Posts by: Soo Hwang

Crypto Regulation Marches On With Potential Consequences for Trading Systems

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A flurry of recent activity has reinforced the SEC’s commitment to regulate crypto assets, including trading systems that trade crypto asset securities.

WHAT HAPPENED?

The SEC shared additional information in April 2023 on whether and how its proposal to expand the definition of “exchange” would affect trading systems for crypto asset securities. The SEC initially issued the proposal in January 2022. This revised proposal responds to comments the agency received requesting clarity on the application of existing rules and the proposal related to crypto asset security trading platforms that meet the proposed definition of an exchange or trading systems that use distributed ledger or blockchain technology, including DeFi systems.

WHAT DOES IT MEAN?

If the proposals take effect, they may require many crypto asset security trading platforms to register as national securities exchanges or as broker-dealers that must comply with Regulation ATS, which governs alternative trading systems. As currently drafted in the proposal, this would include decentralized exchanges operating on order book or automated-market-maker models.

WHAT DOES THE PROPOSAL SAY?

Current regulations say that a trading system must bring together “orders” to qualify as an exchange. The proposal would categorize a trading system as an exchange if it brings together “trading interest.”

Also, the rule now says an exchange must have “established, non-discretionary methods … under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.” The SEC’s proposal would require only that an exchange include “communication protocols” for the interaction of trading interest.

WHAT’S THE CONTEXT?

When the SEC shared additional information on how expanding the definition of “exchange” could affect trading systems, it was just the latest of several signs of the SEC’s stance on regulating crypto assets.

  • SEC Chair Gary Gensler said in a statement that “many crypto trading platforms already come under the current definition of an exchange and thus have an existing duty to comply with the securities laws.”
  • In a statement at a House Financial Services Committee hearing on SEC oversight, Chair Gensler also reiterated his view that, “given that most crypto tokens are securities, it follows that many crypto intermediaries are transacting in securities and have to register with the SEC.”
  • The hearing also touched on the SEC’s proposed $2.15 billion budget for fiscal year 2023, which represents an increase of almost $240 million to what it sought in fiscal year 2022. Notably, fintech accounted for half of the six key areas identified in its budget justification, including goals to:
    • prevent fraud concerning crypto assets.
    • ensure crypto assets register and comply with securities laws where appropriate.
    • craft the right regulatory and enforcement approach to fintech startups.

The SEC’s focus on enforcement of crypto matters does not appear to be slowing. Its Crypto Asset and Cyber Unit was initially envisioned as a 20-person operation but has doubled in size. Moreover, just a few weeks ago, the SEC also shared job postings for additional positions in the unit.

SEC Provides Expectations About Public Company Disclosures Regarding Crypto Ecosystem Impact

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What Happened

The Division of Corporation Finance of the Securities and Exchange Commission (“SEC”) issued a sample letter on December 8, 2022, highlighting considerations that public companies that are in, or connected to, the crypto industry should keep in mind as they prepare their public disclosures, spanning the description of business, management’s discussion and analysis (“MD&A”) and risk factor disclosures.

What Public Companies Need to Consider

While the letter highlights additional points for consideration in the business and MD&A sections, the majority of the comments focus on risk factor disclosure, flagging nine key risks, including:

  • any material gaps identified with respect to risk management processes and policies,
  • the “possibility of regulatory developments related to crypto assets and crypto asset markets,” and
  • material risk of reputational harm from recent disruptions.

Additionally, the sample letter also calls for increased disclosure regarding whether any of the crypto assets held or issued by the company serve as collateral for certain activities, as well as any downstream effects experienced by the company as a result of certain bankruptcies in the crypto industry. The sample letter gives insights into general themes of disclosures that the SEC is focused on, including the following: (i) the risk exposure a company has to other actors in the blockchain and cryptocurrency ecosystem (interdependencies within the industry), and (ii) changes to the value of assets held by the company resulting from fluctuations in the larger blockchain market.

In light of the heightened scrutiny faced by companies with exposure to the crypto industry, careful consideration should be given to any public disclosures regarding their operations in order to address the SEC’s concerns of providing adequate information to make a company’s public disclosures not misleading.

Contact Alice Hsu, Daniel Forester, Joseph Perkins or Soo Hwang for guidance on whether your company could be impacted or if you have any questions about navigating this evolving regulatory landscape.