hard, and we will continue to do that.
In terms of systemic risk, right now this is still a
relatively small market just by ratio. But as you say, we have
to watch it and watch it carefully.
Senator Reed. Mr. Chairman.
Mr. Clayton. So as I mentioned, the SEC does not have
direct jurisdiction over pure cryptocurrencies, but we have had
to watch them because, of course, they are integrated with the
markets that we do oversee. And to your question of does 10
make sense or 15 or 20 make sense, I have a hard time getting
my head around that because if it is an efficient medium of
exchange, 15 of them fluctuating different places probably does
not make a lot of sense to me. That is where I am at.
On systemic effects, I agree with Chairman Giancarlo, but
if people are getting ripped off, that presents reputational
risks that can have systemic effects.
Senator Reed. We can go into a raft of questions, money
laundering, evading, et cetera, but just changing gears one
second, I will make a comment and then follow up with a written
question. There is some consideration, I have heard, of the SEC
allowing in public offering, initial public offering, borrowers
to sue, i.e., forced arbitration. I think that would be a very
bad idea, and I will make the argument and----
Mr. Clayton. I am happy to address the question.
Chairman Crapo [presiding]. Well, we are out of time on
that right now, so we will have to do it in writing.
Senator Reed. We will talk.
Chairman Crapo. Senator Rounds.
Senator Rounds. Thank you, Mr. Chairman.
Gentlemen, I am just curious. I go back to where I learned
with a pen and pencil to begin with as well, and we did not
have a quill at that time, but we did have No. 2 lead. And as I
get into this and learn more about this thing, it is
fascinating to see how quickly things are moving, and yet
everything that we talk about seems to translate back into
dollars and cents yet. That has not changed--until now, and
suddenly we are talking about a new type of exchange, and it
sounds almost like bartering to me. And it is a bartering which
could avoid the determination of a value in dollars and cents.
Which brings up the question of how do you tax it if you
need to, how do you recognize income? But, also, in this
particular case, I notice both of you identified that you have
additional--or you have existing resources and regulatory
oversight capabilities that you are utilizing today. And while
I question whether or not there are seams that have to be
filled, it would appear that there are some basics that maybe a
lot of us do not quite understand that still have to be
answered.
I just want to start out, because I think, Mr. Clayton, you
started with this discussion, with regard to the issue of
whether or not you had control over an ICO and the fact that if
they were issuing in this particular case Bitcoin or the
opportunity to market it, you had identified it as a stock or
at least a value of something. What is in this particular case
that thread that you utilize once again? And can you delve into
that a little bit more about how your agency responds to the
regulatory need in this particular case? What is the specific
item that you look at as being an item which is subject to your
review, a security in what?
Mr. Clayton. The definition of a security is broad, and it
includes--I am not going to use the technical terms. There are
Supreme Court cases and things like that. But it includes
situations where if you are offering me a security--or offering
me something, a coin, and I give you money, and the purpose of
me giving you that money is to profit from your efforts going
forward. So if I give you money, you give me a coin and you
say, ``I am going to take the money and I am going to grow a
business, and that is going to increase the value of that coin.
And, by the way, Chairman Clayton, you can trade it to somebody
else. So you may be able to get value for it tomorrow. In fact,
you probably will get value for it tomorrow. Buy now so you can
get more value for it in a few days.'' That is a security.
Senator Rounds. So commodity-wise, if we are looking at
trading commodities, you would not have an interest in the
subject of investigating or reviewing whether or not the
trading of an ag. commodity was something, and yet when we talk
about the CFTC, we are talking about a different story where
commodities most certainly are an item of interest to you. Is
Bitcoin or are these as currently being traded, are they a
commodity or are they a security? Or are they both?
Mr. Giancarlo. So what is so challenging about Bitcoin is
it has characteristics of multiple different things. One of the
phrases that is often used is that Bitcoin is a medium of
exchange, a store of value, or a means of account. Well, those
three things have different connotations to them. If it is a
medium of exchange, then it is a currency-like instrument. And
yet, as we have seen, a number of means of exchanges have been
closed to Bitcoin. There was recently a Bitcoin conference that
stopped accepting Bitcoin from registrants because they could
not process the payments. But yet it is still spoken of as
perhaps a means of account. And in that case, it has
implications from the Fed and currency.
From our point of view, when it is used as a store of
value, then it is very much like an asset, like a commodity.
And, in fact, what we hear a lot of is people buying and
holding. If you go on to the Twitter universe, you will see a
phrase, ``HODL,'' which means hold on for dear life. And the
thinking is that they buy it and hold it. In fact, I mentioned
in my opening remarks my 30-year-old niece, who bought Bitcoin
years ago, and she is an HODL. She says, ``I am going to own
it. I do not know what is going to come of it, but I want to
hang onto it.'' And she is not a fraudster or a manipulator.
She is just a kid and believes in it. You know, I was
fascinated talking to her, and I think she represents a lot of
folks that think there is something in this I want to hold onto
it.
And so in that regard, from our point of view, it is a
commodity. And if there is a derivative on that, we regulate
it. The problem is in the cash market we do not have regulatory
authority. It means we cannot set the standards. But what we
will do and we are doing is looking for fraud and manipulation,
and we intend to be very aggressive, if nothing else so that
people like my niece can have some security that there are not
fraudsters and manipulators out there, and there are far too
many of them.
Senator Rounds. Thank you, Mr. Chairman. Your suggestion
earlier that we bring them both back in at a later date after
they have had an opportunity to look at the differences would
be very appropriate. Thank you, gentlemen.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Warren.
Senator Warren. Thank you, Mr. Chairman.
Chairman Clayton, on January 26th, Bloomberg published an
article entitled, ``SEC Weighs a Big Gift to Companies:
Blocking Investor Lawsuits''. Now, as you know, class action
lawsuits are how investors can hold companies accountable when
they defraud people, and the article says the SEC is thinking
about letting companies sell shares in initial public offerings
while at the same time allowing those companies to prohibit
investors from bringing class action lawsuits against them.
Wow, I mean, forcing investors to give up class actions
when they have been defrauded. The SEC has never allowed
corporations to bar investors who get cheated from bringing
class action lawsuits.
So I just want to get a straight yes-or-no answer from you
on this. Do you support this enormous change in SEC policy?
Mr. Clayton. So I think you know that I cannot prejudge an
issue that may come before the SEC, but I would be happy to
talk to you about this, and let me get to the bottom line. I
cannot dictate whether this issue comes before us or not
because of the way it has come before the SEC in the past. But
I am not anxious to see a change in this area.
Senator Warren. OK. So I am reading tea leaves here.
Mr. Clayton. I am not----
Senator Warren. I mean, you run this agency. The change
cannot happen without your approval. I think it is fair for
the----
Mr. Clayton. That is actually not right. If it came up
before the agency, I am only one of five votes.
Senator Warren. I am going to guess there are going to be
at least two votes against that and that you at best will be
the deciding vote.
Mr. Clayton. Senator, I do not want to prejudge the issue.
If this issue--I want to be practical. If this issue were to
come up before the agency, it would take a long time for it to
be decided because it would be the subject of a great deal of
debate. And like I said, in terms of where we can do better,
this is not an area that is on my list for where we can do
better.
Senator Warren. OK. So I will tell you what. Chairman
Clayton, I am going to let you get away with that, because what
I am reading is real skepticism about a rule like this. The
SEC's mission is to protect investors, not throw them under the
bus. And I cannot think of anything that would do more harm to
investors than saying they have to pre-waive their rights to
sue a company in a class action when that company cheats them.
So----
Mr. Clayton. Like I said, it is not a change that is on----
Senator Warren. I hear you. So let me ask you about
something else, and that is the fiduciary rule. Financial
advisers who put the high fees, the commissions, the kickbacks,
the prizes they can get for recommending a specific product
ahead of the interests of their clients cost hardworking
Americans trying to save for their retirements about $17
billion every year. And that is why President Obama and the
Department of Labor put the fiduciary rule in place to
eliminate these conflicts of interest in retirement accounts
like 401(k)s and IRAs.
Now, less than a month after you were sworn in as Chairman
of the SEC, you issued a Request for Information asking for
public comment on rulemaking related to the standards of
conduct for investment advisers and broker-dealers. Can you
state to this Committee that any rulemaking you do on this
topic will not weaken the existing protections for retirement
savers?
Mr. Clayton. Making an absolute statement like that----
Senator Warren. Yeah, an absolute statement that you are
not going to weaken rules for people who are trying to save for
their retirement.
Mr. Clayton. From what baseline--let me----
Senator Warren. Well, we have a rule from the Department of
Labor. Now you could strengthen the rule, you could pass the
same rule, or you could weaken the rule. I want to know that
you are not going to weaken the rule. That is all I am asking
you.
Mr. Clayton. Here is what I am trying to do. Let me tell
you what I am trying to do. The relationship between an
investment adviser or a broker-dealer and their client in a
very simple area--they have a 401(k), they have an annuity, and
they have a few stocks--is regulated--throw out the banking
regulators. It is regulated by no less than five people. And
they all have different standards. My main objective is to
bring clarity to that without jeopardizing investor
protections. That is how I am----
Senator Warren. Well, but that is the question I am asking
you, about whether or not you are jeopardizing the protection
that people are trying to save for their retirement get. I get
that you could bring clarity. Clarity could be do whatever you
want. Clarity is what right now has cost American investors
saving for their retirement $17 billion a year.
Mr. Clayton. I think it is a combination of an insufficient
standard in some places, which we are looking to increase----
Senator Warren. Glad to hear that.
Mr. Clayton. --a lack of clarity and also the standard is
only as good as the remedy available. And one of the things
that I am also looking at, believe me, I spend a lot of time in
this space trying to get it right. One of the things we are
looking at is what dollars do you actually collect when
somebody has done you harm, because you could have a really
strong standard, but if there are no dollars there, that is a
problem.
Senator Warren. So I agree with you, Mr. Chairman, if you
want to strengthen enforcement of this rule or strengthen the
rule itself, count me in. But that is what the American people
look to the SEC for. Thank you.
Mr. Clayton. I do.
Senator Warren. Thank you.
Thank you, Mr. Chairman.
Chairman Crapo. Senator Perdue.
Senator Perdue. I want to go change the subject a little
bit back to Bitcoin here or to cryptocurrencies. You know, we
see in IPOs and tax jurisdictional arbitrage. Do you guys see
that today in this developing cryptocurrency and also in ICOs?
Chairman Clayton, do you want to start with that?
Mr. Clayton. Well, yeah----
Senator Perdue. And, by the way, who pays for frivolous
class action lawsuits? Who pays for that?
Mr. Clayton. Shareholders.
Senator Perdue. Yeah, and investors, I would argue
customers, employees, all of the above, right?
Mr. Clayton. Yes.
Senator Perdue. Would you answer the other question for me,
please?
Mr. Clayton. So regulatory arbitrage is one of many issues
that I see in this market. To be frank, tax loss and things
like that are there. Of course they are because it is
recordkeeping, it is difficult to trace.
Senator Perdue. South Korea and China are the ones that
predominantly play in this world. You said before most of the
current investment comes from the U.S. I am not sure--I do not
know if we all know enough yet to know that, right? South Korea
and China are really heavily invested. In fact, South Korea has
a new rule that says you have to use real name bank accounts in
order to trade in this. Those are the kinds of things I am
asking for. Is the arbitrage really going on around the world
here?
Mr. Clayton. There is certainly regulatory arbitrage, but
you are making a great point because this was a largely
unregulated space across the world. And now what you are seeing
is each country taking a perspective, a view, action, et
cetera, which also goes to how functional is this asset class
and how would we regulate it and how does it work. There is a
lot happening that is beyond the kind of understanding of your
average investor. How would you know how----
Senator Perdue. So how can we and two agencies here--I
understand there is interaction between all of our regulatory
agencies, but there is also another axis here that you have to
coordinate, and that is the other country regulators as well.
Mr. Clayton. Correct.
Senator Perdue. So I am asking both of you, what are you
seeing and what are you anticipating we need to do, either
legislatively or rulemaking, to combat that?
Mr. Clayton. Chris, do you want to----
Mr. Giancarlo. Sure, let me jump in. I will just identify
two areas of arbitrage we are seeing. One is regulatory, which
I want to come to, but actually we are also seeing price
arbitrage as well. There is something known as the ``kimchi
premium'' for Bitcoin traded in South Korea because there is so
much interest there that it drives the price up there slightly
higher, so price arbitrage.
But, you know, in the early days of many markets, every
American city had a cotton exchange and the prices were
different there before you developed a national market. So here
we have different regional and international markets and
perhaps as this market matures, if it matures, a single price
may develop.
In terms of regulation, unfortunately I think that some
time ago, perhaps the middle of last year, there was this
perception that Bitcoin was off the regulatory grid. And one of
the things that Chairman Clayton and I have been working so
hard to do is to disabuse that notion. Now, we are limited in
our regulatory authority to set regulatory standards on these
underlying platforms. But when it comes to enforcement, when it
comes to ICOs, we are using our full authority to drive the
message, and other countries are doing that as well, and we
have had frequent conversations. I spoke recently or had
communication recently with the head of the Japan financial
service agency about some things that were going on there. Jay
Clayton spoke very eloquently at the FSB meeting recently in
Basel, Switzerland. We are beginning our communication with
other regulators. And I think the message is getting through
that this is not off the grid, and I think part of that is now
you are seeing it in the Bitcoin price. As the word is getting
out that we will go after misconduct, I think you are starting
to see that reflect in the price, and I think that is an
important step.
Senator Perdue. Well, with what little time we have left, I
would like both of you to respond to the pump-and-dump efforts
that are underway right now. You see this beginning to develop.
I know you are both involved in this. Can you both address what
your agencies are doing to combat that?
Mr. Clayton. Senator Perdue, this is one of the things that
I am worried that investors do not understand, which is when
you have----
Senator Perdue. Me, too.
Mr. Clayton. When you have an unregulated exchange, the
ability to manipulate prices increases significantly. And, you
know, just a few coordinated sales can change a price.
Senator Perdue. Or an email, a fraudulent email.
Mr. Clayton. Correct.
Mr. Giancarlo. I have mentioned we formed this Virtual
Currency Enforcement Task Force. We have got some really good
people on this, and we have brought three actions in the last
few weeks. I said there are more to come. There are more to
come. We are digging deep and learning a lot and seeing a lot.
And I do not want to get ahead of that other than to say that
we are working the beat hard right now.
Senator Perdue. And you have a jurisdictional right to do
that, right?
Mr. Giancarlo. We have enforcement jurisdiction. Yes, we
do.
Senator Perdue. Great. Thank you, Mr. Chairman.
Chairman Crapo. Senator Donnelly.
Senator Donnelly. Thank you, Mr. Chairman. Thanks to both
the witnesses.
This would be to both of you. Now that the SEC and the CFTC
have asserted jurisdiction and warned the public of the risks
posed by virtual currency operators, what other ways can your
agencies prevent retail investors from falling victim to fraud
and manipulation?
Mr. Giancarlo. I am happy to take this question, Senator.
Earlier Ranking Member Brown mentioned what do we do with the
CFPB. We have actually formed a partnership with the CFPB to
consumer education in the area of Bitcoin. One of the things I
have learned recently is that America's libraries are a place
where a lot of people go and research Bitcoin. In fact, they
use the library computers. One of the most frequently searched
items from a library computer is Bitcoin. And so we are teaming
up with CFPB to go out to America's libraries, to educate
librarians who often get some of the questions asked, to be
able to direct library patrons to use our resources, our
Bitcoin website and our other resources.
So we are really getting very creative in the area of
consumer education. I had mentioned we have got several
podcasts on this subject with thousands of downloads. We are
working as hard as we ever were. We have never done as much
work on consumer education as we have done with virtual
currency.
Mr. Clayton. We also have an Office of Investor Education
and Advocacy that has been engaged with a number of groups on
this, and I think they have done a terrific job getting the
word out.
In terms of getting the word out, though, there are
financial intermediaries and other actors that we are counting
on to act responsibly in this area.
Senator Donnelly. OK. Well, let me ask you a follow-up, and
it goes to the point you just made about the libraries and
others. Are you concerned that retail investors will remain
vulnerable to fraudulent and manipulative online solicitations
that are sometimes more difficult for you guys to pick up?
Mr. Giancarlo. Senator, in the broad range of marketplaces,
seniors seem to be the prey of choice for fraudsters and
manipulators. Whether it is in precious metals, whether it is
in foreign exchange, whether it is in a whole range of
products, we see and we prosecute continuously fraudsters who
seek to prey on either the less sophisticated seniors who maybe
do not quite have the retirement nest egg that they believe
they need and fall prey to get-rich-quick schemes or schemes
that say we will guarantee 100 percent returns and all kinds of
nonsense like that. And it is a big part of our enforcement
effort at the agency.
Senator Donnelly. Let me ask you this, and this goes to
perspective and to hopes and dreams. But what warnings would
you give? There was an article in the Washington Post
yesterday, and it was about good, hardworking Americans, people
who have worked really hard and want to have a pension. It was
about a group of our friends and neighbors from Kentucky, and
the title of the article was, ``Bitcoin Is My Potential
Pension''. What would you say to them to help protect them from
winding up in a situation a few years from now where it did not
quite work out the way they were hoping?
Mr. Giancarlo. It is such a troubling development, Senator,
unquestionably, which is why we are putting out so much
materials. But what I would say to them is--it is the same
advice I would give my children. If it sounds too good to be
true, it is. If they are promising ridiculous returns, they are
ridiculous. If you are going to give them money, you had better
be prepared to lose it.
Mr. Clayton. I agree with everything that Chairman
Giancarlo said. I also would say this to them, which is there
are things like disruptive technologies that come along, but
they should not disrupt the way you look at markets or the way
you look at investing. Pumping all of your money into a
disruptive technology has a very high likelihood of not working
out for you as an individual. When we see disruptive
technologies come along, you know, there will be winners, but
there will be many losers.
Senator Donnelly. OK.
Mr. Clayton. That is the way it works.
Senator Donnelly. Let me ask you one other question. How
can both of you best assist law enforcement and Federal
authorities to ensure these virtual currencies are not used by
terrorist groups or Nations like North Korea to evade
sanctions?
Mr. Giancarlo. So we work very closely with law
enforcement. We recently commenced a program with the FBI where
we actually had FBI agents on secondment with our agency in
order to look at this. At the end of the day, the use of these
cash markets for that, it is going to require cooperation
amongst multiple agencies, especially with FinCEN, who often
because of their anti-money-laundering operation may see some
of these issues before we can, and then bring our expertise to
bear and coordinate with our law enforcement agencies.
Mr. Clayton. Same here. I would supplement that with we
also have a Dark Web Working Group that tries to monitor what
is going on in that space in order to identify these types of
issues.
Senator Donnelly. Thank you, Mr. Chairman.
Senator Brown [presiding]. Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman. Welcome,
gentlemen. I think you are both doing a terrific job.
Chairman Giancarlo, when is the last time you bought a
stock exchange-traded fund, mutual fund, or a bond?
Mr. Giancarlo. So I hold generally traded funds----
Senator Kennedy. Yes, but when is the last time you bought
one?
Mr. Giancarlo. Well, probably before I--I pretty much put
my investing----
Senator Kennedy. A year ago?
Mr. Giancarlo. Well, probably before I started at the
Commission.
Senator Kennedy. Two years ago?
Mr. Giancarlo. Yes.
Senator Kennedy. OK. When you bought it, what did you buy?
Equity or bond?
Mr. Giancarlo. Index funds mostly.
Senator Kennedy. Index funds, OK. When you bought it, did
you sit down and read the prospectus for the index fund?
Mr. Giancarlo. Well, you know, I am not supposed to say
this----
Senator Kennedy. Cover to cover?
Mr. Giancarlo. As a lawyer, I am not supposed to say that I
probably did not read it cover to cover.
[Laughter.]
Mr. Giancarlo. But I will confess that I did not read it
cover to cover.
Senator Kennedy. How many investors do you think do that,
do not read it?
Mr. Giancarlo. I think most.
Senator Kennedy. OK. So what is the point? I mean, we are
talking about all the dangers and the risks of cryptocurrencies
like Bitcoin. I am putting aside the shyster fraud issue. I
mean, what is the point of all this over disclosure if nobody
is reading it?
Mr. Giancarlo. Well, I----
Senator Kennedy. And why do we want to do the same thing
with Bitcoin?
Mr. Giancarlo. I will say historically it has been one of
the foundational principles of our securities laws that
adequacy of disclosure, full disclosure, is one of the building
blocks.
I will tell you, having been in business, that most
business people will tell you they study the prospectus only to
see what they can sue on if they need to sue on something if
something goes wrong.
Senator Kennedy. I think you see where I am going. I am
going to ask you both a philosophical question in a second
about how far you think we ought to go to protect people from
themselves. But I do not think the disclosure we have right now
works. I think it is good for the lawyers, and it is good for
the financial advisers. But I think we overdisclose, and I
think you can--I will bet you each have a smart lawyer on your
staff. You could go to them and say, ``Write me a good
disclosure for Bitcoin.'' And you would get it back and look at
it and then pick 50 names from the Washington, DC, phone book
and ask them to come in and say, ``Read this and tell me if it
makes sense to you.'' I mean, what is the point?
How far do you think we ought to go here in terms of a
cryptocurrency--I am separating this from the blockchain
technology. China outlawed it. I think South Korea has, too.
What are you suggesting, that we just go after the shysters and
fully disclose? I mean, is that what you think we ought to do?
Chairman Clayton.
Mr. Clayton. Well, I think that is exactly the question we
are here to pose and take forward, which is, you know, what is
the right way to deal with this new thing? As just a person
watching it, I am not satisfied when I see people thinking that
these trading platforms of cryptocurrencies have the same kind
of protections that a stock exchange would. And I am very
unhappy that people are conducting ICOs like public offerings
of stock when they should know that they should be following
the private placement rules unless they are registering with
us. Those two things make me unhappy. To figure out how to deal
with them is why we are here.
I agree with you that we should be careful not to go too
far. But just to be clear, for me in this ICO space, it is
pretty clear that our securities laws work pretty well.
Disclosure can be improved. It can really be improved.
Senator Kennedy. Well, let me make this suggestion, because
I do not want to go over. The last time I asked questions, I
got a little carried away. I think I went over 3 minutes, and
our Ranking Member put me on double secret probation.
[Laughter.]
Senator Kennedy. So I am not going to do that today.
Senator Brown. Like I have the power to do that.
[Laughter.]
Senator Kennedy. He does.
The disclosure, I mean, you can extend the disclosure we
have now to Bitcoin, and you have not done anything. I am not
suggesting we should not have disclosure, but you have got to
have disclosure that makes sense and helps people other than
the lawyers.
Mr. Clayton. I agree, Senator.
