Facebook CEO Mark Zuckerberg Defends Libra

In testimony before the House Financial Services Committee, Facebook CEO Mark Zuckerberg defended his company’s proposed virtual currency, “Libra.” The Committee also considered several bills related to technology and the financial services industry.

Mr. Zuckerberg emphasized that Facebook would not launch the Libra payment system until it has the support of U.S. regulators. He warned that, while these issues are being “debate[d],” China and other countries are working to launch similar payment systems. He argued that since Libra would be backed by U.S. dollars, it would “extend” U.S. financial leadership. He also addressed several concerns, assuring the legislators that:

– a recent white paper co-authored by Facebook (see previous coverage) was intended to start a dialogue with financial experts and regulators, rather than serve as the “final word”;

– Facebook does not intend to “circumvent” regulators; and

– the intended purpose of Libra is to provide for the transfer of money through an online payment system, not to be a replacement for sovereign currency.

Mr. Zuckerberg also affirmed Facebook’s commitment to preventing discrimination among Facebook’s advertisers. To “combat[]” discrimination, he stated, Facebook has made specific changes to policies in order to prevent discriminatory advertisement targeting. For example, Facebook banned the use of age, gender or zip codes in housing and credit advertisements.

Committee members at the hearing discussed several bills concerning technology and finance related to issues raised by the testimony. These included:

H.R. Draft “Keep Big Tech Out of Finance Act” would prohibit large platform utilities (i.e., Facebook) from (i) being authorized as, or affiliating with, a U.S. financial institution or (ii) operating a digital asset that is intended to be “widely used” as a method for exchange, pursuant to the Federal Reserve.

H.R. Draft “Stablecoins Are Securities Act of 2019” would make clear that a managed stablecoin is subject to the same securities laws’ requirements as other securities that are meant to protect investors, such as disclosure, antifraud and conflicts of interest.

H.R. Draft “Bill to Prohibit the Listing of Certain Securities” would limit issuers of stablecoins access to capital markets prohibiting certain trading on U.S. national securities exchanges.

H.R. Draft “Designing Accounting Safeguards to Help Broaden Oversight and Regulations on Data” would create more “transparency” on how consumer data is collected by requiring commercial data operators to disclose (i) the type of user data collected, (ii) an examination of how valuable the user data is and (iii) third-party contracts involving the collection of the data.

H.R. Draft “Diverse Asset Managers Act” would require SEC registrants to (i) consider at least one “diverse” asset manager when seeking asset management services and (ii) report to the SEC the extent to which diverse asset managers are used.

LOFCHIE COMMENTARY

Facebook’s attempted entry into the digital currency market accelerated the inevitable: Congress and the financial regulators are more closely scrutinizing the entry of technology firms into the financial markets. What was not inevitable was Congressional overreaction. While it now seems universal practice to refer to Libra as a Stablecoin, it is not: it is an asset-backed coin (try “ABCoin”). Because the managers of Libra would have had the ability to shift the assets supporting Libra, Libra is not stable. Because of the management of the underlying assets backing the product, Libra almost certainly would have been a “security,” at least in the absence of an exemption, and therefore, it is not necessary to amend the securities laws to that end.

A true Stablecoin, whether backed by the dollar or another currency (or even a pool of currencies) may be issued as a custodial receipt that is not a security, and need not be regulated as a security. It would thus be a shame if such Stablecoins, which may very well provide an attractive alternative to other payment methods, were made impossible because of an overbroad reaction to Libra.

Mr. Zuckerberg is absolutely correct that the United States benefits if a global stablecoin backed by the dollar were to emerge. Facebook’s principal mistake, which arguably reflects a certain lack of sophisticated understanding of financial regulation, was to go forward with a managed ABCoin, rather than a true Stablecoin.

SEC Commissioner Hester Peirce Describes Regulatory Challenges Posed by Cryptocurrency

In remarks at the University of Missouri School of Law, SEC Commissioner Hester Peirce described the difficulty in applying securities laws in general, and the Howey test in particular, to virtual currency and initial coin offerings. Ms. Peirce expressed concern that the SEC’s application of the Howey test will be “overly broad,” stating that token offerings do not always resemble traditional securities offerings. Some cryptocurrency projects may be unable to proceed because they cannot comply with applicable securities regulations, she said. In addition, she encouraged a “delay in drawing clear lines” for the regulation of virtual currency transactions which may provide more freedom for the technology to develop. Ms. Peirce noted that the SEC staff is working on “supplemental guidance” to “help people think through whether their crypto-fundraising efforts fall under the securities laws.”

