In addition to suggesting SEC crypto enforcement may continue apace, Chair Gensler said he expects to see future filings for ETFs under the Investment Company Act. Elsewhere, a bipartisan infrastructure bill would bring crypto exchanges into the IRS’s transaction reporting regime.
SEC Chair Gary Gensler, speaking to an audience at The Virtual 2021 Aspen Security Forum, suggested that the SEC’s existing digital asset enforcement policy and related guidance is quite clear, although he suggested areas where the SEC may need additional legislative authorities. Gensler also briefly mentioned that he expects to see future filings for ETFs under the Investment Company Act, which includes investor protections. Separately, a bipartisan infrastructure bill contains a surprise provision that would bring digital asset exchanges into the IRS’s transaction reporting regime for securities brokers. The blockchain wrap-up below brings into focus what are likely the most extensive remarks on the subject by Gensler since he became SEC Chair and further explains an infrastructure provision that may get lots of scrutiny in the days ahead.
Aspen Security Forum. The theme of the Aspen Security Forum was national security, which meant that most panels dealt with various aspects of the U.S.’s foreign policy towards its major nation state rivals or its commitments in the Middle East, especially with respect to the ongoing withdrawal of U.S. military forces from Afghanistan. But the Gensler panel, one of only two panels on virtual currencies and digital assets, does fit the conference’s them, as Gensler explained in extended remarks before taking questions from a moderator and then public questions during an open-ended Q&A session.
According to Gensler, who taught blockchain classes at MIT before becoming SEC chair, one of the several discoveries made by the as-yet-unidentified person or persons who are Satoshi Nakamoto, the founder of Bitcoin, was the ability to move things via the Internet without the participation of a central intermediary. Gensler said that innovation makes the $1.6 trillion virtual currency market the subject of national security policy regarding anti-money laundering regulations, sanctions regimes imposed by the U.S. and its allies on nation state bad actors, and tax compliance enforcement, all of which potentially could be undermined by virtual currencies.
However, Gensler also said that despite the hype that has characterized much of the early growth of digital assets, he believes that Nakamoto’s discoveries about Bitcoin are "real" and that they could be a catalyst for change in financial markets. On a personal note, Gensler said he would never have taught blockchain at MIT if he did not believe blockchain could bring real change. As a policy maker, however, Gensler said he is technology-neutral.
Gensler explained that virtual currencies are a new way for private money to compete with public money, although he later cautioned that, historically, private money often fails. He also reiterated that blockchain more generally likely inhabits an unsustainable position so long as it remains largely outside of legal policy structures.
With respect to SEC enforcement, Gensler said the agency’s policies and guidance were quite clear. By way of background, the SEC has been enforcing federal securities laws against initial coin offerings of digital asset securities since at least 2013 and has in the years since issued the DAO Report and then a more detailed digital asset securities framework, in additional to bringing dozens more enforcement cases and publishing a set of evolving guidance on custody issues and platforms.
Gensler said, "Make no mistake: It doesn’t matter whether it’s a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These products are subject to the securities laws and must work within our securities regime."
During a Q&A moderated by Paul Vigna, a reporter for The Wall Street Journal, Gensler was asked about trust issues with virtual currencies. Gensler replied that the 1930s innovations in securities regulation (i.e., the Securities Act and the Exchange Act) created trust and, thus, had the effect of lifting markets. Gensler suggested that adding more investor protections to the digital asset security genre could have a similar effect. As Gensler explained by analogy, people would not drive cars without some modicum of safety derived from the presence of traffic police, traffic lights, and other road safety measures.
Vigna also asked Gensler a series of questions about SEC staffing and priorities for blockchain issues. According to Gensler, the SEC could use more staff dedicated to blockchain. Gensler also said that blockchain is a research-intensive area because, among other things, regulators have to track down the locations of offshore platforms.
Gensler’s delivered remarks and his prepared remarks also said that certain activities of digital asset platforms, among other things, can mimic derivatives, but that the SEC may need additional legislative authorities to address the full range of issues regarding platforms. Gensler explained that Congress should focus on the trading, lending, and decentralized finance aspects of platforms. "Regulators would benefit from additional plenary authority to write rules for and attach guardrails to crypto trading and lending," said Gensler.
