Securities Industry Commentator by Bill Singer Esq

Public Customers Win (Sort Of) Undelineated Cause of Action In Oddball FINRA Arbitration (BrokeAndBroker.com Blog)

Prepared Remarks at SEC Speaks by SEC Chair Gary Gensler

Digital Asset Securities - Common Goals and a Bridge to Better Outcomes (Remarks by Commissioner Caroline A. Crenshaw at "SEC Speaks")

Going Dark: The Growth of Private Markets and the Impact on Investors and the Economy (Remarks by SEC Commissioner Allison Herren Lee at "SEC Speaks")

Remarks at SEC Speaks by Commissioner Elad L. Roisman

Remarks at SEC Speaks 2021 by Gurbir Grewal, Director, Division of Enforcement

Lawless in Austin (Speech by SEC Commissioner Hester M. Peirce at the "Texas Blockchain Summit")

SEC Awards Almost $1.3 Million to Whistleblower

Order Determining Whistleblower Award Claim

The FINRA Expungement of A Customer Complaint That Was Not a Complaint Or From A Customer (BrokeAndBroker.com Blog)

Thanks for having me here today for the annual SEC Speaks. And thank you to Renee for that kind introduction. Before we get into substance, the views I express are my own and do not necessarily reflect the views of the Commission or its staff.

This afternoon, before speaking, I spent some time looking at news coverage of SEC Speaks, as well as getting some highlights from around DC and the world. One of the articles that popped up was about digital assets. These now dominate the headlines. And because I sometimes read Crypto-twitter, I feel like I need to say at the outset that the energy and passion is pervasive and admirable. Likewise, the technology and its potential are positive. I appreciate the time, energy and intellectual curiosity that drives the ongoing development of this technology or, as I typically refer to them, digital assets. I think we can all agree that we're striving toward common goals - promoting innovation, developing markets that are both accessible and resilient, and providing appropriate investor protections. But I have a message I want digital asset market participants to hear:  to move these markets forward there must be a meaningful exchange of ideas between innovators and regulators. And while we share common goals, we may prioritize issues differently and our initial proposed solutions might reflect those distinctions. And that's ok - even good. Different viewpoints coupled with constructive dialogue will yield better results in the long run.

This has been borne out by the success of our now more than 80 year-old regulatory regime. Prior to the creation of the SEC, retail investors were frequently subject to fraud, undisclosed risks, market manipulation, and, often, lost huge sums of money. The framework that Congress created in response and that has evolved over the years through legislation, rulemaking, and litigation has worked remarkably well and is critical to the success of our markets. Our system doesn't just benefit investors by offering protections and deterring violations by holding violators accountable. It also benefits the capital markets writ large, by facilitating widespread participation by investors and other market participants. This has allowed markets to perform better, to be more resilient, to more accurately price risk, and to sustain successful innovation. But how should we best ensure those same protections and advantages extend to digital assets and markets within our jurisdiction? Digital assets represent a small but growing portion of the economy, while small businesses in traditional markets have for generations strengthened our economy through their hard work and their commitment to regulatory compliance. So how do we also ensure that our efforts to support innovation don't preference digital assets projects at the expense of the rest of the market?

The SEC began assessing digital asset issues almost ten years ago. And our approach has been pragmatic and investor focused. One of the SEC's first actions in this space began in 2013, when the staff identified a Ponzi scheme.[1] The defendant had solicited bitcoin owners to send him their bitcoin in exchange for large guaranteed returns, purportedly generated through the defendant's bitcoin arbitrage system.[2] Because the investors paid in Bitcoin, though, the defendant argued this fraud did not fall within the SEC's jurisdiction.[3] Specifically, he argued that the Howey test - a legal test established by the Supreme Court in 1946 to determine whether an offering is a security over which the SEC has jurisdiction - requires an investment of money.[4] Bitcoin, according to the defense, was not money. The court disagreed and held that Bitcoin was a contribution of value for the purposes of Howey, and that the Ponzi scheme fit squarely within the SEC's jurisdiction.[5] The court focused on how Bitcoin was used, not that it was a digital asset or relied on new technology.

After that case, the Commission looked at this issue more broadly and more visibly. In 2017, at the conclusion of a non-public investigation, rather than bring an enforcement action we issued a public report pursuant to Section 21(a) of the Exchange Act.[6] These reports are infrequent and designed to inform the market about how our agency views particular conduct.[7] The focus of this 2017 21(a) report was a digital asset security offering known as The DAO, or Decentralized Autonomous Organization.[8] That was an explicitly investment-focused, profit-seeking venture that claimed to be decentralized. Through general solicitations to retail investors the venture raised $150 million worth of the native digital asset on the Ethereum blockchain, known as ETH.[9] Although we had not previously applied our regulations to a purportedly Decentralized Autonomous Organization, in the report the Commission explained the legal and jurisdictional basis for doing so, the analytical framework used, and the results of that analysis. That analysis focused not on the technology, but on the economic realities of the transactions, including the expectation of profits and the efforts of the promoters. The DAO, the agency made clear, was a securities offering.

We built on that guidance through the staff's publication of an analytical framework for digital assets, and through many subsequent no-action letters, staff statements, risk and investor alerts, speeches, and public testimony.[10] We have also continued to pursue enforcement cases within the SEC's jurisdiction, including, for example, cases for failure to register the offer and sale of digital assets that are securities, for failure to register as a broker or national securities exchange, and for fraud. None of these cases involved new regulations or laws enacted specifically for blockchain projects. Instead, we have applied existing law in a manner consistent with our long practice.[11]

But these markets continue to evolve rapidly, and that, understandably, raises questions for new projects or activities about how best to analyze their obligations under the federal securities laws and how best to comply. And it turns out, few digital assets projects have gone through the registration process. Many operate as if they are not subject to regulatory oversight. The result? Often digital asset investors have no way to determine if the prices and market they see is the product of manipulative trading, or if they have received sufficient disclosures about their investment to accurately price for risk. This is not sustainable, particularly as digital asset markets continue to grow and intersect with traditional markets. Given this, we must think about how best to reconcile a regime that has worked consistently for more than 80 years, with products and systems that are evolving rapidly and may not always be an intuitive fit within the existing system. The threshold tests[12] are well-established, but if a digital asset is a security, it is sometimes less clear how developers can integrate digital asset securities into their projects, while still complying with the laws and honoring the principles on which they are based. So what do we do?

****

There have been many suggested paths forward.[13] For example, several proposals would provide certain digital assets exemptions or safe harbors from registration obligations and other regulatory oversight.[14] Rather than solving for how to make the use of these digital asset securities compliant from the moment investors put their capital at risk, these proposals would define the tokens as outside our jurisdiction, at least for several years. One aspect of these proposals makes a lot of sense to me. Projects should provide the names and biographies of team members. For an industry that promotes transparency, I have been surprised how frequently offerings include secret identities, concealed control persons, and embellished or totally fictional teams. Requiring honest disclosures of the development team on whom investors are relying is a necessary step. However, it is not sufficient by itself.

Although we have perhaps the most successful framework in the world for businesses to raise capital, the projects at which these exemptive proposals are aimed grapple with two unique characteristics. The first is the need to achieve network effects, and the second is the project's choice to use a token with speculative profit potential to raise funds instead of giving up equity or taking on loan obligations. I'll address each in turn.

The network effects aspects of digital assets is a fancy way of saying that for some projects, developers need to widely distribute their tokens, generate sufficient interest in their use and exchange, and align incentives of various cohorts to establish a functional network of motivated participants. Essentially, the economic principle of network effects posits that the more individuals you have actively participating in a network, the more valuable the network is. One frequent example is social media, in which the more users are engaged and participating, the more valuable the entire network becomes.[15] But there are many proven ways to achieve network effects that don't require speculative profit potential.[16] Developers can raise capital in traditional ways and sell or distribute tokens strictly for network use and with no potential for profits, but the vast majority choose not to do so. And while I understand the importance of network effects to new projects, I have seen few examples of investors who purchase tokens seeking speculative profits later becoming committed users of the underlying network. So I remain a bit skeptical that projects can only generate sustainable and valuable network effects primarily from profit-seeking investors, rather than people who actually want to use the network as designed.

In addition, exempting tokens from securities laws would allow developers to raise capital by selling tokens instead of taking out loans or giving up equity. But granting a special exemption to these projects would provide unfair advantages to blockchain related businesses and disadvantage everyone else: participants who raise capital in compliant ways that support healthy markets and informed investors. I am not convinced digital projects should be able to raise money more cheaply, and with fewer burdens, than businesses that employ currently compliant methods. Whatever we do should result in a more level playing field for everyone, not simply shift the advantages.      

I also worry that relaxing regulatory requirements in markets prone to investor protection failures, limited investor redress options because of pseudonymity and disintermediation, and market manipulation, cannot sustain investor confidence or yield lasting broad adoption. To sustain growth, markets need more accountability and a consistent set of rules that apply to all.

Had a safe harbor been in place during the Initial Coin Offering or ICO boom of 2017 and 2018, I think the results would have been even worse for investors and the markets. ICOs and other digital asset offerings raised billions from investors, but most never delivered on their promises.[17] Investors suffered the losses.[18] And I think it is not a coincidence that these problematic offerings pre-dated and continued through the beginning of a multi-year downturn in the value of digital assets, sometimes known as the crypto-winter. The price of bitcoin dropped from a high of nearly $20,000 in December 2017, to under $4,000 and did not reach $20,000 again until December 2020.[19] I believe the ICO era excesses, the failure to register, failure to make robust risk disclosures, and failure to ensure fair markets free from manipulation, contributed to investor losses. I also believe those losses dramatically reduced investor confidence, and that depressed the digital asset market for several years.[20] 

These are some of the reasons I do not think that a safe harbor that permits unlimited capital raising with only limited disclosures, and no registration requirement, is in the best interest of investors. Nor will it be effective at preventing a re-run of the excesses and failures of the recent past. And when investors lose, so do issuers and all the other market participants who seek to profit from their capital, transaction flow, liquidity, and enthusiasm.

Instead of a harbor, my hope is that we can build a bridge. Blockchain technology, and the financial products and services that rely on it, are constantly changing in form, function, and complexity. Given the speed of evolution, I am constantly learning. I'm reading, listening to speeches, and meeting with a variety of thought leaders, including platform developers, investors, trade groups, academics, and fellow regulators.[21] And almost everyone I speak with, including experts, agree that there are aspects to the technology and emerging applications they are still learning too.[22]

I recognize that some complexities are wholly within the discretion of the project development team, and that is true regardless of technology or industry. If you want to start a restaurant that only accepts stock certificates as payment for tacos, for example, that may not be a model that works well with existing frameworks. In that example, it might not be worth the administrative hassle either. So while I do not think there has been a lack of clarity from the SEC, I also don't claim that it is simple for developers to employ digital asset securities in new blockchain network applications in a compliant manner.[23]  I expect that the fact that it may be challenging will not discourage entrepreneurs from using ingenuity and innovative technology to compliantly build the projects of their dreams.

As with all new developments in the markets, digital assets, distributed networks, and how users interact pose new questions. If a business or their counsel is in this position, we stand ready to work with them, but they are best served by taking the lead. The SEC's staff are fantastic, but limited in number.[24] While industry may desire blanket definitions or that we proactively label all the specific projects, assets, and activities that are within our jurisdiction, that is not how our regulatory framework functions. We also do not have the resources to do that.[25] And most importantly, analyzing regulatory compliance has always been, first and foremost, the responsibility of the enterprise and their counsel. That obligation applies with no less force when people choose to design their business around digital assets and blockchain technology. This approach is also a practical necessity because the business has the best access to the facts and circumstances on which any such analysis depends. That is even more true in the digital asset space where the people behind projects are often pseudonymous, may be based internationally while selling to U.S. investors, and where projects frequently change directions or features in a way that would also alter the regulatory analysis.

But I believe that if market participants accept proactive responsibility for compliance, we can build a bridge that promotes innovation while preserving market integrity and providing the investor protections needed for these new markets to grow. To me, this requires interested parties - including token issuers, exchanges, and others - to conduct their own analysis of their regulatory compliance, and be ready to share that with us. If you likely fall within our jurisdiction, work with us to describe your plan to comply or explain why some exemption is appropriate. If you have concerns that you can only comply with certain requirements because the nature of your project doesn't completely fit within our existing framework, come to us with detailed plans for how you will offer a comparable level of disclosure, investor protection, market access, and other important protections guaranteed by the securities laws. Do that before moving forward. When projects do this, I encourage our staff to explore solutions, while remaining faithful to the principles underlying our framework. I do not pretend this path is easy, costless, or fast. A fact that, I know, has deterred many market participants.[26] But beyond being legally required, projects that establish they are compliant will enjoy competitive advantages by differentiating themselves, building investor confidence, and reducing uncertainty and contingent legal obligations (including from private rights of action) that come with operating outside the law. As multiple projects choose this path of compliance, market participants can choose to interact only with other compliant projects, and have the potential to create a more resilient market with more loyal and confident investors.[27] Such a market is likely to succeed long term over those offerings that continue to behave as if regulations do not apply to them. And the more help you can offer us, the more we learn.[28] Working together can also free up resources we can then devote to other issues in this space.

****

In my research, it sometimes seems like the only constant in the digital asset universe may be change. As a firm believer that innovation can yield great benefits for individuals and economies, I'm thinking about where change is occurring, what that means for the SEC, and how we can respond. For example, just a few years ago, a significant majority of bitcoin transactions occurred on exchanges operating in jurisdictions that are not party to our legal treaties, and where we have very little visibility.[29] As China recently banned digital asset exchanges operating within its borders, I went back to look at how that has impacted where bitcoin transactions now occur. Today six of the top 11 centralized bitcoin exchanges by volume are in the U.S., and two others are in Financial Action Task Force ("FATF") member countries.[30] These exchanges may be less subject to manipulative trading, and could have more reliable anti-money laundering programs. But none of those exchanges has registered with us, so I am not sure we have sufficient visibility to verify any of that. I am still gathering information, but I know we will achieve better results by working together to create positive change and make decisions based not only on where we've been but where things are today and where we anticipate they may be tomorrow.

 

[1] See SEC v. Shavers, et. al., 2013 U.S. Dist. LEXIS 130781 (E.D. Tex. Sept. 18, 2014) (granting summary judgment to the SEC and awarding $40.7 million in damages).

[2] See id.

[3] See id.

[4] See SEC v. W. J. Howey Co., 328 U.S. 293 (1946)(an "investment contract" exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others, and the statutory definition of security includes investment contracts).

[5] See id.

[6] See Sec. & Exch. Comm'n, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (July 25, 2017) [hereinafter DAO 21(a) Report].

[7] For conduct that raises novel issues and may also have significant impact for investors and markets, rather than bringing an enforcement action, we may instead use a 21(a) report to explain in detail how we plan to apply the facts and circumstances to our existing laws. See 15 U.S.C. § 78u (2018).

[8] According to the report, DAO is "a term used to describe a 'virtual' organization embodied in computer code and executed on a distributed ledger or blockchain. The DAO was created by Slock.it and Slock.it's co-founders, with the objective of operating as a for-profit entity that would create and hold a corpus of assets through the sale of DAO Tokens to investors, which assets would then be used to fund 'projects.' The holders of DAO Tokens stood to share in the anticipated earnings from these projects as a return on their investment in DAO Tokens. In addition, DAO Token holders could monetize their investments in DAO Tokens by re-selling DAO Tokens on a number of web-based platforms that supported secondary trading in the DAO Tokens." See DAO 21(a) Report, supra note 6, at 1.

