SEC Commissioner Hester Peirce (Crypto Mom) recently gave some remarks before the 51st Annual Institute on Securities Regulation. She called it Broken Windows.
To summarize her eloquent speech, she gave three recommendations on how the SEC can improve its enforcement efforts. Her recommendations were: (1) certain rules should be modernized, removed, or written; (2) more compliance and less enforcement may lead to better overall investor protection; and (3) over-broad information collection and surveillance should be limited.
Some interesting statistics included:
The SEC’s Enforcement Division has approximately 1,400 employees and contractors;
The Commission receives around 20,000 tips, complaints, and referrals each year;
The average time between opening a matter and commencing enforcement is 25 months.
Notably, she discussed the crypto space with some encouraging observations. The current SEC guidance pertaining to digital assets, to my knowledge, is comprised of 23 enforcement actions beginning with the DAO Report, Chairman Clayton’s Testimony on Virtual Currency, Director Hinman’s “sufficiently decentralized” speech, the Turnkey Jet No Action letter, the framework for investment contract analysis, and a plethora of speeches from various high-ranking SEC officials. When taken together, according to the Crypto Mom herself, this guidance offers no path forward for a functioning token network to emerge and has hindered innovation and growth. She said,
Instead, I support creating a non-exclusive safe harbor period within which a token network could blossom without the full weight of the securities laws crushing it before it becomes functional. By allowing legitimate projects to get their tokens into the hands of a broad set of developers and network users without fear of enforcement, we also would allow the SEC’s Enforcement Division to focus its resources on the fraudulent actors in the realm of crypto offerings.
That sounds like a vastly different approach than what we’ve seen so far. The overall sentiment in our community today is one of fear. The SEC has engaged in 22 enforcement actions, 15 of which have settled in fines or disgorgements totaling nearly $56 million and a hand full of court proceedings.
The nearly $56 million in fines levied by the SEC is still a far cry from the over $20 Billion supposedly raised by ICO issuers to the end of 2018. If these numbers are accurate, the SEC’s fines and disgorgements represents less than 0.3% of the overall funds raised.
Yet, in my circles at least, we often hear about the SEC’s enforcement actions in a negative light, as the driving force behind a “brain drain” forcing American companies to seek unregulated pastures overseas. In my own experience, I have not received a single ICO-related call in at least six months, which is quite different than the rush of 2017/18. I am not sure if this is a function of the SEC’s enforcement actions effectively quashing the industry, or, the pool of ICO purchasers dried up after the abysmal results of most ICO investments.
The remainder of Commissioner Peirce’s speech yielded three recommendations that would help the SEC achieve greater overall investor protection.
Recommendation 1: Rulemaking – Write, Modernize, or Eliminate Certain Rules.
Advertising Rules – Commissioner Peirce suggests the SEC should amend/modernize the the testimonial ban promulgated in 1961. In today’s internet age, testimony about whether or not an Investment Advisor provides good services can be helpful, yet as the rules are written, such testimony is banned for its potentially misleading nature.
Micro-Cap BD Publishing Rules – The Micro-Cap space is experiencing pump and dump schemes. Commissioner Peirce points out that an old Rule 15c2-11 requires broker-dealers to review basic information about Over The Counter securities issuers prior to publishing quotes. However, once one Broker Dealer does their due diligence prior to posting information, other Broker Dealers may rely and republish the initial Broker Dealer’s work or quotes. This may have made sense prior to the internet when obtaining pricing information on OTC companies was difficult, however today that rule is creating room for pump and dump schemes. Commissioner Peirce recommends each Broker Dealer should be required to do their own research before publishing information or quotes. For a full description, there is a 228 page rule amendment proposal.
Modernization of Transfer Agent Rules – The transfer agent rules were adopted in 1977 and have been left virtually unchanged since then. In 2015, the SEC contemplated creating a rule where the transfer agent would be required to halt a transfer of a restricted security (think a Reg D or Security Token) if they suspected wrongdoing. The SEC wants to be careful not to impose undue burdens on the transfer agents that could lead to transfer agents not servicing smaller companies. Commissioner Peirce is hopeful that some new rules requiring transfer agents to review certain documentation, such as a legal opinion letter, prior to making the transfer can solve the problem.
Framework for Finders – A finder is kind of like a matchmaker between a startup and their investors. Often times it’s not their day-job, but they are in the right place to introduce an investor to a company in need of funds. A finder often expects some compensation for making the match, often between 5-10% of the amount their introduced investor brings to the company. The way it’s regulated today, a Finder is supposed to be registered as a broker dealer to accept such a payment, but many companies simply call them “consultants” to get around the lengthy process of registering as a Broker Dealer just to engage in a one-off transaction. The SEC’s Advisory Committee on Small and Emerging Companies has acknowledged that the current finder rules are impractical and are proposing an updated framework that will address the concerns.
Recommendation 2: More Compliance; Less Enforcement.
Commissioner Peirce suggested that sometimes it is even more important to overall investor protection efforts to assist companies in complying with the complex and ever-growing set of rules rather than penalizing them with enforcement actions. She gave credit to the Office of Compliance, Inspections, and Examinations (“OCIE”), and its director Pete Driscoll for their great work. In many cases, getting the problems fixed as quickly as possible for the investors matters a lot more than seeing the bad actors prosecuted.
“This approach will not result in OCIE or the Commission receiving fanfare or higher enforcement statistics, but that should never be the point—the point is better compliance for registrants. If an enforcement action does not contribute to better investor protection or greater integrity in the marketplace, then what is the point, particularly given that enforcement actions are very costly for the SEC and the people we charge?”
Recommendation 3: Far-Reaching Implications of Enforcement Actions.
Commissioner Peirce discussed the need for balance between individual privacy and the overall good created by enforcement actions. While the government’s data-collection/surveillance techniques have assisted the SEC to uncover insider trading & cherry-picking schemes, Commissioner Peirce warned that the data-collection can also be a honeypot for cybercriminals. “I would rather have an enforcement program that respects the liberty and privacy of American investors, even if it comes at the cost of lost enforcement opportunities, than an enforcement program that has a hundred-percent success rate at catching wrongdoers.”
In her final comments, she suggested self-regulation is ever important. Apparently back in the days of physically settled trades, traders on the floor would often physically block bad actors from getting their trades filled.
In the crypto space, I believe we do see a lot of self-regulation. While some call it toxic bitcoin maximalisim, the crypto twitter, telegram dojos, crypto scam videos by Tone Vays, and coinjazeera parody articles certainly make sure to shed light on the bad actors in our space.