In its approach to digital assets, the Securities and Exchange Commission has been criticized for regulating by enforcement. In reality, the SEC has taken a twofold approach. In addition to bringing lawsuits against crypto exchanges, the commission has proposed amending the definition of an “exchange” under Rule 3b-16 and the Securities Exchange Act of 1934. [1] The release proposing the change reiterated the applicability of existing rules to platforms that trade digital asset securities under the Securities Act. But the proposed rule’s broad language would seem to force centralized and decentralized digital asset markets to register with the SEC as national exchanges or as alternative trading systems.
In a recent paper, I describe why this new version of an old interpretation of an even older definition was a sloppy attempt to integrate crypto into the securities laws. It attempted to stretch Rule 3b-16 to capture the use of “communication protocols” while maintaining the contradictory claim that existing Rule 3b-16 already served the purpose of crypto-trading regulation. First proposed in 2022, then reopened in 2023, it has yet to be finalized.
To create a sound, well-reasoned, cost-effective statute, the SEC must be willing to commit resources and foster community dialogue. And still, this effort will remain under the threat of anti-government bias prone to curtail the SEC’s executive authority during judicial review. To avoid this, the SEC chose to proceed with enforcement alone. It applied the registration and reporting obligations to a new technology in a disproportionately harsh way to decentralized exchanges.
Today, the SEC employs its covert policymaking stance, a reliance on its adjudicative power to proceed with years-long, risky cases against crypto exchanges with already two inconsistent rulings. [2] Far better, a predictable and reliable agency’s enforcement should go side-by-side with reforms. And reforms should be promulgated in cooperation with industry and the public.
Meanwhile, European regulators have come up with the Markets in Crypto Assets Regulation (MiCA), a comprehensive framework on crypto-assets that became effective from June 2024. MiCA is the first of its kind, but not the first of a kind. It is predated by the Markets in Financial Instruments Directive, the Prospectus Regulation and the Market Abuse Regulation, which MiCA does not replace but supplements.
MiCA pertains only to stablecoins and utility tokens. It creates a lengthy authorization, disclosure, and reporting regime which skews heavily in favor of established financial institutions rather than, as expected, tech companies. It then assigns the enforcement duties to 27 national agencies rather than the European Securities and Markets Authority which has no adjudicative or rulemaking functions and merely serves as an advisory body to the European Commission.
European national agencies vary in level of sophistication and enforcement approach. More important, they diverge in the interpretation of EU statutes by applying different standards, resulting in inconsistencies in application of the law and regulatory arbitrage. Partly, this explains calls for the creation of a “European SEC” and the reemergence of the capital markets union plan. [3] All this offers a cautionary tale to European regulators: Whether in crypto or AI, being first does not entail success against competing jurisdictions if the overall regulatory environment remains unattractive due to inherent weaknesses.
Yet, the administrative state in the U.S. has become weaker too. In the recent cases of Jarkesy, Loper Bright, and West Virginia, the U.S. Supreme Court has reined in the administrative state’s discretion to prosecute and reform. Consequently, this shift has prolonged the rulemaking process by increasing scrutiny of rule proposals. In turn, agencies have become more hesitant to draft rules. This phenomenon is in sharp contrast to European regulators, who generally strive to come up with innovative and forward-looking initiatives.
However, a stringent judicial review process does not give agencies a blank check. It remains true that “one yardstick of an agency’s maturity is the extent to which it proceeds by rule.” [4] When it comes to digital assets, the SEC has lacked this quality. By relying on enforcement to make policy, it has diminished its predictability and reliability. A responsible rule-based approach is essential.
That approach ought to treat decentralized technologies, which are still experimenting, with a light hand. To drive them out of the market entails protecting traditional incumbents from competition. Congress never authorized this. It gave the commission responsibility for protecting investors by preventing fraud and facilitating capital formation by fostering innovation. Achieving both is not an unattainable goal; prioritizing one over another is not wise in the long term.
ENDNOTES
[1] Amendments Regarding the Definition of ‘‘Exchange’’ and Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities, 87 Fed. Reg. 15496 (Mar. 18, 2022) and Supplemental Information and Reopening of Comment Period for Amendments Regarding the Definition of ‘‘Exchange”, 88 Fed. Reg. 29448 (May 5, 2023).
[2] Securities and Exchange Commission v. Ripple Labs Inc., et al., Case No. 20-cv-10832 (S.D.N.Y. Dec. 22, 2020) and Securities and Exchange Commission v. Coinbase, Inc., et al., Case No. 23-cv-4738 (S.D.N.Y. Jun. 6, 2023). The paper also elaborates on the cases against Bittrex and Binance.
[3] Christine Lagarde, Europe needs its own SEC, Financial Times (Nov. 17, 2023) at https://www.ft.com/content/acfc67d9-7f2a-4199-9c79-405fef9cb195.
[4] Warren E. Baker, Policy by Rule or Ad Hoc Approach—Which Should It Be?, 22 Law and Contemporary Problems (Fall 1957) at 671.
This post comes to us from Alexandros Kazimirov, a Transatlantic Technology Law Forum Fellow at Stanford Law School. It is based on his recent paper, “Regulation by Enforcement: Why the Securities and Exchange Commission’s Vision for Digital Asset Markets Lacks Clarity and an Alternative European Model,” available here.