Senator Brown. Senator Warner.
Senator Warner. I usually agree with my friend from
Louisiana. I think we may be on top of something that is
transformational, and I do not think you can separate the
underlying distributed ledger or blockchain from some of these
crypto assets. And if we had the same rate of increase the next
2 years that we have had the last couple years--we are talking
now a couple hundred billion--we would be north of $20 trillion
caught up in this area by 2020. And I think you--I remember
back, I was lucky enough to get in the cell phone business back
in the early 1980s, and everybody thought it was going to be a
small business, and they were wrong and I got rich. I think we
are looking at the same kind of transformation about to take
place, and we are going to have to wrap our arms around it.
We have talked about some of the consumer protection
issues, but we have got money-laundering issues, we have got
cybersecurity issues. A third of the Bitcoin exchanges have
been cyber-hacked between 2009 and 2015.
I am not exactly sure what the right regime ought to be,
but I would argue that--while I commend the Treasury Secretary
for putting a working group together, I would argue this is the
reason we created FSOC in the first place, that this rises
potentially to the level of a systemically relevant event, and
I would just be curious whether you believe--and I commend what
both of you are trying to do, but whether this ought to elevate
to an FSOC-level analysis.
Mr. Clayton. So, Senator, I had the same question you had,
which is: There is a big rise here; if it does keep going is
this a systemic issue? Which is one of the reasons we brought
it up at FSOC, talked about it at FSOC. Again, I commend the
Treasury Secretary for forming the working group.
I want to go back to separating ICOs and cryptocurrencies.
ICOs that are securities offerings, we should regulate them
like we regulate securities offerings. End of story.
Senator Warner. I have a couple more points I want to make.
Mr. Giancarlo. Thank you, Senator. Just real quickly, on
the issue of disclosure, sometimes what we are seeing is not a
problem of absence of disclosure. It is false disclosure. False
disclosure is often fraud, and I think we need to step in
there. But just in terms of discussion, as Chairman Clayton
mentioned, we have begun discussions at FSOC. In addition,
there have also been discussions led by Chairman Clayton at the
Financial Stability Board and also at IOSCO, which is the
International Organization of Securities Commissions. So these
discussions are taking place at the right levels of debate, but
there is so much more to be done.
Senator Warner. Again, to my friend from Louisiana, we have
got this--we are focusing a lot on Bitcoin and crypto assets,
cryptocurrencies, and I think there are even definitional
issues here. But you have got a whole new platform called
``Ethereum'' where they are creating, you know, file sharing or
extra computer time. I am not sure what kind of assets those
fall into? Are they potentially regulated within your realm or
if there is a trading exchange, a tokenization exchange between
excess computer time? I am not sure where that fits at this
point.
Mr. Clayton. The definition of a security I believe--the
people who wrote the 1934 Act and the 1933 Act, they were
smart. They did it on a principled basis. They basically said
if you are giving people money in exchange for a future
development of a business with the hope of a return--and
whether that return comes in the form of server time or your
ability to sell server time--it is a security.
Senator Warner. I concur with the approach you have taken
in terms of the ICOs, and I think there has been some very bad
behavior. Yet certain ICOs the SEC has not stopped; others they
have stopped. Are you going to go back and re-review the ones
that have gone forward?
Mr. Clayton. Let me say another thing about the 1933 and
1934 Acts. When they were written, there was a great
recognition that there was a tremendous amount of securities
activity in this country, and that we were going to rely on
gatekeepers to help us enforce those rules and they would be
liable if they did not help us enforce those rules--
accountants, lawyers, underwriters, sellers, and the like. I am
counting on those people to do their job, and I have made that
clear.
Senator Warner. Let me ask, Chairman Giancarlo, what we
did--and one of the things I am concerned about was that I
think we may have moved too fast on allowing, for example,
futures trading on Bitcoin. And I just wonder. You know, you
have allowed future trading contracts on Bitcoin, yet the SEC
has not allowed ETFs. I am just worried that we need a much
more coordinated effort, because I think the potential, writ
large, amongst crypto assets and the underlying blockchain
could be as transformational as wireless was years ago, and I
think we are going to need a much more coordinated effort.
I know my time has expired, but if you could both quickly
comment on that, I would appreciate it.
Mr. Giancarlo. Well, so I believe it is critically
important that we coordinate on this. I believe that we are all
both individually and collectively understanding our
authorities, understanding this new technology, working around
it. There was communication among myself, Chairman Clayton, the
Treasury Secretary, and others in connection with Bitcoin
futures. And, you know, Bitcoin future are quite different than
the Bitcoin market. Bitcoin is an anonymous area. Bitcoin
futures is fully transparent to the regulator. Bitcoin, retail.
Bitcoin futures, mostly institutional and high net worth.
Bitcoin futures, regulated. Bitcoin futures, regulated.
Bitcoin, unregulated. And with Bitcoin futures we are now
having visibility into underlying spot markets and data from
those markets we would not otherwise have.
Mr. Clayton. I completely agree on coordination. Like I
said, I break it down into three areas. There is this great
technology that I agree with you has promise. There are these
pure cryptocurrencies, which we need to take a look at across
FinCEN, Treasury, CFTC, the Fed. And then there are securities
offerings that are called ICOs that should be undertaken as
securities offerings consistent with our regulatory regime.
Chairman Crapo [presiding]. Senator Cotton.
Senator Cotton. Thank you, and thank you, gentlemen, for
your appearance today.
I want to continue on the line of questioning that Senator
Warner began. Putting aside Bitcoin or other kinds of
cryptocurrencies that are based on blockchain or distributed
ledger technology, what are your thoughts on the potential
value of that underlying technology, of blockchain and
distributed ledger technology, both to enterprises and
consumers and perhaps to Government agencies?
Mr. Giancarlo. It is important to remember that if there
were no Bitcoin, there would be no distributed ledger
technology. It grew out of that technology initiative. And the
potential applications--and, by the way, I am no pie-in-the-sky
dreamer. I just report what I read. But the applications range
from enormous potential in the financial services industry, in
the banking industry, but right down to the way charity dollars
are spent, the way perhaps refugees are accounted for across
the globe.
There was an article just this morning about use of
distributed ledger technology for 2.5 billion people around the
world who do not have access to banking services.
One of the areas that--in our own area of agriculture
futures, 66 million tons of American soybeans were just handled
through a blockchain transaction by the Dreyfus Company for
sale to China. So Bitcoin is now being used--it is used in our
American transportation logistics system, and, most
importantly, the potential of distributed ledger technology for
regulators to be able to do really close market surveillance,
and if it had been available in 2008, if we had been able to
see the counterparty credit exposure of one bank to another
bank in real time with precision, that would have enabled much
more precise policy choices that had to be made in a rush
without good data. So I think distributed ledger technology has
got enormous potential.
Now, how it will be realized, when it will be realized,
what are the other challenges in it, those we cannot say. But
the potential seems extraordinary.
Senator Cotton. Thank you.
Mr. Clayton.
Mr. Clayton. I agree that the potential seems very
significant, and just look around anywhere in our economy where
verification and recordkeeping has cost that is potentially
reduced, that is an opportunity for this technology. That is
just one of them, and I hope people pursue it vigorously.
Senator Cotton. Thank you. Let us turn our attention now to
cryptocurrency and to Bitcoin, since it is the most prominent.
Yesterday, the Dow Jones had its single largest decline in a
point scale, 4.6 percent as a percent, which is high--not the
highest ever. That obviously generated a lot of news coverage.
The dollar has faced 2-percent inflation or less now for many
years. Bitcoin, however, has seen a 32,000-percent increase in
its value over the last 5 years. It has declined by some 60
percent, I think, in just the last 30 days.
What are the factors driving that kind of extreme price
volatility in Bitcoin relative to securities in publicly traded
companies or the U.S. dollar?
Mr. Giancarlo. Well, just recently the volatility you see
in Bitcoin was not as large as volatility we have seen in some
other assets classes, such as the VIX product, which is known
as the fear index or volatility gauge. And so we have seen
extraordinary volatility in Bitcoin, but, you know, in our
world, in commodity derivatives, we are used to volatility in
asset classes, and that is one of the things the emergence of a
futures product is meant to do, is to provide those who are
exposed to that volatility means of hedging and mitigating the
risk to that volatility.
Senator Cotton. Mr. Clayton.
Mr. Clayton. I do not really know what is driving the
volatility in Bitcoin and cryptocurrencies. They are not
correlated with sovereign currencies, so it must be something
different from what would drive the dollar. But that is one of
the issues before us, there does appear to be a lot of
volatility compared to the medium they are supposed to be a
substitute for.
Senator Cotton. So what does that kind of volatility
portend for a cryptocurrency's future as a potential
alternative to legal tender of Nation States or, in the EU's
case, a transnational organization?
Mr. Clayton. You raise a great point. Now, maybe that
volatility tamps down to a stable currency--but an asset that
is highly volatile is not a very effective means of exchange
because you do not know how much you are getting by the time
you receive it or how much you are paying at the time you have
to pay it. If you agree to a price on day one but have to
source it on day ten, you expose yourself to significant risk.
Senator Cotton. Thank you. My time has expired. I do want
to associate myself with the remarks of Senator Donnelly at the
end of his remarks about the risks that cryptocurrencies are
currently posing as a way for rogue Nations, terrorist
organizations, criminal organizations to evade sanctions, not
just in trading but in hacking as well, as we have seen in
media reports on North Korea. So I am glad to hear that you are
working closely with our law enforcement and intelligence
agencies, and I hope that continues.
Thank you.
Chairman Crapo. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. Thank you to
both of you. It is good to welcome a fellow New Jerseyan in
your role, Mr. Chairman.
I have been actively following both Venezuela's and
Russia's interest in developing virtual currencies for the
purposes of evading U.S. sanctions. Last month I sent a letter
to Secretary Mnuchin on this subject, and I asked Under
Secretary Mandelker about this a few weeks ago when she was
here before the Committee.
Under what circumstances would the SEC and the CFTC have a
role in engaging or regulating the proposed new petro or crypto
ruble currencies? More broadly, does the SEC and CFTC have a
role to play in preventing the use of digital currencies by
foreign Governments to evade U.S. sanctions?
Mr. Giancarlo. Our jurisdiction would be very limited in
that area, Senator. As I have spoken about before, we do have
enforcement authority for fraud and manipulation, and so if we
thought that that instrument was being used for fraudulent
purposes, manipulation purposes, we would not hesitate to take
authority. But you are probably touching on an area where the
jurisdictional lapse is probably greatest for the two agencies
sitting before you today.
Senator Menendez. And so let me ask you, manipulation, what
if you are manipulating to avoid U.S. sanctions?
Mr. Giancarlo. You know, I would have to speak to our
enforcement counsel to see how that fits in, but we would
certainly look at it, and if----
Senator Menendez. I would like to have you do so, and I
would love to hear back through the Committee.
Mr. Giancarlo. Thank you.
Senator Menendez. Are you interacting with FinCEN to the
extent that you may have limited jurisdiction? Are you
adequately integrated into the financial regulatory network
that watches for illicit activities? Or are there gaps that
could create vulnerabilities?
Mr. Giancarlo. So as we mentioned before, Senator, Chairman
Clayton and I are part of a Virtual Currency Task Force that
has been put together by the Treasury Secretary that includes
the Fed and FinCEN, and we have already had our first meeting,
a beginning meeting to set up some work streams. We will have
more to come.
It just so happens that I am actually meeting with FinCEN's
virtual currency team this week on a previously scheduled
meeting to get some introductory discussions started of
cooperation between our agencies, and so I look forward to
actually asking them this question as well.
Senator Menendez. OK. And I would just say to both of you,
to the extent that you have a role to play and you lack the
present authorities to do so, I would love to know about that
if you determine that is necessary, because my sense of
cryptocurrency is largely driven to evade U.S. sanctions and to
undermine sovereign currencies. Both of them are a challenge to
the national interest of the United States.
Let me ask you this: We have seen a dramatic increase in
the number of initial coin offerings where private companies
are using digital tokens to raise money instead of going
through the capital markets. The Wall Street Journal reported
that initial coin offerings grew from about 96 million in 2016
to over 4 billion in 2017. Many of these ICOs are relying on
celebrity promoters to gin up the sales. For example, last year
Floyd Mayweather, the boxer, used Instagram to promote the
purchase of Centra tokens.
Now, I have done extensive work on consumer protections in
the prepaid card space where we have seen celebrities like the
Kardashians use their status to sell products that come at a
steep cost to consumers, and this feels eerily similar to that,
just the next avenue of exploitation. And I worry about
unsuspecting investors that do not have the resources to
understand the true risks.
What can the SEC do to better protect investors who may be
persuaded by celebrity promoters to purchase tokens offered in
initial coin offerings without fully understanding the risks?
Mr. Clayton. Senator, I am not going to comment on a
specific instance, but----
Senator Menendez. I am talking about broadly.
Mr. Clayton. Some time ago we put out an alert that said if
you are promoting securities, you are taking on securities law
liability. I believe that that has tamped down some of this
endorsement activity.
I will say it again right here: If you are promoting
securities, you are potentially taking on securities law
liability.
Senator Menendez. Well, let me ask you--I appreciate that,
and I hope that you will think about doing more to protect
consumers. Can you walk us through why the SEC at this point is
not comfortable with approving ETFs with significant
investments in cryptocurrencies?
Mr. Clayton. Our ETF product space is largely a retail
product space, and we have made it clear to the marketplace
that there are a couple of issues with having an ETF that is
based on a cryptocurrency. They go to price discovery, custody,
and, you know, some other issues around volatility. We have let
the industry know that those are issues that are of concern to
us and that we do not want to approve an ETF product with a
cryptocurrency underlier until we can get comfortable with
those issues.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Moran.
Senator Moran. Mr. Chairman, thank you very much. I am
sorry you both have to crane your necks to the left so hard to
have a conversation with me. But I am delighted to be back on
the Committee, Mr. Chairman. Thank you very much.
Let me first start by suggesting to you that if you have
suggestions, I will probably not have the chance to see you in
the Financial Services Appropriations Subcommittee before we
take a look at fiscal year 2019. Assuming that we are
successful in the next few days on fiscal year 2018 and budget
caps, we will have an opportunity to reconsider spending levels
for fiscal year 2018. You have made your request through the
budgetary process and an appearance before our subcommittee,
but if there are priorities in which as we go back to
potentially increase funding and any levels of jurisdiction
within FSGG, I would welcome your input as to what is the
highest priority.
I heard the commentary earlier in regard to one of the
questions, I think, of Senator Reed that the hiring freeze has
created challenges. I do not know that we can overcome that.
But if it is personnel in a particular way or other things, it
would be useful for me to know.
Mr. Clayton. Thank you very much. And I did not want to get
ahead of the process. Our fiscal year 2019 request reflects the
sentiment I have expressed today.
Senator Moran. I do not know that we will see the fiscal
year 2019 request before we are taking a look at the potential
increase in funding for fiscal year 2018, depending on when the
President's budget is released. But I would offer that--it does
not need to be today--if there are any suggestions you would
like to convey to me.
You may have answered this question just now with Senator
Menendez, Chairman Clayton, but doesn't--you indicated why you
were reluctant or unwilling at the moment to approve an ETF
proposal. But doesn't ETF, just as options do on its exchange,
reduce the--mitigate the concerns, reduce the volatility and
increase price discovery and reduce risk? So additional
products--my question really is: Don't additional products help
alleviate some of the challenges that we face? Or is Bitcoin or
cryptocurrency so unique that it is different than other items
that are traded on exchanges?
Mr. Clayton. Yes, I think that the CFTC product has that
effect. It is largely an institutional product, and you can
take both sides of the market and, you know, it gives people a
chance. As for ETFs, you can take both sides of an ETF, but
predominantly they are offered for a long investor, someone who
wants exposure to the rise and fall of Bitcoin or other
currencies, and that is a different dynamic than a futures
product. And we have long taken an investor protection view of
approving those types of products, which is embodied in our
liquidity, custody, and pricing rules. If we get comfortable
with those rules, then we can move forward.
Senator Moran. Very good. Let me raise a different topic
than cryptocurrency. One of the things that I have tried to pay
attention to and often in cooperation with the Senator from New
Mexico, Senator Udall, is trying to modernize our IT system,
particularly within the Federal Government. And you indicated,
Chairman Clayton, about the $500 million loss in a Japanese
cryptocurrency in your written testimony. We have now passed as
part of the national defense authorization bill what has been
labeled as ``MGT Act''. It is the Modernizing Government
Technology Act, and what it does is create a fund for Federal
agencies to rid themselves of their legacy technologies and
have access to dollars to replace that legacy. It encourages
moving to the cloud, again, with the opportunities for us to
have better technologies and safer technology systems to reduce
our vulnerabilities.
I just would encourage you, you have a lot at risk in the
safety and security of the data that you hold, and I would
welcome your reassurances that--I am sure you will tell me that
you are spending many millions of dollars and working
diligently and you have the right personnel in place. But I
would guess if we ask agencies of the Federal Government who
have been hacked themselves and whose data has been released,
they would have told us the same thing prior to that occurring
to them. I would be, first of all, delighted to be reassured
that we will not be reading in tomorrow's paper or next month's
papers that there has been a hack at CFTC or SEC.
Then, second, I just would offer you the opportunity to
take a look at that legislation and see how it might be of
benefit to your agencies and to suggest any ideas that you
would have for what Congress can do to further strengthen
cybersecurity within your worlds.
Mr. Clayton. Thank you.
Senator Moran. You are welcome.
Mr. Clayton. Thank you very much.
Senator Moran. Mr. Chairman, thank you.
Chairman Crapo. Thank you.
Senator Cortez Masto.
Senator Cortez Masto. Thank you. Gentlemen, thank you. I
apologize. I have had another Committee hearing going on at the
same time, but I appreciate your written comments and the
conversation today. It is so important. And as somebody who was
Attorney General of the State of Nevada and worked on consumer
protection issues, obviously weeding out any type of fraud is
important in this space as well.
Let me start with a couple of questions that I have. I
understand that companies that originated outside the
cryptocurrency space like Kodak and Burger King have recently
jumped into the cryptocurrency space. However, some critics
have warned that companies are using blockchain as an
opportunistic venture to pump up stock prices without having a
clear business plan. One company, Long Island Iced Tea, I
understand changed its name to Long Blockchain and watched its
stock soar.
So are you concerned that companies may be utilizing
blockchain as a scheme to pump up their stock prices? I am
going to just open it up to both of you.
Mr. Clayton. The short answer is yes. The longer answer is
I have put out a warning in this space, and I have put out a
warning to securities lawyers as well, which is nobody should
think it is OK to change your name to something that involves
blockchain when you have no real underlying blockchain business
plan and try to sell securities based on the hype around
blockchain.
Senator Cortez Masto. And when you say you put out a
warning, what does that mean specifically?
Mr. Clayton. I made a speech regarding this, which is
published on the SEC website. But this is an area of concern to
us. Anytime there is something new that people seek to raise
the value of their securities without the underlying goods
being there is problematic.
Senator Cortez Masto. Right.
Mr. Giancarlo. Thank you, Senator. So as you know, the
jurisdiction of the CFTC and the SEC is slightly different in
this regard, and so Chairman Clayton is rightfully concerned
with initial coin offerings that are misrepresenting the
affiliation, whether it be with Kodak or otherwise. We focus on
fraud and manipulation broadly in instruments where there is
wild claims for them, and I mentioned earlier a case we
recently brought on a Long Island firm called ``My Big Coin'',
which turned out to be My Big Con. There was nothing there.
They were taking people's money and not investing in anything
other than their own jewelry and houses and fancy cars and this
kind of thing.
We have been very aggressive in using our enforcement
authority. We have recently brought three cases just last month
alone. I have said there will be more, and we are looking into
this and monitoring markets very carefully. We believe that our
big task is bringing enforcement cases and letting people see
that, as well as consumer education, which I have also----
Senator Cortez Masto. Yeah, because it has a deterrent
effect. You hope it does, right?
Mr. Clayton. Yes.
Senator Cortez Masto. OK. Thank you.
It has also been reported that more than 3 million Bitcoins
have been stolen. That is about 14 percent of the Bitcoins or
one in seven Bitcoins stolen. And on January 26th, Coincheck, a
Japanese currency exchange, was hacked. In minutes, $430
million was lost to hackers. This follows another theft of more
than $500 million from another exchange, Mt. Gox. If people put
money into a stock or bond and it was stolen, they would have
help. For example, the Federal Government is still trying to
help investors recover the money stolen by Bernie Madoff. When
virtual currencies are stolen by hackers, what can buyers do to
get their money back, if anything?
Mr. Clayton. This is a very good point, and it is one that
we have emphasized in our investor alerts, that when you engage
in investing online with an offshore entity, the chances that
we can do anything practical to get your money back are very,
very low.
Mr. Giancarlo. In our futures market, for example, we have
what we call ``system safeguards,'' requirements that futures
exchanges have cyberprotections in place and they adopt best
practices. For these underlying spot markets, which we do not
regulate, we do not have the authority to require them to have
cybersafeguards in place.
Senator Cortez Masto. Right.
Mr. Giancarlo. And, you know, a lot of these companies are
young, they are startups. They are focused on putting what
resources they have into developing their technology. And in
the case of some of the cases you mentioned, what I understand
was the cyberprotections just were not there.
Now, I know that the JFSA has been aggressive on this. We
have had some conversations with them. We have asked questions.
What are they doing about it? But, unfortunately, the theft has
already happened.
Senator Cortez Masto. Right.
Mr. Giancarlo. And so this is a problem, that these
underlying stages, while we do have enforcement authority, we
do not have the same regulatory authority that we have in the
markets that we oversee. That is our day job, as one of your
colleagues mentioned earlier, and so, therefore, this is a gap.
Mr. Clayton. Or the same kind of protection rules like
custody.
Senator Cortez Masto. Right.
Mr. Clayton. It was gone.
Senator Cortez Masto. Yeah, so it is the old axiom, ``Buyer
beware.'' So around this space, a lot of education is
important, I would imagine, from all the Federal agencies to
buyers so they know until something else can be done, which I
think we are still trying to figure that out
I notice my time is up. Thank you very much. Thank you.
Chairman Crapo. Thank you, Senator.
I had not planned on having a second round, but I have
agreed to allow Senator Shelby and Senator Warren to each have
one brief question. Senator Shelby.
Senator Shelby. I want to get in the area of what is on a
lot of people's minds today, and I know you do not control the
stock market. You know, what goes up comes down, as we all
know, and we do not know when and so forth. Is this perhaps
more than an ordinary correction, or do you have a judgment on
that at all? Chairman Clayton.
Mr. Clayton. So your question is exactly the question I
asked my staff and some of my colleagues across the Federal
Government.