[9] It also crashed before liftoff due to flawed code and an anonymous user who exploited it to take 3.6 million ETH (then worth more than $55 million) from his fellow investors. See id. at 9. This offering was so prominent that approximately 15% of all then-existing ETH was invested in it. See id. at 9-10. And to undo the harm to such a big percentage of the ETH community, the Ethereum developer and mining community agreed to a hard fork that essentially un-did the investments and the exploit, even though until that point the Ethereum blockchain had been seen as transactionally immutable. See id. But this retroactive investor protection may be unique to the DAO investors. Subsequent exploits and code failures, even those much larger in absolute dollar terms, typically have not garnered sufficient support for another hard fork to rewrite history.

[10] These are available at the SEC's Strategic Hub for Innovation and Financial Technology ("FinHub") website. We also memorably highlighted red flags that investors should be aware of through our Howey Coin mimicking of a fraudulent ICO. See Howey Coins, (last visited Oct. 12, 2021). We have taken all these steps in part because clear direct communication supports our efforts to protect investors, ensure fair and efficient markets and facilitate capital formation. Mystery and surprise interpretations of law do not.

[11] Although our agency has a broad impact and huge markets for which we are responsible, we are a relatively small agency, with approximately 4,400 staff members and oversight responsibility for much of our $110 trillion capital markets, made up of tens of thousands of entities, including registrants, broker-dealers, national securities exchanges, and clearing agencies. And as with the rest of government, our resources are limited. We seek to deploy them as efficiently as possible. We don't have the time or interest to conceive new violations to investigate. If we pursue an investigation, it is because we in good faith believe there has been a violation of a clear law or regulation. When we bring an enforcement action, we lay out the facts and circumstances and how they apply to our laws, so that defendant and members of the public understand what we allege they did wrong. Courts, who serve an important function as impartial arbiters, have consistently found in our favor in enforcement actions relating to digital asset securities, in which we seek to hold violators accountable.  See e.g., SEC v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020); SEC v. Telegram Grp. Inc., 448 F. Supp 3d. 352 (S.D.N.Y. 2020).

[12] See e.g., SEC v. W. J. Howey Co., 328 U.S. 293 (1946) (the Howey test); Reves v. Ernst & Young, 494 U.S. 56 (1990) (the Reves test); Gary Plastic Packaging v. Merrill Lynch, 756 F.2d 230 (2d Cir. 1985) (reasoning applied facts and circumstances to determine whether conduct was within the ambit of federal securities laws).

[13] See, e.g., Clarity for Digital Tokens Act of 2021, H.R. 5496, 117th Cong. (2021); Digital Asset Market Structure and Investor Protection Act, H.R. 4741, 117th Cong. (2021); Blockchain Regulatory Certainty Act, H.R. 528, 116th Cong. (2019); Hester Peirce, Commissioner, Sec. & Exch. Comm'n, Public Statement: Token Safe Harbor Proposal 2.0 (Apr. 13, 2021); Andreessen Horowitz, Letter to Senate Banking Committee Regarding Request for Proposals for Clarifying Laws Concerning Cryptocurrency and Blockchain Technologies (Sept. 27, 2021). These are just a few examples among many others.

[14] Including the Clarity for Digital Tokens Act of 2021 and Commissioner Peirce's Safe Harbor 2.0 proposals.

[15] In those networks, the value comes from user engagement, which can drive investor interest but does not derive from it.

[16] Staying with the social media example, many of these businesses have waited until after they had broad user engagement before they sold securities to the public. They did not depend on their investors to also be the users of the network in order to achieve self-sustaining network effects. And this choice does not appear to have constrained or limited their viability or ability to scale.

[17] See Andrey Kartsev, Best and Worst of ICO Gold Rush: How Technology Created a Market and Greed Doomed It (Sept. 2021) (published in Alendria, a blog on coinmarketcap.com)

[18] See Mathias Fromberger & Lars Haffke, ICO Market Report 2018/2019: Performance Analysis of 2018's Initial Coin Offerings (Dec. 31, 2019) (finding that for ICOs in 2018, within six months only 8% traded above their ICO price, and 70% had lost substantially all their value by 2019).

[19] See CoinMarketCap, (last visited Oct. 12, 2021) (providing historical BTC pricing information).

[20] That three year slump is particularly significant given that Bitcoin is only 12 years old.

[21] And I am not alone. My fellow Commissioners and staff have all devoted considerable attention to these issues, as have many offices and divisions within the SEC. We have invested significant resources to understand the issues, provide meaningful guidance, and respond to inquiries. Last year we elevated our FinHub, which has existed since 2018, into a standalone Office from its original position within the Division of Corporation Finance. We have issued guidance, risk alerts, spoken and written on the issues and engaged in no action discussions and issued no action relief. Our public actions feature prominently on portions of https://www.sec.gov and https://www.investor.gov devoted to digital assets and FinTech. We recently issued a statement (including Commission level no action relief and a request for public input) for special purpose broker dealers who custody digital asset securities, and are considering other proposals. See Commission Statement and Request for Comment: Custody of Digital Asset Securities by Special Purpose Broker-Dealers, Release No. 34-90788 (Apr. 27, 2021) [hereinafter Commission Statement & RFC re Custody by Special Purpose BDs]. Especially relative to its size, we have devoted significant resources to providing clarity to this market.

[22] Fortunately, we do not need perfect knowledge to make choices focused on protecting investors and promoting fair and efficient markets. We can foster compliant innovation without knowing in advance the ultimate end state for the technology. But we'll need to remain flexible in our approach so that we can calibrate our efforts as technology and markets evolve and our knowledge expands.

[23] The SEC has often acknowledged this complexity, including in the Commission Statement and Request for Comment as to Custody of Digital Asset Securities by Special Purpose Broker-Dealers. See Commission Statement & RFC re Custody by Special Purpose BDs, supra note 23, at 3.

[24] The SEC has fewer employees today than it did in 2016, even though over the last five years traditional markets have greatly expanded in number of participants, size, and complexity. And that's to say nothing of the complexities introduced by the digital asset markets, and the resources we have devoted to understand and respond there.

[25] One digital asset listing service identifies 7,100 different tokens, and that number continues to expand. See CoinMarketCap, (last visited Oct. 12, 2021). The resources needed to launch a token in a non-compliant way are dramatically lower than the resources needed to assess and ensure a token offering is compliant with all applicable U.S. laws.

[26] The identity of those who consult with FinHub is non-public, but it is notable that only a fraction of the 7,100 tokens and many other projects that relate to them have sought such a consultation. 

[27] Conversely, some digital asset market participants, developers and promoters operate as if regulations don't apply to them. That approach is less likely to inspire confidence in investors, and pretending as if rules don't apply is not protection against an enforcement action that is worse for everyone than complying up front. Even though it is not easy, ultimately it is easier to get the registration and compliance part right at the start, rather than having to potentially litigate a dispute later.

[28] Over the last several months, my staff and I have engaged with numerous experts, attorneys, developers, and thought leaders to learn more about decentralized finance, or DeFi, so that I can better understand the diverse issues that the growth of this market may raise. And I want to express my appreciation to those who have shared their time, information, ideas, and even their criticisms. I have an open door and welcome the chance to learn and discuss this emerging market, and not just the necessity, but also the value of including robust safeguards and a commitment to compliance.

[29]  Paul Vigna, "Most Bitcoin Trading Faked by Unregulated Exchanges, Study Finds," Wall Street Journal, Mar. 22, 2019.

[30] "FATF is the global money laundering and terrorist financing watchdog." Financial Action Task Force ("FATF"), (last visited Oct. 12, 2021).

Perhaps the single most significant development in securities markets in the new millennium has been the explosive growth of private markets. We've become all too familiar with the statistics: more capital has been raised in these markets than in public markets each year for over a decade[1] with no signs of a change in the trend. The increasing inflows into these markets have also significantly increased the overall portion of our equities markets and our economy that is non-transparent to investors, markets, policymakers, and the public.[2] 

The vast amount of capital in these markets, attributable in part to policy choices made by the Commission over the past few decades, has also created a new, but no longer rare or mythical, kind of business known as Unicorns - private companies with valuations of $1 billion or more. So christened in 2013 when their existence and number was more fittingly associated with fairy tales, they have since grown dramatically in both number and, importantly, in size, reaching dizzying valuations nearing and even exceeding $100 billion.[3] In today's markets, companies can and do stay private far longer than ever before, despite the fact that they often dwarf their public counterparts in size and influence. 

These private businesses are not just big, but also consequential, making significant positive contributions to innovation. They shift paradigms, create jobs, stimulate the need for new services and supply chains. They've even changed the infrastructure of the nation's labor force, ushering in the so-called "gig" worker. In other words, they have a dramatic and lasting impact on our economy, at the local, state, and even national level.[4] But investors, policymakers, and the public know relatively little about them compared to their public counterparts.

The shift toward private markets in recent decades has brought us back to a familiar crossroads, one at which we must evaluate the opacity of large and important segments of the economy and what that opacity means for investors and our public markets. We've been down this road before - twice, in fact. First, in the early 1930s at the inception of the federal securities laws, when lack of transparency had contributed to misallocations of capital and other market disruptions.[5] Congress addressed this opacity in capital markets, and determined that it was in the public interest to create public companies and periodic reporting requirements for those listed on national exchanges.   

Three decades later, in the early 1960s, Congress recognized that opacity in capital markets had again become a problem. The periodic reporting requirements applied only to exchange listed companies, and the over-the-counter (or OTC) markets had grown significantly in the intervening decades. Thus, both Congress and the SEC acted again, creating Section 12(g) of the Exchange Act, and rules thereunder, requiring all issuers with a sufficient number of shareholders (and a minimum amount of assets) to make periodic disclosures, thereby restoring transparency to what had become a significant segment of the capital markets. 

And here we are again watching a growing portion of the US economy go dark, a dynamic the Commission has fostered - both by action and inaction.[6] So today I want to talk about the role, really the obligation, of the SEC to examine and consider whether we should take steps, including pursuant to the broad authority Congress gave us under Section 12(g) of the Securities Exchange Act,[7] to address the reduced transparency in US equity markets.  

I. Going Dark

The expansion of private markets is not the natural result of the evolution of "free" market forces. Rather, it is a product of the framework of laws and regulations through which markets operate. As one observer described it succinctly and directly:

"A market economy is at its core a collection of rules. No rules, no market. Just as every competitive sport has clear rules, competitive markets need rules: no rules, no game."[8]

When we relax or repeal certain of these laws or regulations, we do not move closer to a so-called free market, but rather simply alter incentives and magnify the force and impact of the remaining rules on the books.[9]

Congress and the Commission have steadily relaxed restrictions around private markets in a manner that has spurred their dramatic growth. As a result, an ever-increasing amount of capital is raised in these markets each year, with private offerings accounting for approximately 70 percent of new capital raised in 2019.[10] Because of the vast capital available, relaxed legal restrictions,[11] and greater opportunities for founders and early investors to cash out,[12] companies can remain in the private markets nearly indefinitely, with some growing large enough to exceed the GDPs of all but the top sector of the world's national economies.[13]

Current estimates vary, but generally put the number of Unicorns worldwide at roughly 900, up from an estimated 39 in 2013.[14] The list now includes not just Unicorns (those with an estimated valuation of at least $1 billion) but also so-called "Decacorns" (estimated valuations of $10 billion) and even "Hectocorns" with valuations approaching and exceeding $100 billion.[15] Although some of these large firms are subject to industry-specific regulation, such regulation may be quite sparse (as with the growing number of crypto-related Unicorns) [16] or does little to address financial transparency. 

Unicorns are notable not just for their size, but for their transformational impacts on our way of life. They have, for example, changed the transportation[17] and travel[18] habits of millions across the globe, spawned billions in litigation, changed the legal underpinnings of entire markets,[19] and launched civilians into space.[20] 

Yet, despite their outsize impact, there is little public information available about their activities. They are not required to file periodic reports or make the disclosures required in proxy statements. They are not even required to obtain, much less distribute, audited financial statements. This has consequences for investors and policymakers alike, which in turn may have consequences for the broader economy.  

To begin with, investors may lack adequate information about the business and operations of these companies. While large sophisticated investors have some ability to obtain disclosure, they sometimes almost inexplicably fail to do so.[21]

In many cases, remaining informed requires a position on the board, an avenue open only to a limited number of investors. And the disclosure obligations that do exist are mostly a matter of contract rather than regulation, an approach that may affect both compliance and accuracy.[22] 

Then there's the category of investors in these markets with much at stake and sometimes little to no negotiating power to obtain needed information: employees. Employees who hold equity in the firms where they work often don't have the information they need to determine, for example, the full financial consequences of leaving their jobs when their stock is subject to a mandatory resale obligation. Quitting can become an investment decision that must be made in the dark.[23] They also may not know whether to dispose of shares in a funding round, or sell into secondary markets that have developed for the stock of numerous private firms.[24] Note too that unions bargaining for employee rights and protections may lack important financial information about companies employing tens of thousands of workers.

Consider also another category of investors: those saving for retirement who may indirectly access private markets through institutional investors. More and more of the capital in private markets comes from pension plans, mutual funds, and other institutions,[25] a trend that will likely continue.[26] Because these institutions are stewards for the savings and retirement assets of millions of Americans, the savings of everyday investors is increasingly exposed to the potential risks associated with a lack of transparency.[27]

Importantly, policymakers and the public also have a reduced ability to assess the impact of these issuers on the US economy as a whole. The fact that more capital is now being raised in private markets means that a burgeoning portion of the US economy itself is going dark. Twenty years ago private markets represented (by some estimates) roughly two percent of global investable equity assets. Today, that percentage has increased more than threefold to a current estimate of seven percent.[28] Other estimates reflect that global private equity net asset values have grown twice as fast as public market capitalization in the new millennium, with that trend expected to continue.[29]

The diminishing incentives to raise capital in the public markets portend problems for private markets as well. Private markets may depend in large part on the ability to free ride on the transparency of information and prices in public markets; as public markets continue to shrink, so does the value of that subsidy.[30]

And finally, we must consider whether the growing lack of transparency in capital markets will lead once again to the misallocation of capital that we saw at the inception of the federal securities laws. For example, this opacity could operate to obscure systemic risks such as those posed by climate change.[31]

II. History Repeats

Round 1: 1933-34

As I mentioned, we have been here before. Concern over adequate transparency in the securities markets was the driving force behind the advent of federal securities laws. A relatively small segment of the US population was invested in stock markets at the time, yet the weaknesses in those markets led to "[n]ational emergencies [producing] widespread unemployment and the dislocation of trade, transportation, and industry."[32] The foundational statutory language made clear that the securities laws were intended to protect the "general welfare." The principal remedy was disclosure. Thus, Congress passed the Securities Act of 1933, which essentially required companies seeking capital from the public to file a registration statement. But right away, Congress saw that a one-time obligation to file information was insufficient, and a year later it passed the Securities Exchange Act of 1934 to, among other things, create ongoing periodic reporting obligations.[33]

The '34 Act required all exchange traded companies to file annual, quarterly and other reports, including audited financial statements. The approach went well beyond then-existing disclosure requirements at the New York Stock Exchange,[34] and was described by the bill's sponsor, Rep. Sam Rayburn, as needed to make increasingly complex markets become more honest and "justifiably self-trusting."[35]

The new reporting provisions applied only to listed companies, not over-the-counter markets. At the time, this was a logical approach given that wealth was heavily concentrated in the largest companies[36] and those companies largely traded on exchanges, making them responsible for a "very substantial part of the entire national wealth."[37] Moreover, little trading activity appeared to be occurring in the over-the-counter markets[38] and companies in those markets were not considered to be in the same "class" as those listed on an exchange.[39]   

Round 2: 1963-64

However, by the early 1960s, over-the-counter markets had grown substantially. The increase was described at the time as "tremendous"[40] and "dramatic,"[41] adjectives often used today to describe the evolution of the private markets. Commentators at the time also observed that companies were moving to these markets to avoid required disclosure.[42] In response, Congress commissioned a comprehensive study by the SEC,[43] which found, among other things, a problematic lack of transparency in the growing OTC market, as well as a correlation between lack of disclosure and fraud.[44] Thus an increasing portion of US equity markets lacked transparency, similar to conditions that led to the establishment of the federal securities laws, because regulations had failed "to keep pace with [market] growth and change since enactment of the original securities laws."  

