Scholar argues that traditional enforcement against digital assets will only reduce information for investors.
When Gary Gensler became the new Chair of the U.S. Securities and Exchange Commission (SEC) in April 2021, the cryptocurrency industry rejoiced at the news of an expert on digital assets guiding securities regulation and policy.
Less than six months later, the SEC threatened to sue Coinbase—an exchange for cryptocurrencies and crypto-based products—over an unregistered lending product, and Gensler called out Coinbase by name during U.S. Senate testimony as a possible violator of the securities laws. This public shaming—and any court actions that may follow—could force Coinbase to remove cryptocurrencies and derivative products that it trades rather than risk expensive legal battles.
Such a shift away from open market participation will work against the goals of the SEC, Rutgers Law School professor Yuliya Guseva argues in a recent paper. Guseva advocates a new regime designed to integrate the crypto industry into the securities market instead of relying on enforcement actions.
Securities regulation demands the disclosure of information to protect investors from fraud, to keep securities markets transparent and accurate, and to provide certainty for investment in sound ventures.
The SEC can only achieve these goals if enough information reaches the market, and Guseva argues that the SEC nudged crypto providers to raise funds from the private market—private equity and venture capital firms—instead of complying with the disclosure requirements of public offerings. Private fundraising requires less information—given to fewer investors—and can allow a company to grow outside of regulated markets.
By examining SEC enforcement actions against crypto issuers, Guseva discovered a correlation between increased enforcement and increased filing for private placements from 2017 to 2021. As the SEC cracked down on crypto assets in a bid to protect investors from what it perceived as a range of risky investments, crypto companies shifted to raising capital privately rather than “face off with the Commission.”
Even if crypto companies raised money in the public markets like typical corporations, Guseva admits that the traditional public offering regime does not map perfectly onto the structure and function of crypto assets. For example, information about a crypto product can reside outside the company making the offering: Third-party auditors and gatekeepers evaluate a product’s code outside of any disclosures.
But less tech-savvy investors go without this information, which Guseva says leads to less-informed decisions.
Guseva also proposes that the SEC could and should have predicted this shift to private funding. She analyzes the costs of filing publicly and finds that crypto issuers likely would raise money privately anyway.
When deciding how to raise funds, a company anticipates up-front costs—such as preparing registration materials for the SEC and the market—as well as future costs—such as continuous reporting and possible litigation. Another cost for a company seeking capital is time: Public offerings tend to take more time to prepare and execute than private placements, and technological advancements in the crypto space can make any delay even more costly.
With these costs in mind, Guseva acknowledges that crypto companies already were wary of public offerings. Guseva concludes that the SEC’s more aggressive stance against crypto issuers has increased the costs of a public offering and changed the calculation of crypto companies looking for funds.
To address the lack of information flowing from the crypto industry to investors, Guseva proposes a new disclosure regime tailored to crypto companies. Rather than rely on the limited information from private placements or crypto companies that choose to file a public offering, a new rule could develop gatekeepers—such as crypto exchanges and broker-dealers—to bring better information to the market.
Guseva predicts that if the SEC continues to use its enforcement powers—and to alienate potential gatekeepers, such as Coinbase—instead of adopting new rules designed for crypto technologies, a future will develop in which “no one wins.”
