BLOCKCHAIN—House passes what would be historic shift in regulation of crypto assets - 24 May 2024

SEC Chair Gary Gensler took the rare step of issuing a statement opposing the bill on the ground that it deviates from the Howey standard and could undermine the wider financial marketplace.

After a lengthy delay to deal with an unrelated parliamentary issue, the House voted to send the Financial Innovation and Technology for the 21st Century Act, unofficially referred to as the FIT21 Act, to the Senate. The bill would carve out a separate regulatory framework for crypto assets that its advocates hope would allow many digital assets to avoid the SEC’s framework for determining if an instrument is an investment contract and, thus, a security. The vote also was timed to put members on the record as being for or against legislation to promote the crypto industry in advance of the fall general election. The White House issued a statement opposing the bill in its current form but leaving the door open to a different bill, while SEC Chair Gary Gensler issued a statement strongly opposing the bill. The FIT21 Act passed with significant bipartisan support by a vote of 279-136.

SEC, White House oppose bill. Shortly before the House voted on the FIT21 Act, both the White House and SEC Chair Gary Gensler issued statements opposing the bill. Gensler, in a move rarely taken in public by a regulator, issued a lengthy statement citing the bill’s drift away from the Howey framework and its self-certification provisions as some of the most problematic sections in the bill. Gensler also targeted what he fears could be the bill’s impact on the broader financial market.

“The self-certification process contemplated by the bill risks investor protection not just in the crypto space; it could undermine the broader $100 trillion capital markets by providing a path for those trying to escape robust disclosures, prohibitions preventing the loss and theft of customer funds, enforcement by the SEC, and private rights of action for investors in the federal courts,” said Gensler. “It could encourage non-compliant entities to try to choose what regulatory regimes they wish to be subjected to – not based on economic realities, but potentially based on a label.”

By contrast, the Biden Administration’s statement on the bill was more tempered and did not include an explicit veto threat. The White House said it opposes the FIT21 Act in its current form but appeared to leave room for future legislation that sheds provisions the Administration currently would find objectionable. In the Administration’s view, the FIT21 Act lacks sufficient consumer and investor protections.

“The Administration is eager to work with Congress to ensure a comprehensive and balanced regulatory framework for digital assets, building on existing authorities, which will promote the responsible development of digital assets and payment innovation and help reinforce United States leadership in the global financial system,” said the White House statement.

As of publication, officials at the CFTC had not issued any statements on the FIT21 Act.

FIT21 Act primer. The FIT21 Act would create a framework for digital assets to move from SEC oversight to CFTC oversight by way of a new financial instrument called “investment contract assets,” for which the annual and periodic reporting requirements would end 180 days after a “covered fiscal year” in which the related blockchain system is both functional and certified to be decentralized.

“Investment contract assets” would be defined to mean a fungible digital representation of value that can be exclusively possessed and transferred without the aid of an intermediary that is recorded on a cryptographically secured public, distributed ledger, that is sold pursuant to an investment contract, but which is not otherwise a security.

The bill also includes an exemption modeled after the SEC’s Regulation A and Regulation Crowdfunding that would apply to transactions offering no more than $75 million in a 12-month period provided the offering satisfies requirements for, among other things, non-accredited investors, who could invest the greater of 10 percent of the individual or joint income with a spouse or 10 percent of individual or joint net worth with a spouse. A buyer of digital assets could not acquire more than 10 percent of the units sold.

Advocates of the FIT21 Act posit that that the bill would clarify existing law and free many digital assets from an overly restrictive framework for traditional securities that is enforced by the SEC, thus allowing the digital asset economy in the U.S. to grow and, ultimately, preventing digital asset businesses from moving overseas.

At the House Rules Committee meeting in advance of the full House vote, Rep. French Hill (R-Ark) previewed arguments on the House floor by testifying that the FIT21 Act is not a light-touch regulatory framework but that it instead recognizes that crypto assets are unique and should be regulated differently than traditional securities. He also asserted that the bill could have prevented the FTX collapse and denied claims by lawmakers opposed to the bill that it would create a new regulatory void. Representative Hill also noted that the bill contains strict consumer protections that bar firms from comingling funds and that other provisions address conflicts of interest and custody.