It was time to reassess.[45] Because, unfortunately, as they knew then and we know today, what happens in capital markets, doesn't stay in capital markets[46] - fault lines on Wall Street can crack and spread across the entire country upending the lives of all Americans.

In devising recommendations, the Commission focused on the purpose of the federal securities laws,  taking into account the public interest[47] and the effect of the securities markets on "the general economy."[48] The study described the over-the-counter markets as "large and important" but still "relatively obscure and even mysterious for most investors."[49] Increased transparency through disclosure was the solution.[50]

In considering which companies should be subject to disclosure, the Commission determined, and Congress ultimately agreed, that the purposes of the securities laws would be best served by a test that looked to the number of investors.[51]

Congress implemented the recommendations of the Special Study by enacting Section 12(g) of the Exchange Act, under which issuers with 500 shareholders of record[52] and, at the time, at least $1 million in assets[53] became subject to periodic reporting.[54] In counting "holders of record," Congress and the Commission were aware that shares were sometimes held in "street name" accounts,[55] meaning held in the names of the brokers and banks through which they purchased. These beneficial owners thus would not show up as a holder of record. The number of such beneficial owners at the time, however, was modest[56] and considered difficult to count.[57] 

Still the Commission did propose to include "known beneficial owners," in the shareholder count.[58] The concept was not adopted in the final rule, however, and there was no analysis of the change other than to state that it was for "simplification."[59]  

While the Commission did not ultimately exercise its authority at the time to require issuers to look through to beneficial owners, it is clear the Commission has the authority to do so.[60] In fact, it has already exercised that authority to require issuers to look beyond their list of record holders through to the level of brokers and banks, but no further.[61]

In the JOBS Act, Congress spoke again to the issue, raising the threshold from 500 to 2000, but keeping the threshold at 500 for non-accredited investors.[62] Thus, while expanding only the number of allowable accredited investor shareholders, Congress reaffirmed the view that the number of shareholders (and even the nature of those shareholders) is the proper metric to consider in requiring periodic reporting, so long as a company meets a minimum asset level, now set at $10 million.[63]

But ownership in the securities markets has undergone a fundamental shift since the 1960s.[64] Today, almost no one holds shares in record name,[65] with stock certificates increasingly going the way of landlines and 8-track tapes.[66] Indeed, individuals wanting to be listed as a holder of record can confront unwilling brokers[67] or hefty fees.[68] 

As a result, record ownership has plummeted and in most cases has no meaningful relationship to the number of actual investors. Even some of the largest and most widely traded issuers do not have enough record owners (as that term is currently defined) to meet the requirements of Section 12(g).[69] As a result, the decision to file periodic reports has increasingly become optional.[70] In addition, issuers can exit the periodic reporting process, perhaps by engaging in "creative" shareholder recording methods.[71] And there is a growing possibility that an issuer could have active secondary markets with hundreds perhaps thousands of investors and no obligation to file periodic reports.[72] 

The tie between the actual number of shareholders and periodic reporting has come untethered from its moorings in today's markets. Our reporting regime is now to closer to where it was in 1964, before Congress intervened to add Section 12(g), with a large and important market segment increasingly obscured, and our rules and regulations ripe for reappraisal.[73]

III. Looking Forward

Where does this leave us? Investors and the public are increasingly left in the dark when it comes to ever expanding segments of the economy. This has implications for the future vitality of the private markets (which depend in many ways on the transparency and discipline of public markets) and it has implications for optimizing capital allocation across both markets.

Time and again, we take regulatory action on the grounds that it may encourage companies to go public.[74] But if that is a legitimate goal of the securities laws, then we should also work to ensure that the boundaries between public and private markets are sensibly drawn and maintained, and that the incentives for going public remain balanced.  

 Accordingly, we should consider whether to recalibrate the way issuers must count shareholders of record under Section 12(g) (and Rule 12g5-1) in order to hew more closely to the intent of Congress and the Commission in requiring issuers to count shareholders to begin with. In other words, it's time for us to reassess what it means to be a holder of record under Section 12(g). We have received rulemaking petitions asking us to examine this issue.[75] The North American Securities Administrators Association has supported a reexamination,[76] as have academics[77] and other experts.[78] A former Chair of the SEC flagged the issue in Congressional testimony as well.[79] 

As we reexamine how issuers should count shareholders, we should broadly consider a number of important factors that may implicate our public-private boundary: 

• We should better understand the issue of disclosure arbitrage and the circumstances under which public companies may deregister because they have fewer than 300 shareholders of record yet in fact have a sizeable investor base.[80] Data shows that the number of shareholders of record (as currently defined) in public companies has dropped dramatically over time.[81] What opportunities has this created for deregistration and do we think it wise and consistent with our mission to permit this?
  
  
• We should better understand how the growing lack of transparency is affecting ordinary investors such as retirees invested through mutual and pension funds, and employees who may become overinvested in a company's shares without the ability to assess their true value.[82]
  
  
• We should analyze how shares are held in the private markets. Although street name ownership is common in the public markets, some evidence suggests it may be less common in the private markets.[83] And if shares in private markets are more commonly held in the names of beneficial owners, might those accounts be transferred into street name later in a company's life cycle in ways that could escape notice under the anti-evasion provisions of Rule 12g5-1(b)(3)?[84] 

If the number of shareholders is to have any meaning at all as a trigger for going public, we should look broadly at the different forms of beneficial ownership. This means considering to what extent issuers should have to look through to the actual investors whose economic well-being is at stake, including looking beyond street name accounts held at brokers and banks, as well as potentially looking through special purpose vehicles and partnerships.[85]

Of course re-evaluating how issuers count shareholders is not the only potential avenue for addressing policy concerns related to how we determine public company status. Others have suggested additional approaches (beyond just number of shareholders). They include, for example, considering revenues or market capitalization, a certain level of "public float" in private trading venues, or number of employees.[86] Some of these approaches may require Congressional action. But the Commission can and should act now within our existing authority to restore transparency in capital markets. That means, at a minimum, it's time to revisit how we define shareholders of record under 12(g). And more broadly, it means recalling the fundamental importance of transparency in capital markets, and the need to continually reassess whether we have the right balance between public and private markets - one that supports both innovation and a well-informed, optimized allocation of capital.  

= = = = =

 

[1] See Morgan Stanley, Public to Private Equity in the United States: A Long-Term Look (Aug. 4, 2020) ("Further, companies have raised more money in private markets than in public markets in each year since 2009. For example, companies raised $3.0 trillion in private markets and $1.5 trillion in public markets in 2017. These changes in how investors invest and how companies raise capital have important implications for holding periods, the perceived volatility of the returns, and liquidity.").

[2] See McKinsey, A year of disruption in the private markets: McKinsey Global Private Markets Review 2021 (Apr. 2021) ("Global private equity AUM reached $4.5 trillion in  the first half of 2020-growing 6 percent from  year-end 2019, or an annualized 16.2 percent since 2015."); Vanguard, The role of private equity in strategic portfolios (Oct. 2020) ("[T]he asset size of the private equity market has been gradually growing on an absolute basis and relative to the public equity market over the last 20 years. Private equity has risen from 2% to 7% of total investable global equity assets."). 

[3] See, e.g., Tomio Geron, Facebook Prices Third-Largest IPO Ever, Valued At $104 Billion, Forbes (May 17, 2012); Riley de Leon, Stripe raises new capital, reaching $95 billion valuation ahead of highly anticipated market debut, CNBC (Mar. 14, 2021); Michael Sheetz, Elon Musk's SpaceX raised $850 million, jumping valuation to about $74 billion, CNBC (Feb. 16, 2021); see also CBInsights, The Complete List of Unicorn Companies.

[4] Consider for example Airbnb, which just went public last year, or Uber, which just went public in 2019. Both had already altered the way we get from place to place and how we find accommodations before going public. See Erin Griffith, Airbnb prices I.P.O. at $68 a share, for a $47 billion valuation, New York Times (Dec. 9, 2020); Michael J. de la Merced & Kate Conger, Uber I.P.O. Values Ride-Hailing Giant at $82.4 Billion, New York Times (May 9, 2019). See also, infra, notes 17-18.

[5] H. Rep. No. 84, 73d Cong., 1st. Sess. (1933) (describing "irresponsible selling of securities," and providing that "[w]hatever may be the full catalogue of the forces that brought to pass the present depression, not least among these has been this wanton misdirection of the capital resources of the Nation"); H. Rep. No. 1383, 73d Cong., 2d Sess. (1934) ("Just as artificial manipulation tends to upset the true function of an open market, so the hiding and secreting of important information obstructs the operation of the markets as indices of real value."); Cynthia A. Williams, The Securities Exchange Commission and Corporate Social Transparency, 112 Harv. L. Rev. 1197 (1999) (describing the House report on the '34 Act, and providing that "[o]ne concern was that unregulated stock exchanges caused the misallocation of capital: that the securities markets could 'draw funds from local banks which would otherwise seek moderate investment in local business enterprise, to finance the pool of a far-away metropolitan speculator distributing through the stock exchanges the securities of a huge corporate merger designed ultimately to swallow and destroy local enterprise.' And, as the House Committee Report concluded, this misallocation of capital ultimately affected not only investors 'but eventually the operating profits of every business in the country no matter how unrelated to stock exchanges.'") (internal citations omitted).

[6] There are numerous examples over the last decade of the Commission relaxing restrictions on exempt offerings - some statutorily required, and some not. See, e.g., Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Final Rule, Rel. No. 33-10884, 209 (Nov. 2, 2020) (including amendments to raise offering limits for three different exempt offerings; relax statutorily imposed investment limitations for certain investors; shorten the integration safe harbor period from six months to 30 days; expand the use of test-the-waters communications across all exempt offerings and for all types of investors; reduce disclosure requirements under Regulation D; permit the creation of a Crowdfunding special purpose vehicle, among other things); see also Changes to Exchange Act Registration Requirements to Implement Title V and Title VI of the JOBS Act, Final Rule, Rel. No. 33-10075 (May 3, 2016); Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and 144A Offerings, Final Rule, Rel. No. 33-9354 (July 10, 2013). Also notable are the steps the Commission has declined to take such as finishing its 2013 proposal to amend Form D to enhance its ability to evaluate the Regulation D market and failing to adjust the accredited investor wealth thresholds to account for inflation. See Amendments to Regulation D, Form D, and Rule 156, Proposed Rule, Rel. No. 33-9416 (July 10, 2013); Amending the Accredited Investor Definition, Final Rule, Rel. No. 33-10824, 143 (Aug. 26, 2020).

[7] 15 U.S. Code § 78l(g).

[8] See Tariq Fancy, The Secret Diary of a 'Sustainable Investor' - Part 3, Medium (Aug. 20, 2021).

[9] See John C. Coates, Testimony Before the Subcommittee on Securities, Insurance, and Investment of the Committee on Banking, Housing, and Urban Affairs United States Senate on Examining Investor Risks in Capital Raising (Dec. 14, 2011) ("While the various proposals being considered have been characterized as promoting jobs and economic growth by reducing regulatory burdens and costs, it is better to understand them as changing, in similar ways, the balance that existing securities laws and regulations have struck between the transaction costs of raising capital, on the one hand, and the combined costs of fraud risk and asymmetric and unverifiable information, on the other hand").

[10] See Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Proposed Rule, Rel. No. 33-10763 (Mar. 4, 2020) ("In 2019, registered offerings accounted for $1.2 trillion (30.8 percent) of new capital, compared to approximately $2.7 trillion (69.2 percent) that we estimate was raised through exempt offerings.").

[11] See deregulatory examples cited, supra note 6; see also Renee Jones, The Unicorn Governance Trap, 166 U. Pa. L. Rev. Online 165 (2017) (summarizing  the easing of regulatory restrictions on the issuance and transfer of startup shares, including reducing Rule 144 holdings periods and eliminating the prohibition on general solicitation in Regulation D Rule 506 offerings).

[12] See Patrick Henry, et al., Deloitte, The growing private equity market (Nov. 5, 2020) ("From 2006 to 2019, the number of SBO [secondary buyout] exits increased by 5.2% per year, while PE exits via IPOs declined by 7.3% per year."); Elisabeth de Fontenay, Written Testimony before the United States House of Representatives Committee on Financial Services Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets, 'Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment' (Sept. 11, 2019) ("Large companies also flush with capital have become highly active in the private-investment space as well: sales of private firms to these so-called 'strategic acquirers' have replaced the IPO as the primary exit for venture capital investments."); see also Diana Milanesi, The Rise of the Secondary Trading of Private Company Shares in the United States, Europe, and the United Kingdom: New Opportunities and Unique Challenges, TTLF Working Papers No. 46, Stanford-Vienna Transatlantic Technology Law Forum (2019) ("[A]s the length of time that companies take to go public has increased, many companies are going through their main growth period while remaining private, thus increasing the demand for secondary investment opportunities. As a result of these trends, secondary transactions involving shares of private companies have grown significantly in the United States, Europe and the United Kingdom in recent years"). Note that exit by acquisition may not be the best value-enhancing strategy for the acquirer. See McKinsey, Mastering three strategies of organic growth (Aug 21, 2017) ("A look at the share-price performance of 550 US and European companies over 15 years revealed that, for all levels of revenue growth, companies with more organic growth generated higher shareholder returns than those whose growth relied more heavily on acquisitions.). 

[13] Compare, for example, Facebook valued at roughly $104 billion at time of IPO with gross domestic product by country and note that Facebook's IPO valuation exceeded the GDPs of all but the top third of the world's economies. Compare Tomio Garon, Facebook Prices Third-Largest IPO Ever, Valued At $104 Billion, Forbes (May 17, 2012) with CBInsights, The Complete List of Unicorn Companies.

[14] See CBInsights, The Complete List of Unicorn Companies; Gene Teare, The World's Unicorns Are Now Valued At $3T - Up By A Trillion In The Past Year. Who Invested?, Crunchbase (July 19, 2021); see also Motive Capital Corp., Form 8K (Sept 13, 2021) ("Since 2018, the number of unicorns has almost tripled creating a $2.4TN market cap opportunity in those names alone.").

[15] See CBInsights, The Complete List of Unicorn Companies

[16] See Chris Metinko, Crypto-Corns? Unicorn Numbers Explode As Venture Investment Surges In Crypto, Crunchbase (Aug. 27, 2021).

[17] Uber, for example, at the time it went public in 2019 at a valuation of roughly $75 billion, operated on six continents, in 63 countries and 700 cities, employed over 22,000 people, and had 91 million active users. See Uber Technologies, Inc., Form S-1 Registration Statement (April 11, 2019.); see also Scott Beyer, Uber Has Revolutionized Transit More In 7 Years Than The Government Has In 7 Decades, Forbes (Oct. 28, 2016). 

[18] Airbnb, for example, at the time it went public in 2020 at a valuation of roughly $47 billion, operated in 220 countries and regions around the world, had some 54 million active users and a total of 825 million guest arrivals since inception. Airbnb, Inc., Form S-1 Registration Statement (Nov. 16, 2020); see also Suzanne Bearne, Airbnb is forcing everyone to up their game: how hotels are changing tack, Guardian (Apr. 11, 2018).

[19] See Tina Bellon, Gig companies' push for state-level worker laws faces divided labor movement, Reuters (June 9, 2021) ("New York is just one of several states where gig economy companies led by Uber (UBER.N), Doordash (DASH.N), Lyft (LYFT.O) and Instacart are courting unions and state officials in an effort to cement their workers' status as independent contractors across the United States. . .. According to a Reuters review, the companies over the past few months set up lobbying groups in Massachusetts, New York, New Jersey, Illinois, Colorado and Washington to push for laws that declare app-based ride-hail and food delivery drivers independent contractors, while proposing to offer them some benefits.").

