The plan directs the agency to develop a robust regulatory framework to prevent market abuse as public comments from SEC staff keep technology advances high on the agenda.
On August 25, 2022, the Securities and Exchange Commission (SEC) published a draft strategic plan (the Plan) for fiscal years 2022–2026. The plan focuses on three goals that, according to SEC Chairman Gary Gensler, advance the SEC’s mission to protect investors; maintain fair, orderly and efficient markets; and facilitate capital formation. The plan is open for public comment until 29 September 2022.
The objectives of the plan are:
- Protection of retail investors against fraud, manipulation and misconduct
Investor protection remains a core value for the current SEC, while keeping technological innovation essential to the agency’s considerations:
- The SEC will treat all financial activities under consistent and effective regulation and enforcement, “regardless of the … technology or business model.”
- The SEC will continue to focus on accountability and deterring bad actors through its enforcement program.
- The SEC will continue to develop and implement faster and more comprehensive methods for using and analyzing data to better prevent, detect, and enforce misconduct.
- The SEC will continue to build its capabilities to identify systemic risk to ensure that orderly markets are maintained.
In a recent speech, Chairman Gensler reiterated this framework when he said that investor protection remains relevant “regardless of the underlying technologies.”
- Implementing a regulatory framework that evolves with innovation
The SEC plans to focus on an agenda that develops a regulatory framework that keeps pace with continuous innovation:
- The SEC will update existing rules and approaches to reflect evolving technologies, business models, and capital markets to ensure that core regulatory principles are applied in all appropriate contexts.
- The SEC will continue to appropriately supervise global entities and coordinate with regulators from other jurisdictions while maintaining appropriate data protection policies.
- The SEC will explore strategies to better prepare for and address systemic and infrastructure risks in the capital markets.
- The SEC will continue to focus on investor education and outreach that targets diverse and underserved communities, as well as emerging and popular investment topics.
- Supporting diversity, equality and inclusion in the workforce
Advances in technology also stand out as part of the SEC’s efforts to support the diversity, equity, inclusion, accessibility and equal opportunity of its internal workforce, including the following:
- The SEC will encourage collaboration within and among SEC offices to maintain maximum flexibility in responding to market trends and technological innovation, including by maximizing telecommuting opportunities to leverage the benefits of telecommuting that have been highlighted during the pandemic .
- The SEC will continue to build its internal control and risk management capabilities, with a focus on data and information security, to optimize control over systems and data, both internally and across the SEC’s suppliers and supply chains.
- The SEC will continue to modernize key systems, innovate with new technologies such as machine learning, and improve the ability of its workforce to manage and use technology to pursue its mission.
A nod to digital assets
Regarding digital assets, the SEC notes in the plan that the rapid growth of digital assets poses an evolutionary risk to securities markets and that the SEC must continue to improve its expertise in “product markets beyond equities” — including digital assets.
The plan asserts that to address emerging risks, “the SEC should seek new authority from Congress when necessary, continue to collaborate effectively with other regulators, and engage more actively in digitization initiatives.” However, the plan does not specify what powers the SEC intends to exercise. Nevertheless, Chairman Gensler recently stated that “over the last five years … the Commission has spoken with a pretty clear voice [with respect to the applicability of the securities laws in the crypto space] … Not liking the message is not the same as not getting it.”
Digital assets and financial intermediaries dealing in digital assets remain a high priority on the SEC’s agenda
The SEC’s focus on digital asset management was reaffirmed in a series of speeches and public comments in the SEC Speaks series (September 2022), by Chairman Gensler and senior SEC officials such as Director of Enforcement Gurbir Grewal.
These comments are consistent with recent proposals that could have a significant impact on the digital asset industry. For example, in June 2022 the SEC published its list of agency rules (the Reg Flex agenda), which included two notable entries at the final rule stage:
- Amendments to Exchange Act Rule 3b-16 for definition of “exchange”; Regulation ATS and Regulation SCI for ATSs that trade in US Treasuries, NMS shares and other securities; and
- Additional definition of dealers.