Senator Shelby. OK.
Mr. Clayton. Because we should be asking those questions.
By this morning, there was nothing to indicate that any of our
systems did not function as they were expected to function
yesterday. This was the largest volume since November 2016.
There was a significant price change. We have two types of
limits. We have single stock limits, and then we have market
limits, the circuit breakers. Neither one of those were hit in
any great detail. The single stock was nine; the circuit
breakers did not get hit.
So as I sit here today, there is nothing that came out of
this that concerns me from a functioning standpoint. But days
like yesterday, our job is to look at them.
Senator Shelby. From a regulatory standpoint, are you
saying that you do not see anything amiss?
Mr. Clayton. Yes.
Senator Shelby. From a regulatory standpoint.
Mr. Clayton. Yes.
Senator Shelby. You cannot control what goes up and what
goes down. But what spooked the markets? Is it profit taking
perhaps? Is it a whiff of maybe inflation out there? Because
people that watch the markets and participate in the markets
see that the Fed is beginning to raise interest rates, dealing
with price stability as they see it. And the Fed has
information perhaps we do not have. The economy is hot,
unemployment is low, and so forth. Is it a combination of all,
or can we really say?
Mr. Clayton. Well, I cannot really say because I--you know,
there are a lot of opinions on those things. Our job is to look
at the functioning----
Senator Shelby. Absolutely.
Mr. Clayton. --and look at the systemic risks.
Senator Shelby. That is right.
Mr. Clayton. And I am asking myself, is there anything that
happened yesterday that gives me a different view of systemic
risk than I had the day before? And so far, no. But that is a
question I ask myself almost every day.
Senator Shelby. Of course, we all know that when the market
is going up, people are elated. That is natural. When it is
going down, some people profit, but not a lot of people are
elated. Is that fair?
Mr. Clayton. That is fair.
Senator Shelby. Do you have any comment, Mr. Chairman?
Mr. Giancarlo. Well, I am just smiling because of just a
recollection of a saying that a mentor of mine who actually was
my introduction in to the financial markets used to say. When I
would ask him--and he was an old hand in the markets--what
drove the market up yesterday, or down, he would say, ``Oh, it
was up? More people bought than sold. Oh, it was down? More
people sold than bought.'' And we laugh, but what he said to
me, he said, you know, ``When you listen to the pundits and
they say, `Well, the market was up yesterday because of this,'
that may have been why or it may not have been why.'' But the
reporters or the pundit needed a reason, so they pick something
out and that becomes the reason for the day.
I do not mean to be facetious, but markets are very, very
complex. Very, very complex.
Senator Shelby. Very much.
Mr. Giancarlo. And sometimes it is oversimplifying, and you
hear it on the news, you hear it by people that are stock
pickers, and they say, ``Well, it was because of this.'' Well,
I do not know how anybody really knows.
Now, if there are fundamental moves, fundamental changes,
that is where we have to do--and I share Chairman Clayton's
view. Our job is to look at the structural underpinnings and
see whether there is anything that is not functioning.
Senator Shelby. See if the fundamentals are sound.
Mr. Giancarlo. See if the fundamentals are sound. So you
will not be surprised to know that we had a late night last
night and an early morning this morning, checking in with our
exchanges to make sure that things are in order, making sure
that the margin levels held, to make sure there was no
significant margin breaches. And I can say that the system
held. The system worked as it was designed to do. The margin
levels worked as they were designed to work. And so the right
systems and the right policies are in place. But the markets
are always evolving, always organic, and that is why we need to
stay very close to them.
Senator Shelby. The market always corrects. The question
is: Is this an ordinary--maybe not an ordinary correction, but
is it a correction, the market will correct itself, and we go
from there? Is that fair?
Mr. Giancarlo. Yes.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Crapo. Senator Warren.
Senator Warren. Thank you, Mr. Chairman.
So I want to go back to virtual currency, and I want to ask
about initial coin offerings, ICOs. Some ICOs raise money for
legitimate companies, but others we know are just Ponzi
schemes. And many of the investors in ICOs are just everyday
Americans lured by aggressive marketing promising very high
returns. In fact, it is now so bad that Facebook recently
banned all ads for virtual currency-related products and ICOs
because there were so many ``deceptive and misleading''
advertising that targeted regular consumers. So I just want to
ask a little question around how we make ICOs safer.
Chairman Clayton, the SEC evidently recognized the risk, so
it announced last summer that it would consider certain coins
to be securities under the Securities Act, meaning that they
have to be registered with the Commission and comply with
disclosure requirements. In 2017, companies raised more than $4
billion in ICOs. How many of those companies registered their
ICO with the SEC?
Mr. Clayton. Not one.
Senator Warren. Not one. And as of today, how many
companies have registered for upcoming ICOs?
Mr. Clayton. Not one.
Senator Warren. Not one, so we are still at zero. Can you
just say a word about why that is so?
Mr. Clayton. Yes. I do not think the gatekeepers that we
rely on to assist us in making sure our securities laws are
followed have done their job. We have made it clear what the
law is. As I have said many times, there are thousands and
thousands of private placements that go on every year in the
U.S. We want them to go on. We want people to raise capital.
But we want them to do it right.
Senator Warren. Right.
Mr. Clayton. What ICOs do is they take the disclosure-like
benefits of a private placement and then add to it the public
general solicitation and retail investor promise of a secondary
market without registering with us. And folks somehow got
comfortable that this was new and it was OK and it was not a
security, it was just some other way to raise money. Well, I
disagree with them.
Senator Warren. So it is not new, it is--or it is new, but
it is not OK and it is not another way to raise money.
Mr. Clayton. Correct.
Senator Warren. I am understanding you to say it is a
violation of the law.
Mr. Clayton. Yes.
Senator Warren. Registration really matters. When companies
do not register their tokens as securities, they can hide
information, and the SEC does not have the information it needs
to monitor this market.
Mr. Clayton. I am perfectly happy for these people to do
private placements, but do them right. Do not try and do it as
a private placement but get all the benefits of a public----
Senator Warren. And then lever over into a public----
Mr. Clayton. Yeah, and do all the other shenanigans that
are----
Senator Warren. Well, good. So should I take today as you
are sounding a warning bell for people, maybe they better pay a
little closer attention to the law or the SEC is going to pay
closer attention to them?
Mr. Clayton. Yes, and it is not the first time. But I
really appreciate the opportunity to do it today.
Senator Warren. Thank you.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Senator. And thank you to our
witnesses. We appreciate not only your testimony today but the
work that you are doing in this critical area.
I would ask you to get back to me on recommendations as you
refine your evaluation of our current financial legislative
system and whether we need to provide further clarification
from Congress.
With that, this hearing is adjourned.
[Whereupon, at 11:54 a.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
This morning, we will receive testimony from SEC Chairman Jay
Clayton and CFTC Chairman Chris Giancarlo on the growing world of
virtual currencies and the oversight conducted by their two agencies.
Virtual currencies are meant to act as a type of money that can be
traded on online exchanges for conventional currencies, such as
dollars, or used to purchase goods or services, predominantly online.
Additionally, developers, businesses and individuals are selling
virtual coins or tokens through initial coin offerings, also known as
ICOs, to raise capital.
Over the last year, many Americans have become increasingly
interested in virtual currencies, especially given the meteoric rise in
valuation and recent fall of Bitcoin.
Just for perspective, on January 2 of last year, Bitcoin broke the
$1,000 barrier, then peaked in December of 2017 at almost $20,000 and
as of this morning is trading at roughly $6,900.
Today, the market capitalization of Bitcoin is roughly $115
billion.
This is an incredible rise given that in 2013, when this Committee
had subcommittee hearings on the topic, the total value of Bitcoin in
circulation was approximately $5 billion.
As virtual currencies have become more widespread, financial
regulators and heads of financial institutions have noticed and voiced
their opinions.
Regulators and heads of industry have tried to educate investors so
that they make informed decisions, and ensure that the markets they
oversee and participate in are appropriately working.
For its part, the SEC has put forth many statements and guideposts
to help the markets and investors. Namely, the SEC has: issued investor
bulletins on initial coin offerings; issued an investigative report on
what characteristics make an ICO a security offering; issued several
statements by Chairman Clayton on the issue; brought enforcement
actions against fraudsters; and issued joint statements with the CFTC
about enforcement of virtual currency related products.
The CFTC has also been helping inform the markets by: launching a
dedicated website on virtual currencies to educate investors; bringing
enforcement actions against individuals involved in cryptocurrency
related scams; issuing several statements by Chairman Giancarlo and
other Commissioners on the issue; and scheduling hearings on the
topics.
Much of the recent news about virtual currencies has been negative;
between the enforcement actions brought by your agencies, the hack of
the international Coincheck exchange, and the concerns raised by
various regulators and market participants, there is no shortage of
examples that increase investor concerns.
It is also important to note that the technology, innovation, and
ideas underlying these markets present significant positive potential.
These aspects underpinning virtual currencies have the ability to
transform for investors the composition of, and ability to access, the
financial landscape, thus changing and modernizing capital formation
and transfer of risk.
Technology is forward looking, and we look to our regulators to
continue carrying out their mandates, including investor protection, as
the markets evolve.
I look forward to learning more about virtual currency oversight
from the two witnesses, including what their agencies are doing to
ensure appropriate disclosures and safeguards for investors.
______
PREPARED STATEMENT OF JAY CLAYTON
Chairman, U.S. Securities and Exchange Commission
February 6, 2018
Chairman Crapo, Ranking Member Brown, and distinguished senators of
the Committee, thank you for the opportunity to testify before you
today. \1\ I am pleased that the Committee is holding this hearing to
bring greater focus to the important issues that cryptocurrencies,
initial coin offerings (ICOs) and related products and activities
present for American investors and our markets.
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\1\ The views expressed in this testimony are those of the
Chairman of the Securities and Exchange Commission and do not
necessarily represent the views of the President, the full Commission,
or any Commissioner.
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I am also pleased to join my counterpart, Commodity Futures Trading
Commission (CFTC) Chairman Christopher Giancarlo, for our second time
testifying together before Congress. Since I joined the Commission in
May, Chairman Giancarlo and I have built a strong relationship.
Cryptocurrencies, ICOs and related subjects are the latest in a host of
market issues on which we and our staffs have been closely
collaborating to strengthen our capital markets for investors and
market participants. \2\
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\2\ See Jay Clayton and J. Christopher Giancarlo, ``Regulators Are
Looking at Cryptocurrency'', Wall St. J. (Jan. 24, 2018), available at
https://www.wsj.com/articles/regulators-are-looking-at-cryptocurrency-
1516836363?mod=searchresults&page=1&pos=2.
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The mission of the SEC is to protect investors, maintain fair,
orderly, and efficient markets and facilitate capital formation. We do
so through our enforcement of the Federal securities laws and our
oversight of the securities markets and their participants including
(1) approximately $75 trillion in securities trading annually on U.S.
equity markets; (2) the disclosures of approximately 4,100 exchange-
listed public companies with an approximate aggregate market
capitalization of $31 trillion; and (3) the activities of over 26,000
registered entities and self-regulatory organizations, including
investment advisers, broker-dealers, transfer agents, securities
exchanges, clearing agencies, mutual funds, exchange-traded funds
(ETFs), the Financial Industry Regulatory Authority (FINRA), and the
Municipal Securities Rulemaking Board (MSRB), among others.
For those who seek to raise capital to fund an enterprise, as many
in the ICO space have sought to do, a primary entry into the SEC's
jurisdiction is the offer and sale of securities, as set forth in the
Securities Act of 1933. \3\ As I will explain in greater detail below,
determining what falls within the ambit of a securities offer and sale
is a facts-and-circumstances analysis, utilizing a principles-based
framework that has served American companies and American investors
well through periods of innovation and change for over 80 years.
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\3\ Under Section 2(a)(1) of the Securities Act and Section
3(a)(10) of the Exchange Act, a security includes, among other items,
``an investment contract.'' See 15 U.S.C. 77b-77c. An investment
contract is an investment of money in a common enterprise with a
reasonable expectation of profits to be derived from the
entrepreneurial or managerial efforts of others. See SEC v. Edwards,
540 U.S. 389, 393 (2004); SEC v. W.J. Howey Co., 328 U.S. 293, 301
(1946); see also United Housing Found., Inc. v. Forman, 421 U.S. 837,
852-53 (1975).
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The cryptocurrency and ICO markets, while new, have grown rapidly,
gained greater prominence in the public conscience and attracted
significant capital from retail investors. We have seen historical
instances where such a rush into certain investments has benefited our
economy and those investors who backed the right ventures. But when our
laws are not followed, the risks to all investors are high and
numerous--including risks caused by or related to poor, incorrect or
nonexistent disclosure, volatility, manipulation, fraud, and theft.
To be clear, I am very optimistic that developments in financial
technology will help facilitate capital formation, providing promising
investment opportunities for institutional and Main Street investors
alike. From a financial regulatory perspective, these developments may
enable us to better monitor transactions, holdings and obligations
(including credit exposures) and other activities and characteristics
of our markets, thereby facilitating our regulatory mission, including,
importantly, investor protection.
At the same time, regardless of the promise of this technology,
those who invest their hard-earned money in opportunities that fall
within the scope of the Federal securities laws deserve the full
protections afforded under those laws. This ever-present need comes
into focus when enthusiasm for obtaining a profitable piece of a new
technology ``before it's too late'' is strong and broad. Fraudsters and
other bad actors prey on this enthusiasm.
The SEC and the CFTC, as Federal market regulators, are charged
with establishing a regulatory environment for investors and market
participants that fosters innovation, market integrity and ultimately
confidence. To that end, a number of steps the SEC has taken relating
to cryptocurrencies, ICOs and related assets are discussed below.
Message for Main Street Investors
Before discussing regulation in more detail, I would like to
reiterate my message to Main Street investors from a statement I issued
in December. \4\ Cryptocurrencies, ICOs and related products and
technologies have captured the popular imagination--and billions of
hard-earned dollars--of American investors from all walks of life. In
dealing with these issues, my key consideration--as it is for all
issues that come before the Commission--is to serve the long term
interests of our Main Street investors. My efforts--and the tireless
efforts of the SEC staff--have been driven by various factors, but most
significantly by the concern that too many Main Street investors do not
understand all the material facts and risks involved. Unfortunately, it
is clear that some have taken advantage of this lack of understanding
and have sought to prey on investors' excitement about the quick rise
in cryptocurrency and ICO prices. \5\
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\4\ In December, I issued a statement that provided my general
views on the cryptocurrency and ICO markets. The statement was directed
principally at two groups: (1) Main Street investors and (2) market
professionals--including, for example, broker-dealers, investment
advisers, exchanges, lawyers, and accountants--whose actions impact
Main Street investors. See ``Statement on Cryptocurrencies and Initial
Coin Offerings'' (Dec. 11, 2017), available at https://www.sec.gov/
news/public-statement/statement-clayton-2017-12-11.
\5\ In one instance, the SEC brought an enforcement action against
a purported Bitcoin mining company that claimed to have a product ``so
easy to use that it is `Grandma approved.' '' In this case, in less
than 6 months, the company allegedly raised more than $19 million from
more than 10,000 investors. The SEC charged that company with operating
a Ponzi scheme. See Press Release 2015-271, ``SEC Charges Bitcoin
Mining Companies'' (Dec. 1, 2015), available at https://www.sec.gov/
news/pressrelease/2015-271.html; ``SEC Obtains Final Judgment Against
Founder of Bitcoin Mining Companies Used To Defraud Investors'' (Oct.
4, 2017), available at https://www.sec.gov/litigation/litreleases/2017/
lr23960.htm.
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There should be no misunderstanding about the law. When investors
are offered and sold securities--which to date ICOs have largely been--
they are entitled to the benefits of State and Federal securities laws
and sellers and other market participants must follow these laws.
Yes, we do ask our investors to use common sense, and we recognize
that many investment decisions will prove to be incorrect in hindsight.
However, we do not ask investors to use their common sense in a vacuum,
but rather, with the benefit of information and other requirements
where judgments can reasonably be made.
This is a core principle of our Federal securities laws and is
embodied in the SEC's registration requirements. Investors should
understand that to date no ICOs have been registered with the SEC, and
the SEC also has not approved for listing and trading any exchange-
traded products (such as ETFs) holding cryptocurrencies or other assets
related to cryptocurrencies. If any person today says otherwise,
investors should be especially wary.
Investors who are considering investing in these products should
also recognize that these markets span national borders and that
significant trading may occur on systems and platforms outside the U.S.
Investors' funds may quickly travel overseas without their knowledge.
As a result, risks can be amplified, including the risk that U.S.
market regulators, such as the SEC and State securities regulators, may
not be able to effectively pursue bad actors or recover funds.
Further, there are significant security risks that can arise by
transacting in these markets, including the loss of investment and
personal information due to hacks of online trading platforms and
individual digital asset ``wallets.'' A recent study estimated that
more than 10 percent of proceeds generated by ICOs--or almost $400
million--has been lost to such attacks. \6\ And less than 2 weeks ago,
a Japanese cryptocurrency market lost over $500 million in an apparent
hack of its systems. \7\
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\6\ See ``EY Research: Initial Coin Offerings (ICOs)'' (Dec.
2017), available at http://www.ey.com/Publication/vwLUAssets/ey-
research-initial-coin-offerings-icos/%24File/ey-research-initial-coin-
offerings-icos.pdf.
\7\ See Reuters, ``Japan Raps Coincheck, Orders Broader Checks
After $530 Million Cryptocurrency Theft'', Jan. 28, 2018, available at
https://www.reuters.com/article/us-japan-cryptocurrency/japan-raps-
coincheck-orders-broader-checks-after-530-million-cryptocurrency-theft-
idUSKBN1FI06S.
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In order to arm investors with additional information, the SEC
staff has issued investor alerts, bulletins and statements on ICOs and
cryptocurrency-related investments, including with respect to the
marketing of certain offerings and investments by celebrities and
others. \8\ If investors choose to invest in these products, they
should ask questions and demand clear answers. I would strongly urge
investors--especially retail investors--to review the sample questions
and investor alerts issued by the SEC's Office of Investor Education
and Advocacy. \9\
---------------------------------------------------------------------------
\8\ ``Statement on Potentially Unlawful Promotion of Initial Coin
Offerings and Other Investments by Celebrities and Others'' (Nov. 1,
2017), available at https://www.sec.gov/news/public-statement/
statement-potentially-unlawful-promotion-icos; ``Investor Alert: Public
Companies Making ICO-Related Claims'' (Aug. 28, 2017), available at
https://www.sec.gov/oiea/investor-alerts-and-bulletins/
ia_icorelatedclaims; ``Investor Bulletin: Initial Coin Offerings''
(July 25, 2017), available at https://www.sec.gov/oiea/investor-alerts-
and-bulletins/ib_coinofferings; ``Investor Alert: Bitcoin and Other
Virtual Currency-Related Investments'' (May 7, 2014), available at
https://www.investor.gov/additional-resources/news-alerts/alerts-
bulletins/investor-alert-bitcoin-other-virtual-currency; ``Investor
Alert: Ponzi Schemes Using Virtual Currencies'' (July 23, 2013),
available at https://www.sec.gov/investor/alerts/
ia_virtualcurrencies.pdf.
\9\ See ``Sample Questions for Investors Considering a
Cryptocurrency or ICO Investment Opportunity'' (Dec. 2017), available
at https://www.sec.gov/news/public-statement/statement-clayton-2017-12-
11#_ftnref8.
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These warnings are not an effort to undermine the fostering of
innovation through our capital markets--America was built on the
ingenuity, vision, and spirit of entrepreneurs who tackled old and new
problems in new, innovative ways. Rather, they are meant to educate
Main Street investors that many promoters of ICOs and cryptocurrencies
are not complying with our securities laws and, as a result, the risks
are significant.
With my remaining testimony, I would like to provide the Committee
an overview of the Commission's ongoing work on cryptocurrencies and
ICOs.
Cryptocurrencies and Related Products and Trading
Speaking broadly, cryptocurrencies purport to be items of inherent
value (similar, for instance, to cash or gold) that are designed to
enable purchases, sales, and other financial transactions. Many are
promoted as providing the same functions as long-established currencies
such as the U.S. dollar but without the backing of a Government or
other body. While cryptocurrencies currently being marketed vary in
different respects, proponents of cryptocurrencies often tout their
novelty and other potential beneficial features, including the ability
to make transfers without an intermediary and without geographic
limitation and lower transaction costs compared to other forms of
payment. Critics of cryptocurrencies note that the purported benefits
highlighted by proponents are unproven and other touted benefits, such
as the personal anonymity of the purchasers and sellers and the absence
of Government regulation or oversight, could also facilitate illicit
trading and financial transactions, as well as fraud.
The recent proliferation and subsequent popularity of
cryptocurrency markets creates a question for market regulators as to
whether our historic approach to the regulation of sovereign currency
transactions is appropriate for these new markets. These markets may
look like our regulated securities markets, with quoted prices and
other information. Many trading platforms are even referred to as
``exchanges.'' I am concerned that this appearance is deceiving. In
reality, investors transacting on these trading platforms do not
receive many of the market protections that they would when transacting
through broker-dealers on registered exchanges or alternative trading
systems (ATSs), such as best execution, prohibitions on front running,
short sale restrictions, and custody and capital requirements. I am
concerned that Main Street investors do not appreciate these
differences and the resulting substantially heightened risk profile.
It appears that many of the U.S.-based cryptocurrency trading
platforms have elected to be regulated as money-transmission services.
Traditionally, from an oversight perspective, these predominantly
State-regulated payment services have not been subject to direct
oversight by the SEC or the CFTC. Traditionally, from a function
perspective, these money transfer services have not quoted prices or
offered other services akin to securities, commodities and currency
exchanges. In short, the currently applicable regulatory framework for
cryptocurrency trading was not designed with trading of the type we are
witnessing in mind. As Chairman Giancarlo and I stated recently, we are
open to exploring with Congress, as well as with our Federal and State
colleagues, whether increased Federal regulation of cryptocurrency
trading platforms is necessary or appropriate. We also are supportive
of regulatory and policy efforts to bring clarity and fairness to this
space.
The SEC regulates securities transactions and certain individuals
and firms who participate in our securities markets. The SEC does not
have direct oversight of transactions in currencies or commodities,
including currency trading platforms.
While there are cryptocurrencies that, at least as currently
designed, promoted, and used, do not appear to be securities, simply
calling something a ``currency'' or a currency-based product does not
mean that it is not a security. To this point I would note that many
products labeled as cryptocurrencies or related assets are increasingly
being promoted as investment opportunities that rely on the efforts of
others, with their utility as an efficient medium for commercial
exchange being a distinct secondary characteristic. As discussed in
more detail below, if a cryptocurrency, or a product with its value
tied to one or more cryptocurrencies, is a security, its promoters
cannot make offers or sales unless they comply with the registration
and other requirements under our Federal securities laws. \10\
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\10\ It is possible to conduct an offer and sales of securities,
including an ICO, without triggering the SEC's registration
requirements. For example, just as with a Regulation D exempt offering
to raise capital for the manufacturing of a physical product, an ICO
that is a security can be structured so that it qualifies for an
applicable exemption from the registration requirements.