[20] See Steve Gorman, SpaceX capsule with world's first all-civilian orbital crew returns safely, Reuters (Sept. 19, 2021).

[21] See, e.g., Francine McKenna, The investors duped by the Theranos fraud never asked for one important thing, MarketWatch (Mar. 20, 2018) ("Conspicuously absent from the package that went to investors are income statements, balance sheets and cash-flow statements audited and signed by a qualified public accounting firm."); This failure to get info is not limited to companies with a headline grabbing downfall. See, e.g., Elisabeth de Fontenay, Written Testimony before the United States House of Representatives Committee on Financial Services Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets, 'Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment' (Sept. 11, 2019) ("To illustrate this concern, consider that before it went public earlier this year, the car sharing service Uber was the largest of the private company unicorns. In January 2016, while raising additional equity capital at a $62.5 billion valuation, its shares were marketed to high-net-worth individuals who were not given any financial statements whatsoever for the company."). 

[22] For a thoughtful review of the information generally available to investors in private markets, see Jennifer S. Fan, Regulating Unicorns: Disclosure and the New Private Economy, 57 B.C. L. Rev. 583 (2016).   

[23] Consider the example of employees at Good Technology, whose share value plummeted practically overnight after the company was acquired, but who had paid hefty tax bills for years based on a much higher valuation. Katie Benner, When a Unicorn Start-Up Stumbles, Its Employees Get Hurt, New York Times (Dec. 23, 2015).

[24] See Morgan Stanley, Public to Private Equity in the United States: A Long-Term Look (Aug. 4, 2020) ("Finally, there are now ways for employees who are compensated in equity to sell shares. In some cases, funding rounds give employees a chance to cash out. For example, Airbnb, Inc. raised an $850 million round that allowed employees with sufficient tenure to sell $200 million worth of stock.135 In addition, a number of marketplaces, including SharesPost, Forge, EquityZen, NASDAQ Private Market, ClearList, and Carta, provide liquidity for sellers and buyers. About one-half of private companies surveyed allow their employees to sell shares."); see also Matt Levine, Boards Have to Pay Attention, Bloomberg (Sept. 13, 2021) ("The average public company trades 126% of its market capitalization every year; a billion-dollar public company will do about $1.26 billion of stock-market volume per year, or about $5 million per day. The average private company (on Forge) trades about 0.2% of its value per year (on Forge); a billion-dollar unicorn will do about $2 million worth of trading in a year. Forge has traded $10 billion of private-company stock since its inception.").

[25] In 2020, public pension plans invested 9% of their assets in the private markets. See American Investment Council, Private equity delivers the strongest returns for retirees across America: 2021 Public Pension Study. See also PitchBook Analyst Note: Crossing Over Into Venture (Apr. 2021) (discussing the increasing participation of crossover investors in pre-IPO capital raising).

[26] See Henry, et al., supra note 12 ("Since bond yields are expected to stay low and public equity returns are likely to be below historical annualized returns over the next 10 years, institutional investors-pension funds, insurance companies, endowments, foundations, investment companies, banks, and family offices-are increasing allocation to private capital.").

[27] Transactions in these markets also appear costly. See Matt Levine, Money Stuff: Public Markets Don't Matter Like They Used To, Bloomberg (Aug. 5, 2020)  ("Also while private-company trades are infrequent, they are also expensive... In public markets, brokers and wholesalers and exchanges compete fiercely and controversially over fractions of pennies to execute trades. In the private market Forge makes about 2.5% or 3%."). 

[28] See Vanguard, supra note 2.

[29] See Mckinsey, supra note 2; see also Joshua Franklin and Laurence Fletcher, Hedge funds muscle in to Silicon Valley with private deals, Financial Times (Sept. 9, 2021) ("The data from Goldman Sachs Prime Services highlight how hedge funds, typically known for investments in publicly traded assets, have been drawn to private markets in an effort to fire up largely lacklustre returns. It also shows how private equity and venture capital have shot into mainstream finance. The asset class has soared to more than $7tn in value and is expected to double again by 2025, while the number of US public companies has roughly halved since 1996.").

[30] See Elisabeth de Fontenay, The Deregulation of Private Capital and the Decline of the Public Company, 68 Hastings L.J. 445 (2017) ("[P]rivate companies are thriving in part by freeriding on the information contained in public company stock prices and disclosure. This pattern is unlikely to be sustainable. Public companies have little incentive to subsidize their private company competitors in the race for capital and we are already witnessing a sharp decline in initial public offerings and stock exchange listings. With fewer and fewer public companies left to produce the information on which private companies depend, the outlook is uncertain for both sides of the securities-law divide.").

[31] As the Commission moves forward with disclosure requirements concerning climate change, for example, issuers could avoid new disclosures required in our periodic reports by moving to the private markets. Alternatively, they could re-deploy assets that contribute to climate change to the private markets. Thus, their public company disclosure could improve but, because carbon-related assets are being shifted to the private markets, the effect on our understanding of climate change risk would remain unchanged. (This is not to say that private companies don't have an important role to play in climate solutions. See, e.g., Yakob Reyes, Tom Steyer: Private companies starting to invest more in climate solutions (Sept. 23, 2021).) Likewise, this shift could obscure important market dynamics that affect the growing economic inequality in our country. Issuers in the private markets need not make their board composition public. Evidence exists that issuers in these markets are far less diverse than those filing periodic reports and disclosing board composition. See Andrew Ross Sorkin, The Missing Piece in the Push for Boardroom Diversity, New York Times (Sept. 7, 2021) ("The 18 top venture capital and private equity firms in the nation - Andreessen Horowitz, Blackstone, Carlyle, Greylock, KKR and Sequoia among them - have invested in 843 private companies that have gone public since 2000. . .. Of the 4,700-some board seats at those companies over the same period, only 49 have been held by Black directors.").

[32] 15 USC 78b(4).

[33] 15 U.S.C §78m. The '33 Act immediately drew commentary on the need for more than a one-time disclosure. See William O. Douglas, Protecting the Investor, 23 Yale L.J. Rev. 521 (N.S.) (1934).

[34] See Robert L. Knauss, A Reappraisal of the Role of Disclosure, 62 Mich. L. Rev. 607 (1964) ("The New York Stock Exchange had required annual reports of listed companies for several years before enactment of the Exchange Act. The Exchange Act codified this approach, applying it to all registered exchanges and requiring that reports be filed with the Commission as well as the Exchange. Nothing need be given to purchasers, but current information about the company is on file."). 

[35] H. R. Rep. No. 1383, 73d Cong., 2d Sess. (1934) ("Just in proportion as it becomes more liquid and complicated, an economic system must become more moderate, more honest, and more justifiably self-trusting."). 

[36] Id. ("Since the war the interest of the public at large in the ownership of corporate enterprise has grown bigger, the size of the corporate unit has increased, the diffusion of corporate ownership has widened, all correlatively. Not only is nearly one half of the entire national wealth of the country represented by corporate stocks and corporate and Government bonds, but nearly one half of that corporate wealth is vested in the 200 largest nonbanking corporations which, piercing the thin veil of the holding company and disregarding a. relatively few notable exceptions, are owned in each case by thousands of investors and are controlled by those owning only a very small proportion of the corporate stock.").

[37] Id. ("Stock exchanges which handle the distribution and trading of a very substantial part of the entire national wealth and which have developed a technique of sucking funds from every corner of the country cannot operate under the same traditions and practices as pre-war stock exchanges which handled substantially only the transactions of professional investors and speculators. And standards of corporate management adequate to inspire investor confidence in the 'caveat stockholder' era of closely held stock.").

[38] See Knauss, supra note 34 ("The justification for bringing these companies under federal regulation is that it is in the public interest. At the time the Exchange Act was passed, the bulk of securities in which there was active trading were listed on at least one of the numerous exchanges."). 

[39] See Stock Exchange Regulation, Hearing before the Committee on Interstate and Foreign Commerce, HR 73rd Cong., 2nd Sess., on HR 7852 and HR 8720, March *, 1934, at 614 (statement of Oliver J. Troster, Secretary of the New York Security Dealers Association) ("The function of the exchange which makes a business of trading in securities is simple in such a case, being merely to provide a place where buying and selling orders can be matched at one price at a fixed rate of commission. The normal over-the-counter security does not belong to this class. It is ordinarily of a type which could not be successfully listed or dealt in on an exchange."). 

[40] See Knauss, supra note 34 ("Since the 1930's the over-the-counter market has had tremendous growth."). See also Report of the Special Study of the Securities Markets of the SEC, H. Doc. No. 95, 88th Cong., 1st Sess., Part 1 (Apr. 3, 1963) ("The volume of over-the-counter sales also has grown. The study estimates that in 1949, this volume was $4.9 billion, compared with $38.9 billion in 1961, a gain of almost eight times. Another basis for gaging the growth of the over-the-counter markets is by the number of different stocks appearing in the daily sheets published by the National Quotation Bureau. This number, which includes various foreign, investment company, and exchange-listed issues, has expanded quite steadily from approximately 3,700 on January 15, 1939, to 8200 on January 15, 1963.") [hereinafter Special Study].

[41] Special Study, Part 2 ("In recent years the volume of over-the-counter trading has grown dramatically. In 1961, the dollar volume of stock sales in the over-the-counter markets was approximately eight times as great as in 1949. This increase in growth was accompanied by an increase in the number of issues traded in the over-the-counter markets-issues which varied widely among themselves in numerous respects."); see also Usha Rodrigues, The Once and Future Irrelevancy of Section 12(g), 2015 U. Ill. L. Rev. 1529 (2015) ("Indeed, the estimated dollar volume of OTC securities in 1963 had grown to sixty one percent of the national security exchanges.").

[42] See Knauss, supra note 34 ("("Since the Exchange Act, many companies have refrained from listing, and others, such as banks, have delisted in order to avoid the required disclosures."). 

[43] H.R. Rep. No. 882, 87th Cong., 1st. Sess. (Aug. 10, 1961) ("House Joint Resolution 438 would authorize $750,000 for the Securities and Exchange Commission to make a study and investigation of the adequacy, for the protection of investors, of the rules of national securities exchanges and national securities associations."). 

[44] See Special Study, Part 3 ("The correlation between fraud and lack of disclosure unfortunately can be shown still to exist."); see also Knauss, supra note 34 ("Evidence compiled by the Special Study shows unquestionably that voluntary reporting and the quality of proxies issued by over-the-counter companies are inadequate. Investor fraud appears more prevalent with regard to unlisted securities, and unquestionably a more free and open market is needed for these securities."). 

[45] See Special Study, Part 1. ("The tremendous growth in the securities markets over the past 25 years, and most particularly the increased public participation, imposed strains on the regulatory system and revealed structural weaknesses. Neither the securities acts, the Commission, nor the industry itself fully anticipated the problems arising from the entry of unqualified persons, the spectacular development of the over-the-counter market, the vast number of companies going public for the first time, or a variety of other striking changes. Some of these problems resulted from inadequacies in established enforcement machinery, both Government and industry. Others reflect patterns of conduct now tolerated, but which, upon exposure and analysis, appear incompatible with the public interest.").

[46] Consider the relationship between market downturns and economic downturns from the Great Depression to the Great Recession. See also Special Study, Part 1 ("Turning briefly to the general public interest in securities markets, as distinguished from the direct and indirect interests of public investors, it may first be noted that the state of the trading markets unquestionably has an important bearing on the flow of new capital into private enterprise, and thus on the country's rate of economic growth. During the 5 year period 1957-61, as an illustration, corporations in the United States made expenditures for plant and equipment of $148 billion plus $38 billion for other investments and increased net working capital. Of this total expansion, $39 billion came from the issuance of stocks and bonds representing the additional funds needed beyond reinvested earnings and depreciation."). 

[47] See Special Study, Part 1 ("The latter sense is expressed by section 2 of the Exchange Act, which succinctly states various reasons why securities markets are 'affected with a national public interest.' . . . The emphasis on the public interest in this and other clauses of section 2 is echoed repeatedly in the substantive provisions of the statute. Over and over again Congress proclaimed that the regulatory authority conferred on the Commission was to be exercised 'in the public interest' and 'for the protection of investors.' Thus, while the private ownership of exchanges was not disturbed, the Exchange Act, in the words of the House of Representatives committee report preceding its enactment, proceeded on the theory that 'the exchanges are public institutions which the public is invited to use for the purchase and sale of securities listed thereon, and are not private clubs to be conducted only in accordance with the interests of their members. The great exchanges of this country upon which millions of dollars of securities are sold are affected with a public interest in the same degree as any other great utility.' Similarly, 'the public interest" and "protection of investors' were established as the dominant considerations in the operation and regulation of over-the-counter markets.").

[48] See id. ("Securities markets in the United States are, in contemplation of law and in fact, public markets. They are public both in the sense that large numbers of people are directly or indirectly involved in owning and trading securities, and in the broader sense that the performance of securities markets affects the general economy and well-being in important ways."). 

[49] See id. ("The over-the-counter markets are large and important, they are heterogeneous and diffuse, they are still relatively obscure and even mysterious for most investors, and they are also comparatively unregulated. These characteristics are not unrelated: The obscurity stems in part from the markets' very size, variety, and diffuseness, while the relative lack of regulations reflects a failure to keep pace with their growth and change since enactment of the original securities laws plus the difficulty of encompassing their wide variety in uniform regulatory measures.").

[50] See Special Study, Part 9 ("Disclosure is the cornerstone of Federal securities regulation; it is the great safeguard that governs the conduct of corporate managements in many of their activities; it is the best bulwark against reckless corporate publicity and irresponsible recommendation and sale of securities."). 

[51] The Commission understood that the approach would extend the periodic disclosure requirements to some issuers with "inactive" trading markets. See Special Study, Part 3 ("The cumulative effect of differing shareholder-size coverage criteria should also be considered. It will be observed that a standard of coverage of 300 or more shareholders would include well over half (62 percent) of all companies; would include only a small proportion of all very inactive companies (13 percent of those with less than 25 transfers and 32 percent of those not quoted) and would include almost all of the active companies."). The Commission considered and rejected a host of additional possible alternatives to number of shareholders, including trading activity, number of shares outstanding, number of shares in public hands, the concentration of holdings, and corporate earnings.

[52] The legislation adopted by Congress was designed to implement the Special Study. Much of it was based upon language provided by the SEC, including the provisions addressing issuers that would become subject to continuous disclosure. Even the change from Special Study Recommendation of 300 to 500 came from the Commission.

[53] The statute set the amount at $1 million. See 15 U.S.C. 78l. The amount has since been raised to $10 million. See 17 CFR 240.12g-1. 

[54] 15 USC 78l(g). 

[55] See Hearings on H.R. 6789, H.R. 6793, S. 1642 before a Subcommittee of the House Committee on Interstate and Foreign Commerce, 88th Cong., 1st Sess.(1963) (Statement by the SEC with Respect to Proposed Amendments) ("A survey by the New York Stock Exchange in 1959 estimated that approximately 8 percent of all securities held by public investors were held in street name by broker-dealers."); see also Special Study, Part 3 ("All of these numbers are in terms of record holdings, as distinguished from beneficial. As a general rule, therefore, they presumably understate the numbers of investors affected, since a single record holding is more likely to represent several beneficial holders than visa versa.").

[56] See Special Study, Part 3 ("While table IX-1 shows that 40 percent of all issuers had from 10 percent to 29 percent of their shares registered in names of broker-dealers or bank nominees, it is impossible to state the exact extent to which taking account of the underlying beneficial holdings would shift the distribution of companies and result in different numbers of companies covered at different shareholder levels.").

