The plan directs the agency to develop a robust regulatory framework to prevent market misconduct as SEC officials’ public comments keep advances in technology high on the agenda.
On August 25, 2022, the Securities and Exchange Commission (SEC) published a draft Strategic Plan (the Plan) for fiscal years 2022–2026. The Plan focuses on three goals that, according to SEC Chairman Gary Gensler, advance the SEC’s mission to protect investors; maintain fair, orderly and efficient markets; and facilitate capital formation. The Plan is open for public comment until 29 September 2022.
The objectives of the Plan are:
- Protect retail investors from fraud, manipulation and misconduct
Investor protection remains a core value for the current SEC, while technological innovation is essential to the agency’s considerations:
- The SEC will handle all financial activities under consistent and effective regulation and enforcement, “regardless of … the technology, or the business model.”
- The SEC will continue to focus on accountability and deterrence of bad actors through its enforcement program.
- The SEC will continue to develop and implement faster and more comprehensive methods to leverage and analyze data to better prevent, detect, and enforce misconduct.
- The SEC will continue to build its systemic risk identification capabilities to ensure the maintenance of orderly markets.
In a recent speech, Chairman Gensler echoed this framework when he said that investor protection remains relevant, “regardless of the underlying technologies.”
- Implementing a regulatory framework that evolves with innovation
The SEC plans to focus on an agenda that develops a regulatory framework that keeps pace with continued innovation:
- The SEC will update existing rules and approaches to reflect evolving technologies, business models, and capital markets, ensuring that core regulatory principles apply in all applicable contexts.
- The SEC will continue to appropriately supervise global entities and coordinate with regulators from other jurisdictions while maintaining appropriate data protection policies.
- The SEC will explore strategies to better prepare for and address systemic and infrastructure risks in the capital markets.
- The SEC will continue to focus on investor education and outreach that addresses diverse and underserved communities, as well as on emerging and popular investment topics.
- Supporting diversity, equality and inclusion in the workforce
Advances in technology have also featured prominently as part of the SEC’s efforts to support diversity, equity, inclusion, accessibility and equal opportunity of its internal workforce, including the following:
- The SEC will promote collaboration within and across SEC offices to maintain maximum flexibility to respond to market trends and technological innovations, including by maximizing telecommuting opportunities to leverage the benefits of telecommuting highlighted during the pandemic.
- The SEC will continue to build its internal control and risk management capabilities, with a focus on data and information security to optimize controls on systems and data, both internally and across the SEC’s suppliers and supply chains.
- The SEC will continue to modernize key systems, innovate with new technologies such as machine learning, and improve its workforce’s ability to manage and leverage technology to pursue its mission.
A nod to digital assets
Regarding digital assets, the SEC notes in the Plan that the rapid growth in digital assets represents an evolutionary risk to the securities markets, and that the SEC must continue to improve its expertise into “product markets outside of equities” – including digital assets.
The plan asserts that to address emerging risks, “the SEC should pursue new authorities from Congress where necessary, continue to work effectively with other regulators, and engage more proactively in digitization initiatives.” However, the plan does not specify what powers the SEC intends to pursue. Regardless, Chairman Gensler recently stated that “for the past five years … the Commission has spoken with a pretty clear voice [with respect to the applicability of the securities laws in the crypto space] … Not liking the message is not the same as not receiving it.”
Digital assets and financial intermediaries that deal in digital assets remain a high priority on the SEC agenda
The SEC’s focus on prevailing digital assets was confirmed in a series of speeches and public comments at the SEC Speaks series (September 2022), by Chairman Gensler and senior SEC staff, such as Director of Enforcement Gurbir Grewal.
These comments are consistent with recent proposals that could have a significant impact on the digital assets industry. For example, in June 2022 the SEC released its Agency Rule List (the Reg Flex Agenda) which includes two notable entries in the Final Rule Stage:
- Amendments to Exchange Act Rule 3b-16 Regarding Definition of “Exchange”; Regulation ATS and Regulation SCI for ATSs trading US government bonds, NMS stocks and other securities; and
- Further definition of traders.