By way of example, Gensler suggested that a typical digital platform lists 50 to 100 tokens that are available for customers to trade or lend and for which the odds are high that at least some of the listed tokens are securities. He observed that trading of digital assets is a global phenomenon and that customers can trade on these platforms 24/7. He also observed that many platforms are located overseas but, despite assurances to the contrary, may still be allowing U.S. investors to trade via virtual private networks (VPNs). Gensler suggested during the public Q&A that the law on tokens is clearer than many entrepreneurs think, so platforms should talk to the SEC about getting registered.
Gensler also said that the stablecoin market is another source of concern. Citing data published by The Block, Gensler said that the stablecoin market is roughly $113 billion in size and that, in July, nearly 75 percent of all trading on digital platforms occurred between stablecoins and virtual currencies as a mode of facilitating the exchange of one virtual currency for another.
"Thus, the use of stablecoins on these platforms may facilitate those seeking to sidestep a host of public policy goals connected to our traditional banking and financial system: anti-money laundering, tax compliance, sanctions, and the like," said Gensler. "This affects our national security, too."
Gensler noted the development of Facebook’s Diem and the presence of four large stablecoins that have existed for a while, although he did not mention the SEC’s ongoing enforcement case against Ripple Labs Inc.’s XRP. During the public Q&A, Gensler also declined to answer a question about the securities status of Ethereum.
Infrastructure bill. In related developments, the Infrastructure Investment and Jobs Act (H.R. 3684), the bipartisan infrastructure bill (not to be confused with a likely follow-on Democrat-only reconciliation infrastructure bill) originally sponsored by Rep. Peter DeFazio (D-Ore), Chair of the House Transportation and Infrastructure Committee, but largely renegotiated in recent weeks by Sen. Rob Portman (R-Ohio), includes a provision that would bring digital asset exchanges within the IRS’s transaction reporting regime.
Section 80603 of the Infrastructure Investment and Jobs Act would amend Internal Revenue Code (IRC) Section 6045, which generally requires persons conducting the business of a broker to report certain information about their customers to the IRS, to include within the definition of "broker" in the code "any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person."
The Infrastructure Investment and Jobs Act also would amend IRC Section 6045 regarding the additional information required for securities transactions by revising the interrelated definitions of "covered security" and "specified security" to include within "specified security" any digital asset, in addition to the existing items, which encompass corporate stock, debt instruments, commodities, and other financial instruments for which the Treasury Secretary determines that adjusted basis reporting is appropriate. For purposes of applying the revised definitions, the "applicable date" would be "January 1, 2023, in the case of any specified security which is a digital asset."
Section 80603 of the Infrastructure Investment and Jobs Act also adds a definition of "digital asset" to IRC Section 6045, which would define the term to mean "any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary."
The Infrastructure Investment and Jobs Act would further amend IRC Section 6050I to clarify that "cash" includes "any digital asset." This is the section of the IRC that many people would recognize as the section that, among other things, requires the reporting to the IRS of cash amounts received totaling more than $10,000.
Lastly, the Infrastructure Investment and Jobs Act would amend IRC Section 6724, which provides for no penalty to be imposed if a failure is due to reasonable cause and not to willful neglect. Specifically, the amendment would define "information return" to include any statement of the amount of payments to another person required by specified IRC sections "relating to returns for certain digital assets."
The infrastructure bill is likely to be amended by the Senate in the coming days or weeks. Already, Sen. Pat Toomey (R-Pa), Ranking Member of the Senate Banking Committee, has said he will offer an amendment to language he described as "unworkable" within the tax provision regarding cryptocurrency reporting. "By including an overly broad definition of broker, the current provision sweeps in non-financial intermediaries like miners, network validators, and other service providers," said Sen. Toomey. "Moreover, these individuals never take control of a consumer’s assets and don’t even have the personal-identifying information needed to file a 1099 with the IRS."
The IRS would likely benefit from the proposed reporting provision because it has thus far been able to only begin to grasp the full extent of tax avoidance and tax evasion related to crypto currency transactions through the several John Doe summonses it has obtained from federal courts. Those summonses have provided a degree of insight to the IRS into the transactions executed by customers of a small number of cryptocurrency exchanges.
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