[57] See id. ("Only record holdings are considered; it was not possible to determine numbers of beneficial owners."). Is it really so complicated today? Public companies can and do receive information about the number of beneficial holders of their shares from the brokers and banks who hold in street name every proxy season. See Letter from James J. Angel (Mar. 1, 2015) ("One good approximation for the number of beneficial shareholders is the number of voting materials that issuers pay to transmit to their shareholders."). There is also evidence that private companies already have this information. See Mary L. Schapiro, Chair, U.S. Securities and Exchange Commission, Statement before the Committee on House Oversight and Government Reform (May 10, 2011) ("Conversely, the shareholders of most private companies, who generally hold their shares directly, are counted as "holders of record" under the definition.").  

[58] Shortly after adoption of the 1964 amendments, the Commission proposed to count as holders of record those beneficial owners that were "readily" available. See SEC Rel. No. 34-7426, Proposed Rule (1964) (proposing that "securities registered in the name of a broker, dealer or bank or nominee for any of them, which at the time are being held by the broker or dealer in customers' accounts or by the bank in custody or investment advisory accounts, shall be included as held of record by the number of separate accounts for which the securities are held. Each registered owner known by the issuer, or a person maintaining its record of security holders, to be a broker, dealer or bank or nominee for any of them shall be requested to furnish the issuer the number of such separate accounts. A recipient of such a request will be expected to comply only to the extent the information can be readily supplied, and the issuer may rely in good faith on such information as is received in response to the request."). See also Special Study, Part 3 ("It is assumed that the statutory amendment or appurtenant regulations would define 'shareholders' to include known beneficial holders.").

[59] See SEC, Report on Authority to Enforce Exchange Act Rule 12g5-1 and Subsection (b)(3) (Oct. 15, 2012) ("Shortly after Congress enacted Section 12(g), the Commission adopted Exchange Act Rule 12g5-1 to define 'held of record' and to define 'total assets' for purposes of Section 12(g) in 1965. The Commission determined not to require issuers to count as holders of record the separate accounts in which securities are held by brokers, dealers, banks or their nominees for the benefit of other persons. The Commission explained that this would 'have the effect of simplifying the process by which companies determine whether or not they are covered by [Section 12(g)].'") [hereinafter 12g5-1 Report].

[60] This was made clear in part through the inclusion of explicit authority in Section 12(g) rather than relying on the more general authority in Section 3(b). See Investor Protection Hearings on H.R. 6789, H.R. 6793, S. 1642 before a Subcommittee of the House Committee on Interstate and Foreign Commerce, 88th Cong., 1st Sess. (1963) (Statement by the SEC with Respect to Proposed Amendments) ("Although the terms 'total assets' and 'held of record' probably would fall within the scope of section 3(b), this provision would clarify the Commission's authority as to these terms and insure adequate power to prevent circumvention of the statutory standards for registration."). See also S. Rep. No. 379, 88th Cong., 1st  Sess., at 19 (1963).

[61] See SEC Compliance and Disclosure Interpretation 152.01 ("Institutional custodians, such as Cede & Co. and other commercial depositories, are not single holders of record for purposes of the Exchange Act's registration and periodic reporting provisions. Instead, each of the depository's accounts for which the securities are held is a single record holder.").

[62] The JOBS Act, and related rulemaking, was not the first time since 1964 that the scope 12(g) reporting requirements was adjusted. The Commission approved an NASD rule amendment in 1999 that brought OTC Bulletin Board companies within the scope of periodic reporting requirements. See SEC Rel. No. 34-40878 (Jan. 4, 1999).

[63] During the passage of the JOBS Act, Senator Jack Reed's proposed amendment to change the method of counting from record to beneficial was defeated amidst pushback from large banks. See 158 Cong. Rec. S1884 (Mar. 21, 2012).

[64] See 12g5-1 Report ("Since 1964 and the advent of Section 12(g) and the rules promulgated by the Commission thereunder, a fundamental shift has taken place in how securities are held in the United States. When Section 12(g) was enacted, most investors in U.S. publicly-traded issuers owned their securities in registered form, which means that the securities were directly registered in the name of a specific investor on the record of security holders maintained by or on behalf of the issuer. Today the vast majority of investors own their securities as a beneficial owner through a securities intermediary, such as a broker-dealer or bank. This is often referred to as holding securities in nominee or 'street name.'").

[65] See id. ("Based on an analysis of available data over the period 2008 through 2010, the Commission's Division of Risk, Strategy and Financial Innovation estimates that over 85% of the holders of securities in the U.S. markets hold through a broker-dealer or a bank that is a Depository Trust Company participant.").

[66] The Commission, for good reason, discouraged record ownership in an effort to "immobilize" stock certificates. See 12g5-1 Report ("Consistent with congressional intent, the Commission has encouraged the immobilization of stock certificates through the use of securities depositories. These changes and the move towards immobilization had the effect of decreasing the number of investors who held in registered form and greatly increasing the number of investors who own their securities as a beneficial owner or in street name.").

[67] See id. ("But, nearly all stock brokerage firms now require their customers to hold stock "in street name." Many will not accept a sell order, unless they hold the stock in street name."). 

[68] See Petition for Commission Action to Require Exchange Act Registration of Over-the-Counter Equity Securities, (July 3, 2003) ("Brokerage firms penalize investors who wish to take physical possession of a stock certificate by charging a fee, usually $50 for each transfer. In addition, investors are warned that sales will take longer to accomplish because the broker must take physical possession of the certificate, and physical possession of a stock certificate is dangerous, as the certificate can be stolen or forged."). 

[69] See 12g5-1 Report ("It should be noted that given the percentage of securities of issuers that are immobilized and trade through DTC, there are also numerous exchange listed companies that have a small number of record holders.  However, companies whose securities are listed on a national securities exchange are required to be registered pursuant to Section 12(b), and to comply with the reporting and other obligations under the Exchange Act, regardless of the number of record holders."). 

[70] See id. ("It should be noted that a significant subset of companies may still choose to voluntarily register under Section 12(g). Currently, there are 1,321 companies who are registered under Section 12(g) even though they have less than 300 holders of record and hence, appear to be eligible to deregister."). 

[71] See NASAA Letter to Senator Jack Reed (Mar. 22, 2012). ("Thus, many small and large private companies can avoid reporting requirements by creative shareholder recording methods."). 

[72] See 12g5-1 Report) ("In these ways, issuers with more than 2000 beneficial owners, but less than 2000 holders of record, can be actively traded in the over-the-counter markets or in private secondary markets, without triggering the threshold requirements to report under the Exchange Act. Investors in these securities do not necessarily have the disclosures provided by Exchange Act reporting, though generally there must be some information available to a broker-dealer in order to initiate or resume publication of a price quote in a security."). 

[73] See id. ("In addition, market participants and shareholders may hold through other forms of holding that appear on the company's stock record book as one record holder, when such record holder holds on behalf of many beneficial owners. In these ways, issuers with more than 2000 beneficial owners, but less than 2000 holders of record, can be actively traded in the over-the-counter markets or in private secondary markets, without triggering the threshold requirements to report under the Exchange Act. Investors in these securities do not necessarily have the disclosures provided by Exchange Act reporting, though generally there must be some information available to a broker-dealer in order to initiate or resume publication of a price quote in a security."). 

[74] Such actions are generally designed to scale back reporting obligations in an effort to cut costs under the hypothesis this will encourage public offerings. See, e.g., Amendments to the Accelerated Filer and Large Accelerated Filer Definitions, Proposed Rules, Rel. No. 34-85814 (May 9, 2019) (asserting that exempting more companies from the requirement that auditors attest to management's assessment of the effectiveness of the issuer's internal control over financial reporting "may be a positive factor in the decision of additional companies to register their offering or a class of their securities"); Smaller Reporting Company Definition, Final Rules, Rel. No. 33-10513 (June 28, 2018) (asserting that making smaller reporting company status-and the corresponding reduced disclosure requirements-available to more registrants "could encourage capital formation because companies that may have been hesitant to go public may choose to do so if they face reduced disclosure requirements.").

[75] See Petition for Commission Action to Require Exchange Act Registration of Over-the-Counter Equity Securities, July 3, 2003.

[76] See Michael Pieciak, Testimony before House Financial Services Subcommittee Hearing IPOs/Retail Investment Private Market Exemptions Barriers (Sept. 11, 2019) ("The Commission has interpreted the term 'held of record' to narrowly mean only those shareholders listed on corporate records. The vast majority of shareholders of public companies are not listed on corporate records; instead, their stock is held through custodians such as banks and brokerage firms who hold shares through accounts at a depository company, and it is the depository company that is listed as the registered holder in corporate records."). 

[77] See, e.g., Jennifer Fan, Regulating Unicorns: Disclosure and the New Private Economy, 57 B.C. L. Rev. 583 (2016); Renee Jones, The Unicorn Governance Trap, 166 U. PA. L. Rev. Online 165 (2017); Ann Lipton, Not Everything is About Investors: The Case For Mandatory Stakeholder Disclosure, 37 Yale J. Reg. 499 (2020); Verity Winship, Private Company Fraud, 54 U.C. Davis L. Rev. 663 (2020); Elizabeth Pollman, Private Company Lies, 109 Geo. L. J. 353 (2020). There are contrary academic views. See, e.g., Andrew L. Platt, Unicornophobia (Sept. 1, 2021), forthcoming Harv. Bus. L. Rev (2022).

[78] See Tyler Gellasch & Lee Reiners, Global Financial Markets Center, From Laggard to Leader: Updating the Securities Regulatory Framework to Better Meet the Needs of Investors and Society (Feb. 2021) ("The SEC should consider amending its definition of 'shareholder of record,' which currently permits private issuers to easily avoid the Section 12(g) trigger by obfuscating the actual owners of their securities. Further, the SEC should consider revising the application of exemptions to offering rules for private funds to capture funds with more than $1 billion in assets or more than 100 beneficial owners to require them to register as investment companies.").

[79] See Mary L. Schapiro, Statement before the Committee on House Oversight and Government Reform (May 10, 2011) ("I believe that both the question of how holders are counted and how many holders should trigger registration need to be examined."). 

[80] See id. ("At the same time, it has allowed a number of public companies, many of whom likely have substantially more than 500 shareholders, to stop reporting, or 'go dark,' because there are fewer than 500 'holders of record' due to the fact that the public companies' shares are held in street name."). Investors have asserted that this "going dark" phenomenon has occurred with some frequency, resulting in significant harm to their investments. See Comments on Rulemaking Petition: Petition for Commission Action to Require Exchange Act Registration of Over-the-Counter Equity Securities.

[81] See 12g5-1 Report ("These changes and the move towards immobilization had the effect of decreasing the number of investors who held in registered form and greatly increasing the number of investors who own their securities as a beneficial owner or in street name. This trend impacts Section 12(g) and Rule 12g5-1, as investors who own their securities as beneficial owners or in street name, or through other entities, are not counted as holders of record under Rule 12g5-1.").

[82] See H.R. Rep. No. 398, 114th Cong., 2nd Sess. (2016) (Minority Views) ("Another concern is that the bill only encourages employees to own more of their employer's stock, rather than encouraging more employees to own their employer's stock. Therefore, the bill could expose employees to concentration risk in their retirement accounts. This is made worse by the fact that the JOBS Act made it easier for privately-held companies to remain private by, for example, exempting employees who receive stock as a result of a compensation plan from being counted as 'holders of record.' By allowing companies to stay private longer, if not forever, the bill would enable companies to encourage overinvestment by employees in a company that they cannot value and that may never permit them to sell, except back to the company."). 

[83] See Schapiro, supra note 79 ("[T]he shareholders of most private companies, who companies, who generally hold their shares directly, are counted as 'holders of record' under the definition."). 

[84] The anti-evasion provisions are important, but consider whether they have proven valuable in practice. For example, when Facebook went public it revealed a far higher number of allowable shareholders (nearly 1400) than the threshold of 500. See Facebook Form S-1, Amendment No.7. A study by SEC staff in 2012 revealed that these anti-evasion provisions have been little used. See 12g5-1 Report ("Rule 12g5-1(b)(3) has been invoked by the Commission or in private litigation sparingly and little precedent interpreting the rule is available.").  

[85] The JOBS Act created an exemption from counting for Crowdfunding shareholders, and since then the Commission has compounded this exemption by permitting the creation of Crowdfunding special purpose vehicles. It also created an exemption for Regulation A shareholders under certain circumstances.  

[86] See Gellasch & Reiners, supra note 78, at 11; see also Jay R. Ritter, Considering Causes and Remedies for Declining IPO Volume, Harvard Law School Forum on Corporate Governance (Apr. 2, 2012) (based on testimony before the Senate Committee on Banking, Housing, and Urban Affairs) ("My suggestion would be to keep the 500 shareholders of record threshold, but exclude current and former employees from the count, and to add a public float requirement."); John C. Coffee, Jr, Statement at Hearings Before the Senate Committee on Banking, Housing and Urban Affairs (Dec. 1, 2011) (suggesting a public float test).  

Good morning.  To open, I have to note that my remarks are my own and do not reflect the views of the Commission or my fellow Commissioners.

I. Introduction

The last 18 months have been unprecedented and while we have all had to make changes and adapt I have found that the purpose of my job has been consistent.  I have been going to the office throughout the pandemic and every morning, when I walk into my office, the first thing I see is a slightly faded piece of computer paper on the wall that reads "it's a privilege."  I printed it over a decade ago and I have carried it to every job I have had since.  It has never been more true of any job than it is of the job I have now: it is truly a privilege and an honor to serve on the U.S. Securities and Exchange Commission.  Today, I want to focus my remarks on one aspect of this great responsibility: preserving and expanding opportunities for businesses in our economy to raise capital and for investors to share in their success. 

There is little disagreement that the U.S. capital markets remain the envy of the world.  Their depth, liquidity, and transparency are unmatched.  Their remarkable quality is not merely a point of pride; it fundamentally affects how our economy runs, and therefore how our people, and people all over the world, are able to live their lives.  These are the markets I have the privilege of overseeing.

As is often noted, the U.S. is unusual in its pronounced reliance on debt and equity securities markets. In Europe and Asia, capital formation tends to rely primarily on bank loans and only secondarily on the sale of securities. [1]  Here, the pattern is reversed, with about 80 percent of debt financing coming from the sale of securities and about 20 percent coming from bank debt.[2]  Companies in the U.S. also rely more heavily on equity than elsewhere.[3]  Because of their considerable depth, U.S. markets remain the lodestar for early stage companies with large ambitions. 

At the SEC, our tripartite mission sets the template for how to oversee this precious resource.  First, we protect investors.  Investors who feel that markets are transparent and that the legal system provides recourse against wrongdoers will feel that they are taking fair risks when they invest in companies of all sizes and stages.  Second, we maintain fair, orderly, and efficient markets.  Companies and their investors can grow, develop, and retool when there is a robust and efficient secondary market for their securities.  And third, we facilitate capital formation.  That is, we must do all of this without putting a stranglehold on the proverbial gold-laying goose. 

II. Capital Formation: A Look-Back

It has been said that regulation is a one-way ratchet, easy to tighten but almost never loosened.  I am pleased to say that in the last several years the SEC has pushed back on this notion, systematically and thoughtfully streamlining and refining or rewriting rules that are no longer working as intended or as well as they should.  Many of you watching today have been integral to this process, sending comment letters or meeting with our staff to let us know where our regulations can be improved.  I want to take a minute to look back on what we have accomplished. 

Our efforts in this area these last few years have taken several different approaches. 

