Hester Peirce doesn’t want the government to protect you from dumb cryptocurrency investments.
Speaking at a taping of Laura Shin’s Unchained podcast at NYU’s Stern School of Business on March 26, the Securities and Exchange Commission’s “Crypto Mom”—a nickname she picked up after dissenting from the commission’s June 2018 decision not to approve a cryptocurrency exchange traded fund (ETF)—expressed a belief that her agency should be focused on protecting securities investors from fraud, not hindering speculation.
“At the SEC, we often think if we don’t have a rule in place, people are just going to buy stuff and they’re not going to even ask for any information. And that’s pretty ridiculous,” she said. “Yes, there’s a group of people who are willing to give their money on a hope and a dream and a little title called ‘crypto’ and nothing more. But I think, especially as the space is maturing, people are saying, ‘Wait a minute, I invested money in this project and now I have nothing. So, if I’m going to invest in another project, I’m going to ask a bunch of questions.’ And I think that’s a very healthy attitude to cultivate in people.”
The basic problem securities laws are trying to solve, she said, is making sure that a promoter trying to raise money is providing complete and accurate information that allows investors to make informed decisions.
“We’ve got to remember that there is really a natural inclination on the part of people to seek out information when they need it,” said Peirce, adding that there was plenty of information available in the cryptocurrency space.
“It’s a brutal space, where people are willing to rip each other to shreds, to say that each other’s projects are terrible,” online and on social media, she said. “Someone will say, ‘this project’s a complete fraud.’”
And sometimes it is, she added, pointing to the agency’s history of enforcement actions targeting initial coin offerings that qualified as securities offerings.
While a number focused on ICOs that did not register as securities, there have been examples of “outright fraud,” she said, “where people are taking advantage of the fact that crypto is really trendy. So, they’re throwing up white papers that sometimes are stolen from someone else, sometimes are completely not consistent with the underlying code, and they’re just running off with the money to a nice sunny location. And that’s the last we hear of them. We’re going to go after that kind of fraud, whether it’s labeled crypto or something else.”
The bottom line, she said, is that “people are out there, and they’re talking about this stuff, and I think that’s a really healthy way to get information out. Yes, the reason for the SEC’s existence is to get good disclosure out there to investors. And I think that’s a really important role. But I also don’t kid myself that absent our involvement, it won’t happen at all.”
Regulating a bridge too far
Regulatory overreach is a theme Peirce returned to several times. One of those came up around the question of when a cryptocurrency can go from a security at its ICO but become sufficiently decentralized that it becomes a non-security utility token—like Ethereum, although she wouldn’t address specific examples.
The Supreme Court’s Howey test gives some guidance, she said. Among the relevant factors are if there a broad group contributing to running the network, and if promoters are not maintaining a formal secondary market, she noted.
“I might not come to the same conclusion as some of my colleagues might, because I think often, you’re trying to look at what was in the purchaser’s head when she bought a token,” Peirce said. “Was she thinking, I’m going to make lots of money? Or was she thinking, I’m going to have a functional utility token? That’s a really strange road to go down because there are lots of products that you might buy thinking, ‘I’m going to be able to sell this for a lot of money somewhere down the line,’ but that doesn’t necessarily make it a security.”
She added, “If we’re candid about this, this is an area where we have to be careful. If we go crazy, our jurisdiction could expand to include almost anything. I mean, [companies] advertise watches. They show a picture of the father and the son and say, you buy this watch and this is your legacy for your child. I’ve even seen people say some of the best investments they’ve made are things like watches. If that’s the case, do we really want to walk down that road? I don’t. I’ve got enough to do on the security side.”
Another example came when discussing decentralized exchanges, which allow peer-to-peer cryptocurrency trades without going through a central service that holds and moves the coins for the two parties.