Ms. Peirce stated that regulators tend to be unenthusiastic about innovation, given that it forces unwanted adjustments on them, as well as the possibility of negative consequences that are difficult to predict. The Commissioner said that the SEC must be open to innovation, given its potential to make our “lives easier, more enjoyable and more productive.” She raised a number of questions as to regulatory changes that might be considered in light of new technology; changing the ways in which firms communicate with their investors, for example, or revising the SEC’s recordkeeping rules.

Ms. Peirce also praised the SEC’s new office of “Small Business Capital Formation” and its first Advocate, Martha Miller.

Lofchie Comment: It’s a great thing when we have regulators who are thoughtful about the exercise of regulatory power, and are willing to weigh in a public forum the benefits and detriments of the use of that power. (I look forward, even if it requires quite a long look forward, to seeing her on late night television talk shows.)

SEC Office of Investor Advocate Reviews FY 2018 Activities

The SEC Office of the Investor Advocate (“OIA”) identified “problematic products or practices” and summarized steps the agency and self-regulatory organizations took to respond to investor concerns during the past year.

In a “Report on Activities,” the OIA Investor Advocate identified “potentially problematic products or practices during Fiscal Year 2018” as reported by the SEC, NASAA, FINRA and the MSRB. These include, among others: (i) initial coin offerings, cryptocurrency and blockchain; (ii) a variety of scams and schemes (related to, e.g., regulator impersonations, Ponzi schemes, natural disasters and investments in “unicorns,” binary options, oil and gas, marijuana, microcap stocks and real estate, among others); (iii) cybersecurity; (iv) investment fees and expenses; (v) suitability of wrap fee programs; (vi) registrations of third-party providers, marketers and gatekeepers; (vii) a variety of risks (e.g., trading on margin, data aggregation, disclosure, and use of credit cards); and (vii) other practices (e.g., pennying and prearranged trading in connection with primary offerings).

In the report, the OIE focused on five key policy areas: public company disclosure, equity market structure, municipal market reform, accounting and auditing, and fiduciary duty.

On some of the broader policy questions, the OIA:

  • approved of the SEC’s current approach to ICOs, including its emphasis on the responsibilities of gatekeepers and others under securities laws;
  • encouraged FINRA to publicize the “data sets, models, and rankings” it uses to evaluate broker risk to help retail investors;
  • urged the SEC to prioritize reforming “outdated transfer agent regulations”; and
  • supported the continuing publication of investor education materials regarding the use of margin debt, although the OIA did not recommend any immediate regulatory changes.

Investor Advocate Rick A. Fleming recounted specific steps the OIA took to address investor concerns. The OIA:

  • requested additional research on the impact of proposed amendments to modernize public company reporting requirements;
  • collaborated with SEC staff and several SROs to “encourage equity market structure reforms designed to enhance market resilience, efficiency, transparency, and fairness”;
  • reviewed rulemaking proposals to reform the regulation of the fixed income markets and municipal securities markets;
  • supported the SEC’s proposed amendments concerning enhanced municipal securities disclosure under Exchange Act Rule 15c2-12;
  • provided feedback in response to MSRB’s draft amendments to rules on primary offering practices;
  • continued monitoring accounting and auditing standard setters:
  • urged the FASB to return to its earlier proposal for harmonizing its definition of materiality with “the courts, the SEC, and the PCAOB” due to investor concerns;
  • encouraged the SEC’s attention to problems regarding non-GAAP financial measures;
  • monitored developments with respect to auditor attention requirements;
  • sought internal and external feedback on accounting and auditing issues;
  • assisted the SEC in researching how proposed Regulation Best Interest would affect investors; and
  • submitted a comment supporting FINRA’s proposal to amend Rule 2111.

Mr. Fleming also stated that budgetary constraints affected some 2018 initiatives, including the agency’s failure to “build out” the Ombudsman role and certain research functions.

SEC Commissioner Peirce Criticizes “Mixed Messages” on Cryptocurrency

SEC Commissioner Hester M. Peirce expressed concern over the United States’ conflicting regulatory approach to cryptocurrency, stating that U.S. regulators are sending “mixed messages” to entrepreneurs. She encouraged the SEC to be less conservative in the approval process for crypto-exchange-traded products.

In a speech before blockchain entrepreneurs in Switzerland, Ms. Peirce stated that the U.S. regulatory environment likely is not giving crypto entrepreneurs a “welcoming impression.” According to Ms. Peirce, the U.S.’s “diffused financial regulatory system” leaves entrepreneurs unclear about which laws apply to their projects. Additionally, Ms. Peirce noted that regulators are not uniform in their approach to cryptocurrencies. For example, while the CFTC has approved crypto-derivatives markets, the SEC has not approved the application of any exchange-traded products based on cryptocurrencies or crypto-derivatives, she said.