While none of these potential regulations specifically target digital assets, the message from Chairman Gensler is that the SEC’s existing securities framework is sufficient to encompass securities and intermediaries in the crypto market. Furthermore, Chairman Gensler reiterated what he previously said, that “the vast majority” of digital tokens are investment contracts (ie, securities) under the US Supreme Court’s 1946 Howey test.
For example, the amendments to the definition of Exchange in the current version of Exchange Act Rule 3b-16(a) would replace the phrase “use established non-discretionary methods” with “make available established non-discretionary methods.” This amended definition will significantly expand the scope of the rules to capture systems that passively provide a protocol or simply provide access to such a protocol to “interact, negotiate and reach an agreement” regarding a security transaction. Although the Exchange proposal did not expressly make any references to crypto or digital assets, the expansion of Rule 3b-16’s definitions could be considered to include online portals that provide access to decentralized exchanges that offer digital assets and DeFi- protocols, including aggregation-type services. (For further information, see Latham’s previous post here and here.)
The amendments to the definition of Trader, if finalized as proposed, would include persons and entities that use automated and algorithmic trading technology to execute transactions and provide market liquidity, which may include persons acting as liquidity providers on digital asset exchanges and DeFi platforms to the extent they deal with securities. The original proposal stated that the “Rule[s] … shall apply to securities … including any digital asset that is a security or a government security within the meaning of the Exchange Act.” (For further information, see this previous Latham post). “Given that many crypto-tokens are securities,” according to Chairman Gensler, “it follows that many crypto-intermediaries transact in securities and must register with the SEC in some capacity.” This scope would include centralized or decentralized (DeFi) exchanges, as well as crypto lending platforms that transact in securities.
Chairman Gensler further noted that to mitigate conflicts of interest and investor risks, analyzing the exchange, broker-dealer, lending and custody functions of digital asset intermediaries is not off the table. Dual registration with the SEC and the Commodity Futures Trading Commission (CFTC) may also be appropriate, depending on the intermediary’s offerings.
Enforcement and Disclosure
On enforcement, Director Grewal said the SEC remains technology-agnostic when pursuing enforcement actions, and will “impartially enforce the laws and rules on the books for the benefit of investors and our markets.” He also echoed the views of Chairman Gensler by repeating that “the Howey and Vice versa tests remain necessary and accurate means of identifying instruments that fall within the jurisdiction of the securities laws.” To the extent that the securities laws are violated, and essential disclosures and protections are not provided to investors, the SEC will take action.
Focusing on investor protection, Chairman Gensler also noted in his speech that the SEC’s “fundamental goal is to provide investors with the protection and disclosure they deserve — and that are required by law.” To that end, the SEC is committed to preventing fraud, manipulation, front-running, wash-selling and other misconduct in the digital asset market. At a September 15, 2022 hearing before the Senate Committee on Banking, Housing and Urban Affairs, Chairman Gensler reiterated that the SEC considers compliance with investor protection rules essential for crypto-securities and their intermediaries.
Across the aisle, SEC Commissioner Mark Uyeda commented on what many in the industry view as the SEC’s “regulation through enforcement” approach in the digital asset space. Contrary to Chairman Gensler and Director Grewal’s steadfast position that most digital tokens constitute securities under clear and existing precedent, Commissioner Uyeda highlighted the concerns expressed by market participants “regarding the lack of regulatory guidance in this space” and the fears that this “lack of predictability regarding our regulation may encourage crypto firms to relocate to other jurisdictions.” To alleviate these concerns, Commissioner Uyeda urged the Commission to consider proposing rules and issuing further interpretive exemptions to address the unique issues raised by digital assets in order to take advantage of the benefits of public comments and to reduce any uncertainty regarding which digital assets constitute securities and how market participants dealing in such securities can meet their compliance obligations.
Finally, in light of the SEC’s strong interest in digital assets, Cicely LaMothe, the acting deputy director of the Division of Corporate Finance’s disclosure operations, noted during the SEC Speaks event that the SEC plans to open an office within the Division of Corporate Finance dedicated is reviewing public submissions related to digital assets. The SEC decided to establish this new office with both legal and accounting branches to “address the unique and evolving filing review issues related to crypto-assets,” she said. Chairman Gensler briefly mentioned disclosures in his speech, hinting that given the nature of digital asset investments, “it may be appropriate to be flexible in applying existing disclosure requirements.”
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