Crypto SRO Faces Strong Regulatory Headwinds03.28.2019
Within the past eight months, Wall Street has witnessed multiple calls to establish a self-regulatory organization to supervise and set forth a code of conduct for crypto market participants. However, market regulators remain cool to the idea.
In August 2018, Bitstamp, bitFlyer, Bittrex, and the Gemini Trust Company formed the Virtual Commodity Association Working Group whose mandate includes “establishing and an industry-sponsored, self-regulatory organization (SRO) to oversee virtual commodity marketplaces. The months later ten institutional trading firms created the Association for Digital Asset Markets (ADAM), which also is working to develop comprehensive standards for the crypto markets.
“If ADAM were successful, it would be something of great value for the industry and the people operating within it,” said Richard Walker, a partner at the law practice of King & Spalding and who spoke on a panel at SIFMA’s C&L Annual Seminar. “Hopefully, it would be something that the regulators would throw their weight behind.”
Digital assets create new issues for market regulators, but fellow panelist Brett Redfearn, director of the Division of Trading and Markets at the Securities and Exchange Commission, noted that innovative offerings do not necessarily require the re-invention of the regulatory wheel.
“There certainly will be some issues in respect to cryptocurrencies,” he said. “The custody challenges are something that Bob Colby and I are very familiar in terms of the difficulties in trying to establish possession and control, which we are still trying to nail down. Notwithstanding that, we are open to everything, but we do have a securities-law framework that we think is probably valid for any type of security.”
Many initial coin offerings have fallen under the securities umbrella, agreed Robert Colby, the chief legal officer at FINRA. “As one wise commenter said to me yesterday, ‘A lot of these ICOs are techno wrappers around penny stocks.”
FINRA’s first crypto-related enforcement action, which was against the issuers of HempCoin, was relatively easy for the regulator since the issuers already had declared HempCoin a security, he added. “There was nothing there other than a name and assets being collected and dispersed, said Colby.
The number of regulatory enforcement actions is only growing, according to Redfearn. “If you look at the number of enforcement actions that have come from the amount of manipulation, fraud, and other things like bad sales practices that have happened in this space, it is astronomical.”
In the meantime, the SEC’s Division of Trading & Markets plans to proceed extremely cautiously as it continues to build up its internal expertise with an expected hire of another expert in digital technologies, he added.
The bipartisan Lummis-Gillibrand bill requires segregation of customer assets and unbundling of custody.
The agencies found a shortcoming related to data quality and data management.
Technology does not change the need for transparency in corporate structures, governance, audit and controls.
Blockchain technology can be compatible with the existing federal securities law framework.
The Committee expects to hear from companies and individuals, including Sam Bankman-Fried, in December.