In criticizing U.S. regulators’ “mixed messages,” Ms. Peirce also addressed the SEC’s recent hesitancy in approving crypto-exchange-traded products. Ms. Peirce encouraged the SEC to empower investors to make decisions about whether or not to invest in these products. Ms. Peirce urged the SEC to be more transparent, and to better explain the agency’s decision-making process for exchange-traded crypto-products.

Lofchie Comment: No doubt the SEC believes that crypto-investments are very risky and that they are saving investors, particularly retail investors, from making bad investments. If SEC Commissioners believe that the public offering of crypto-securities constitutes an “emergency” that justifies “aggressive” regulatory action, then, at a minimum, while the SEC stalls exchange-traded crypto products, it should seek legislation endorsing such authority. Presumably, if the authority were granted, it would be subject to limits and to procedural conditions, including the transparency sought by Commissioner Pierce. In the absence of such a Congressional grant of authority, the SEC should not seek to exceed its legislated powers. It is worth noting that the advantage of allowing public trading of crypto-securities is that it would facilitate short sellers coming in, which should serve to dampen prices (assuming that the short sellers agree with the SEC’s skepticism on valuations).

Senate Banking Committee Considers State of Cryptocurrency and Blockchain

The U.S. Senate Committee on Banking, Housing and Community Affairs held a hearing on the state of cryptocurrency and blockchain. The two invited witnesses were Coin Center Director of Research Peter Van Valkenburgh and NYU Professor of Economics Nouriel Roubini.

Mr. Van Valkenburgh lauded the benefits of decentralized computing (i.e., blockchain) but criticized the surrounding “hype.” According to Mr. Van Valkenburgh, the terminology used to describe blockchain is often “vague and undefined,” leading to an overall lack of public understanding. In particular, he criticized the public perception that blockchain is the “solution to any number of social, economic, organizational, or cybersecurity problems.” However, Mr. Van Valkenburgh advocated for the continued exploration of decentralized computing, and advised regulators to take a “light-touch approach” in order to allow the technology to develop “unfettered.”

Conversely, Dr. Roubini criticized cryptocurrencies as the “mother of all bubbles,” and called the underlying blockchain technology the “most over-hyped – and least useful – technology in human history . . . nothing more than a glorified spreadsheet or database.”

In a statement given at the hearing, Senator Sherrod Brown (D-OH) expressed concern about the potential for fraudulent activity in cryptocurrencies and said that the malign effects of blockchain on our society are currently more prominent than the benefits. Senator Mike Crapo (R-ID) said that the “regulatory and oversight questions still remain,” but added that he wanted to better understand the opportunities and challenges regarding blockchain in order to regulate more effectively.

 

SEC Commissioner Urges Regulators Not to Impose Their Investment Judgment on Investors

SEC Commissioner Hester Peirce asserted that commissioners should not substitute their judgment for decisions made by investors, particularly with regard to (i) the decision to invest in a company that requires its shareholders to arbitrate any shareholder claims against the company (rather than go to litigation) and (ii) investments in bitcoin or other digital assets.

In remarks at the University of Michigan Law School, Ms. Peirce stated that (i) the SEC is no better than an investor at evaluating the investor’s best interest. She pointed to the SEC’s decision not to approve the public offering of the Winklevoss Bitcoin Trust. Ms. Peirce said that regulators should have allowed investors to decide whether a new investment is worthwhile.

Likewise, she said that the SEC should reject calls for it to become a “more activist regulator” and should not attempt to stretch SEC authority to limit mandatory arbitration between a public company and its shareholders. In this regard, Ms. Peirce questioned whether prior actions of the SEC, in discouraging corporations that were going public from requiring shareholders to arbitrate disputes, were actually within the scope of the SEC’s authority. Ms. Peirce observed that the SEC is required by the Federal Arbitration Act to “respect private contracts that favor arbitration.”

Lofchie Comment: Commissioner Peirce has become the voice of “liberalism” (in the very, very old-fashioned sense of the word): belief in limited government, government respecting the rights and abilities of individuals to make decisions, and government agencies not stretching the bounds of their authority to accomplish what officials decide is “good policy.” Note Commissioner Peirce’s views (and wit) in Motherhood and Humble Pie: Remarks before the Cato Institute’s FinTech Unbound Conference (summarized here). At a time when so many call for the government to expand its authority over private persons, Commissioner Peirce’s defense of the individual (including the individual’s right to screw up) is welcome.