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In this regard, the SEC is monitoring the cryptocurrency-related
activities of the market participants it regulates, including brokers,
dealers, investment advisers, and trading platforms. Brokers, dealers
and other market participants that allow for payments in
cryptocurrencies, allow customers to purchase cryptocurrencies
(including on margin) or otherwise use cryptocurrencies to facilitate
securities transactions should exercise particular caution, including
ensuring that their cryptocurrency activities are not undermining their
anti-money-laundering and know-your-customer obligations. \11\ As I
have stated previously, these market participants should treat payments
and other transactions made in cryptocurrency as if cash were being
handed from one party to the other.
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\11\ I am particularly concerned about market participants who
extend to customers credit in U.S. dollars--a relatively stable asset--
to enable the purchase of cryptocurrencies, which, in recent
experience, have proven to be a more volatile asset.
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Finally, financial products that are linked to underlying digital
assets, including cryptocurrencies, may be structured as securities
products subject to the Federal securities laws even if the underlying
cryptocurrencies are not themselves securities. Market participants
have requested Commission approval for new products and services of
this type that are focused on retail investors, including
cryptocurrency-linked ETFs. While we appreciate the importance of
continuing innovation in our retail fund space, there are a number of
issues that need to be examined and resolved before we permit ETFs and
other retail investor-oriented funds to invest in cryptocurrencies in a
manner consistent with their obligations under the Federal securities
laws. These include issues around liquidity, valuation, and custody of
the funds' holdings, as well as creation, redemption, and arbitrage in
the ETF space.
Last month, after working with several sponsors who ultimately
decided to withdraw their registration statements, the Director of our
Division of Investment Management issued a letter to provide an
overview of certain substantive issues and related questions associated
with registration requirements and to encourage others who may be
considering a fund registered pursuant to the Investment Company Act of
1940 to engage in a robust discussion with the staff concerning the
above-mentioned issues. \12\ Until such time as those questions have
been sufficiently addressed, I am concerned about whether it is
appropriate for fund sponsors that invest substantially in
cryptocurrencies and related products to register. We will continue
engaging in a dialogue with all interested parties to seek a path
forward consistent with the SEC's tripartite mission.
---------------------------------------------------------------------------
\12\ See ``Staff Letter: Engaging on Fund Innovation and
Cryptocurrency-Related Holdings'' (Jan. 18, 2018), available at https:/
/www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-
011818.htm.
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ICOs and Related Trading
Coinciding with the substantial growth in cryptocurrencies,
companies and individuals increasingly have been using so-called ICOs
to raise capital for businesses and projects. Typically, these
offerings involve the opportunity for individual investors to exchange
currency, such as U.S. dollars or cryptocurrencies, in return for a
digital asset labeled as a coin or token. The size of the ICO market
has grown exponentially in the last year, and it is estimated that
almost $4 billion was raised through ICOs in 2017. Note that this
number may understate the size of the ICO market (and the potential for
loss) as many ICOs ``trade up'' after they are issued.
These offerings can take different forms, and the rights and
interests a coin is purported to provide the holder can vary widely. A
key question all ICO market participants--promoters, sellers, lawyers,
officers, and directors and accountants, as well as investors--should
ask: ``Is the coin or token a security?'' As securities law
practitioners know well, the answer depends on the facts. But by and
large, the structures of ICOs that I have seen involve the offer and
sale of securities and directly implicate the securities registration
requirements and other investor protection provisions of our Federal
securities laws. As noted above, the foundation of our Federal
securities laws is to provide investors with the procedural protections
and information they need to make informed judgments about what they
are investing in and the relevant risks involved. In addition, our
Federal securities laws provide a wide array of remedies, including
criminal and civil actions brought by the DOJ and the SEC, as well as
private rights of action.
The Commission previously urged market professionals, including
securities lawyers, accountants, and consultants, to read closely an
investigative report it released. On July 25, 2017, the Commission
issued a Report of Investigation pursuant to Section 21(a) of the
Securities Exchange Act of 1934 \13\ regarding an ICO of DAO Tokens.
\14\ In the Report, the Commission considered the particular facts and
circumstances presented by the offer and sale of DAO Tokens and
concluded that DAO Tokens were securities based on longstanding legal
principles, and therefore that offers and sales of the DAO Tokens were
subject to the Federal securities laws. The Report also explained that
issuers of distributed ledger or blockchain technology-based securities
must register offers and sales of such securities unless a valid
exemption from registration applies, and that platforms that provide
for trading in such securities must register with the SEC as national
securities exchanges or operate pursuant to an exemption from such
registration.
---------------------------------------------------------------------------
\13\ Section 21(a) of the Exchange Act authorizes the Commission
to investigate violations of the Federal securities laws and, in its
discretion, to ``publish information concerning any such violations.''
The Report does not constitute an adjudication of any fact or issue
addressed therein, nor does it make any findings of violations by any
individual or entity.
\14\ Report of Investigation Pursuant to Section 21(a) of the
Securities Exchange Act of 1934: The DAO (July 25, 2017), available at
https://www.sec.gov/litigation/investreport/34-81207.pdf.
---------------------------------------------------------------------------
The Commission's message to issuers and market professionals in
this space was clear: those who would use distributed ledger technology
to raise capital or engage in securities transactions must take
appropriate steps to ensure compliance with the Federal securities
laws. The Report and subsequent statements also explain that the use of
such technology does not mean that an offering is necessarily
problematic under those laws. The registration process itself, or
exemptions from registration, are available for offerings employing
these novel methods.
The statement I issued in December that was directed to Main Street
investors and market professionals provided additional insight into how
practitioners should view ICOs in the context of our Federal securities
laws. Certain market professionals have attempted to highlight the
utility or voucher-like characteristics of their proposed ICOs in an
effort to claim that their proposed tokens or coins are not securities.
Many of these assertions that the Federal securities laws do not apply
to a particular ICO appear to elevate form over substance. The rise of
these form-based arguments is a disturbing trend that deprives
investors of mandatory protections that clearly are required as a
result of the structure of the transaction. Merely calling a token a
``utility'' token or structuring it to provide some utility does not
prevent the token from being a security. \15\ Tokens and offerings that
incorporate features and marketing efforts that emphasize the potential
for profits based on the entrepreneurial or managerial efforts of
others continue to contain the hallmarks of a security under U.S. law.
It is especially troubling when the promoters of these offerings
emphasize the secondary market trading potential of these tokens, i.e.,
the ability to sell them on an exchange at a profit. In short,
prospective purchasers are being sold on the potential for tokens to
increase in value--with the ability to lock in those increases by
reselling the tokens on a secondary market--or to otherwise profit from
the tokens based on the efforts of others. These are key hallmarks of a
security and a securities offering.
---------------------------------------------------------------------------
\15\ See SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351
(1943) (``[T]he reach of the [Securities] Act does not stop with the
obvious and commonplace. Novel, uncommon, or irregular devices,
whatever they appear to be, are also reached if it be proved as matter
of fact that they were widely offered or dealt in under terms or
courses of dealing which established their character in commerce as
`investment contracts,' or as any interest or instrument commonly known
as a `security'.''); see also Reves v. Ernst & Young, 494 U.S. 56, 61
(1990) (``Congress' purpose in enacting the securities laws was to
regulate investments, in whatever form they are made and by whatever
name they are called.'').
---------------------------------------------------------------------------
On this and other points where the application of expertise and
judgment is expected, I believe that gatekeepers and others, including
securities lawyers, accountants and consultants, need to focus on their
responsibilities. I have urged these professionals to be guided by the
principal motivation for our registration, offering process and
disclosure requirements: investor protection and, in particular, the
protection of our Main Street investors. \16\
---------------------------------------------------------------------------
\16\ See ``Opening Remarks at the Securities Regulation
Institute'' (Jan. 22, 2018), available at https://www.sec.gov/news/
speech/speech-clayton-012218.
---------------------------------------------------------------------------
I also have cautioned market participants against promoting or
touting the offer and sale of coins without first determining whether
the securities laws apply to those actions. Engaging in the business of
selling securities generally requires a license, and experience shows
that excessive touting in thinly traded and volatile markets can be an
indicator of ``scalping,'' ``pump and dump,'' and other manipulations
and frauds. Similarly, my colleagues and I have cautioned those who
operate systems and platforms that effect or facilitate transactions in
these products that they may be operating unregistered exchanges or
broker-dealers that are in violation of the Securities Exchange Act of
1934.
I do want to recognize that recently social media platforms have
restricted the ability of users to promote ICOs and cryptocurrencies on
their platforms. I appreciate the responsible step.
Enforcement
A number of concerns have been raised regarding the cryptocurrency
and ICO markets, including that, as they are currently operating, there
is substantially less investor protection than in our traditional
securities markets, with correspondingly greater opportunities for
fraud and manipulation. The ability of bad actors to commit age-old
frauds with new technologies coupled with the significant amount of
capital--particularly from retail investors--that has poured into
cryptocurrencies and ICOs in recent months and the offshore footprint
of many of these activities have only heightened these concerns.
In September 2017, the Division of Enforcement established a new
Cyber Unit focused on misconduct involving distributed ledger
technology and ICOs, the spread of false information through electronic
and social media, brokerage account takeovers, hacking to obtain
nonpublic information and threats to trading platforms. \17\ The Cyber
Unit works closely with our cross-divisional Distributed Ledger
Technology Working Group, which was created in November 2013. We
believe this approach has enabled us to leverage our enforcement
resources effectively and coordinate well within the Commission, as
well as with other Federal and State regulators.
---------------------------------------------------------------------------
\17\ See Press Release 2017-176, ``SEC Announces Enforcement
Initiatives To Combat Cyber-Based Threats and Protect Retail
Investors'' (Sept. 25, 2017), available at https://www.sec.gov/news/
press-release/2017-176.
---------------------------------------------------------------------------
To date, we have brought a number of enforcement actions concerning
ICOs for alleged violations of the Federal securities laws. In
September 2017, we brought charges against an individual for defrauding
investors in a pair of ICOs purportedly backed by investments in real
estate and diamonds. \18\ According to the SEC's complaint, investors
provided approximately $300,000 in funding and were told they could
expect sizeable returns despite neither company having real operations.
In December 2017, we obtained an emergency asset freeze to halt an
alleged ICO fraud that purportedly raised up to $15 million from
thousands of individual investors beginning in August 2017. \19\
According to the complaint, the scam was operated by a recidivist
securities law violator and promised investors a more than 1,300
percent profit in under 29 days. As another example, after being
contacted by the SEC last December, a company halted its ICO to raise
capital for a blockchain-based food review service, and then settled
proceedings in which we determined that the ICO was an unregistered
offering and sale of securities in violation of the Federal securities
laws. \20\ Before tokens were delivered to investors, the company
refunded investor proceeds after the SEC intervened.
---------------------------------------------------------------------------
\18\ Press Release 2017-185, ``SEC Exposes Two Initial Coin
Offerings Purportedly Backed by Real Estate and Diamonds'' (Sept. 29,
2017), available at https://www.sec.gov/news/press-release/2017-185-0.
\19\ Press Release 2017-219, ``SEC Emergency Action Halts ICO
Scam'' (Dec. 4, 2017), available at https://www.sec.gov/news/press-
release/2017-219.
\20\ Press Release 2017-227, ``Company Halts ICO After SEC Raises
Registration Concerns'' (Dec. 11, 2017), available at https://
www.sec.gov/news/press-release/2017-227.
---------------------------------------------------------------------------
And most recently, we halted an allegedly fraudulent ICO that
targeted retail investors promoting what it portrayed as the world's
first decentralized bank. \21\ We were able to freeze some of the
allegedly ill-gotten cryptocurrency assets and obtained a receiver to
try to marshal these assets back to harmed investors.
---------------------------------------------------------------------------
\21\ Press Release 2018-8, ``SEC Halts Alleged Initial Coin
Offering Scam'' (Jan. 30, 2018), available at https://www.sec.gov/news/
press-release/2018-8.
---------------------------------------------------------------------------
I also have been increasingly concerned with recent instances of
public companies, with no meaningful track record in pursuing
distributed ledger or blockchain technology, changing their business
models and names to reflect a focus on distributed ledger technology
without adequate disclosure to investors about their business model
changes and the risks involved. A number of these instances raise
serious investor protection concerns about the adequacy of disclosure
especially where an offer and sale of securities is involved. The SEC
is looking closely at the disclosures of public companies that shift
their business models to capitalize on the perceived promise of
distributed ledger technology and whether the disclosures comply with
the Federal securities laws, particularly in the context of a
securities offering.
With the support of my fellow Commissioners, I have asked the SEC's
Division of Enforcement to continue to police these markets vigorously
and recommend enforcement actions against those who conduct ICOs or
engage in other actions relating to cryptocurrencies in violation of
the Federal securities laws. In doing so, the SEC and CFTC are
collaborating on our approaches to policing these markets for fraud and
abuse. \22\ We also will continue to work closely with our Federal and
State counterparts, including the Department of Treasury, Department of
Justice, and State attorneys general and securities regulators.
---------------------------------------------------------------------------
\22\ See Joint Statement by SEC and CFTC Enforcement Directors
Regarding Virtual Currency Enforcement Actions (Jan. 19, 2018),
available at https://www.sec.gov/news/public-statement/joint-statement-
sec-and-cftc-enforcement-directors.
---------------------------------------------------------------------------
Conclusion
Through the years, technological innovations have improved our
markets, including through increased competition, lower barriers to
entry and decreased costs for market participants. Distributed ledger
and other emerging technologies have the potential to further influence
and improve the capital markets and the financial services industry.
Businesses, especially smaller businesses without efficient access to
traditional capital markets, can be aided by financial technology in
raising capital to establish and finance their operations, thereby
allowing them to be more competitive both domestically and globally.
And these technological innovations can provide investors with new
opportunities to offer support and capital to novel concepts and ideas.
History, both in the United States and abroad, has proven time and
again that these opportunities flourish best when pursued in harmony
with our Federal securities laws. These laws reflect our tripartite
mission to protect investors, maintain fair, orderly and efficient
markets and facilitate capital formation. Being faithful to each part
of our mission not in isolation, but collectively, has served us well.
Said simply, we should embrace the pursuit of technological
advancement, as well as new and innovative techniques for capital
raising, but not at the expense of the principles undermining our well-
founded and proven approach to protecting investors and markets.
Thank you for the opportunity to testify before you today and for
your support of the Commission and its workforce. I stand ready to work
with Congress on these issues and look forward to answering your
questions.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF J. CHRISTOPHER GIANCARLO
Chairman, U.S. Commodity Futures Trading Commission
February 6, 2018
Introduction: Virtual Currency
Thank you, Chairman Crapo, for the invitation to testify before the
Committee. Thank you, Ranking Member Brown, and all the Members of the
Committee for this opportunity to discuss virtual currencies.
At the outset, I would like to note that this hearing is timely,
even fortuitous. Emerging financial technologies broadly are taking us
into a new chapter of economic history. They are impacting trading,
markets and the entire financial landscape with far ranging
implications for capital formation and risk transfer. They include
machine learning and artificial intelligence, algorithm-based trading,
data analytics, ``smart'' contracts valuing themselves and calculating
payments in real-time, and distributed ledger technologies, which over
time may come to challenge traditional market infrastructure. They are
transforming the world around us, and it is no surprise that these
technologies are having an equally transformative impact on U.S.
capital and derivatives markets.
The more specific topic for today's hearing, however, is virtual
currency. Broadly speaking, virtual currencies are a digital
representation of value that may function as a medium of exchange, a
unit of account, and/or a store of value. Virtual currencies generally
run on a decentralized peer-to-peer network of computers, which rely on
certain network participants to validate and log transactions on a
permanent, public distributed ledger, commonly known as the blockchain.
Supporters of virtual currencies see a technological solution to
the age-old ``double spend'' problem--that has always driven the need
for a trusted, central authority to ensure that an entity is capable
of, and does, engage in a valid transaction. Traditionally, there has
been a need for a trusted intermediary--for example a bank or other
financial institution--to serve as a gatekeeper for transactions and
many economic activities. Virtual currencies seek to replace the need
for a central authority or intermediary with a decentralized, rules-
based and open consensus mechanism. \1\ An array of thoughtful
business, technology, academic, and policy leaders have extrapolated
some of the possible impacts that derive from such an innovation,
including how market participants conduct transactions, transfer
ownership, and power peer-to-peer applications and economic systems.
\2\
---------------------------------------------------------------------------
\1\ See generally, CFTC Talks, Episode 24, Dec. 29, 2017,
Interview with Coincenter.org Director of Research, Peter Van
Valkenburgh, at http://www.cftc.gov/Media/Podcast/index.htm.
\2\ See Marc Andreessen, ``Why Bitcoin Matters'', New York Times
DealBook (Jan. 21, 2014), https://dealbook.nytimes.com/2014/01/21/why-
bitcoin-matters/; Jerry Brito and Andrea O'Sullivan, ``Bitcoin: A
Primer for Policymakers'', George Mason University Mercatus Center (May
3, 2016), https://www.mercatus.org/publication/bitcoin-primer-
policymakers; Christian Catalini and Joshua S. Gans, ``Some Simple
Economics of the Blockchain'', Rotman School of Management Working
Paper No. 2874598, MIT Sloan Research Paper No. 5191-16 (last updated
Sept. 21, 2017), https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2874598; Arjun Kharpal, ``People Are
`Underestimating' the `Great Potential' of Bitcoin, Billionaire Peter
Thiel Says'', CNBC (Oct. 26, 2017), https://www.cnbc.com/2017/10/26/
bitcoin-underestimated-peter-thiel-says.html; Hugh Son, ``Bitcoin `More
Than Just a Fad,' Morgan Stanley CEO Says'', Bloomberg (Sept. 27,
2017), https://www.bloomberg.com/news/articles/2017-09-27/bitcoin-more-
than-just-a-fad-morgan-stanley-ceo-gorman-says; Chris Brummer and
Daniel Gorfine, ``FinTech: Building a 21st-Century Regulator's
Toolkit'', Milken Institute (Oct. 21, 2014), available at http://
www.milkeninstitute.org/publications/view/665.
---------------------------------------------------------------------------
Others, however, argue that this is all hype or technological
alchemy and that the current interest in virtual currencies is
overblown and resembles wishful thinking, a fever, even a mania. They
have declared the 2017 heightened valuation of Bitcoin to be a bubble
similar to the famous ``Tulip Bubble'' of the 17th century. They say
that virtual currencies perform no socially useful function and, worse,
can be used to evade laws or support illicit activity. \3\ Indeed,
history has demonstrated to us time-and-again that bad actors will try
to invoke the concept of innovation in order to perpetrate age-old
fraudulent schemes on the public. Accordingly, some assert that virtual
currencies should be banned, as some Nations have done. \4\
---------------------------------------------------------------------------
\3\ Virtual currencies are not unique in their utility in illicit
activity. National currencies, like the U.S. Dollar, and commodities,
like gold and diamonds, have long been used to support criminal
enterprises.
\4\ Countries that have banned Bitcoin include Bangladesh,
Bolivia, Ecuador, Kyrgyzstan, Morocco, Nepal, and Vietnam. China has
banned Bitcoin for banking institutions.
---------------------------------------------------------------------------
There is clearly no shortage of opinions on virtual currencies such
as Bitcoin. In fact, virtual currencies may be all things to all
people: for some, potential riches, the next big thing, a technological
revolution, and an exorable value proposition; for others, a fraud, a
new form of temptation and allure, and a way to separate the
unsuspecting from their money.
Perspective is critically important. As of the morning of February
5, the total value of all outstanding Bitcoin was about $130 billion
based on a Bitcoin price of $7,700. The Bitcoin ``market
capitalization'' is less than the stock market capitalization of a
single ``large cap'' business, such as McDonalds (around $130 billion).
The total value of all outstanding virtual currencies was about $365
billion. Because virtual currencies like Bitcoin are sometimes
considered to be comparable to gold as an investment vehicle, it is
important to recognize that the total value of all the gold in the
world is estimated by the World Gold Council to be about $8 trillion
which continues to dwarf the virtual currency market size. Clearly, the
column inches of press attention to virtual currency far surpass its
size and magnitude in today's global economy.
Yet, despite being a relatively small asset class, virtual currency
presents novel challenges for regulators. SEC Chairman Clayton and I
recently wrote:
The CFTC and SEC, along with other Federal and State regulators and
criminal authorities, will continue to work together to bring
transparency and integrity to these markets and, importantly, to deter
and prosecute fraud and abuse. These markets are new, evolving, and
international. As such they require us to be nimble and forward-
looking; coordinated with our State, Federal, and international
colleagues; and engaged with important stakeholders, including
Congress. \5\
---------------------------------------------------------------------------
\5\ Jay Clayton and J. Christopher Giancarlo, ``Regulators Are
Looking at Cryptocurrency: At the SEC and CFTC We Take Our
Responsibility Seriously'', Wall Street Journal, Jan. 24, 2018, https:/
/www.wsj.com/articles/regulators-are-looking-at-cryptocurrency-
1516836363.
---------------------------------------------------------------------------
It is this perspective that has guided our work at the CFTC on
virtual currencies.
Introduction: The Mission of the CFTC
The mission of the CFTC is to foster open, transparent,
competitive, and financially sound derivatives markets. \6\ By working
to avoid systemic risk, the Commission aims to protect market users and
their funds, consumers, and the public from fraud, manipulation, and
abusive practices related to derivatives and other products that are
subject to the Commodity Exchange Act (CEA).
---------------------------------------------------------------------------
\6\ See CFTC, ``Mission and Responsibilities'', http://
www.cftc.gov/About/MissionResponsibilities/index.htm.
---------------------------------------------------------------------------
The CFTC was established as an independent agency in 1974, assuming
responsibilities that had previously belonged to the Department of
Agriculture since the 1920s. The Commission historically has been
charged by the CEA with regulatory authority over the commodity futures
markets. These markets have existed since the 1860s, beginning with
agricultural commodities such as wheat, corn, and cotton.
Over time, these organized commodity futures markets, known as
designated contract markets (DCMs) regulated by the CFTC, have grown to
include those for energy and metals commodities, collectively including
crude oil, heating oil, gasoline, copper, gold, and silver. The agency
now also oversees these commodity futures markets for financial
products such as interest rates, stock indexes, and foreign currency.
