The U.S. House Committee on Financial Services (Committee) met last Wednesday[1] to discuss the rapidly growing cryptocurrency market exchange and the regulatory landscape that currently governs it.
Executives from six major crypto asset companies, including Coinbase and Circle, testified at the hearing, calling for clearer standards and guidance from regulators. Among other things, the witnesses raised concerns about the current regulatory framework used to determine whether digital assets should be regulated as securities under the federal securities laws. They also discussed the need for oversight by a centralized body capable of taking a flexible approach to regulating the crypto assets industry in light of its complex, dynamic nature. Specifically, Coinbase CEO Alesia Haas expressed a need for regulation by “a nimble group that is constantly looking at the changes in crypto.”[2]
The Committee’s hearing memorandum reflects its concern that investments in digital assets are thus “vulnerable to fraud, manipulation, and abuse.”[3] As a result, and “[g]iven the digital asset sector’s growth and evolution, several questions have arisen as to how regulators can ensure investor protections, ensure consumer protections, and maintain market integrity.”[4] Some, but not all, digital market exchanges and issuers have obtained national charters and/or state money transmitter and sale of checks licenses from various states.[5]
The U.S. Securities and Exchange Commission (SEC) has sought to protect investors by requiring the registration and disclosure of any offerings of digital assets that fall under the definition of securities as set forth in the Securities Act of 1933,[6] which encompasses a variety of enumerated terms, including “investment contracts.” Securities are broadly defined under the statute, and courts liberally construe that definition.
To determine whether an offering, including one involving cryptocurrency, constitutes an “investment contract” under the federal securities statute, courts apply the U.S. Supreme Court’s “Howey test.”[7] Under the Howey test, courts analyze whether the offering is (a) an investment of money (b) in a common enterprise and (c) with an expectation of profits to be derived solely from the efforts of others.[8] As the SEC has explained, the Howey test not only requires a fact-specific analysis of “the form and terms of the instrument itself,” but also focuses “on the circumstances surrounding the digital asset [or other instrument or offering] and the manner in which it is offered, sold, or resold.”[9]
Howey, decided in 1946, focused on whether an offering of citrus groves, along with management services, constituted an “investment contract” under the statute.[10]
The SEC has offered some guidance on the application of Howey in the digital asset context but has acknowledged that the outcome of the test depends on the specific facts and circumstances in each case.[11] At Wednesday’s hearing, former U.S. banking regulator and current CEO of bitcoin mining company Bitfury Brian Brooks stated that the uncertain classification of digital assets was “the most important issue in the short-term for the industry.”[12] Brooks emphasized that the Howey test is a “balancing test” rather than a clear rule.[13]
The witnesses also answered questions from the Committee on a range of topics, such as the demographic differences between cryptocurrency investors and investors in traditional instruments and the extent to which the growth of digital assets and decentralized finance can drive financial inclusion and benefit underserved communities.[14] These questions reflect the Committee’s awareness of the potential benefits that the ever-evolving digital asset industry may offer–not only in the United States, but also on a global scale.
[1] Hearings, the U.S. House Committee on Financial Services, https://financialservices.house.gov/events/eventsingle.aspx?EventID=408705 (last visited Dec. 10, 2021) (hereinafter, “Hearings”).
[2] Id.
[3] Memorandum: December 8, 2021, Digital Assets and the Future of Finance: Understanding the Challenges and Benefits of Financial Innovation in the United States, 3 (Dec. 3, 2021), https://financialservices.house.gov/uploadedfiles/hhrg-117-ba00-20211208-sd002.pdf.
[4] Id. at 1.
[5] Id. at 3.
[6] 15 U.S.C. § 77a et seq.
[7] SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
[8] Id.
[9] Framework for “Investment Contract” Analysis of Digital Assets, SEC, https://www.sec.gov/files/dlt-framework.pdf (last modified Apr. 3, 2019) (hereinafter, “Framework”).
[10] 328 U.S. 293.
[11] See Framework.
[12] Hearings.
[13] Id.
[14] Id.