A. Expanding Opportunity

In some cases, we expanded exemptions and opportunities to include more issuers, offerings, and investors.  For example, we expanded the definition of smaller reporting companies, giving more companies the option of using scaled disclosure and of having longer lead times to implement many of our disclosure-based rulemakings. [4]  We also expanded the number of issuers who qualify as non-accelerated filers, allowing more companies the time and opportunity to mature before having to undertake the heavy lift of preparing for the Sarbanes-Oxley Section 404(b) attestations.  We changed the rules to allow all issuers to "test the waters" before filing a registration statement, and now also allow all issuers to file with us confidentially, allowing companies to receive an initial review and feedback from the staff before making their filing public.[5]  We also expanded access to the Regulation A exemption, which has been newly revitalized under the JOBS Act, allowing reporting issuers to use the exemption.[6]  We also expanded the ability of companies to use equity as compensation for their workers, by raising the cap from $5 million to $10 million on securities issued under Rule 701.[7]  And we opened up a new path for investors to qualify as "accredited investors," by allowing certain license-holders within the financial services industry to qualify-a move that will increase the investment opportunities for more individual investors as well as expand the pool of potential investors for non-public companies.[8]

B. Streamlining Regulation

We also refined existing disclosures to ensure that they meet the needs of investors without adding unnecessary expense for businesses.  Our biggest undertakings in this area were the sweeping Disclosure Update and Simplification rule, fondly known as "DUSTR" within the building, and the amendments we adopted pursuant to the FAST Act, which streamlined and updated many of our Regulation S-K disclosures.[9]  These rulemakings are the kind of blocking and tackling that required countless hours of staff effort to comb through our often Byzantine rules, and to conduct outreach, review, and listening sessions with issuers and investors alike to tease out what was working and what could be revised.  I think we made very few headlines with these rulemakings, but it is the sort of maintenance that we should undertake on a regular basis.  I won't go so far as to assume that any regulation will "spark joy" but just as a regular de-cluttering regime at home can make a space more livable, a regular de-cluttering regime of our regulations can make our markets more efficient as well.[10]  Under the heading of simplification, we also tackled our alphabet soup of exemptions, working to harmonize them into a more coherent mosaic.[11]  And we streamlined and updated our MD&A disclosures.[12]  We also updated and revised two industry guides: Industry Guide 7 and Industry Guide 3.[13]

C. Opening Doors

In addition to adopting several final rules, we opened the door to further engagement on a number of items.  The concept of the accredited investor and his or her role in small business capital formation has been a topic of ongoing discussion.  From its inception in the last century, it has traditionally been understood, when applied to individuals, to require a certain level of wealth or income.  It is not hard to see that this is a clumsy way of defining a class of investors who are supposed to be qualified by their financial sophistication.  When we recently adopted our rule expanding the definition, we also included an invitation for the public to submit additional recommendations for ways to include more investors in this definition.[14]  We also put forward a proposed exemption for so-called "finders" who may serve as matchmakers for small companies and potential investors, but who may, in so doing, run afoul of our broker-dealer rules.[15]  The process of developing a workable finders exemption has been ongoing for years.  Although we have not yet adopted a rule or exemption to meet this need, I hope that our proposal will help to propel the discussion toward a solution.

D. The Other Pieces of the Puzzle

While the pieces of our mission are sometimes presented as a system of trade-offs, as though we must sacrifice investor protection if we want to pursue capital formation, I believe this viewpoint is misguided.  Our mission should work as a coherent whole, where appropriately tailored rules allow investors and businesses to work hand-in-hand, providing a stable framework within which to collaborate.  To this end, we also pursued rulemakings to enhance disclosure in several areas, improve the efficiency and operation of securities exchanges, while using our enforcement and examination programs to improve compliance and provide redress in the case of wrongdoing by market participants.[16]

III. Covid-19: A Case Study in Capital Market Resilience

Facilitating capital access is not a luxury but essential to the well-being of our economy.  For those of us in the U.S., the combination of entrepreneurial spirit and high quality securities markets means living within a nimble economy able to shift resources in response to changing needs.  While these changes typically occur over time, we recently experienced a rapid shift unlike any we have experienced before.

A. Companies Retool and Adapt

In mid-March 2020, literally overnight vast swaths of the population embarked on a radically new way of life.  These changes had immediate effects in the broader economy. Our country's nimble businesses pivoted and redeployed billions of dollars in resources to meet new needs.  The onset of the Covid-19 pandemic caused immense and immediate changes to the American economy. But we have seen the power of American businesses to be innovative in the face of crisis. Entire industries transformed, almost overnight, to meet new demands in new markets.

Take, for example, the growth of delivery services. Nationwide lockdowns threatened to destroy the restaurant industry. Meanwhile, drivers across the country were seeing severely lower demand as Americans stayed home. So what happened? Entire industries reallocated resources and capital, and food delivery boomed, allowing restaurants to stay open and drivers to remain employed.[17] The year 2020 saw U.S. food delivery sales more than double, increasing from roughly $23 billion to $51 billion. One source notes that 70 percent of that increase was attributable to the pandemic.[18]

Covid-19 has dramatically changed the way many of us "go to" work, or how our kids learn in school, replacing traditional offices and classrooms with video- and tele-conferencing software. The pandemic has led to an increase in touchless technology, sensors, and other AV solutions.[19] One prominent videoconferencing provider saw its annual sales rise over 300 percent and profitability increase more than 30-fold in 2020.[20] We have also seen the emergence of telehealth services. As of this past February, telehealth usage was nearly 40 times higher than before the pandemic.[21]

These are only a few of the many examples from our nation's experience throughout the pandemic showing how our economy was able to quickly respond to dramatic changes in people's needs and living conditions. Companies had to raise and reallocate capital on the fly in order to meet the demands of the American people during this pandemic. It's a true testament to the resilience of our economic system that such moves were able to happen so quickly, even amidst dramatic uncertainty about the virus and rapidly changing public health circumstances.

B. Too Many Businesses Left Behind

We in America are truly fortunate.  Our country's successful avoidance of the economic worst case scenario in 2020 could not have happened without robust, efficient, and responsive capital markets. We must not forget these lessons even as the early months of the pandemic fade further and further into the past. Our economy remains vulnerable to future shocks, whether from later variants of Covid-19, from other pandemics, from unanticipated national security crises, or any other unhappy surprises. Our ability to persevere through future crises relies on the dynamism of our capital markets and our unparalleled workforce and entrepreneurs.

And we cannot forget: while many firms adapted, not every business could weather the storm of the pandemic. A Federal Reserve study estimated that 2020 saw 200,000 businesses above historical norms close permanently, with closures concentrated among smaller businesses.[22]  To ensure that more businesses can grow and evolve throughout the rest of this pandemic and during future economic crises, we must make sure that capital raising opportunities are even more broadly accessible.[23]

Businesses owned by underrepresented groups were also especially hard hit by the absence of strong capital markets.[24] This problem, of course, predates the Covid-19 pandemic.[25]  The SEC's Small Business Capital Formation Advisory Committee has held several discussions focused on the difficulties underrepresented founders face.[26]  If we want to further aid these entrepreneurs, and help them rebound and grow in ways that meet their needs and those of their communities, we must continue to focus on facilitating capital formation.

Strengthening our capital markets will continue to be key to navigating these challenges. Obstacles to capital formation slow economic recoveries and push workers out of the workforce. The result is diminishing skills and opportunities, and thus diminished economic productivity in the long term. In other words, slowing and weaker capital markets will reverberate throughout the economy for years.[27]

IV. Looking Ahead

Whatever the future holds, it is apparent that our economy will continue to transform in unexpected ways. If we don't proactively address these challenges, many business will face the prospect of bankruptcy or obsolescence.[28] The best way to be ready for this uncertain future is to allow the market to allocate capital as it digests information. We should not hang onto outdated models at the risk of stifling innovation when we need it most.[29]

Market regulators perform best when they respond to the needs of the market, rather than using regulation to bend the market to their own idiosyncratic vision.  The work of the Commission these last several years has been necessary, if a bit overdue.  There is, however, still work to be done. 

One of the features of this recent spate of rulemaking of which I am most proud is that we tackled the unglamorous, and therefore often neglected, work of revisiting and revising our own rulemakings.  We affirmatively did not simply move the ratchet further in the same direction, we often moved it in varying directions, as appropriate.  We got the elbow grease going and picked through our rules, technical bit by technical bit, revising and pruning in a way that, I believe, will result in a stronger, more resilient, and more growth-friendly market.  We may have the best securities markets in the world, but without our continued self-examination and hard work, there is no reason to believe they will stay that way.

We, as Americans, have inherited a vibrant mechanism for capital formation and innovation, built over time.  My job and my privilege today as a regulator is to continue this good work, ensuring that we do not get in the way of the ingenuity and industry of entrepreneurs here and abroad who rely on our markets.  This means fulfilling every part of our mission: protecting investors, maintaining fair, orderly, and efficient markets, and last but definitely not least, facilitating capital formation.

= = = = =

 

[1] See Securities Industry and Financial Markets Association, 2021 Capital Markets Fact Book, at 6, (Jul. 2021), available at www.sifma.org/wp-content/uploads/2021/07/CM-Fact-Book-2021-SIFMA.pdf.

[2] Id.

[3] Id.

[4] U.S. Securities and Exchange Commission, Final Rule, Smaller Reporting Company Definition, Release Nos. 33-10513; 34-83550, (Jun. 28, 2018), available at  www.sec.gov/rules/final/2018/33-10513.pdf.

[5] U.S. Securities and Exchange Commission, Final Rule, Solicitation of Interest Prior to a Registered Public Offering, Release No. 33-10699 (Sept. 26, 2019), available at www.sec.gov/rules/final/2019/33-10699.pdf; and U.S. Securities and Exchange Commission, Announcement, Draft Registration Statement Processing Procedures Expanded, (Jun. 29, 2017) available at www.sec.gov/corpfin/announcement/draft-registration-statement-processing-procedures-expanded.

[6] U.S. Securities and Exchange Commission, Final Rule, Conditional Small Issues Exemption under the Securities Act of 1933 (Regulation A), Release No. 33-10591, (Sept. 19, 2018), available at www.sec.gov/rules/final/2018/33-10591.pdf.

[7] U.S. Securities and Exchange Commission, Final Rule, Exempt Offerings Pursuant to Compensatory Arrangements, Release No. 33-10520, (Jul. 18, 2018), available at www.sec.gov/rules/final/2018/33-10520.pdf.

[8] U.S. Securities and Exchange Commission, Final Rule, Accredited Investor Defintion, Release Nos. 33-10824; 34-89669 (Aug. 26, 2020), available at www.sec.gov/rules/final/2020/33-10824.pdf.

[9] U.S. Securities and Exchange Commission, Final Rule, Disclosure Update and Simplification, Release No. 33-10532; 34-83875, IC-33203 (Aug. 17, 2018), available at www.sec.gov/rules/final/2018/33-10532.pdf; U.S. Securities and Exchange Commission, Final Rule, FAST Act Modernization and Simplification of Regulation S-K, Release No. 33-10618; 34-85381; IA-5206; IC-33426 (Mar. 20, 2019) available at www.sec.gov/rules/final/2019/33-10618.pdf.

[10] See Marie Kondo, The Life-Changing Magic of Tidying Up, Ten Speed Press (Oct.  14, 2014).

[11] U.S. Securities and Exchange Commission, Final Rule, Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Release Nos. 33-10884; 34-90300; IC-34082; (Nov. 2, 2020), available at www.sec.gov/rules/final/2020/33-10884.pdf.

[12] U.S. Securities and Exchange Commission, Final Rule, Management's Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, Release No. 33-10890; 34-90459; IC-34100 (Nov. 19, 2020), available at www.sec.gov/rules/final/2020/33-10890.pdf.

[13] U.S. Securities and Exchange Commission, Final Rule, Modernization of Property Disclosures for Mining Registrants, Release Nos. 33-10570; 34-84509; (Oct. 31, 2018), available at www.sec.gov/rules/final/2018/33-10570.pdf; and U.S. Securities and Exchange Commission, Final Rule, Update of Statistical Disclosures for Bank and Savings and Loan Registrants, Release No. 33-10835; 34-89835; (Sept. 11, 2020), available at www.sec.gov/rules/final/2020/33-10835.pdf.

[14] U.S. Securities and Exchange Commission, Final Rule, Accredited Investor Defintion, Release Nos. 33-10824; 34-89669 (Aug. 26, 2020), available at www.sec.gov/rules/final/2020/33-10824.pdf.

[15] U.S. Securities and Exchange Commission, Proposed Exemptive Order and Request for Comment, Notice of Proposed Exemptive Order Granting Conditional Exemption from the Broker Registration Requirements of Section 15(a) of the Securities Exchange Act of 1934 for Certain Activities of Finders, (Oct. 7, 2020), available at www.sec.gov/rules/exorders/2020/34-90112.pdf.

[16] See U.S. Securities and Exchange Commission, Selected Accomplishments May 2017 - December 2020, (Dec. 23, 2020), available at www.sec.gov/selected-sec-accomplishments-may-2017-2020.

[17] MarketWatch: Sumagaysay, Levi. "The Pandemic Has More than Doubled Food-Delivery Apps' Business. Now What?" MarketWatch, 25 Nov. 2020, available at www.marketwatch.com/story/the-pandemic-has-more-than-doubled-americans-use-of-food-delivery-apps-but-that-doesnt-mean-the-companies-are-making-money-11606340169.

[18] Oblander, Elliot Shin and McCarthy, Daniel, How has COVID-19 Impacted Customer Relationship Dynamics at Restaurant Food Delivery Businesses? (April 26, 2021), available at papers.ssrn.com/sol3/papers.cfm?abstract_id=3836262; see also Forman, Laura. "For Food Delivery, Covid-19 Was a Sugar High." The Wall Street Journal, (Apr. 30, 2021,) available at www.wsj.com/articles/for-food-delivery-covid-19-was-a-sugar-high-11619780401.

[19] Lane, Rob. "AV in Changing Times." AV Magazine, 28 Aug. 2020, available at www.avinteractive.com/features/technology/av-changing-times-27-08-2020/.

[20] "Zoom Sees More Growth after 'Unprecedented' 2020." BBC News, 1 Mar. 2021, available at www.bbc.com/news/business-56247489.

[21] Bestsennyy, Oleg, et al. "Telehealth: A Quarter-Trillion-Dollar Post-Covid-19 Reality?" McKinsey & Company, 22 July 2021, available at www.mckinsey.com/industries/healthcare-systems-and-services/our-insights/telehealth-a-quarter-trillion-dollar-post-covid-19-reality.

[22] Crane, Leland D., Ryan A. Decker, Aaron Flaaen, Adrian Hamins-Puertolas, and Christopher Kurz (2021). "Business Exit During the COVID-19 Pandemic: NonTraditional Measures in Historical Context," Finance and Economics Discussion Series 2020-089r1. Washington: Board of Governors of the Federal Reserve System, available at doi.org/10.17016/FEDS.2020.089r1; see also Simon, Ruth. "Covid-19's Toll on U.S. Business? 200,000 Extra Closures in Pandemic's First Year." The Wall Street Journal, 16 Apr. 2021, available at www.wsj.com/articles/covid-19s-toll-on-u-s-business-200-000-extra-closures-in-pandemics-first-year-11618580619.

[23] Dua, André, et al. "Which Small Businesses Are Most Vulnerable to COVID-19--and When." McKinsey & Company, 25 June 2020, ("[Governments should consider] promoting structural reforms that encourage financial institutions to provide longer-term access to capital and create incentives for small businesses to upgrade their facilities and digitize"), available at www.mckinsey.com/featured-insights/americas/which-small-businesses-are-most-vulnerable-to-covid-19-and-when.

[24] "Coronavirus Pandemic Hits Minority-Owned Small Businesses Disproportionately Hard, New Poll Shows." U.S. Chamber of Commerce, 4 Aug. 2020, available at www.uschamber.com/press-release/coronavirus-pandemic-hits-minority-owned-small-businesses-disproportionately-hard-new.