The definition of ``commodity'' in the CEA is broad. It can mean a
physical commodity, such as an agricultural product (e.g., wheat,
cotton) or natural resource (e.g., gold, oil). It can mean a currency
or interest rate. The CEA definition of ``commodity'' also includes
``all services, rights, and interests . . . in which contracts for
future delivery are presently or in the future dealt in.''
In the aftermath of the 2008 financial crisis, President Obama and
Congress enhanced the CFTC's regulatory authority. With passage of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act), the agency now also oversees most of the U.S. swaps market in
addition to exchange traded futures markets.
Futures, swaps and other derivatives markets are essential means
for commercial and financial risk mitigation and transfer. These
markets allow the risks of variable production costs, such as the price
of raw materials, energy, foreign currency, and interest rates, to be
transferred from those who cannot afford them to those who can. They
are the reason why American consumers enjoy stable prices in the
grocery store, whatever the conditions out on the farm.
But derivatives markets are not just useful for agricultural
producers. They impact the price and availability of heating in
American homes, the energy used in factories, the interest rates
borrowers pay on home mortgages, and the returns workers earn on their
retirement savings. More than 90 percent of Fortune 500 companies use
derivatives to manage commercial or market risk in their worldwide
business operations. In short, derivatives serve the needs of society
to help moderate price, supply and other commercial risks to free up
capital for economic growth, job creation, and prosperity.
To ensure the integrity of U.S. derivatives markets, the CFTC
regulates derivatives market participants and activities. The agency
oversees a variety of individuals and organizations. These include swap
execution facilities, derivatives clearing organizations, designated
contract markets, swap data repositories, swap dealers, futures
commission merchants, commodity pool operators, and other entities. The
CFTC also prosecutes derivative market fraud and manipulation,
including misconduct in underlying spot markets for commodities.
I. CFTC Authority and Oversight Over Virtual Currencies
In 2015, the CFTC determined that virtual currencies, such as
Bitcoin, met the definition of ``commodity'' under the CEA.
Nevertheless, the CFTC does NOT have regulatory jurisdiction under the
CEA over markets or platforms conducting cash or ``spot'' transactions
in virtual currencies or other commodities or over participants on such
platforms. More specifically, the CFTC does not have authority to
conduct regulatory oversight over spot virtual currency platforms or
other cash commodities, including imposing registration requirements,
surveillance and monitoring, transaction reporting, compliance with
personnel conduct standards, customer education, capital adequacy,
trading system safeguards, cybersecurity examinations, or other
requirements. In fact, current law does not provide any U.S. Federal
regulator with such regulatory oversight authority over spot virtual
currency platforms operating in the United States or abroad. However,
the CFTC DOES have enforcement jurisdiction to investigate through
subpoena and other investigative powers and, as appropriate, conduct
civil enforcement action against fraud and manipulation in virtual
currency derivatives markets and in underlying virtual currency spot
markets.
In contrast to the spot markets, the CFTC does have both regulatory
and enforcement jurisdiction under the CEA over derivatives on virtual
currencies traded in the United States. This means that for derivatives
on virtual currencies traded in U.S. markets, the CFTC conducts
comprehensive regulatory oversight, including imposing registration
requirements and compliance with a full range of requirements for trade
practice and market surveillance, reporting and monitoring and
standards for conduct, capital requirements, and platform and system
safeguards.
II. Assertion of CFTC Authority
The CFTC has been straightforward in asserting its area of
statutory jurisdiction concerning virtual currencies derivatives. As
early as 2014, former CFTC Chairman Timothy Massad discussed virtual
currencies and potential CFTC oversight under the Commodity Exchange
Act (CEA). \7\ And as noted above, in 2015, the CFTC found virtual
currencies to be a commodity. \8\ In that year, the agency took
enforcement action to prohibit wash trading and prearranged trades on a
virtual currency derivatives platform. \9\ In 2016, the CFTC took
action against a Bitcoin futures exchange operating in the U.S. that
failed to register with the agency. \10\ Last year, the CFTC issued
proposed guidance on what is a derivative market and what is a spot
market in the virtual currency context. \11\ The agency also issued
warnings about valuations and volatility in spot virtual currency
markets \12\ and launched an unprecedented consumer education effort
(detailed in Section IV herein).
---------------------------------------------------------------------------
\7\ Testimony of CFTC Chairman Timothy Massad before the U.S.
Senate Committee on Agriculture, Nutrition, and Forestry (Dec. 10,
2014), http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-6.
\8\ In re Coinflip, Inc., Dkt. No. 15-29 (CFTC Sept. 17, 2015),
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/
legalpleading/enfcoinfliprorder09172015.pdf.
\9\ In re TeraExchange LLC, Dkt. No. 15-33 (CFTC Sept. 24, 2015),
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/
legalpleading/enfteraexchangeorder92415.pdf.
\10\ In re BXFNA Inc. d/b/a Bitfinex, Dkt. No. 16-19 (CFTC June 2,
2016), http://www.cftc.gov/idc/groups/public/@lrenforcementactions/
documents/legalpleading/enfbfxnaorder060216.pdf.
\11\ CFTC, Retail Commodity Transactions Involving Virtual
Currency, 82 FR 60335 (Dec. 20, 2017), www.gpo.gov/fdsys/pkg/FR-2017-
12-20/pdf/2017-27421.pdf.
\12\ CFTC, A CFTC Primer on Virtual Currencies (Oct. 17, 2017),
http://www.cftc.gov/idc/groups/public/documents/file/
labcftc_primercurrencies100417.pdf.
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a. Enforcement
The CFTC Division of Enforcement is a premier Federal civil
enforcement agency dedicated to deterring and preventing price
manipulation and other disruptions of market integrity, ensuring the
financial integrity of all transactions subject to the CEA, and
protecting market participants from fraudulent or other abusive sales
practices and misuse of customer assets. Appendix A hereto summarizes
recent CFTC enforcement activities.
The CFTC has been particularly assertive of its enforcement
jurisdiction over virtual currencies. It has formed an internal virtual
currency enforcement task force to garner and deploy relevant expertise
in this evolving asset class. The task force shares information and
works cooperatively with counterparts at the SEC with similar virtual
currency expertise.
In September 2017, the CFTC took enforcement action against a
virtual currency Ponzi scheme. \13\ Over the past few weeks, the CFTC
filed a series of civil enforcement actions against perpetrators of
fraud, market manipulation and disruptive trading involving virtual
currency. These include:
---------------------------------------------------------------------------
\13\ On September 21, 2017, the CFTC filed a complaint in Federal
court in the Southern District of New York against Nicholas Gelfman and
Gelfman Blueprint, Inc., see http://www.cftc.gov/idc/groups/public/
@lrenforcementactions/documents/legalpleading/
enfgelfmancomplaint09212017.pdf.
i. My Big Coin Pay Inc., which charged the defendants with commodity
fraud and misappropriation related to the ongoing solicitation
---------------------------------------------------------------------------
of customers for a virtual currency known as My Big Coin;
ii. The Entrepreneurs Headquarters Limited, which charged the
defendants with a fraudulent scheme to solicit Bitcoin from
members of the public, misrepresenting that customers' funds
would be pooled and invested in products including binary
options, and instead misappropriated the funds and failed to
register as a Commodity Pool Operator; and
iii. Coin Drop Markets, which charged the defendants with fraud and
misappropriation in connection with purchases and trading of
Bitcoin and Litecoin.
These recent enforcement actions confirm that the CFTC, working
closely with the SEC and other fellow financial enforcement agencies,
will aggressively prosecute bad actors that engage in fraud and
manipulation regarding virtual currencies.
b. Bitcoin Futures
It is important to put the new Bitcoin futures market in
perspective. It is quite small with open interest at the CME of 6,695
bitcoin \14\ and at Cboe Futures Exchange (Cboe) of 6,695 bitcoin (as
of Feb. 2, 2018). At a price of approximately $7,700 per Bitcoin, \15\
this represents a notional amount of about $94 million. In comparison,
the notional amount of the open interest in CME's WTI crude oil futures
was more than one thousand times greater, about $170 billion (2,600,000
contracts) as of Feb 2, 2018, and the notional amount represented by
the open interest of Comex gold futures was about $74 billion (549,000
contracts).
---------------------------------------------------------------------------
\14\ Each CME contract represents 5 bitcoin.
\15\ The price changes day to day.
---------------------------------------------------------------------------
Prior to the launch of Bitcoin futures, the CFTC closely observed
the evolution of virtual currencies over the past several years. One
exchange, CME Group, launched a Bitcoin Reference Rate in November
2016. And, another exchange, CBOE Futures Exchange (Cboe), first
approached the CFTC in July 2017. The CFTC anticipated receiving
proposals for the launch of Bitcoin futures products in late 2017.
Under CEA and Commission regulations and related guidance, futures
exchanges may self-certify new products on 24-hour notice prior to
trading. In the past decade and a half, over 12,000 new futures
products have been self-certified. \16\ It is clear that Congress and
prior Commissions deliberately designed the product self-certification
framework to give futures exchanges, in their role as self-regulatory
organizations, the ability to quickly bring new products to the
marketplace. The CFTC's current product self-certification framework
has long been considered to function well and be consistent with public
policy that encourages market-driven innovation that has made America's
listed futures markets the envy of the world.
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\16\ Prior to the changes made in the Commodity Futures
Modernization Act of 2000 (CFMA) and the Commission's subsequent
addition of Part 40, exchanges submitted products to the CFTC for
approval. From 1922 until the CFMA was signed into law, less than 800
products were approved. Since then, exchanges have certified over
12,000 products. For financial instrument products specifically, the
numbers are 494 products approved and 1,938 self-certified. See http://
www.cftc.gov/IndustryOversight/ContractsProducts/index.htm.
---------------------------------------------------------------------------
Practically, both CME and Cboe had numerous discussions and
exchanged numerous draft product terms and conditions with CFTC staff
over a course of months prior to their certifying and launching Bitcoin
futures in December 2017. This type of lengthy engagement is not
unusual during the self-certification process for products that may
raise certain issues. The CFTC staff undertook its review of CME's and
Cboe's Bitcoin futures products with considered attention. Given the
emerging nature and heightened attention of these products, staff
conducted a ``heightened review'' of CME's and Cboe's responsibilities
under the CEA and Commission regulations to ensure that their Bitcoin
futures products and their cash-settlement processes were not readily
susceptible to manipulation, \17\ and the risk management of the
associated Derivatives Clearing Organizations (DCOs) to ensure that the
products were sufficiently margined. \18\
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\17\ See CEA Section 5(d)(3), 7 U.S.C. 7(d)(3); Section 5(d)4), 7
U.S.C. 7(d)(4); 17 CFR 38.253 and 38.254(a), and Appendices B and C to
Part 38 of the CFTC's regulations.
\18\ CEA Section 5b(c)(2)(D)(iv), 7 U.S.C. 7a-1(c)(2)(D)(iv)
(``The margin from each member and participant of a derivatives
clearing organization shall be sufficient to cover potential exposures
in normal market conditions.'').
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Staff obtained the voluntary cooperation of CME and Cboe with a set
of enhanced monitoring and risk management steps.
1. Designated contract markets (DCMs) setting exchange large trader
reporting thresholds at five bitcoins or less;
2. DCMs entering direct or indirect information sharing agreements
with spot market platforms to allow access to trade and trader
data making up the underlying index that the futures contracts
settle to;
3. DCMs agreeing to engage in monitoring of underlying index data
from cash markets and identifying anomalies and
disproportionate moves;
4. DCMs agreeing to conduct inquiries, as appropriate, including at
the trade settlement and trader level when anomalies or
disproportionate moves are identified;
5. DCMs agreeing to regular communication with CFTC surveillance
staff on trade activities, including providing trade settlement
and trader data upon request;
6. DCMs agreeing to coordinate product launches to enable the CFTC's
market surveillance branch to monitor developments; and
7. DCOs setting substantially high initial \19\ and maintenance
margin for cash-settled instruments.
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\19\ In the case of CME and Cboe Bitcoin futures, the initial and
maintenance margins were ultimately set at 47 percent and 44 percent by
the respective DCOs. By way of comparison that is more than 10 times
the margin required for CME corn futures products.
The first six of these elements were used to ensure that the new
product offerings complied with the DCM's obligations under the CEA
core principles and CFTC regulations and related guidance. The seventh
element, setting high initial and maintenance margins, was designed to
ensure adequate collateral coverage in reaction to the underlying
volatility of Bitcoin.
In crafting its process of ``heightened review'' for compliance,
CFTC staff prioritized visibility, data, and monitoring of markets for
Bitcoin derivatives and underlying settlement reference rates. CFTC
staff felt that in gaining such visibility, the CFTC could best look
out for Bitcoin market participants and consumers, as well as the
public interest in Federal surveillance and enforcement. This
visibility greatly enhances the agency's ability to prosecute fraud and
manipulation in both the new Bitcoin futures markets and in its related
underlying cash markets.
As for the interests of clearing members, the CFTC recognized that
large global banks and brokerages that are DCO clearing members are
able to look after their own commercial interests by choosing not to
trade Bitcoin futures, as some have done, requiring substantially
higher initial margins from their customers, as many have done, and
through their active participation in DCO risk committees.
After the launch of Bitcoin futures, some criticism was directed at
the self-certification process from a few market participants. Some
questioned why the Commission did not hold public hearings prior to
launch. However, it is the function of the futures exchanges and
futures clearinghouses--and not CFTC staff \20\--to solicit and address
stakeholder concerns in new product self-certifications. The CFTC
staff's focus was on how the futures contracts and cash settlement
indices are designed to bar manipulation and the appropriate level of
contract margining to meet CEA and Commission regulations.
---------------------------------------------------------------------------
\20\ Unlike provisions in the CEA and Commission regulations that
provide for public comment on rule self-certifications, there is no
provision in statute or regulation for public input into CFTC staff
review of product self-certifications. It is hard to believe that
Congress was not deliberate in making that distinction.
---------------------------------------------------------------------------
Interested parties, especially clearing members, should indeed have
an opportunity to raise appropriate concerns for consideration by
regulated platforms proposing virtual currency derivatives and DCOs
considering clearing new virtual currency products. That is why CFTC
staff has added an additional element to the Review and Compliance
Checklist for virtual currency product self-certifications. That is,
requesting DCMs and SEFs to disclose to CFTC staff what steps they have
taken in their capacity as self-regulatory organizations to gather and
accommodate appropriate input from concerned parties, including trading
firms and FCMs. Further, CFTC staff will take a close look at DCO
governance around the clearing of new virtual currency products and
formulate recommendations for possible further action.
The CFTC's response to the self-certification of Bitcoin futures
has been a balanced one. It has resulted in the world's first federally
regulated Bitcoin futures market. Had it even been possible, blocking
self-certification would not have stopped the rise of Bitcoin or other
virtual currencies. Instead, it would have ensured that virtual
currency spot markets continue to operate without effective and data-
enabled Federal regulatory surveillance for fraud and manipulation. It
would have prevented the development of a regulated derivatives market
that allowed participants to take ``short'' positions that challenged
the 2017 rise of Bitcoin prices.
III. Adequacy of CFTC Authority
The CFTC has sufficient authority under the CEA to protect
investors in virtual currency derivatives over which the CFTC has
regulatory jurisdiction under the CEA. As noted above, the CFTC does
NOT have regulatory jurisdiction over markets or platforms conducting
cash or ``spot'' transactions in virtual currencies or over
participants on those platforms. For such virtual currency spot
markets, CFTC only has enforcement jurisdiction to investigate and, as
appropriate, conduct civil enforcement action against fraud and
manipulation.
Any extension of the CFTC's regulatory authority to virtual
currency spot markets would require statutory amendment of the CEA.
\21\ The CFTC is an experienced regulator of derivatives markets that
mostly serve professional and eligible contract participants. Such
extension of regulatory authority would be a dramatic expansion of the
CFTC's regulatory mission, which currently does not give the CFTC
regulatory authority (distinct from enforcement authority) over cash
commodity markets.
---------------------------------------------------------------------------
\21\ The CFTC has jurisdiction over retail foreign currency
markets and retail commodity transactions that use leverage, margin, or
financing with some exceptions. Congress responded to concerns in the
regulation of leveraged retail FX by providing the CFTC oversight
responsibilities for Retail Foreign Exchange Dealers (RFEDs). The CFTC
Re-authorization Act of 2008 amended the CEA to create a new
registration category for RFEDs that include disclosure requirements
and leverage limitations to customers.
---------------------------------------------------------------------------
IV. Educating Investors and Market Participants
The CFTC believes that the responsible regulatory response to
virtual currencies must start with consumer education. Amidst the wild
assertions, bold headlines, and shocking hyperbole about virtual
currencies, there is a need for much greater understanding and clarity.
Over the past 6 months, the CFTC has produced an unprecedented
amount of consumer information concerning virtual currencies (listed in
Appendix B hereto). These consumer materials include an information
``primer'' on virtual currencies (Appendix C hereto), consumer and
market advisories on investing in Bitcoin and other virtual currencies
(Appendix D hereto), a dedicated CFTC ``Bitcoin'' webpage, several
podcasts (available on the Commission's website and from various
streaming services) concerning virtual currencies and underlying
technology, weekly publication of Bitcoin futures ``Commitment of
Traders'' data and an analysis of Bitcoin spot market data.
In addition, the CFTC's Office of Consumer Education and Outreach
(OCEO) is actively engaging with responsible outside partners to better
educate consumers on Bitcoin and other virtual currencies. The OCEO is
currently partnering with:
The Consumer Finance Protection Bureau (CFPB) to train U.S.
public library staff to identify and report consumer in virtual
currencies;
the American Association of Retired Persons (AARP) to
distribute a virtual currency ``Watchdog Alert'' to 120,000
AARP members;
North American Securities Administrators Association
(NASAA) Investor Educators, who are responsible for conducting
outreach to the public on avoiding investment fraud, including
in virtual currencies;
the National Attorneys General Training and Research
Institute (NAGTRI), which is the research and training arm of
the National Association of Attorneys General (NAAG), to inform
State AGs about the availability of CFTC's virtual currency
resources; and
The Federal Reserve Bank of Chicago to help consumers
manage their finances better, OCEO will again coordinate with
NFA, FINRA, and SEC to hold a webinar on fraud prevention in
virtual currencies.
V. Interagency Coordination
As noted, the CFTC's enforcement jurisdiction over virtual
currencies is not exclusive. As a result, the U.S. approach to
oversight of virtual currencies has evolved into a multifaceted, multi-
regulatory approach that includes:
The Securities and Exchange Commission (SEC) taking
increasingly strong action against unregistered securities
offerings, whether they are called a virtual currency or
initial coin offering in name.
State Banking regulators overseeing certain U.S. and
foreign virtual currency spot exchanges largely through State
money transfer laws.
The Internal Revenue Service (IRS) treating virtual
currencies as property subject to capital gains tax.
The Treasury's Financial Crimes Enforcement Network
(FinCEN) monitoring Bitcoin and other virtual currency
transfers for anti-money-laundering purposes.
The CFTC actively communicates its approach to virtual currencies
with other Federal regulators, including the Federal Bureau of
Investigation (FBI) and the Justice Department and through the
Financial Stability Oversight Council (FSOC), chaired by the Treasury
Department. The CFTC has been in close communication with the SEC with
respect to policy and jurisdictional considerations, especially in
connection with recent virtual currency enforcement cases. In addition,
we have been in communication with overseas regulatory counterparts
through bilateral discussions and in meetings of the Financial
Stability Board (FSB) and the International Organization of Securities
Commissions (IOSCO).
VI. Potential Benefits
I have spoken publicly about the potential benefits of the
technology underlying Bitcoin, namely Blockchain or distributed ledger
technology (DLT). \22\ Distributed ledgers--in various open system or
private network applications--have the potential to enhance economic
efficiency, mitigate centralized systemic risk, defend against
fraudulent activity and improve data quality and governance. \23\
---------------------------------------------------------------------------
\22\ J. Christopher Giancarlo, Keynote Address of Commissioner J.
Christopher Giancarlo before the Markit Group, 2016 Annual Customer
Conference, New York, May 10, 2016, http://www.cftc.gov/PressRoom/
SpeechesTestimony/opagiancarlo-15.
\23\ Id.
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DLT is likely to have a broad and lasting impact on global
financial markets in payments, banking, securities settlement, title
recording, cybersecurity, and trade reporting and analysis. \24\ When
tied to virtual currencies, this technology aims to serve as a new
store of value, facilitate secure payments, enable asset transfers, and
power new applications.
---------------------------------------------------------------------------
\24\ See, e.g., Larry Greenemeier, ``Can't Touch This: New
Encryption Scheme Targets Transaction Tampering'', Scientific American,
May 22, 2015, http://www.scientificamerican.com/article/can-t-touch-
this-new-encryption-scheme-targets-transaction-tampering/.
---------------------------------------------------------------------------
Additionally, DLT will likely develop hand-in-hand with new
``smart'' contracts that can value themselves in real-time, report
themselves to data repositories, automatically calculate and perform
margin payments and even terminate themselves in the event of
counterparty default. \25\
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\25\ See Massimo Morini and Robert Sams, ``Smart Derivatives Can
Cure XVA Headaches'', Risk Magazine, Aug. 27, 2015, http://
www.risk.net/risk-magazine/opinion/2422606/-smart-derivatives-can-cure-
xva-headaches; see also Jeffrey Maxim, ``UBS Bank Is Experimenting with
`Smart-Bonds' Using the Bitcoin Blockchain'', Bitcoin Magazine, June
12, 2015, https://bitcoinmagazine.com/articles/ubs-bank-experimenting-
smart-bonds-using-bitcoin-blockchain-1434140571; see also Pete Harris,
``UBS Exploring Smart Bonds on Block Chain'', Block Chain Inside Out,
June 15, 2015, http://harris-on.typepad.com/block_chain_io/2015/06/ubs-
exploring-smart-bonds-on-block-chain.html; See, generally, Galen Stops,
``Blockchain: Getting Beyond the Buzz'', Profit & Loss, Aug.-Sept.
2015, at 20, http://www.profit-loss.com/articles/analysis/technology-
analysis/blockchain-getting-beyond-the-buzz.
---------------------------------------------------------------------------
DLT may enable financial market participants to manage the
significant operational, transactional, and capital complexities
brought about by the many mandates, regulations, and capital
requirements promulgated by regulators here and abroad in the wake of
the financial crisis. \26\ In fact, one study estimates that DLT could
eventually allow financial institutions to save as much as $20 billion
in infrastructure and operational costs each year. \27\ Another study
reportedly estimates that blockchain could cut trading settlement costs
by a third, or $16 billion a year, and cut capital requirements by $120
billion. \28\ Moving from systems-of-record at the level of a firm to
an authoritative system-of-record at the level of a market is an
enormous opportunity to improve existing market infrastructure. \29\
---------------------------------------------------------------------------
\26\ See, e.g., ``Oversight of Dodd-Frank Act Implementation'',
U.S. House Financial Services Committee, http://
financialservices.house.gov/Dodd-Frank/ (last visited Mar. 2, 2016).