While none of these potential rules specifically target digital assets, Chairman Gensler’s message is that the SEC’s existing securities framework is sufficient to cover securities and intermediaries in the crypto market. Additionally, Chairman Gensler reiterated what he has said before that the “vast majority” of digital tokens are investment contracts (ie, securities) under the US Supreme Court’s 1946 Howey test.
For example, the amendments to the definition of Exchange in the current version of Exchange Act Rule 3b-16(a) would replace the phrase “uses established non-discretionary methods” with “provides established non-discretionary methods.” This amended definition would greatly expand the scope of the rules to cover systems that passively provide a protocol or simply provide access to such a protocol for “interacting, negotiating, and reaching an agreement” with respect to a securities transaction. Although the exchange proposal does not explicitly make any references to crypto or digital assets, the expansion of the definitions of Rule 3b-16 can be seen as bringing in the scope of online portals that provide access to decentralized exchanges that trade digital assets and DeFi protocols , including aggregation-type services. (for additional information, see Latham’s previous post here and here.)
The changes to the definition of dealer, if finalized as proposed, would include persons and entities that use automated and algorithmic trading technology to execute trades and provide market liquidity, which may include persons acting as liquidity providers to digital asset exchanges and DeFi platforms to the extent that they deal with securities. The original proposal stated that “The rule[s] … will apply to securities … including any digital asset that is a security or government security within the meaning of the Exchange Act.” (for more information, see this previous post by Latham). “Given that many crypto tokens are securities,” according to Chairman Gensler, “it follows that many crypto intermediaries transact securities and must register with the SEC in some capacity.” This scope would include centralized or decentralized (DeFi) exchanges as well as crypto-lending platforms that transact securities.
In addition, Chairman Gensler noted that to mitigate conflicts of interest and risks for investors, the separation of exchange, broker-dealer, lending and custody functions of digital asset intermediaries is not ruled out. Dual registration with the SEC and the Commodity Futures Trading Commission (CFTC) may also be appropriate depending on the broker’s offerings.
Performance and Disclosure
On enforcement, Director Grewal said the SEC continues to remain technology agnostic when taking enforcement actions and will “impartially apply the laws and rules on the books for the benefit of investors and our markets.” He also echoed Chairman Gensler’s views, reiterating that “ Howie and Reversed tests remain vital and accurate means of identifying instruments that fall within the jurisdiction of the securities laws. To the extent that securities laws are violated and essential disclosures and protections are not provided to investors, the SEC will take action.
Focusing on investor protection, Chairman Gensler also noted in his speech that “the fundamental purpose of the SEC is to provide investors with the protections and disclosures they deserve – and that are required by law.” To this end, the SEC is committed to the prevention of fraud, manipulation, promotional sales, clear sales and other wrongdoing in the digital asset market. In a September 15, 2022, hearing before the Senate Banking, Housing, and Urban Affairs Committee, Chairman Gensler reiterated that the SEC considers compliance with investor protection rules essential for crypto-securities and their intermediaries.
Across the aisle, SEC Commissioner Mark Uyeda commented on what many in the industry see as the SEC’s “regulation by enforcement” approach to the digital asset space. Contrary to Chairman Gensler and Director Grewal’s firm position that most digital tokens constitute securities under clear and existing precedent, Commissioner Uyeda highlighted the concerns expressed by market participants “regarding the lack of regulatory guidance in this space” and the fear that this “lack of predictability in our regulation may encourage crypto firms to relocate to other jurisdictions.” To alleviate these concerns, Commissioner Uyeda urged the Commission to consider proposing rules and issuing additional interpretive notices to address the unique issues, raised by digital assets to take advantage of public comment and reduce any uncertainty as to which digital assets constitute securities and how market participants trading such securities can meet their compliance obligations.
Finally, in line with the SEC’s strong interest in digital assets, Cicely LaMothe, acting deputy director of disclosure operations for the corporate finance division, noted at the SEC Speaks event that the SEC plans to open an office within the division for corporate finance dedicated to reviewing public documents related to digital assets. The SEC decided to create this new office with legal and accounting branches to “address the unique and evolving filing review issues related to crypto assets,” she said. Chairman Gensler briefly mentioned disclosures in his speech and hinted that given the nature of digital asset investments, “it may be appropriate to be flexible in applying existing disclosure requirements.”