“I do think that we’re going to confront a very difficult situation when you’ve got a truly decentralized exchange where someone’s written some code and that’s being used to do exchanges,” Peirce said. “I don’t want someone who’s writing code to have to worry that that she’s going to get blamed down the road for what someone else did with her code. That’s an area that I’m particularly concerned about. We don’t want to outlaw writing code.”
Is regulation kneecapping the U.S. crypto industry?
Peirce said one of her goals when she first came to the SEC is to improve the agency’s outlook towards innovation broadly, and cryptocurrency is a natural area to focus on in this regard.
“I think that I can play a role in looking at ways that we can open the doors to make it easier for people to do what they’re trying to do, compliant with our securities laws,” she noted. “I’ve picked on the SEC because that’s where I can have an influence, but a lot of government agencies are not good innovation. They tend to be quite conservative because it’s safer. I think sometimes we have to take risks and that might not always work out well. That’s where I’m a little bit more willing to say, ‘We’ll let you do this, but if you get hurt, the onus is on you. You’ve chosen to take this risk, so we’re not going to protect you if you get hurt.’”
One fact that bears this out, Peirce said, is that there is a lot of innovation going on in Asia in terms of cryptocurrency regulation. “Are we missing out on something,” she asked. “Is there something that we could be doing differently so that some of that innovation would be happening here in the U.S. instead?”
That basic idea is part of the reason she opposed the decision to disapprove the proposal by the BATS BZX Exchange to list an ETF, Peirce said.
“I was pretty uncomfortable with the rationale that was guiding the decision,” she said, adding that in her opinion it was essentially the SEC’s discomfort with the underlying markets. That is a bad rationale, she argued, noting that there are a lot of other markets that are messy as well.
And while her fellow commissioners would disagree, Peirce said, “I did think there was a whiff of merit regulation in this decision, which was essentially us saying we don’t think this product would be good for investors. I don’t know whether that particular product or another exchange traded product based on cryptocurrency would be good for investors, but I think that investors can make that decision better than I can.”
Which isn’t to say that she doesn’t acknowledge the industry’s ongoing problems. She pointed to the recent report by Bitwise suggesting that 95 percent of the trading volume reported by cryptocurrency exchanges is faked, But she also called it a prime example of the industry proactively addressing SEC regulators’ concerns.
“If you really look at the data they present, they say there is this stuff going on and we’ve identified [it],” Peirce said. “But there’s this other piece of the market where we see a really effective well-functioning market.”
The pornography definition of crypto securities
One of the SEC’s main failings when it comes to the cryptocurrency market is that it still has not been able to provide would-be coin issuers or cryptocurrency exchanges with clear guidelines on what is a security, or what they need to do to comply with the regulations.
Peirce has been among the agency’s highest-profile critics in this regard, pushing for clear guidance, which has taken longer to materialize than many in the industry had hoped.
Without that guidance, crypto exchange operators and promoters are essentially left with the cryptocurrency version of US Supreme Court Justice Potter Stewart’s famous line about the definition of obscene and pornographic materials: “I know it when I see it.”
Which left Peirce to repeat advice she has given several times before when asked what she would do if she was running a cryptocurrency exchange. “I recommend for everyone who’s involved in this space and has a question in the back of his mind about whether or not there’s an issue with the securities law, come talk to us,” she said. “Again, the sooner you come in the better. It’s better if you come in before you start doing things, but come talk to us and work through the issues with us.”
That is a lot better, she added, than having the SEC come to you.
For one thing, the agency is not done with its enforcement actions, Peirce said, raising a chuckle by noting that while the SEC doesn’t necessarily have the resources to go after every violation, “It’s not like we’re doing a Noah’s Ark approach, where we’re only doing two of a particular kind of case.”
That said, she did add that by this point, exchange operators should have an idea if a product trading on their platform is a security or not. “I think it’s really important to do the due diligence on that,” she said. “You do have a very prescriptive set of rules around exchanges that trade securities, so you’ve got to be aware that you could trip those and that you could end up in a not a good place.”