\27\ Santander InnoVentures, Oliver Wyman, and Anthemis Group,
``The FinTech Paper 2.0: Rebooting Financial Services'' 15 (2015),
http://santanderinnoventures.com/wp-content/uploads/2015/06/The-
Fintech-2-0-Paper.pdf.
\28\ Telis Demos, ``Bitcoin's Blockchain Technology Proves Itself
in Wall Street Test'', Apr. 7, 2016, Wall Street Journal, http://
www.wsj.com/articles/bitcoins-blockchain-technology-proves-itself-in-
wall-street-test-1460021421.
\29\ Based on conversations with R3 CEV, http://r3cev.com/.
---------------------------------------------------------------------------
Outside of the financial services industry, many use cases for DLT
are being posited from international trade to charitable endeavors and
social services. International agricultural commodities merchant, Louis
Dreyfus, and a group of financing banks have just completed the first
agricultural deal using distributed ledger technology for the sale of
60,000 tons of U.S. soybeans to China. \30\ Other DLT use cases
include: legal records management, inventory control and logistics,
charitable donation tracking and confirmation; voting security and
human refugee identification and relocation. \31\
---------------------------------------------------------------------------
\30\ Emiko Terazono, ``Commodities Trader Louis Dreyfus Turns to
Blockchainhttps'', Financial Times, Jan. 22, 2018, www.ft.com/content/
22b2ac1e-fd1a-11e7-a492-2c9be7f3120a.
\31\ Frisco d'Anconia, ``IOTA Blockchain To Help Trace Families of
Refugees During and After Conflicts'', Cointelegraph.com, Aug. 8, 2017,
https://cointelegraph.com/news/iota-blockchain-to-help-trace-families-
of-refugees-during-and-after-conflicts.
---------------------------------------------------------------------------
Yet, while DLT promises enormous benefits to commercial firms and
charities, it also promises assistance to financial market regulators
in meeting their mission to oversee healthy markets and mitigate
financial risk. What a difference it would have made on the eve of the
financial crisis in 2008 if regulators had access to the real-time
trading ledgers of large Wall Street banks, rather than trying to
assemble piecemeal data to recreate complex, individual trading
portfolios. I have previously speculated \32\ that, if regulators in
2008 could have viewed a real-time distributed ledger (or a series of
aggregated ledgers across asset classes) and, perhaps, been able to
utilize modern cognitive computing capabilities, they may have been
able to recognize anomalies in marketwide trading activity and
diverging counterparty exposures indicating heightened risk of bank
failure. Such transparency may not, by itself, have saved Lehman
Brothers from bankruptcy, but it certainly would have allowed for far
prompter, better-informed, and more calibrated regulatory intervention
instead of the disorganized response that unfortunately ensued.
---------------------------------------------------------------------------
\32\ See supra n. 22.
---------------------------------------------------------------------------
VII. Policy Considerations
Two decades ago, as the Internet was entering a phase of rapid
growth and expansion, a Republican Congress and the Clinton
administration established a set of enlightened foundational
principles: the Internet was to progress through human social
interaction; voluntary contractual relations and free markets; and
Governments and regulators were to act in a thoughtful manner not to
harm the Internet's continuing evolution. \33\
---------------------------------------------------------------------------
\33\ The Telecommunications Act of 1996 (See Telecommunications
Act of 1996 (Pub. L. No. 104-104, 110 Stat. 56 (1996))) and the ensuing
Clinton administration ``Framework for Global Electronic Commerce''
(See Clinton administration, Framework for Global Electronic Commerce,
http://clinton4.nara.gov/WH/New/Commerce/) established a simple and
sensible framework: (a) the private sector should play the leading role
in innovation, development, and financing; and (b) Governments and
regulators should ``do no harm'' by avoiding undue restrictions,
supporting a predictable, consistent, and simple legal environment and
respecting the ``bottom-up'' nature of the technology and its
deployment in a global marketplace.
---------------------------------------------------------------------------
This simple approach is well-recognized as the enlightened
regulatory underpinning of the Internet that brought about such
profound changes to human society. During the almost 20 years of ``do
no harm'' regulation, a massive amount of investment was made in the
Internet's infrastructure. It yielded a rapid expansion in access that
supported swift deployment and mass adoption of Internet-based
technologies. Internet-based innovations have revolutionized nearly
every aspect of American life, from telecommunications to commerce,
transportation and research and development. This robust Internet
economy has created jobs, increased productivity and fostered
innovation and consumer choice.
``Do no harm'' was unquestionably the right approach to development
of the Internet. Similarly, I believe that ``do no harm'' is the right
overarching approach for distributed ledger technology.
Virtual currencies, however, likely require more attentive
regulatory oversight in key areas, especially to the extent that retail
investors are attracted to this space. SEC Chairman Clayton and I
recently stated in a joint op-ed, that:
Our task, as market regulators, is to set and enforce rules
that foster innovation while promoting market integrity and
confidence. In recent months, we have seen a wide range of
market participants, including retail investors, seeking to
invest in DLT initiatives, including through cryptocurrencies
and so-called ICOs . . . initial coin offerings. Experience
tells us that while some market participants may make fortunes,
the risks to all investors are high. Caution is merited.
A key issue before market regulators is whether our historic
approach to the regulation of currency transactions is
appropriate for the cryptocurrency markets. Check-cashing and
money-transmission services that operate in the U.S. are
primarily State-regulated. Many of the internet-based
cryptocurrency trading platforms have registered as payment
services and are not subject to direct oversight by the SEC or
the CFTC. We would support policy efforts to revisit these
frameworks and ensure they are effective and efficient for the
digital era. \34\
---------------------------------------------------------------------------
\34\ See supra n. 5.
As the Senate Banking Committee, the Senate Agriculture Committee
and other Congressional policymakers consider the current state of
regulatory oversight of cash or ``spot'' transactions in virtual
currencies and trading platforms, consideration should be given to
shortcomings of the current approach of State-by-State money
transmitter licensure that leaves gaps in protection for virtual
currency traders and investors. Any proposed Federal regulation of
virtual currency platforms should be carefully tailored to the risks
posed by relevant trading activity and enhancing efforts to prosecute
fraud and manipulation. Appropriate Federal oversight may include: data
reporting, capital requirements, cybersecurity standards, measures to
prevent fraud and price manipulation and anti-money laundering and
``know your customer'' protections. Overall, a rationalized Federal
framework may be more effective and efficient in ensuring the integrity
of the underlying market.
Conclusion
We are entering a new digital era in world financial markets. As we
saw with the development of the Internet, we cannot put the technology
genie back in the bottle. Virtual currencies mark a paradigm shift in
how we think about payments, traditional financial processes, and
engaging in economic activity. Ignoring these developments will not
make them go away, nor is it a responsible regulatory response. The
evolution of these assets, their volatility, and the interest they
attract from a rising global millennial population demand serious
examination.
With the proper balance of sound policy, regulatory oversight, and
private sector innovation, new technologies will allow American markets
to evolve in responsible ways and continue to grow our economy and
increase prosperity. This hearing is an important part of finding that
balance.
Thank you for inviting me to participate.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM JAY CLAYTON
Q.1. When I asked you how much of the $4 billion raised by
initial coin offerings (ICOs) last year was raised in the
United States, you said that it was unclear and hard to
estimate ``because this has been conducted largely on an
unregulated basis,'' but there is enough to make it worth
paying attention. Later, when asked why no ICOs were registered
with the SEC, you stated that you do not think gatekeepers
``have done their job,'' even though you have made the law
clear. You also explained that you want private placements to
happen, but you ``want them to do it right,'' and ICOs have
taken ``the disclosure-like benefits of a private placement''
but used general solicitation and the promise of secondary
trading among retail investors without registering with the
SEC.
Based on these responses, you seem to share my concern that
ICOs are evading the registration requirements of the
securities laws and failing to satisfy private-placement
requirements. Accordingly, I have several follow-up questions
and requests about the SEC's efforts to police ICOs:
Please describe the strategy, policies, and procedures that
the SEC is using to track and monitor ICOs and secondary
trading of ``tokens'' issued in ICOs.
A.1. I do share your concern that a number of initial coin
offering (ICO) participants are evading the registration
requirements of the Securities Act of 1933 by failing to either
register the token offering or to qualify for an exemption from
the registration requirements. With the support of my fellow
Commissioners, I have asked the SEC's Enforcement staff to
continue to police these markets vigorously and recommend
enforcement actions against those who conduct or facilitate
ICOs or engage in other actions relating to digital assets in
violation of the Federal securities laws.
Last year, the SEC announced two initiatives to build on
the Enforcement Division's ongoing efforts to address cyber-
based threats and protect retail investors. One such effort was
to create a Cyber Unit to focus on targeting cyber-related
misconduct, including in the insider trading and ICO spaces.
The other was to establish a Retail Strategy Task Force to
implement initiatives that directly affect retail investors.
The Cyber Unit and Retail Strategy Task Force are helping to
build upon and leverage the expertise already developed by the
cross-divisional Distributed Ledger Technology Working Group,
formed in 2013, to address violations of the Federal securities
laws.
I want to emphasize that our efforts are not limited to the
offerings of coins or tokens. The number of broker-dealers and
investment advisers engaged in this space has grown, and we are
reviewing their activities as well. The SEC's National
Examination Program announced in its public priorities that it
will continue to monitor the sales of ICOs and
cryptocurrencies, and where the products are securities, will
conduct examinations of investment advisers and broker-dealers
to assess regulatory compliance. Areas of focus include, among
other things, whether financial professionals maintain adequate
controls and safeguards to protect these assets from theft or
misappropriation, and whether financial professionals are
providing investors with disclosure about the risks associated
with these investments, including the risk of investment
losses, liquidity risks, price volatility, and potential fraud.
Through these various functions, the SEC staff surveils
publicly available data sources; receives and reviews tips,
complaints and referrals, which can be submitted to the SEC via
https://www.sec.gov/whistleblower/submit-a-tip; and liaises
with domestic and international regulatory and law enforcement
partners and with members of the public to gather information.
The staff also established a dedicated email address at
[email protected] to centralize communications from the public on
FinTech issues to engage with issuers and other market
participants about these issues. I have made cross-border
awareness of and attention to these issues a priority,
including in connection with our participation in the Financial
Stability Board (FSB) and International Organization of
Securities Commissions (IOSCO).
With respect to secondary trading of tokens, because token
trading platforms by and large are not registered as national
securities exchanges or operating pursuant to the Regulation
ATS exemption, and certain of them appear to operate overseas,
the SEC's direct knowledge of the nature and full extent of
trading by those platforms has been limited. The SEC's
Divisions of Enforcement and Trading and Markets recently
issued a joint statement on potentially unlawful online
platforms for trading digital assets. The statement emphasizes
that investors should use a platform or entity registered with
the SEC to get the protections offered by the Federal
securities laws and SEC oversight. \1\ Notwithstanding the fact
that these platforms largely have not registered with us or
operated pursuant to an exemption, the SEC staff has continued
to monitor publicly available sources; review tips, complaints
and referrals, and work with regulatory partners, members of
the public, and members of the industry to obtain information
on secondary trading as described above. The Commission has
brought enforcement actions against online platforms for
operating as unregistered national securities exchanges and
will continue to do so where appropriate.
---------------------------------------------------------------------------
\1\ If those tokens are securities and the platforms on which they
trade register as national securities exchanges or operate as
alternative trading systems (ATSs), those exchanges and ATSs are
required to report information about their operations and trading to
the SEC. For example, ATSs file quarterly reports on Form ATS-R to
disclose to the SEC their trade volume, the securities traded, and
trading participants, which augments the SEC's oversight to monitor the
activities of these markets.
Q.2. Please provide statistics on ICOs tracked by the SEC and/
or any third-party data obtained and used by the SEC to follow
ICOs.
Please provide: the total number of offerings and monetary
value, and the exemptions used and/or purported to be used for
those ICOs, by number of offerings and monetary value.
A.2. Although a number of public data sources purport to track
ICOs, we do not have definitive data on their number or value.
In this regard, it is noteworthy that many of the platforms
that facilitate trading in digital assets are not regulated and
do not provide information that is subject to regulatory
review. In addition, much of the information found in public
data sources is unaudited.
In addition, while the SEC possesses offering data with
respect to registered offerings, data with respect to ICOs
purporting to qualify for an exemption from registration is
more spotty (e.g., with respect to offerings conducted under
Regulation D, which requires the provision of only limited data
to the Commission and does not require the issuer to designate
whether the offering is an ICO), or non-existent (e.g., with
respect to offerings relying on statutory exemptions rather
than Commission rules).
In connection with the efforts described above, the SEC
staff reviews third-party data sources to examine market data
for ICOs. Publicly reported numbers from third-party data
sources indicate on a worldwide basis more than $6.2 billion
has been raised in 2018; $3.9 billion in 2017; and $95 million
in 2016.
Q.3. I am concerned that the anonymity afforded by blockchain
technology may allow issuers to evade the geographic and
accredited-investor restrictions that they claim to impose on
ICOs. How is the SEC ensuring that ICOs do not evade these
requirements? In answering this question, please address: o How
is the SEC ensuring that issuers in ICOs that are restricted to
non-U.S. investors do not sell securities to U.S. investors
through blockchain or other technology?
How is the SEC ensuring that issuers in ICOs that are
restricted to accredited investors do not sell securities to
nonaccredited investors through blockchain or other technology?
How is the SEC ensuring that securities issued in
unregistered ICOs are not sold to U.S. investors in secondary
trading in violation of the securities laws through blockchain
or other technology?
A.3. The Federal securities laws provide that all offers and
sales of securities to persons within the United States must be
registered or qualify for an exemption. These laws apply to
protect United States investors regardless where the issuer is
located. Just as with any other offer and sale of securities,
the SEC will bring enforcement actions where appropriate for
violations of the registration provisions of the Federal
securities laws.
The Federal securities laws provide certain exemptions from
registration for both primary offerings of securities and
resales of securities, notably concerning accredited investors.
Failure to comply with the conditions for such exemptions can
result in violations of the registration provisions of the
Federal securities laws. To the extent offering participants
are able to qualify for an exemption from registration, our
efforts will examine whether the procedures they are following
are designed to ensure compliance with an appropriate
exemption, and we are aware of issues raised by anonymity and
other aspects of ICOs that make compliance with private
placement exemptions more difficult on a relative basis. The
SEC will continue to review information related to individual
ICOs, ask for additional information from issuers and trading
platforms, and bring enforcement actions where appropriate for
violations of the registration provisions of the Federal
securities laws.
The SEC already has brought enforcement actions alleging
violations of the registration and anti-fraud provisions of the
Federal securities laws. See SEC v. REcoin Group Foundation,
LLC et al. (E.D.N.Y.) (Sep. 29, 2017); SEC v. PlexCorps et al.,
17-cv-7007 (E.D.N.Y.) (Dec. 1, 2017); SEC v. AriseBank et al.,
3:28-cv-0186 (N.D. Tex.) (Jan. 25, 2017); see also In re
Munchee, Inc., Admin. File No. 3-18304 (Dec. 11, 2017) (settled
administrative action alleging registration violations).
Additionally, the SEC has brought enforcement actions against
virtual currency-denominated platforms operating as
unregistered securities exchanges. See SEC v. Jon E. Montroll
and Bitfunder, 18-cv-1582 (S.D.N.Y.) (Feb. 21, 2018); In re BTC
Trading, Corp. and Ethan Burnside, Admin. File No. 3-16307
(Dec. 8, 2014).
This is the same approach--clarifying the application of
longstanding law, then prosecuting violations--that the SEC has
taken for any offers and sales of securities for many years.
The SEC will continue to police these markets vigorously--
including through the use of our investigatory tools, such as
issuing document requests and administrative subpoenas,
conducting witness interviews, and taking sworn testimony--and
staff will recommend enforcement actions against those who
conduct ICOs or engage in other actions relating to digital
assets in violation of the Federal securities laws.
Q.4. What is the SEC doing to ensure that gatekeepers are doing
their jobs?
Without commenting on any specific ongoing investigations,
has the SEC considered taking enforcement actions against any
accountants, securities lawyers, consultants, or other
gatekeepers in connection with ICOs?
A.4. Our securities laws are based in substantial part on, and
in many ways require, market professionals holding themselves
to high standards. In December, I issued a public statement on
cryptocurrencies and ICOs directed in part to market
professionals. I have since made other public statements that
these professionals, especially gatekeepers, need to act
responsibly and hold themselves to high standards. I have made
it clear that gatekeepers need to focus on their
responsibilities, keeping in mind the principal motivation for
our registration, offering process and disclosure
requirements--to protect retail investors. I'm counting on them
to do their jobs.
We have encouraged market professionals to contact our
staff for assistance and have set up a dedicated email address,
[email protected], for this very purpose. Within the SEC, a group
of staff across the agency has been tasked with focusing on
these issues and are exploring the best ways to message our
expectations to professionals.
SEC staff is examining approaches to ICOs that may be
contrary to our securities laws and the professional
obligations of the securities bar. In this regard, staff is
focusing on professional advisers and other gatekeepers, and,
as with other areas of the securities laws, the SEC will
consider bringing enforcement actions where appropriate.
Q.5. Do you believe a virtual currency exchange or platform
utilized in an ICO could have liability under the securities
laws for an illegal unregistered ICO?
A.5. The SEC's Report of Investigation Pursuant to Section
21(a) of the Securities Act of 1934: The DAO (The DAO Report),
issued on July 25, 2017, reminded entities that engage in
exchange activity, including with respect to the trading of
tokens that meet the definition of ``security,'' regarding
their obligation to register as a national securities exchange
or operate pursuant to an exemption from such registration.
More recently, the Divisions of Enforcement and Trading and
Markets issued a statement with information for investors and
market participants about the applicability of the Federal
securities laws to online trading platforms that operate as an
``exchange'' for securities trading.
As The DAO Report and the statement make clear, a platform
can be found to have violated Section 5 of the Exchange Act by
effecting trades in a token that is a security without
registering as a national securities exchange or operating
pursuant to an exemption from such registration. In addition,
as The DAO Report addresses, those who participate in an
unregistered offer and sale of securities not subject to a
valid exemption can be liable for violating the registration
provisions of the Federal securities laws. Accordingly, such a
platform could also be found to have violated Section 5 of the
Exchange Act to the extent it participated in the offer or sale
of the token in the ICO itself, including (for example) by
soliciting offers to buy the securities for value. The SEC will
bring enforcement action against unregistered securities token
exchanges as the facts and circumstances warrant.
Q.6. In response to my questions about how the SEC is handling
a reported reduction in its enforcement staff headcount by 100,
you stated that ``personnel'' is your ``biggest challenge at
the moment,'' with ``a hiring freeze'' and attrition having
reduced SEC staff headcount. You then said you ``could use more
people'' in the Divisions of Enforcement and Trading and
Markets, adding that ``[t]hose are the two areas where I think
the American people would get the greatest return for
additional bodies.''
Please explain the hiring freeze, i.e., how and when it was
authorized, when it was implemented, staffing levels at the
time of implementation, and when or under what conditions you
expect it to be lifted.
A.6. In late Fiscal Year (FY) 2016, the SEC implemented a
general freeze on external hiring, with limited exceptions. As
a result, the filling of 365 total positions was suspended.
Limited backfills of vacancies have been allowed for specific
needs. Recently, I submitted the SEC's budget request for FY
2019 seeking $1.658 billion in support of 4,628 positions. The
funds will allow us to restore 100 positions, approximately
one-quarter of the total reduction resulting from the hiring
freeze, to address critical priority areas and enhance the
agency's expertise in key areas. These key areas include
cybersecurity and risk management, protecting Main Street
investors, facilitating capital formation, and effective
oversight of our capital markets. I expect that a significant
number of these positions would be in or related to our Trading
and Markets and Enforcement Divisions.
Q.7. As noted in Question 2, you stated the SEC is under a
``hiring freeze''. The day following the hearing, The Wall
Street Journal reported that former Representative Scott
Garrett plans to take a position as your advisor at the SEC. Is
this report accurate? Assuming it is:
What is, or will be, Mr. Garrett's role at the SEC? Please
explain if this is a new role. Specifically, please state (i)
his title; (ii) the division where he works or will work; (iii)
his responsibilities; (iv) who he reports to (and, if
applicable, who that individual reports to), and (v) who, or
how many staff, he supervises or will supervise, if any.
Has Mr. Garrett started work at the SEC yet? If not, when
will Mr. Garrett start work at the SEC?
Why does the hiring freeze not appear to apply to Mr.
Garrett?
Did you consider any other individuals for Mr. Garrett's
role? If so, what were these other individuals' backgrounds and
qualifications?
A.7. Mr. Garrett began working at the SEC on March 5, 2018, as
a senior advisor to the General Counsel in the Office of the
General Counsel. He is not acting as my advisor. Mr. Garrett
has an important, specialized, and narrowly tailored role. He
will be working primarily on projects involving other Federal
financial regulators that oversee our capital markets (e.g.,
the CFTC, Federal Reserve, and the Treasury Department).
Information sharing, and in particular, sharing information
regarding market operations, is important to the SEC. Mr.
Garrett will focus on matters where we need to seek greater
information sharing and regulatory cooperation. As a former
member of Congress with many years of experience interacting
with and overseeing Federal financial regulatory agencies, Mr.
Garrett is well positioned to help ensure that appropriate
protocols are in place to foster information sharing and
regulatory coordination that improve our ability to oversee the
capital markets and its participants.
Our current plan for FY2018 allows for limited external
hiring, including the position Mr. Garrett occupies. This
hiring action is consistent with our prioritization of hiring
professionals to assist the agency in fulfilling its mission
generally and the specific needs discussed above. The agency
hired Mr. Garrett as an attorney, an ``excepted-service''
position, which means that the position was excepted from
competitive hiring procedures.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
FROM JAY CLAYTON
Q.1. We've heard a lot about the potential for fraud with ICOs.
What are the potential benefits of ICOs? For example, do
ICOs have the potential to expand access to capital for small
businesses?
A.1. If done in conformance with our securities laws, ICOs may
allow small businesses to raise capital in an efficient and
cost-effective manner. At the same time, these ICOs could
provide investors with additional investment opportunities.
Importantly, though, when offering these investment
opportunities to investors in the form of an ICO, issuers must
be sure to comply with our securities laws, including with
respect to providing adequate disclosures to investors about
the risks of the investment and how the money raised will be
used. We should embrace the pursuit of technological
advancement, as well as new and innovative techniques for
capital raising, but not at the expense of the principles
undermining our well-founded and proven approach to protecting
investors and markets.