SEC Director of Investment Management Outlines Policy Initiatives

In testimony before the U.S. House Committee on Financial Services, SEC Division of Investment Management (the “Division”) Director Dalia Blass outlined the following underlying aims of the Division: (i) improve the retail investor experience; (ii) modernize the regulatory framework and engagement; and (iii) utilize resources efficiently. The Division is working on the following rule proposals or potential rulemaking areas:

  • propose Regulation Best Interest;
  • modernize fund disclosure both by reviewing the content of disclosures and by allowing funds to provide shareholder reports online;
  • improve disclosure as to variable annuities;
  • finalize a rule for the issuance of exchange-traded funds (“ETFs”), so that the SEC exemptive process can more efficiently process exemptive relief requests for ETFs not within the scope of the rule;
  • reduce obstacles to publishing research on investment funds in compliance with the Fair Access to Investment Research Act of 2017;
  • harmonize and improve registration and reporting requirements for business development companies and closed-end registered investment companies (“RICs”);
  • regulate the use of derivatives by RICs;
  • publish guidance regarding valuation procedures;
  • update investment adviser marketing rules;
  • improve investment company liquidity disclosures;
  • support fund innovation as to cryptocurrency-related holdings; and
  • review the proxy process.

Lofchie Comment: While the SEC talks the talk as to facilitating innovation, walking the walk is far more difficult. ETFs, for example, have become a significant product in the financial markets, and yet the SEC is only now considering a rule to routinize their issuance. As to cryptocurrency funds, one really has to question whether the SEC wants them to go forward, or is hoping that interest in the product is a bubble that will pop before the SEC is pushed to act. Compare SEC Rejects Another Nine Proposed Bitcoin ETFs with SEC Commissioner Peirce Calls on SEC to Embrace Innovation and Allow Cryptocurrency Risk-Taking.

Federal District Court Confirms that Cryptocurrencies are “Commodities” under CFTC Jurisdiction

The U.S. District Court for the District of Massachusetts ruled that cryptocurrencies fall within the definition of a “commodity” under the Commodity Exchange Act.

In a Motion to Dismiss, defendants argued that an allegedly fraudulent cryptocurrency, My Big Coin, is not a “commodity” since it does not deal in “contracts for future delivery” and thus is not within the CFTC’s jurisdiction over commodities. The plaintiff responded that there is future trading in cryptocurrencies and, as a result, My Big Coin falls under CFTC jurisdiction.

The Court denied the Motion to Dismiss and held that Congress defines a commodity by focusing on categories (e.g., cryptocurrency), not specific items (e.g., My Big Coin).

SEC Staff Comment on Suspension of Trading of Virtual Currency Tracking Certificates

The SEC Division of Trading and Markets and Division of Corporation Finance (the “Divisions”) commented on the SEC’s September 9th Order temporarily suspending trading of certain bitcoin and ether tracking certificates. The Divisions asserted that the lack of accurate and consistent information pertaining to Bitcoin Tracker One and Ether Tracker One (together, the “certificates”) led to confusion amongst market participants. The Divisions cautioned market participants that seek to quote, trade, or facilitate transactions in the certificates to examine the legal and regulatory implications of doing so. The SEC staff is currently working with the CFTC staff in connection with the regulatory considerations relevant to the certificates under the Commodity Exchange Act.

SEC Commissioner Peirce Calls on SEC to Embrace Innovation and Allow Cryptocurrency Risk-Taking

SEC Commissioner Hester M. Peirce urged the SEC to embrace FinTech innovation and permit more risk-taking by investors in cryptocurrencies.

In remarks before the Cato Institute’s FinTech Unbound Conference, Ms. Peirce elaborated on her dissent from the SEC’s rejection of an exchange-traded product (“ETP”) that was designed to give investors exposure to bitcoin. Ms. Peirce explained her disagreement with the SEC’s decision to deny an exchange’s bid to list shares of the Winklevoss Bitcoin Trust (see previous coverage), asserting that “it seemed to turn on the Commission’s assessment of bitcoin rather than on the exchange’s plans for trading the [ETP].” She went on to state:

“The focus on the lack of regulation of cryptocurrencies particularly troubled me. What authority do we have to require that assets underlying securities be regulated as if they were securities? Even if we had this authority, private markets can and do regulate themselves.”

Ms. Peirce urged the SEC to:

  • avoid the temptation to replace the market’s product testing with the agency’s own and allow investors to determine the value of these innovations for themselves;
  • create a space for innovation to occur in SEC-regulated markets or accept that investors will seek out innovations in less regulated markets;
  • establish an environment in which investors can openly communicate with the SEC and its staff; and
  • reaffirm the agency’s commitment to expanding investor access, including through innovative technologies.

Lofchie Comment: Ms. Peirce’s speech is witty and thoughtful.