[25] Azevedo, Mary Ann. "Untapped Opportunity: Minority Founders Still Being Overlooked." Crunchbase News, 4 June 2020, ("[A]ccess to capital presents an even greater challenge when it comes to people of color, women, and individuals of limited wealth"), available at news.crunchbase.com/news/untapped-opportunity-minority-founders-still-being-overlooked/.  See also see also Hwang, Victor. "Breaking down Barriers to Capital Access." Ewing Marion Kauffman Foundation, (23 May 2019), available at www.kauffman.org/currents/breaking-down-barriers-to-capital-access/.

[26] U.S. Securities and Exchange Commission, Press Release, "Increasing Opportunities for Underrepresented Founders and Investors on the Agenda for the SEC Small Business Capital Formation Advisory Committee Meeting on April 30," (Apr. 26, 2021), available at www.sec.gov/news/press-release/2021-73; U.S. Securities and Exchange Commission, Press Release, "Small Business Capital Formation Advisory Committee Aug. 4 Meeting to Focus on How Capital Markets Are Serving Underrepresented Founders," (Jul. 29, 2020), available at https://www.sec.gov/news/press-release/2020-166.

[27] Carlsson-Szlezak, Philipp, et al. "Understanding the Economic Shock of Coronavirus." Harvard Business Review, (Feb. 1, 2021), available at hbr.org/2020/03/understanding-the-economic-shock-of-coronavirus.

[28] Spellacy, Michael, et al. Capital Markets Help with the Pandemic. Accenture, (Jan. 21, 2021), available at www.accenture.com/us-en/insights/capital-markets/capital-markets-helping-with-pandemic.

[29] See id. ("It's clear that innovation is a precondition not just for profitability but for survival.")

Thank you for that introduction and good morning everyone. It's an honor and privilege to speak with both my SEC colleagues and so many from the securities industry and defense bar about a topic that affects all of us: trust. More specifically, the decline in trust in our financial markets and what we can do to restore it. But before I begin, as you heard me say yesterday, I'll remind you that these views are my own.[1]

Many Americans' trust in our institutions is faltering. From Congress to law enforcement to the courts, no sector is immune from this trend. According to a recent Gallup poll, only a small percentage of Americans have any significant level of confidence in banks, technology companies, or big business.[2] These levels, in fact, are near historic lows.[3]

This decline in trust is bad for everyone. When it comes to the financial markets, it undermines the investor confidence needed for the fair, efficient, and orderly operation of our capital markets. Put simply, if the public doesn't think the system is fair, at a minimum, they are not going to invest their hard-earned money. This hurts all those companies, professionals, and other market participants who are playing by the rules and doing the right thing every day. And all of this has the potential to be detrimental to our economy.

While there's no single cause for this decline when it comes to our financial institutions, part of it is due to repeated lapses by large businesses, gatekeepers, and other market participants, coupled with the perception that we-the regulators-are failing to hold them appropriately accountable, or worse still, the belief by some that there are two sets of rules: one for the big and powerful and another for everyone else.

Each day, however, the Enforcement Division's staff work tirelessly to enhance that trust and make clear that there is only one set of rules by prosecuting the bad actors who break them, without fear or favor. Despite the challenges of a once in a lifetime pandemic, they did so over the last fiscal year by bringing more standalone enforcement actions than the prior year, including cases involving auditor misconduct, insider trading, bribery schemes, and misleading claims surrounding SPAC transactions.[4]   

But of course, the risks we protect against are not fixed and what's important to investors and the market can evolve over time. That's why the Division is - as it always has - taking proactive steps to police those issues as well by bringing a number of first of their kind enforcement actions. For example, in the crypto space, the Commission recently brought the first enforcement action involving securities using decentralized finance, or "DeFi," technology;[5] took enforcement actions against trading platforms that illegally facilitate or tout trading in crypto securities;[6] and charged the promoters of a fraudulent $2 billion digital asset securities offering.[7] We also brought the first enforcement action involving Regulation Crowdfunding[8] and the first enforcement action against an alternative data provider, where we charged App Annie and its co-founder and former CEO with engaging in deceptive practices.[9]

          I'm proud of the dedication of our team in Enforcement and believe that by both continuing these types of proactive enforcement efforts and sharpening our focus in additional areas, we will enhance Americans' trust in our financial institutions. And it's those additional areas of focus that I want to turn to next. They include emphasizing corporate responsibility, gatekeeper accountability and appropriate remedies, particularly prophylactic ones.

Corporate Responsibility

          With respect to corporate responsibility, Congress has enacted many laws and the SEC has adopted many rules to ensure that corporations are being responsible and playing fair. But too often, they ignore these rules and fail to implement sufficient controls or procedures to ensure compliance. In some cases, firms are practically inviting fraud or waiting for misconduct to occur; in others, they are actively covering it up or minimizing it. All of this serves to undermine public trust and confidence. Enhancing it will require, among other things, robust enforcement of laws and rules concerning required disclosures, misuse of nonpublic information,[10] violation of record-keeping obligations,[11] and obfuscation of evidence from the SEC or other government agencies.[12]

We'll consider all of our options when this sort of misconduct occurs prior to or during our investigations. For example, if we learn that, while litigation is anticipated or pending, corporations or individuals have not followed the rules and maintained required communications, have ignored subpoenas or litigation hold notices, or have deliberately used the sort of ephemeral technology that allows messages to disappear, we may well conclude that spoliation of evidence has occurred and ask the court for adverse inferences or other appropriate relief. These rules are not just "check the box" exercises for compliance departments; they are important to ensure that the SEC and other law enforcement agencies can understand what happened and make appropriate prosecutorial decisions. When that doesn't happen, there can and should be consequences.

And with respect to disclosures, timely and accurate disclosures of material events are essential to investor protection and enhancing trust and confidence in the markets. They not only enable average investors to make informed investing decisions, but also ensure that informed investors are able to hold management and boards accountable when they fall short. As an example, cybersecurity is a critical issue in our securities markets and our economy as a whole. And we have been vigilant in both ensuring that market participants safeguard essential data and systems[13] and pursuing public companies that do not reasonably disclose material cybersecurity incidents. This includes charging public companies for misleading disclosures about cybersecurity events, or for inadequate controls related to such disclosures.[14]

Gatekeeper Accountability

But restoring trust requires more than SEC enforcement actions. We must all work together to ensure that companies are following the rules. And this leads me to my second point: the essential role that gatekeepers like so many of you play.

When gatekeepers are living up to their obligations, they serve as the first lines of defense against misconduct. But when they don't, investors, market integrity, and public trust all suffer. Encouraging your clients to play in the grey areas or walk right up to the line creates significant risk. It's when companies start testing those lines that problems emerge and rules are broken. And even if that's not the case, the public loses faith in institutions that appear to be trying to get away with as much as they can. That's why gatekeepers will remain a significant focus for the Enforcement Division, as evidenced by some of our recent actions. 

For example, the Commission recently charged an attorney with playing a critical role in the unregistered sale of millions of shares of securities by two groups engaged in securities fraud.[15] This kind of behavior is an abuse of the public trust, and has no place in the legal profession.

But it's not just the lawyers. We have also brought number of enforcement actions involving significant misconduct by audit partners at major accounting firms.[16] It's also not just the cases with salacious facts that warrant our attention. The Commission recently charged an accountant with failing to register his firm with the Public Company Accounting Oversight Board and comply with PCAOB auditing standards in his audit of a public company client.[17] These basic requirements are essential to the gatekeeping function.

Crafting Appropriate Remedies

Finally, in addition to punishing misconduct, our remedies must deter it from happening in the first place. If the public understands that our decisions are motivated by these principles, it also increases their trust that institutions are playing by the rules and being held accountable when they do not.

 When it comes to accountability, few things rival the magnitude of wrongdoers admitting that they broke the law, and so, in an era of diminished trust, we will, in appropriate circumstances, be requiring admissions in cases where heightened accountability and acceptance of responsibility are in the public interest. Admissions, given their attention-getting nature, also serve as a clarion call to other market participants to stamp out and self-report the misconduct to the extent it is occurring in their firm.    

Officer and director bars, likewise, are a critical tool in our efforts. The authority to impose them in cases involving scienter-based violations is broad and there is no legal requirement that the individual be an officer or director of a public company, or indeed a public company employee at all, for a bar to be appropriate.[18] Rather, when considering whether to recommend seeking a bar, we generally think about whether the individual is likely to have an opportunity to become an officer or director of a public company in the future. We also think about a number of factors that courts have laid out, although as courts have made clear, those factors are "neither mandatory nor exclusive."[19]

My point here is this: if there is egregious conduct and a chance the person could have the opportunity to serve at the highest levels of a public company, we may well seek an officer and director bar to keep that person from being in a position to harm investors again.

Another related tool we have to help prevent future misconduct is the conduct based injunction, which enjoins a defendant from engaging in specific conduct in the future. Conduct based injunctions can apply to a wide variety of areas, including restrictions on stock trading and participating in securities offerings. In the case I mentioned a moment ago against the attorney who facilitated the unregistered sales of securities by fraudsters, the settlement included a five-year conduct based injunction that restricts his ability to prepare opinion letters.[20] This sort of conduct-specific relief is key to preventing bad actors from repeating their misconduct.

Undertakings are also an important remedy aimed at future compliance with the securities laws. In certain cases, our settlements include undertakings that are tailored to address the underlying violations and affect future compliance, which can include limiting the activities, functions, or operations of a company. In addition, the Commission can require the settling party to hire an independent compliance consultant to review policies and procedures and to determine improvements that can prevent future misconduct. Where we see misconduct that has harmed investors, we will look hard at whether undertakings will be required to prevent that conduct - or similar conduct - from happening again.

You should expect to see us recommend aggressive use of these prophylactic tools to protect investors and the marketplace, and relatedly the public's trust that all institutions and individuals are playing by the same rule set. And we'll take a particularly hard look at whether we need to deploy these tools if the specific offender is a recidivist. When a firm repeatedly violates our laws or rules, they should expect that the remedial relief we seek will take that repeated misconduct into account. 

Trusting and Empowering SEC Staff

Before I close, I want to address another area where trust is key. And that is the trust that my Deputy Director, Sanjay Wadhwa, and I have in our colleagues. The SEC's Enforcement staff are extraordinarily talented and possess great experience and judgment. Sanjay and I want to empower them by, among other things, adjusting certain substantive decision-making processes around the Division. Sanjay will talk about some of these changes in more detail, but one that I'll mention relates to Wells meetings.

While I appreciate the importance of the Wells process, there are ways we can make that process more streamlined and efficient for everyone, starting with the Wells meeting itself. There are certainly cases that present novel legal or factual questions, or raise significant programmatic issues. In those cases the Director or Deputy should be directly participating in the Wells meeting, and there should be robust engagement. But many cases do not present such issues, and in those cases, I don't believe that it is a productive use of anyone's time for the Director or Deputy Director to sit in on a second or third meeting with defense counsel at the end of an investigation. In those circumstances, it is more efficient and appropriate for the Associate Director or Unit Chief to take the Wells meeting and engage in a dialogue, alongside the staff who are best positioned to assess the record.

Sanjay and I will still review Wells submissions, and we will, of course, still provide them to the Commission in connection with the related recommendations, but don't expect a meeting in each and every case. And when we do take a Wells meeting, there are certain things that will make those meetings more productive and efficient for everyone, as Sanjay will discuss in a moment.

There are also some well-established - but not always observed - rules about Wells submissions themselves that can lead to their rejection by the staff, such as attempts to limit their use or admissibility, or attempts to include a settlement offer, as you'll hear more about from Jonathan Hecht later in this panel's discussion.

* * *

The decline in public trust in our institutions is real and it hurts everyone. And it's our shared responsibility to address it. I've outlined the many steps that we're taking to do so, but I am confident that together we can do even more. Thank you for joining us today and I look forward to working with each of you on this collective endeavor.

= = = = =

[1] The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.

[2] See "Americans' Confidence in Major U.S. Institutions Dips" (July 14, 2021), available at https://news.gallup.com/poll/352316/americans-confidence-major-institutions-dips.aspx (finding that, in 2021, 33% of respondents have "a great deal" or "quite a lot" of confidence in banks; 29% in technology companies; and 18% in big business).

[3] See "Confidence in Institutions," available at https://news.gallup.com/poll/1597/confidence-institutions.aspx.

[4] See Press Release 2021-144, SEC Charges Ernst & Young, Three Audit Partners, and Former Public Company CAO with Audit Independence Misconduct (Aug. 2, 2021), available at https://www.sec.gov/news/press-release/2021-144; Press Release 2021-56, Auditor Charged for Failure to Register with PCAOB and Multiple Audit Failures (Apr. 5, 2021), available at https://www.sec.gov/news/press-release/2021-56; Press Release 2021-32, SEC Charges Two Former KPMG Auditors for Improper Professional Conduct During Audit of Not-for-Profit College (Feb. 23, 2021), available at https://www.sec.gov/news/press-release/2021-32; Press Release 2021-203, SEC Charges Investment Bank Compliance Analyst with Insider Trading in Parents' Accounts and Obtains Asset Freeze (Sept. 29, 2021), available at https://www.sec.gov/news/press-release/2021-203; Press Release 2021-181, SEC Charges Former Pharmaceutical Global IT Manager in $8 Million Insider Trading Scheme (Sept. 17, 2021), available at https://www.sec.gov/news/press-release/2021-181; Press Release 2021-158, SEC Charges Netflix Insider Trading Ring (Aug. 18, 2021), available at https://www.sec.gov/news/press-release/2021-158; Press Release 2021-103, Six Charged in Silicon Valley Insider Trading Ring (June 15, 2021), available at https://www.sec.gov/news/press-release/2021-103; Press Release 2021-112, SEC Charges Amec Foster Wheeler Limited With FCPA Violations Related to Brazilian Bribery Scheme (June 25, 2021), available at https://www.sec.gov/news/press-release/2021-112; Press Release 2021-124, SEC Charges SPAC, Sponsor, Merger Target, and CEOs for Misleading Disclosures Ahead of Proposed Business Combination (July 13, 2021), available at https://www.sec.gov/news/press-release/2021-124.

[5] Press Release 2021-145, SEC Charges Decentralized Finance Lender and Top Executives for Raising $30 Million Through Fraudulent Offerings (Aug. 6, 2021), available at https://www.sec.gov/news/press-release/2021-145.

[6] See Press Release 2021-147, SEC Charges Poloniex for Operating Unregistered Digital Asset Exchange (Aug. 9, 2021), available at https://www.sec.gov/news/press-release/2021-147; Press Release 2021-125, ICO "Listing" Website Charged With Unlawfully Touting Digital Asset Securities (July 14, 2021), available at https://www.sec.gov/news/press-release/2021-125.

[7] Press Release 2021-172, SEC Charges Global Crypto Lending Platform and Top Executives in $2 Billion Fraud (Sept. 1, 2021), available at https://www.sec.gov/news/press-release/2021-172; Press Release 2021-90, SEC Charges U.S. Promoters of $2 Billion Global Crypto Lending Securities Offering (May 28, 2021), available at https://www.sec.gov/news/press-release/2021-90.

[8] Press Release 2021-182, SEC Charges Crowdfunding Portal, Issuer, and Related Individuals for Fraudulent Offerings (Sept. 20, 2021), available at https://www.sec.gov/news/press-release/2021-182.

[9] Press Release 2021-176, SEC Charges App Annie and its Founder with Securities Fraud (Sept. 14, 2021), available at https://www.sec.gov/news/press-release/2021-176.

[10] See, e.g., 15 U.S.C. § 80b-4a.

[11] See, e.g., 15 U.S.C. § 78q(a).

[12] See, e.g., Fed. R. Civ. P. 37(e).