Q.2. According to your testimony, ICOs raised nearly $4 billion
in 2017. While the SEC has filed enforcement actions that argue
that certain ICOs should have been registered with the SEC,
your testimony states that no ICOs have yet to be registered
with the SEC.
Why have no ICOs been registered with the SEC?
Is one possible explanation for the lack of ICO
registrations that the registration requirements are too
stringent and not adapted to the unique nature of an ICO?
A.2. I am not aware of unique features of ICOs that would
prevent and further complicate compliance, as opposed to other
types of securities offerings, with the Federal securities
laws. The SEC has assisted numerous issuers in registering
novel and unusual products over the years, utilizing a
principles-based framework that has served American companies
and American investors well through periods of innovation and
change.
While I will not speculate as to why no issuer to date has
chosen to conduct an ICO as a registered offering, we have
received inquiries about registering ICOs with the SEC and will
continue to work with parties that seek to do so. The staff has
held itself out as ready and willing to engage with would-be
issuers and other market participants who would like to conduct
offerings in compliance with the Federal securities laws but
may need compliance assistance or exemptive, no-action, or
other forms of regulatory relief in order to comply with our
rules and regulations that may have been written with a more
traditional offering in mind. Unfortunately, too few have
sought to take us up on that offer.
Q.3. What guidance has the SEC provided to companies as to
whether their ICO should be registered with the SEC?
Does the SEC intend to provide more guidance as to when
ICOs should be registered with the SEC? For example, beyond
enforcement actions, the SEC could issue no action letters, put
out a concept release or proposed rule, or otherwise provide
further written guidance as to what constitutes a security.
How--if at all--has the SEC tried to work with companies
that want to register their ICOs with the SEC?
A.3. The SEC and its staff have issued a number of statements,
investor alerts and bulletins, and press releases. \2\ The
Commission also issued The DAO 21Report and has brought a
number of enforcement actions consistent with the requirements
of the Federal securities laws. We have made clear that, for
decades, we have applied a flexible, principles-based analysis
to determine whether an instrument is a security. This analysis
has served our markets and our investors well for many years as
investment opportunities and market structures have changed. In
short, where purchasers make an investment of money with an
expectation of profits derived from the entrepreneurial and
managerial efforts of others, there is an investment contract
and therefore a security. The focus is not on form, but on the
economic realities of the transaction and relationship.
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\2\ See testimony appendix
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Again, we have been clear on this issue. We have applied
our securities law framework to a number of different ICOs and
shown each time that the ICO was a security. I worry that many
have sought to make this analysis more complicated than it
really is, in the hopes of coming to a conclusion that the
securities laws should not apply and, as a result, they are
free to seek investments from the general public without regard
to disclosure and procedural rules that have served our markets
so well.
That said, to the extent additional guidance in this area
would be appropriate or helpful, we will continue to be open to
providing it. We also stand ready to engage with issuers
seeking to register ICOs or to discuss potential ICO
structures. We have established a [email protected] email address
dedicated to FinTech-specific inquiries. I have encouraged
market participants, including issuers and their advisers, to
engage with the SEC staff to aid in their analysis under the
Federal securities laws. Through the [email protected] email
address, and in-person meetings, the SEC staff regularly
communicates with dozens of individuals and practitioners
regarding the Federal securities laws and regulations
thereunder, and to date, the staff has had numerous potential
issuers seeking guidance on how to register or qualify an ICO.
Q.4. Does the SEC intend to evaluate whether all of the
registration requirements for a securities offering should also
apply to registering an ICO?
A.4. The SEC staff has substantial experience in assisting
issuers in registering novel and unusual products, making
appropriate accommodations to adapt to particular circumstances
of each offering. While I am not aware of unique features of
ICOs that would prevent and further complicate compliance with
the Federal securities laws, SEC staff stand ready to engage
with interested issuers and market participants on issues
related to securities offerings involving ICOs and other
cryptocurrency-related products.
Q.5. Are you concerned about the potential for bitcoin and
other cryptocurrencies to facilitate money laundering by
criminals such as human traffickers, gangs like MS-13, or
terrorists like Hezbollah?
What--if any--role does your agency have in addressing this
problem, including through cooperation with other agencies?
A.5. Several characteristics of cryptocurrencies can facilitate
efforts to evade our money-laundering laws and regulations and,
as a result, facilitate criminal and other illicit activity.
For example:
Anonymity/Tracing money. Many of the
cryptocurrencies are specifically designed to be
pseudonymous or truly anonymous. Attribution of a
specific private key to an individual or entity could
be difficult or impossible, especially where tools such
as digital tumblers and misers are used to make tracing
and attribution difficult. Traditional financial
institutions (such as banks) often are not involved
with cryptocurrency transactions, again making it more
difficult to follow the flow of money.
International scope. Cryptocurrency transactions
and users span the globe. Although the SEC has methods
for obtaining information from abroad (including
through cross-border agreements), there may be
restrictions on how the SEC can use the information,
and it may take more time to get the information than
in the case of domestic activity. In many cases, the
SEC may be unable to obtain relevant information
located overseas.
No central authority. As there is no central
authority that collects cryptocurrency user
information, the SEC generally must rely on other
sources, such as cryptocurrency exchanges or users, for
this type of information.
Seizing or freezing cryptocurrency. Law enforcement
officials may have difficulty seizing or freezing
illicit proceeds held in cryptocurrencies.
Cryptocurrency wallets may be encrypted and, unlike
money held in a bank or brokerage account,
cryptocurrencies may not be held by a third-party
custodian.
New technologies. Cryptocurrencies involve new and
developing technologies, ever evolving.
The SEC staff collaborates regularly with other agencies
(Federal, State, and international) on matters of mutual
interest and has frequent communications with other financial
regulators. In particular, the SEC's Division of Enforcement
has long-standing and on-going cooperation efforts with a
number of Federal law enforcement and regulatory partners, such
as the DOJ, FBI, IRS, and CFTC, to name a few, in addition to
State and international regulators. In matters of mutual
interest, SEC Enforcement staff will collaborate as appropriate
with these partners through, among other ways, information
sharing arrangements, access grants, and memoranda of
understanding. In addition, SEC staff participates in forums
organized within the law enforcement and regulatory
communities.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM JAY CLAYTON
Q.1. On January 26th, Bloomberg reported that the SEC is
considering breaking with its prior position, and permitting
issuers to slip forced arbitration clauses into initial public
offerings, which would bar investors from suing issuers for
wrongdoing, such as fraud. During your testimony, you said that
you ``cannot prejudge an issue that may come before the SEC,''
but added that you are ``not anxious to see a change in this
area.''
Isn't it the case that the SEC has previously opposed
barring investors in initial public offerings from pursuing
legal remedies against issuers for offenses like fraud? If so,
what--if anything--has changed?
Does your comment during your testimony that you are ``not
anxious to see a change'' in this area reflect your belief that
investors should not be barred from suing issuers for fraud and
other securities violations?
A.1. This matter is complex. It involves our securities laws,
matters of other Federal and State law, an array of market
participants and activities, as well as matters of U.S.
jurisdiction. It also involves many public policy
considerations. Further, this issue has come before the
Commission in a variety of ways and contexts and may do so in
the future. Views of market participants on this issue,
particularly in the case of an initial public offering (IPO) of
a U.S. company, are deeply held and, in many cases, divergent.
In response to the recent heightened interest from Congress and
others relating to the inclusion of mandatory arbitration
provisions in the charters or bylaws of U.S. companies
contemplating an IPO, I have (1) made several statements \1\
and (2) more recently, asked the Division of Corporation
Finance (the Division) to review how this issue has arisen in
the past, and may arise in the future, in connection with
filings made by companies with the Division.
---------------------------------------------------------------------------
\1\ See, e.g., Remarks before the SEC Investor Advisory Committee
(March 8, 2018), available at https://www.sec.gov/news/public-
statement/statement-clayton-2018-3-8.
---------------------------------------------------------------------------
A summary provided by the Division of its prior approach to
this issue, as well as how the Division would expect to proceed
if the issue were presented in the context of an IPO of a U.S.
company, is below. The summary reflects the Division's view
that should a U.S. company pursue a registered IPO with a
mandatory arbitration clause in its governing documents, the
decision about whether to declare the filing effective should
be made by the Commission, not the Division by delegated
authority. I agree with the Division's view on process and, in
particular, that this would be a decision for the Commission.
Although I have made several prior statements on this issue,
for reasons of clarity and completeness, I summarize my
perspective on the issue below.
As a threshold matter, and recognizing the complexity and
importance of this issue, I reiterate my personal view that any
analysis of this issue or decision making by the Commission in
the context of a registered IPO by a U.S. public company should
be conducted in a measured and deliberative manner.
The Federal securities laws provide a basis for private
rights of action by investors in the event of material
misstatements as part of securities offerings. There is a long
history of claims of this type being brought against U.S.
publicly traded companies in our Federal and State courts,
including as class actions. The Division's summary notes that,
in the case of foreign private issuers that have conducted
registered offerings in the United States and U.S. companies
that are not listed, direct and indirect limitations on such
actions have been prevalent for many years. In addition, and
beginning several years prior to my arrival at the Commission,
certain U.S. companies conducting exempt Regulation A offerings
have included mandatory arbitration clauses in their governing
documents or subscription agreements. The Division's summary
discusses these and other matters in more detail.
It is my view that if we are presented with this issue in
the context of a registered IPO of a U.S. company, I would
expect that any decision would involve Commission action (and
not be made through delegated authority) and that the
Commission would give the issue full consideration in a
measured and deliberative manner. Such a review would take into
account various considerations, including developments in
applicable law and any other relevant considerations. Since
this hearing, I have reiterated these views and sought to
appropriately frame this issue and my preference for such a
process in my public statements.
These statements have not only addressed my perspective on
the appropriate procedure for analyzing this matter but also
its relative priority. With respect to priority, generally
speaking, my view is that the Commission should allocate its
limited rulemaking and other related resources to a portfolio
of matters that (1) present currently pressing and significant
issues for investors and our markets, (2) are central to our
mission, (3) are ripe for consideration, and/or (4) are
addressable through a reasonable share of Commission and staff
time. To me, such matters currently include, among others and
in no particular order, (1) standards of conduct for investment
professionals, (2) Congressionally-mandated rulemaking, (3) the
regulation of investment products, including ETFs, (4) the
impact of distributed ledger technology (including
cryptocurrencies and ICOs), (5) FinTech developments, (6) the
elimination of burdensome regulations that do not enhance
investor protection or market integrity with an eye toward
facilitating capital formation, (7) an examination of equity
and fixed income market structure, and (8) of course,
inevitable issues that we have not yet identified but will
emerge as pressing.
These statements have made it clear that I have not formed
a definitive view on whether or not mandatory arbitration for
shareholder disputes is appropriate in the context of an IPO
for a U.S. company. I believe any decision would be facts and
circumstances dependent and could inevitably divert a
disproportionate share of the Commission's resources from the
priorities I noted above. In short, this issue is not a
priority for me. Although the issue is not a priority for me,
it does not mean that it is not worthwhile to analyze, and I
have encouraged those with strong views to support their
position with robust, legal and data driven analysis. If this
matter does come before the Commission, such analysis will
assist the Commission in its deliberative process.
Summary Provided by the Division of Corporation of
Finance
The Division of Corporation Finance (the Division) oversees
periodic filings by reporting companies and filings of issuers
seeking to raise money in the capital markets through, for
example, initial public offerings. The Federal securities laws
generally focus on requiring companies to provide full and fair
disclosure of material information to investors and the
Division's oversight of filings is intended to facilitate
compliance with those laws.
State laws generally provide the parameters for companies
to establish their corporate governance through their
organizational documents, such as their charter or bylaws. The
Commission does not have rules permitting or prohibiting
companies from using arbitration provisions.
The Commission's processes with respect to arbitration
provisions have been and may in the future be implicated
through the Division's role in overseeing and processing
filings by companies. The most often identified channel for
this issue to arise is if a U.S. company sought to include a
mandatory arbitration provision in its governing documents when
it filed an initial registration statement to offer and sell
securities publicly. Following is an overview of circumstances
in which mandatory arbitration provisions have been and could
be present in the governance documents of companies that make
filings with the Commission.
Registered Offerings by U.S. Companies
A company may not sell securities in the United States
unless (1) it has an effective registration statement on file
with the SEC or (2) an exemption from registration is
available. Section 8(a) of the Securities Act of 1933
(Securities Act) provides that a registration statement will
become effective 20 days after it is filed and authorizes the
Commission to accelerate the effective date of a registration
statement after taking into account the adequacy of the
disclosure and certain other considerations. \2\ This authority
to accelerate the effective date has been delegated to the
Division by the Commission. By statute, registration statements
become effective with the passage of time. As a matter of
practice, a company will nearly always include in any pre-
effective registration statement a legend, referred to as a
``delaying amendment,'' in order to prevent the registration
statement from becoming effective automatically following the
passage of time and to better control the timing of its
offering. During this time, the Division staff may review the
filing. In the course of a filing review, Division staff will
evaluate the company's disclosure and may issue comments to
elicit better compliance with disclosure requirements, and the
company will amend its registration statement to address the
comments as appropriate. Following this review and comment
process, the company submits a request to accelerate the
effective date of the registration statement.
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\2\ In its entirety, Section 8(a) states that ``The effective date
of a registration statement shall be the twentieth day after the filing
thereof or such earlier date as the Commission may determine, having
due regard to the adequacy of the information respecting the issuer
theretofore available to the public, to the facility with which the
nature of the securities to be registered, their relationship to the
capital structure of the issuer and the rights of holders thereof can
be understood, and to the public interest and the protection of
investors [emphasis added].''
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When this issue last arose in the context of an initial
public offering (IPO) of a U.S. company in 2012, the Division
took the position, based on a consideration of relevant Federal
laws and case law, that it would not use its delegated
authority to accelerate the effective date of a U.S. company's
registration statement when the company's governing documents
contained a mandatory arbitration provision covering disputes
arising under Federal securities laws. In that context, the
Division was unable to conclude that such provisions are
consistent with ``the public interest and protection of
investors'' as required by Securities Act Section 8(a) in light
of, among other things, the anti-waiver provision in Section 14
of that Act. \3\ More specifically, at that time, the Division
advised a company that it did not anticipate exercising its
delegated authority to accelerate the effective date of the
registration statement if such a provision was included in the
company's governing documents and that the Commission would
need to make any decision on a request for acceleration. In
that situation, the company decided not to include the
mandatory arbitration provisions in its governing documents in
connection with its IPO.
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\3\ Section 14 states that ``Any condition, stipulation, or
provision binding any person acquiring any security to waive compliance
with any provision of this title or of the rules and regulations of the
Commission shall be void.''
---------------------------------------------------------------------------
If this issue were to come before the Division in a U.S.
company's registration statement for an IPO today, as discussed
in more detail below, the Division would not use its delegated
authority to accelerate the effective date of the registration
statement. Instead, the Division would refer a request for
acceleration to the full Commission.
The historical treatment of this issue in other
circumstances, such as in the qualification of Regulation A
offerings and in the processing of registration statements
filed by foreign private issuers, is described below.
Other Circumstances
For many years, U.S. and non-U.S. companies have made other
types of filings with the Commission that have included
mandatory arbitration provisions for shareholder disputes in
their governing or offering documents. These circumstances and
the relevant considerations are described further below. In
these circumstances, the relevant statutes and rules generally
require appropriate disclosure regarding material risks to the
issuer or of the offering, which would include risks relating
to mandatory arbitration provisions and any impact on holders
of the offered securities.
Regulation A: Some companies utilizing the exemption from
registration available under Regulation A have included
mandatory arbitration clauses in their governing documents or
subscription agreements. Under Regulation A, a company may not
sell its securities until the Division has qualified its
offering statement. In these exempt offerings, neither the
Federal securities laws nor the Commission's rules require the
Division to make the same public interest determination as is
required when accelerating the effective date of a registration
statement in the context of an IPO.
In 2015, after reviewing the relevant law and regulations,
the Commission staff concluded that there would not be grounds
to withhold qualification of a Regulation A offering on the
basis that the issuer had included a mandatory arbitration
provision in its governing documents. Since then, in light of
the Commission staff's 2015 determination, certain offerings
that have included a mandatory arbitration clause have been
qualified under Regulation A, provided that the material risks
of such a dispute resolution approach had been disclosed and
the issuer otherwise qualified for the exemption.
Foreign Private Issuers: For many years, a number of
foreign companies with securities listed or traded in the
United States have included mandatory arbitration and other
analogous provisions in their filings. Registration statements
of foreign private issuers offering and selling securities in
the United States also generally include disclosures regarding
limitations investors may face as a result of the issuer's
foreign status and home country laws and regulations. These
disclosures have typically included a risk factor informing
investors that due to jurisdictional issues it may be difficult
for them to obtain or enforce judgments or bring original
actions, including actions styled as class actions, against the
company. In these instances and in situations where mandatory
arbitration has been required, either due to local law
requirements or otherwise, the Division staff has focused on
the disclosure of the material risks related to these
limitations and has declared these filings effective.
Exchange Act Reporting Companies: There are several other
ways a company could be in the Securities Exchange Act of 1934
(Exchange Act) reporting regime and have a mandatory
arbitration provision in its governing documents. For example,
a registration statement for a class of securities pursuant to
Exchange Act Section 12(g) becomes effective automatically 60
days after filing. As another example, a public reporting
company could amend its bylaws or seek shareholder approval of
a charter amendment or to include an arbitration provision
(assuming that the applicable State law allows for the
enforceability of such a provision). \4\ In any of these
situations, the Commission's rules would require appropriate
disclosures to investors.
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\4\ See Claudia H. Allen, ``Bylaws Mandating Arbitration of
Stockholder Disputes'', 39 Del. J. of Corp. Law 751, 779 782 (2015)
(discusses circumstances where arbitration clauses included in public
issuers' filings) (Allen).
---------------------------------------------------------------------------
Considerations
Mandatory arbitration clauses involve complexities beyond
the Commission and its rules. For example, they raise issues
under the State corporate laws under which the issuers are
organized. In addition, Federal case law regarding mandatory
arbitration continues to evolve. Since 2012, when this issue
was last presented to the Division in the context of an IPO of
a U.S. company, the Supreme Court has affirmed the strong
Federal interest in promoting the arbitration of claims under
Federal laws. \5\ Over the last several years, commentators
have observed that there is uncertainty as to whether the
Commission would have a basis to deny an acceleration request
in these circumstances. \6\ If a U.S. company were to file for
an IPO with governing documents that included a mandatory
arbitration provision, the Commission would need to evaluate
the specific facts and circumstances in the context of not just
the Federal securities laws but also State corporate and other
Federal law. This is a complex legal and policy issue that
requires careful consideration. As such, and as discussed
above, if the issue were presented to the Division in the
context of an IPO for a U.S. company, the Division would
decline to exercise its delegated authority to accelerate the
effective date of a registration statement and instead refer
the matter to the Commission for its consideration.
---------------------------------------------------------------------------
\5\ See, e.g., American Express Co. v. Italian Colors Restaurant,
133 S. Ct. 2304 (2013) (holding that, under the Federal Arbitration Act
(FAA), courts must ``rigorously enforce'' arbitration agreements
according to their terms unless the FAA's mandate has been ``overridden
by a contrary congressional command'').
\6\ See, e.g., Allen at 778 (fn 141).
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCHATZ
FROM JAY CLAYTON
Q.1. During your testimony you mentioned that initial coin
offerings (ICO) seem to be security offerings, which would
bring under the jurisdiction of your agency to regulate. One
major concern that members of the committee, financial experts,
and investors all share is that ICOs may actually be Ponzi
schemes.
How can investors discern between legitimate ICOs with
legitimate value and those that are fraudulent schemes?
A.1. Your question goes to the heart of the Federal securities
laws--ensuring that investors, especially retail investors,
have adequate information to make informed investment
decisions. I believe that it is difficult for investors to make
determinations whether an investment opportunity is at risk of
being a Ponzi scheme or another scheme in the absence of
disclosures of material information by ICO issuers. While many
ICOs issue a ``White Paper'' in conjunction with the offering,
many of these White Papers are, in essence, outlines of an
idea, and none that I have seen provide the scope and depth of
information one would find in a statutory prospectus. Many
provide nothing comparable in the way of disclosure. In the
absence of this critical information, I do not know how an
average investor would be able to discern with a reasonable
degree of confidence whether the ICO is ``legitimate'' or
whether there is significant risk that it is a fraudulent
scheme. As part of my December statement on cryptocurrencies
and ICOs, I cautioned investors to ask clear questions and
demand answers from ICO issuers and promoters.
In addition to publicized enforcement actions, the SEC and
its staff have issued a number of statements, investor alerts,
and bulletins targeted to retail investors. Investors can
access much of this information by visiting the
www.investor.gov website ``Spotlight on Initial Coin Offerings
and Digital Assets.''
Q.2. Do you need new statutory authority to regulate ICOs (and
other areas of cryptocurrencies) or do you believe already-
existing authorities sufficiently address this new area?
If new statutory authority is required, what should the
authority aim to achieve?
A.2. The registration and disclosure requirements of the
Federal securities laws provide flexibility in describing the
terms of the securities, as well as the particular businesses
that may be issuing these securities. Over the past 84 years,
the SEC and its staff have worked with companies issuing novel
types of securities and have used a principles-based approach
to assure appropriate disclosure is made to investors, and this
approach has worked well. In addition, the Federal securities
laws have anti-fraud and other remedial provisions that are
principles-based, broad, and flexible and that are aimed at
protecting investors from fraud, including fraud arising from
securities offerings, actions of intermediaries, and market
manipulation. These provisions provide the SEC with important
tools that can be applied to securities activities involving
novel technologies--regardless of how those technologies are
used. I believe offerings of digital assets that are securities
should be treated and evaluated no differently. Nevertheless,
the staff will continue monitoring developments in this area
and consider the need for additional authorities.
As Chairman Giancarlo and I testified, we are open to
exploring with Congress, as well as with our Federal and State
colleagues, whether increased Federal regulation of
cryptocurrency trading platforms--or spot markets--is necessary
or appropriate. We also are supportive of regulatory and policy
efforts to bring clarity and fairness to this space and are
conferring with our colleagues at the U.S. Department of the
Treasury and the Federal Reserve Board with respect to any
potential legislative suggestions. To the extent that new
issues arise in our markets that the SEC is unable to address,
we will alert Congress to gaps in authority and request
additional authority where necessary.
Q.3. In SEC v. W.J. Howey Co., the Supreme Court created the
``Howey Test'' which has since been the test for determining
whether a financial transaction is a security or not. However,
cryptocurrencies are not squarely compatible with the test that
was designed to address more traditional instruments and
contracts.
