On April 14, 2023, the US Securities and Exchange Commission (SEC) reopened the public comment period and provided additional information on changes proposed in January 2022 to the definition of “exchange” under Rule 3b-16. The SEC previously reopened the comment period in May 2022. The measure from April 2023 provides additional information and financial analysis regarding trading systems dealing in crypto-asset securities that will be newly included in the definition of “exchange” under the proposed rules.
By way of background, the 2022 release proposed sweeping changes to the scope of SEC oversight of securities intermediaries, including securities exchanges and alternative trading systems, or ATSs. Although the 2022 release never used the term “crypto” or “digital asset”, many commentators noted that the scope of the changes could sweep into various decentralized and blockchain-based financial applications.
The 2023 Reopening Release reiterates the SEC’s views regarding the applicability of existing rules to platforms dealing in crypto-asset securities, including DeFi platforms. For example, the release notes that the SEC “preliminarily believes that new Rule 3b-16(a) systems, including some so-called ‘DeFi’ systems, trade a certain amount of crypto-asset securities, and will under the proposed amendments to Exchange Act Rule 3b-16(a ), be required to register as a national securities exchange or comply with the conditions of regulation ATS.” The reopening release also solicits information and public comments on trading of crypto-asset securities on such systems and certain aspects of the proposed changes that apply to all securities.
The April 2023 proposal comes at a time when the SEC has stepped up its rhetoric and enforcement efforts around unregistered cryptocurrency exchanges. In a series of recent actions that have received extensive media coverage, the SEC has sued (or threatened to sue) several prominent cryptocurrency exchanges for failing to register with the SEC as a broker-dealer or exchange under existing SEC rules. Furthermore, in prepared remarks at a recent House Financial Services Committee oversight hearing, the SEC chairman was clear in his view that:
As I have said several times, the vast majority of cryptotokens are securities.
The investing public generally buys crypto tokens because these investors expect a profit and hope for a better future. These thousands of tokens are often backed by websites and social media accounts and are generally backed by entrepreneurs. The public generally relies on the efforts of other people behind these symbols to generate profits on their investments.
Given that most crypto tokens are securities, it follows that many crypto brokers deal in securities and must register with the SEC.
Crypto intermediaries – whether they call themselves centralized or decentralized – often offer a mix of services that are typically separated from each other in the rest of the securities markets: exchange functions, broker-dealer functions, custody and clearing functions, and lending functions. The intermingling of the various functions within crypto intermediaries creates inherent conflicts of interest and risks for investors – risks and conflicts that the Commission does not allow in any other marketplace.
Crypto investors should benefit from compliance with the same laws as [Speaker of the House Sam] Rayburn and [President Franklin D.] Roosevelt enacted to protect against fraud, manipulation, fronting, wash selling and other misconduct. As Justice Thurgood Marshall so well put it, “The purpose of Congress in enacting the securities laws was to regulate investments, in whatever form they may be made and by whatever name they may be called.”
That is the law; it is not a choice. For example, calling yourself a DeFi platform is not an excuse to defy securities laws.
Right now, unfortunately, this market is full of non-compliance. This non-compliance not only puts investors at risk, but also puts the public’s confidence in our capital markets at risk.