During floor debate, Rep. Hill, the sponsor of FIT21, said the bill is needed because the SEC and the CFTC cannot agree in court whether a digital asset like Ether is a security or a commodity. He said this lack of clarity created an opportunity for Congress to act.

Representative Steven Lynch (D-Mass) called the FIT21 Act one of the top three worst bills he has seen brought to the House floor. He characterized the bill as a radical rewrite of securities laws that will allow financial companies to escape the cop on the beat (the SEC) in favor of regulation by the CFTC, which is many times smaller than the SEC. According to Lynch, his amendment to bar taxpayer bailouts of crypto firms should have been brought to a vote because enactment of the FIT21 Act would put the country on a course to more financial firm bailouts.

Critics of the bill have previously pointed out that the proposed framework for regulating digital assets could place such assets under the purview of the much smaller and less-well-funded CFTC, whose capabilities for oversight and enforcement may be more strained than those at the SEC. More significantly, the FIT21 Act would purport to allow many digital assets to escape the SEC’s Howey framework for determining if an instrument is an investment contract and, thus, a security.

The minority views expressed in Part 2 of the House Report note the novelty of the new definitions used in the FIT21 Act: “For example, while the ‘Howey’ test, which is the current standard for determining whether something is a security under current law, has decades of judicial precedent to clarify how to apply it in different situations, the new definitions and tests in this bill come with zero judicial precedent, making it very unclear how these new standards would be applied by the courts.”

At the Rules Committee meeting, House Financial Services Committee Ranking Member Maxine Waters (D-Calif) reiterated this view when she testified that while “investment contract assets” may initially require some disclosures to investors for a limited period of time, they likely would eventually become commodities with fewer protections. She even suggested that the language in the bill could be used to bring other non-crypto financial instruments into the proposed crypto framework. According to Rep. Waters, significant, substantive language was added to the bill by the Rules Committee after the House FSC markup.

The bill also provides for oversight of digital asset intermediaries. For one, these entities must file with either the SEC and/or the CFTC a notice of intent to register as digital asset brokers, dealers, and trading systems (SEC), or as digital commodity exchanges, brokers, and dealers (CFTC). Two additional titles in the bill would provide for the registration of various crypto intermediaries.

The FIT21 Act would contemplate numerous joint SEC-CFTC rulemakings to fully implement its provisions. The bill also would codify the status of the SEC’s Strategic Hub for Innovation and Financial Technology (FinHub) and the CFTC’s LabCFTC. The bill would further mandate numerous studies by the SEC, CFTC and the GAO into a variety of topics, including decentralized finance and non-fungible digital assets (i.e., non-fungible tokens or NFTs).

Amendments. Only four amendments were allowed on the House floor. An amendment offered by Rep. Greg Casar (D-Texas) would have reset the FIT21 Act’s new transaction exemption offering amount from $75 million to $5 million. The amendment failed in a close vote.

Representative Brittany Pettersen (D-Colo) succeeded in having adopted her amendment to write into the Bank Secrecy Act explicit coverage of crypto intermediaries. The FIT21 Act in several locations had stated, however, that digital asset brokers, digital asset dealers, commodity brokers, and digital commodity dealers should be treated as financial institutions under the Bank Secrecy Act. The amendment was adopted by voice vote.

An amendment offered by Rep. Ralph Norman (R-SC), and passed by a vote of 411-0, would require the Treasury Department and the GAO to separately study whether governments of foreign adversaries are involved in crypto markets, whether these actors collect personal information or trading data, and whether they misuse or steal the intellectual property of digital asset registrants.

Lastly, an amendment proposed by Rep. Scott Perry (R-Pa) would clarify via an additional sense of Congress that the CFTC may not regulate commodities on spot markets other than digital commodities under the FIT21 Act. The amendment would address concerns that granting the CFTC new authorities over spot markets could prompt the agency to regulate other types of commodities on spot markets. The CFTC, however, would retain its ability to enforce its antifraud authorities in spot markets. The amendment was adopted by a vote of 225-191.
 

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