Does Howey apply to cryptocurrencies?
More specifically, is the ``efforts of others'' requirement
met?
Who should arbitrate whether a particular cryptocurrency
should be considered an investment contact, commodity, or some
other financial instrument?
Do you believe that responsibility should belong to a
specific Federal agency or should it be made in an interagency
forum, such as the Financial Stability Oversight Council?
A.3. Determining whether a transaction involves a security does
not turn on labelling--such as the characterization of
something as a ``cryptocurrency.'' Whether a token or a digital
asset called a cryptocurrency is a security is determined by
applying long-established law to the facts and circumstances of
the particular instrument being sold. As you noted, under
Supreme Court case law in SEC v W.J. Howey and its progeny,
where purchasers make an investment of money with an
expectation of profits derived from the entrepreneurial and
managerial efforts of others, there is a security. Determining
whether the Howey test results in an investment being a
security requires an assessment of the facts and circumstances
of each case, including the economic realities underlying a
transaction. Such analysis looks to the substance of the
transaction, not merely its form or other naming conventions.
As is the case with any ``investment contract'' analysis,
securities counsel assisting its client may exercise judgment
in making an initial determination. The SEC staff may confer
with counsel to express different views and explain its basis.
If these differences remain unresolved and the company offers
the instrument, the SEC may authorize an enforcement action on
the basis that the instrument is a security. If litigated, a
court would make the ultimate determination.
As is the case with any instrument being offered or sold,
the SEC is the agency appropriately charged with determining
whether a particular instrument is an ``investment contract,''
and, thus, a security. This principles-based framework has
served American companies and investors well throughout periods
of innovation and change for 84 years. Such determinations have
been made without recourse to an interagency forum. The SEC
staff does confer, and will continue to confer, with other
agencies as appropriate to discuss particular products that may
raise issues under different regulatory regimes.
With respect to the ``managerial efforts of others'' prong
of the Howey test, the DAO Report noted that the central issue
turned on ``whether the efforts made by those other than the
investor are the undeniably significant ones, those essential
managerial efforts which affect the failure or success of the
enterprise.'' \1\ In the case of The DAO, its investors
``relied on the managerial and entrepreneurial efforts of
Slock.it and its co-founders, and The DAO's Curators, to manage
The DAO and put forth project proposals that could generate
profits for The DAO's investors.'' The DAO Report further noted
that The DAO's investors' expectations of future profits were
primed by market efforts of The DAO and its co-founders.
Whether any other particular token or cryptocurrency met this
test would be a facts-and-circumstances analysis, utilizing the
principles-based framework.
---------------------------------------------------------------------------
\1\ SEC v. Glenn W. Turner Enters., Inc., 474 F.2d 476, 482 (9th
Cir. 1973).
---------------------------------------------------------------------------
With respect to a ``true'' cryptocurrency, it may well be
that the Howey test leads to the conclusion that the
cryptocurrency is not a security and the cryptocurrency is a
commodity. Again, however, such a determination would need to
be made on an individual basis based on the facts and
circumstances, without regard to what the product is named.
Q.4. The concept of banks is familiar to the average American.
Banks comply with extensive regulations to ensure safety and
protect consumer confidence and are insured by the Federal
Deposit Insurance Corporation (FDIC). Cryptocurrency
investments are quite different. But many retail investors do
not seem to appreciate how different cryptocurrencies are from
real currencies. For example, there is no FDIC-like protection
for investments in cryptocurrency.
Should cryptocurrency wallets and exchanges be subject to
similar rules aimed at protecting consumer funds under their
control?
A.4. I agree with the premise in your question that banks are
subject to regulations designed to ensure their safety and
soundness and bank cash deposits are insured by the FDIC. In
the securities industry, customers receive protection for cash
and securities held at broker-dealers under the SEC's customer
protection rule, which requires broker-dealers to hold customer
fully paid and excess margin securities in possession or
control and free of lien and to segregate the net amount of
cash owed to customers. These provisions, along with the SEC's
net capital rule applicable to broker-dealers, are designed to
facilitate the prompt return of securities and cash to
customers if the broker-dealer fails financially.
Moreover, if the failed broker-dealer cannot promptly
return these assets, there is a special bankruptcy regime to
protect customers. Specifically, the Securities Investor
Protection Act (SIPA) gives the customers a priority claim over
other creditors to customer securities and cash held by the
failed broker-dealer. In addition, if the amount of customer
securities and cash held by the failed firm is insufficient to
make each customer whole, SIPA provides up to $500,000 per
customer (of which $250,000 can be used for cash claims) to
make up any shortfalls.
In a recent statement from the Divisions of Enforcement and
Trading and Markets, SEC staff noted that there may be online
trading platforms--such as digital wallet services--that, while
not exchanges, directly or indirectly offer trading or other
services to investors in ICOs and cryptocurrencies. To the
extent these services involve securities, this would trigger
certain requirements under the Federal securities laws,
including registration as a broker-dealer, transfer agent, or
clearing agency, among others, and the customer protections
that go along with that registration.
With respect to cryptocurrencies that are not securities,
the question of whether wallets and exchanges should be subject
to a regime that provides for consumer insurance and
supervisory oversight is part of the broader questions of
whether a separate regulatory regime is necessary or
appropriate for those cryptocurrencies. We are discussing this
question with our fellow regulators and expect to consult with
the Committee on any recommendations.
With these matters as context, I generally agree with your
assessment that investors in cryptocurrencies and ICOs are not
receiving the protections that are comparable to bank deposits
and brokerage accounts.
Q.5. Do you think consumers fully understand the level of
inherent risk associated with investing in cryptocurrencies?
A.5. I have significant concerns that Main Street investors
have not been given clear disclosures that would provide a
basis for understanding the material facts and risks involved
when it comes to ICOs and cryptocurrencies. Worse, I have seen
examples where it appears promoters are intentionally confusing
ICOs with SEC-registered IPOs. Unfortunately, I believe it is
clear that some have taken advantage of this lack of
understanding. In response, I have urged investors,
particularly retail investors, to ask questions and demand
clear answers from issuers and promoters of cryptocurrencies
and ICOs. The SEC staff also has taken a number of steps to
alert investors to this very point and arm investors with
information on these assets. For example, the SEC staff has
issued a number of investor alerts, statements, and warnings.
So, too, have SROs, State securities regulators, and other
Federal, State, local, and international regulators. The
www.investor.gov website ``Spotlight on Initial Coin Offerings
and Digital Assets,'' lists a series of statements, investor
alerts and bulletins, announcements of enforcement actions, and
further provides contact information. It is important for
investors to be informed about critical questions related to
these products and for them to understand the risks involved.
Q.6. Currently, States play a major role in regulating
cryptocurrencies. The result has been a wide range of
approaches with a patchwork of regulatory schemes that can
prove difficult to navigate. o Should a formal interagency
committee be created to aid financial regulatory agencies
create coordinated regulation and oversight of new financial
products, services, and platforms associated with
cryptocurrencies?
What role should States play in regulating
cryptocurrencies?
A.6. Federal and State regulators play an important role in
protecting Main Street investors against fraudulent and illegal
activities. Coordination among Federal and State regulators
concerning the introduction of new types of financial products
occurs through a number of long-established channels. The SEC
staff has worked with a number of agencies over the years to
discuss products that may raise issues under different
regulatory regimes, and currently we are participating in the
FSOC subcommittee formed at the direction of the Secretary of
the Treasury to coordinate the regulatory approach to issues
regarding cryptocurrencies, ICOs, and other digital assets.
To the extent a digital asset operates as a ``true''
currency, trading in such instruments does not fall under the
SEC's jurisdiction. Currency trading--such as trading in euros,
dollars, or yen--implicates regulation by FinCEN and State laws
regarding money transfers, among others. Traditional money-
transmission services that operate in the United States are
primarily State-regulated and many of the internet-based
cryptocurrency trading platforms have registered as payment
services that are not subject to direct oversight by the SEC or
the CFTC. To the extent these financial instruments take on
other characteristics or are used in particular markets, they
may be subject to regulation by the SEC and/or CFTC. The SEC
has been collaborating with the CFTC on our approaches to
policing these markets for fraud and abuse and will continue to
work closely with our Federal and State counterparts, including
the Department of Treasury, Department of Justice, and State
attorneys general and securities regulators to ensure
appropriate oversight consistent with our respective statutory
missions.
Should additional legislative, regulatory, or other policy
efforts be necessary to address these issues, I stand ready to
work with Congress and our regulatory counterparts.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM J. CHRISTOPHER GIANCARLO
Q.1. On January 18, 2018, the Director of the SEC's Division of
Investment Management wrote a letter to industry raising
concerns about potential ``fraud and manipulation'' that could
impact prices in both cryptocurrency markets and the
derivatives markets linked to them. As a result of these and
other concerns, the Director wrote: ``Until the questions
identified above can be addressed satisfactorily, we do not
believe that it is appropriate for fund sponsors to initiate
registration of funds that intend to invest substantially in
cryptocurrency and related products.''
This letter follows the SEC's previous denial of an
application to list Bitcoin exchange-traded funds in March 2017
and reports that the SEC told other exchanges to withdraw their
applications. One former SEC lawyer characterized the SEC's
first application denial as ``essentially saying that until
significant Bitcoin markets are regulated, the listing exchange
really can't address concerns about the potential for
manipulative trading,'' leading some observers to believe that
the SEC would change its position after the launch of the CME
and Cboe Bitcoin futures exchanges. However, between the
Investment Management letter and the SEC's requests for certain
exchange applicants to withdraw their applications, it appears
that there are still serious concerns at the SEC about the
potential for fraud and manipulation in cryptocurrency and
related futures markets, even after the launch of the CME and
Cboe exchanges.
I have several questions related to these developments:
Do you believe that the SEC's concerns about the risks of
fraud and manipulation in the cryptocurrencies and related
futures markets are accurate? Do you believe that the SEC is
being too conservative waiting until its concerns are resolved
before approving new products?
A.1. There are different statutory provisions and regulatory
standards for how products under the SEC's or CFTC's
jurisdiction are listed to trade. With respect to the SEC,
commodity-trust exchange traded products, (ETP) (e.g., the
Winklevoss Bitcoin ETP submitted in 2017) are exchange rule
changes. The SEC must determine whether the proposed rule
change is consistent with the statutory provisions, and the
rules and regulations that apply to national securities
exchanges. The SEC must approve the filing if it finds that the
proposed rule change is consistent with these legal
requirements and it must disapprove the filing if it does not
make such a finding. The proposed rule change is published in
the Federal Register and subject to notice and comment. Under
the Commodity Exchange Act (CEA) and Commission regulations,
futures exchanges can self-certify new futures contracts on 24-
hour notice prior to trading. There are limited grounds for the
CFTC to ``stay'' self-certification such as filing a false
statement in the certification. It is clear that Congress and
prior Commissions deliberately designed the CFTC's product
self-certification framework to give futures exchanges the
ability to quickly bring new products to the marketplace.
Q.2. If you believe that the SEC is being too conservative, or
its markets and products are sufficiently different from the
CFTC's, please explain how the risks in your markets are
different from the risks that led the SEC to identity fraud and
manipulation concerns in the cryptocurrencies and related
derivatives markets.
A.2. The functional role of futures and securities are also
fundamentally different. Futures are risk management
instruments, typically very short term in nature (hence weekly
and quarterly expirations) and designed to help firms manage
risk exposures, while ETPs are investment products, held by
retail investors for long periods--for example, an ETP can be
held as part of a retail investor's retirement investment in an
IRA account. The regulatory approach to these two sets of
instruments reflects these economic and functional differences.
Q.3. Additionally, are there specific risks or events that
would cause you to reconsider the markets underlying the
Bitcoin futures and other derivatives?
A.3. The CFTC's approach to Bitcoin futures was a balanced
approach that took into account promoting responsible
innovation and development that is consistent with its
statutory mission.
The information access and risk management protocols
established for the Bitcoin futures contracts reflects an
appropriate and thoughtful balance of flexibility provided in
the statute to the exchanges to self-certify new futures
contracts, and for CFTC to monitor that these contracts
continue to be in compliance with the CEA's core principles.
Q.4. Your written testimony mentioned that CME's and Cboe's
Bitcoin futures exchanges have information-sharing agreements
with the Bitcoin exchanges they rely on.
Could you please submit a model or sample information-
sharing agreement for the record? This would help the Committee
and others in Congress understand the unique risks in these
markets, how oversight is being conducted, and whether
additional legislation related to virtual currencies is
necessary.
A.4. One purpose of the Commodity Exchange Act is to serve the
public interest by providing a means for managing and assuming
price risks, discovering prices, or disseminating pricing
information. The CEA sets forth a series of Core Principles
applicable to a board of trade designated by the Commission as
a contract market. Those core principles, also adopted by the
Commission in Part 38 of its Regulations, contain requirements
that (core principle 3) the board of trade list contracts that
are not readily susceptible to manipulation and that (core
principle 4) the board of trade ``shall have the capacity and
responsibility to prevent manipulation, price distortion, and
disruptions of the delivery or cash settlement process through
market surveillance, . . . including (A) methods for conducting
real-time monitoring of trading.''
Designated contract markets that list futures contracts
that are cash settled must also have, in accordance with
Commission Regulation 38.253, ``rules or agreements that allow
the designated contract market access to information on the
activities of its traders in the reference market.'' The
Commission has also published guidance and acceptable practices
for contract markets to comply with these referenced core
principles on an ongoing basis. In particular, the Commission's
guidance for cash settled contracts provides that ``at a
minimum, an acceptable program of monitoring cash-settled
contracts must include access, either directly or through an
information-sharing agreement, to traders' positions and
transactions in the reference market for traders of a
significant size in the designated contract market near the
settlement of the contract.'' See Part 38, Appendix B, Core
Principle 4, Section (b)(3) (Cash-settled contracts).
The Cboe Futures Exchange (CFE) has entered into an
information sharing agreement with the Gemini auction platform
concerning the Cboe's listed Bitcoin contracts. The information
sharing agreement is described starting in the last paragraph
of page 5 of the CFE certification filing, continuing on to
page 6, which is linked here: http://www.cftc.gov/filings/ptc/
ptc120117
cfedcm001.pdf.
Specifically, the certification states that ``the Amendment
modifies [CFE] Rule 216 to make clear that CFE may enter into
information sharing agreements with trading venues like the
Gemini Exchange. In particular, CFE is amending Rule 216 to
clarify that CFE may have information sharing agreements with
trading venues other than domestic or foreign self-regulatory
organizations, associations, boards of trade, and swap
execution facilities. CFE is also amending Rule 216 to make
clear that CFE may be a direct party to any information sharing
agreements under Rule 216 or be a party as a third party
beneficiary to information sharing agreements entered into by
CFE affiliates. In this regard, Cboe Options has entered into
an information sharing agreement with Gemini that provides CFE
with the ability to access Gemini Exchange trade data for
regulatory purposes, including in connection with the
surveillance and regulation of trading in XBT futures on CFE's
market. Pursuant to this information sharing agreement, CFE
Regulation (CFER) will receive on a regular basis from Gemini,
order and trade detail information from the Gemini Exchange
market for Bitcoin in U.S. dollars, which CFER will utilize to
conduct cross market surveillance of the Gemini Exchange
Bitcoin auction and the CFE XBT futures settlements. This
information sharing agreement also permits CFE to share that
data with the Commission. One way in which this information
sharing will occur is that CFE plans to share Gemini Exchange
market data with the Commission.''
The Chicago Mercantile Exchange (CME) also self-certified
its Bitcoin futures contract which can be reviewed here: http:/
/www.cftc.gov/filings/ptc/ptc120117cmedcm001.pdf. The Bitcoin
contract utilizes an index, referred to as the Bitcoin
Reference Rate or BRR, for settlement. According to the CME's
certification filing, the BRR is calculated by Crypto
Facilities, a financial services firm, and the BRR is also
governed by an oversight committee. In order for a trading
venue to be considered a constituent exchange by the BRR, CME's
certification further states at pages 4-5, that certain
criteria must be met including that ``the venue cooperates with
inquiries and investigations of regulators and the Calculation
Agent upon request.''
In addition, the Commission is closely coordinating with
other regulators who have access to cash platform data, in
particular the Financial Crimes Enforcement Network (FinCEN)
within the Department of Treasury.
Q.5. On January 19, 2018, you said in a speech that you had
directed CFTC staff to develop a ``heightened review'' process
for virtual currencies derivatives, including a checklist for
new products, and that you had asked the CTFC's General Counsel
to discuss the statutory support for codifying these principles
through rulemaking.
Could you please provide an update on the process and
status of these discussions?
A.5. The elements of the ``heightened review'' process are
publicly available on the CFTC's website in its January 4,
2018, ``Backgrounder on Oversight of and Approach to Virtual
Currency Futures Markets.''
Q.6. Is the CFTC staff developing a proposed rule for notice
and comment?
A.6. CFTC staff is currently preparing staff-level guidance on
the heightened review process that will be publicly available
on the CFTC's website.
Q.7. Will the full Commission vote on the rule?
A.7. If a rule was proposed, it would go through the notice-
and-comment process under the Administrative Procedure Act
(APA) and require a Commission vote to implement.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
FROM J. CHRISTOPHER GIANCARLO
Q.1. The CFTC's backgrounder on its oversight and approach to
virtual currency futures markets states that virtual currency
``self-certification under heightened review means that the
CFTC not only has clear legal authority, but now also will have
the means to police certain underlying spot markets for fraud
and manipulation.''
How will the CFTC exercise this authority in light of your
testimony that ``the CFTC does NOT have regulatory jurisdiction
under the CEA over markets or platforms conducting cash or
`spot' transactions in virtual currencies or other commodities
or over participants on such platforms.''
A.1. In 2015, the CFTC determined that virtual currencies, such
as Bitcoin, met the definition of ``commodity'' under the CEA.
Nevertheless, to be clear, the CFTC does not have regulatory
jurisdiction over markets or platforms conducting cash or
``spot'' transactions in virtual currencies or other
commodities or over participants on such platforms. More
specifically, the CFTC does not have authority to conduct
regulatory oversight over spot virtual currency platforms or
other cash commodities, including imposing registration
requirements, surveillance and monitoring, transaction
reporting, compliance with personnel conduct standards,
customer education, capital adequacy, trading system
safeguards, cybersecurity examinations, or other requirements.
In fact, current law does not provide any U.S. Federal
regulator with such regulatory oversight authority over spot
virtual currency platforms operating in the United States or
abroad. However, the CFTC does have enforcement jurisdiction to
investigate through subpoena and other investigative powers
and, as appropriate, conduct civil enforcement action against
fraud and manipulation in virtual currency derivatives markets,
and in underlying virtual currency spot markets just like other
commodities.
In contrast to its lack of regulatory authority over
virtual currency spot markets, the CFTC does have both
regulatory and enforcement jurisdiction under the CEA over
derivatives on virtual currencies traded in the United States.
This means that for derivatives on virtual currencies traded in
U.S. markets, the CFTC conducts comprehensive regulatory
oversight, including imposing registration requirements and
compliance with a full range of requirements for trade practice
and market surveillance, reporting and monitoring and standards
for conduct, capital requirements, and platform and system
safeguards.
Q.2. Are you concerned about the potential for Bitcoin and
other cryptocurrencies to facilitate money laundering by
criminals such as human traffickers, gangs like MS-13, or
terrorists like Hezbollah?
A.2. I am very concerned about the potential for the use of
cryptocurrency for illicit activity. The CFTC does not have the
regulatory authority to prevent or stop the use of it for those
purposes, which has to be done by law enforcement agencies,
with whom we actively cooperate on cryptocurrency and other
matters. We are committed to referring any illicit activity to
our law enforcement partner agencies.
Q.3. What--if any--role does your agency have in addressing
this problem, including through cooperation with other
agencies?
A.3. I met recently with the new head of FinCEN, and the
financial crimes unit, and they assured me that their anti-
money-laundering procedures are in place for all domestic
virtual currency trading platforms, which we do not regulate at
the CFTC, but about which we are concerned. We are broadly
concerned about the use of virtual currencies for illicit
activities, and yet no Federal regulator has direct authority
over these markets. I think policymakers in Congress, as well
as the regulatory agencies, should focus first and foremost on
developing a plan for where we go next.
And, I think the industry itself has something to do in
this area as well. A number of virtual currency platforms in
the U.K. are banding together to develop a self-regulatory
organization to clean up the industry of these problems. I
think advocates for virtual currencies need to know that they
have a responsibility for cleaning up this industry if they
really want it to be something that bears respect and becomes
part of not only our future but their future as well.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCHATZ
FROM J. CHRISTOPHER GIANCARLO
Q.1. Currently, States play a major role in regulating
cryptocurrencies. The result has been a wide range of
approaches with a patchwork of regulatory schemes that can
prove difficult to navigate.
Should a formal interagency committee be created to aid
financial regulatory agencies create coordinated regulation and
oversight of new financial products, services, and platforms
associated with cryptocurrencies?
A.1. The creation of a formal interagency committee to aid
financial regulatory agencies to coordinate and oversee new
financial products, services, and platforms associated with
cryptocurrencies is an interesting idea that would have
potential benefits. Currently, the CFTC actively communicates
its approach to virtual currencies with other Federal
regulators, including the Federal Bureau of Investigation (FBI)
and the Justice Department and through the Financial Stability
Oversight Council (FSOC), chaired by the Treasury Department.
Q.2. What role should States play in regulating
cryptocurrencies?
A.2. With respect to the role of States, I believe that the
States have an important role to play, at least, if not beyond,
the point that a Federal regulator is designated to have
regulatory jurisdiction over virtual currency platforms.
Q.3. The CFTC has authorized Bitcoin options on the Chicago
Mercantile Exchange and Cboe Options Exchange.
What procedures and regulations are in place to ensure the
volatility of Bitcoin does not spread such that it risks the
stability of the more traditional financial sectors trading the
future?
A.3. The seventh element of the ``heightened review'' process
for virtual currency product certifications provides that
derivatives clearing organizations (DCOs) set substantially
high initial margin and maintenance margin for cash-settled
Bitcoin futures. This element was designed to ensure adequate
collateral coverage in reaction to the underlying volatility of
Bitcoin.
Futures exchanges also have risk controls and tools to
manage periods of volatility as well as unexpected spikes in
volatility. CFTC regulations require futures exchanges to
conduct real-time market monitoring of trading activity and
market conditions, and to establish and maintain risk control
mechanisms to prevent and reduce the potential risk of price
distortions and market disruptions, including restrictions that
pause or halt trading. See 17 CFR 38.157, 38.251, and 38.255.
CFE and CME also have position limits on their Bitcoin futures,
which limits the number of Bitcoin futures contracts a market
participant may own.