[13] See, e.g., Press Release 2021-169, SEC Announces Three Actions Charging Deficient Cybersecurity Procedures (Aug. 30, 2021), available at https://www.sec.gov/news/press-release/2021-169.

[14] See, e.g., Press Release 2021-154, SEC Charges Pearson plc for Misleading Investors About Cyber Breach (Aug. 16, 2021), available at https://www.sec.gov/news/press-release/2021-154; Press Release 2021-102, SEC Charges Issuer With Cybersecurity Disclosure Controls Failures (June 15, 2021), available at https://www.sec.gov/news/press-release/2021-102.

[15] See Litigation Release No. 25199, SEC Charges Attorney with Participation in Illegal, Unregistered Securities Offerings (Sept. 8, 20201), available at https://www.sec.gov/litigation/litreleases/2021/lr25199.htm.

[16] See Press Release 2021-144, SEC Charges Ernst & Young, Three Audit Partners, and Former Public Company CAO with Audit Independence Misconduct (Aug. 2, 2021), available at https://www.sec.gov/news/press-release/2021-144; Press Release 2020-115, SEC Charges Three Former KPMG Audit Partners for Exam Sharing Misconduct (May 18, 2020), available at https://www.sec.gov/news/press-release/2020-115.

[17] See Press Release 2021-56, Auditor Charged for Failure to Register with PCAOB and Multiple Audit Failures (Apr. 5, 2021), available at https://www.sec.gov/news/press-release/2021-56.

[18] See 15 U.S.C. § 77t(e); 15 U.S.C. § 78u(d)(2).

[19] SEC v. Bankosky, 716 F.3d 45, 48 (2d Cir. 2013).

[20] See Litigation Release No. 25199, SEC Charges Attorney with Participation in Illegal, Unregistered Securities Offerings (Sept. 8, 2021), available at https://www.sec.gov/litigation/litreleases/2021/lr25199.htm.

Thank you to the Texas Blockchain Summit for the chance to be here today.  I have to start with my disclaimer that my views are my own and not those of the Securities and Exchange Commission or my fellow Commissioners.  I am interested, however, in what my colleagues have to say, which is why Chair Gensler's habit of calling the cryptoverse the "Wild West" has captured my attention.[1]  He is not alone in referring to the crypto landscape as the Wild West, a place we imagine to have been lawless-a society in which the gunslinger with the best reflexes and worst morals wins at everyone else's expense.  Merriam-Webster defines the "Wild West" as "the western U.S. in its frontier period characterized by roughness and lawlessness."[2]  Bringing government into that kind of an environment to establish some order seems like a no-brainer.  Today, however, I will offer a different take on the Wild West and, with that picture in mind, suggest a way forward in crypto regulation.

The West of the past called to people who were chafing against the staid and stale societies of the East and looking to throw themselves into building a new future in a more promising place.  The Western frontier was a place for the adventurous, the rough around the edges, the idealists, the free-thinkers, and the restless.  I am from Ohio, which was once what the West meant to people coming from the states on the Eastern seaboard.  Reflecting that history, the part of Ohio I am from is called the "Western Reserve."[3]  My alma mater, not a military academy as some think, still carries the name of the region-Case Western Reserve University.  People from Connecticut settled the region in the early decades of the 19th century.  These settlers left the relatively well-populated and well-ordered Connecticut and moved West with big dreams to a stunningly beautiful and bountiful part of the country, but also one replete with dangers, disappointments, and difficulties.  Western life was rough at first, as described in The Western Reserve: The Story of New Connecticut in Ohio: "conditions were wretched during the first quarter of a century, and [] no improvement was likely to come without a transportation system and a supply of cash."[4]  Those things did come, and "[t]he enterprise and boundless energy which brought Moses Cleaveland[5] and his men to survey the wilderness and sustained the first settlers through the hard years in their clearings among the forests have never lagged or faltered."[6]  That spirit and energy became the basis for a thriving industrial, educational, and cultural hub in Ohio.[7]

I recently read a fascinating book by David McCullough, The Pioneers, which discusses the post-Revolutionary War settlement of another part of Ohio-Marietta-this time by people from Massachusetts.  He tells the story of the difficult journey West and the successes, disasters, dangers, and failures that shaped what eventually became a thriving community.  To these immigrants, the West offered hope and promise in contrast to the East, as McCullough explains:

Unprecedented financial panic had gripped the new nation since the end of the Revolutionary War.  The resources and credit of the government were exhausted.  Money, in the form of scrip issued by the government, was nearly worthless.  . . . Trade was at a standstill. . . . Farmers were being imprisoned for debt. . . . As it was, the severe economic depression that followed the war would last even longer than the war.  But out west now there was land to be had as never imagined-vast land, rich       land . . . West was opportunity.  West was the future.[8]

The settlers who moved West came not only with high expectations, but with a whole range of talents and professions.  They cultivated other skills by necessity after they had arrived.  The society was rougher than the one they had left, but nevertheless it was governed by the societal norms they had carried with them, by law, and by mutual concern heightened by the difficult conditions in the early years.  Even if they emulated the old Eastern society in many ways, these new frontier societies were created by their inhabitants.  McCullough describes, for example, the work by Marietta's leading citizens to ensure that Ohio was a free state and to develop educational institutions and make them accessible to the general population.  It was not, of course, all good in the West.  Ohio's very name-Iroquois for "Great River"-and the Native American names of many other places in Ohio serve as a reminder of the inhabitants who were forced out as immigrants from the East arrived. 

Ohio was the frontier in the early 19th century, but later in the century people were still looking West, further West, for opportunity.  John Soule wrote in the Indiana Express in 1851, "Go west, young man."[9]  Horace Greeley picked up this phrase fifteen years later, when he wrote: "Washington is not a place to live in.  The rents are high, the food is bad, the dust is disgusting and the morals are deplorable.  Go West, young man, go West and grow up with the country."[10]

Texas may come to mind more readily than my native Ohio when we think of the old West.  Here too, though, the Wild West was marked by more order than the movies would have us believe.  Andrew Morriss, who, after a stint at Case Western Reserve University, moved West and eventually ended up in Texas, researched the Wild West and identified numerous forms of effective private regulation, which were effective precisely because they faced competition.  He explained, for example, that Texas cattlemen, whose ranches were delineated by clear property lines, were able to "creat[e] order on their ranches."[11]  One ranch's code "prohibited cowboys from gambling, carrying six-shooters, keeping private horses, running game with [ranch] horses, drinking, and stealing cattle from other ranches."[12]  As detailed in an article titled "The -Not So Wild, Wild West," western order was not limited to ranchers imposing gambling bans on their cowboys, but also included an array of private organizations dedicated to maintaining order:

[I]t appears in the absence of formal government, that the western frontier was not as wild as legend would have us believe. The market did provide protection and arbitration agencies that functioned very effectively, either as a complete replacement for formal government or as a supplement to that government.[13]

These accounts do not paint a picture of perfect order, but they suggest that societal order does not always come from the public sector.  Morriss explained that frontiers foster private order: "The frontier is a difficult place.  Conditions are harsh, social capital is spread thin, and many of the institutions we take for granted are missing or scarce."[14]  Morriss then gives a shout-out to a noted economist and political philosopher Friedrich Hayek, noting that "Hayekian legal institutions flourished on the frontier, and were lost as civilization advanced.  This suggests that current frontiers are likely to foster Hayekian legal institutions."[15]

History did not allow us to see how these private arrangements would evolve to meet new challenges over time, for as Morriss further notes, "once there was wealth in the West, government's arrival was inevitable."[16]  Perhaps, then, it is inevitable on the crypto frontier too.

Let us turn our attention there now.  The crypto frontier, like the Wild West, appears pretty wild at first glance:  home to lots of codeslingers and speculators and some hucksters too, this new West also has its inter- and intra-protocol fights, friendships forged through shared difficulties and successes, colorful personalities, passions, dreams, hardships, spectacular failures, and remarkable victories.  But as in the West of the past, there is order and discipline in all of that rough and tumble.  Because crypto is built on code, the code itself serves as a governor of conduct.  But crypto is built on people too, and these people hold each other accountable not only through unbridled public discourse, but through using or not using a protocol.  Protocol users, competitors, bug bounty hunters, and sophisticated skeptics monitor protocols for hints of centralization, administrator keys vulnerable to compromise, slow speed, high costs, lax security, and so forth. A system outage, rugpull, insider trading incident, or exposed flaw in the code gives rise to an inevitable firestorm.  Decentralized communities collectively figure out how to deal with unanticipated problems.  These cooperative and competitive disciplining mechanisms have helped to clean up the crypto frontier though there is more work to be done.  The persistence of both self-regulation and calls by the crypto community for clarity from government regulators suggest that lawlessness is not the prevailing culture of the crypto frontier.

On the other hand, ironically, our gunslinging ways in the old, supposedly staid, government regulatory world back East are causing people to question our commitment to the rule of law.  Let me explain by raising several questions about our regulatory approach to date.  I will conclude by suggesting that it is not too late for government regulators to set clear rules that respect the unique attributes and challenges of life on the crypto frontier.

I. Is There Really Legal Clarity Around Digital Assets?

A fundamental area of conflict between the SEC and the public is how much legal clarity there is around digital assets.  The safe harbor I proposed for token distribution events acknowledges there is uncertainty about when crypto asset offerings implicate the securities laws,[17] but the prevailing attitude at the SEC is that there is clarity, so why bother with a safe harbor?

The idea that there is clarity as to when crypto assets are securities must come as a surprise to the lawyers advising crypto projects that have struggled with this issue for years.  Take, for example, the public feedback we received relating to the Commission's statement regarding the custody of digital asset securities by broker-dealers, which distinguishes between "digital asset securities" and "non-security digital assets," the latter of which we will not permit to be custodied by special purpose broker-dealers.[18]  In response, many commenters asked for clarity on what constitutes a "digital asset security" and asserted that it would be unfair to expect a broker-dealer to conduct the analysis given the lack of clarity.[19]  Moreover, if clarity means that essentially all tokens are to be deemed securities, then why even establish a Commission positon on special purpose broker-dealers at all?  

II. Are We Enforcing Rules by Settling or Settling for Ambiguity?

The SEC points to Supreme Court precedent[20] and our own growing list of enforcement actions and says the case is closed-most digital assets are securities.  Even if we were to accept enforcement as a proper way to provide clarity, it is not working.  Definitive determinations of security-ness have only occurred in the few instances in which a court (rather than the Commission) has decided the matter.[21]  Even in those instances, a determination that a token was offered initially as a security does not say anything about the token itself being a security, either at the time of the initial sale or in secondary transactions. 

Most of our crypto enforcement actions, however, have not been litigated actions; rather they have ended in settlements, which are not good vehicles for careful legal analysis.  When a party settles an SEC enforcement action, it often is trying to get the case wrapped up so it can move on.  It has no incentive to force the SEC, as a condition of the settlement, to lay out a clear legal analysis.  In cases when a platform is involved, the SEC generally states only that some of the digital assets were securities without specifying which ones are or why.  Commissioner Elad Roisman and I raised this issue in conjunction with the Coinschedule settlement.[22]  Perhaps this approach is understandable since the parties to the settlement might not include the parties with the keenest interest in the security/non-security status of that token.  Nevertheless, if the SEC cannot easily articulate an unassailable legal theory for why particular assets are securities, is the line as clear as the SEC maintains it is?  The ambiguity ultimately serves us well because it effectively forces any actor with any connection to digital assets into our regulatory jurisdiction. 

III. Are We Fighting for Investors or Fighting for Jurisdiction?

As stablecoins grow in popularity, they are drawing increasing interest from an array of regulators jockeying for regulatory position.  Should stablecoin issuers be registered as banks?  Should stablecoins be backed by deposit insurance?  Should stablecoins be designated as systemically important by the Financial Stability Oversight Council?  Are stablecoins money market funds?  Should the Consumer Financial Protection Bureau step in to protect consumers? 

Given the stunning growth of stablecoins, regulators understandably are asking whether they fit into an existing regulatory framework and what their consumer protection and long-term financial stability implications are.  As they undertake this inquiry, however, I hope they will do so with an appreciation for the following:

1. Many people find stablecoins to be a convenient payments tool that facilitates the movement and exchange of cryptocurrencies, so any regulatory step that would curtail the use of stablecoins must be justified by a benefit that outweighs the lost convenience.
2. Regulators should be careful with broad generalizations since stablecoins are not uniform in operation, peg, underlying reserves, or transparency.
3. Overly broad application of the law to capture stablecoins inadvertently might capture other products and services.
4. Attempts to dismiss stablecoins by drawing on the experience with 19th century private bank notes are based on a misunderstanding of both.[23] 
5. While trying to understand stablecoins is fine, stablecoin fear is unwarranted.  As Federal Reserve Vice Chair Randal Quarles explained:

[W]e do not need to fear stablecoins. The Federal Reserve has traditionally supported responsible private-sector innovation. Consistent with this tradition, I believe that we must take strong account of the potential benefits of stablecoins, including the possibility that a U.S. dollar stablecoin might support the role of the dollar in the global economy.[24] 

IV. Are We Protecting Investors or Denying Investors Opportunity?

Embedded within the negative Wild West analogy for the crypto-frontier is a concern that unwitting and unwilling investors are being harmed by participating in the crypto markets.  To those who do not view the opportunity to participate in these markets as valuable, the lack of regulatory clarity in the United States could actually be a way of protecting investors from harm: If ambiguity prevents them from participating, so much the better!  From this perspective, that some projects and platforms, for example, exclude Americans because of regulatory uncertainty is actually a good thing.  It is only the projects that fail to keep Americans out that face enforcement actions.[25]   

Widespread geoblocking of Americans should concern American regulators even if it does lighten their regulatory load.  Consider, for example, recent well-publicized examples of airdrops that excluded Americans.  An airdrop is essentially a free allocation of tokens to, for example, participants in a network.  These tokens are a way of rewarding network participants.  Why would we want US participants to be excluded from receiving the reward due them?  Take a look at Twitter after one of these airdrops- the SEC is not being thanked. 

Whether by slow-walking product approvals or directly disapproving products using creatively applied standards, regulators can make certain products unavailable to investors.  The Commission's approach to pooled crypto investment vehicles illustrates the problem.[26]  The currently available product offerings-including over-the-counter products and mutual funds with limited exposure to crypto futures, ETFs with exposure to the crypto industry, and public companies holding crypto on their balance sheets-are less direct, less convenient and more expensive for investors than the spot-crypto-based exchange-traded products offered in other countries.  From the perspective of a regulator who does not really like the product anyway, nothing is lost.  The investor, however, loses an opportunity to participate that is worth something to her even if she chooses not to buy the particular product; just having the option of doing so is valuable.  As C.S. Lewis noted, "Of all tyrannies, a tyranny sincerely exercised for the good of its victims may be the most oppressive . . . This very kindness stings with intolerable insult."[27]

V. Are We Going to Pretend Everything is Centralized So We Can Regulate It?

Chair Gensler has pointed out correctly that labeling something decentralized does not necessarily make it so.  We saw this phenomenon at play in a recent purported DeFi enforcement action, which charged a company and two top executives that ran an illegal offering.[28]  And maybe it was at play to a lesser degree in a case from several years ago against the creator of a decentralized trading venue that had some centralized features.[29]

But what happens when we are dealing with a protocol that facilitates peer-to-peer or person-to-code transactions without a centralized intermediary?  Is there anyone who could be held liable in a manner consistent with the rule of law and our constitutional principles? Can we hold responsible the developer of an open-source protocol for how others use it or what others layer on top of it? 

Perhaps we should not even get to these questions.  After all, if people avail themselves of an automated market maker to exchange crypto, have they not done so with an appreciation that it is the code that determines how that trade will happen and that nobody stands ready to reverse a bad trade?  Truly decentralized platforms do not mesh well with a regulated approach designed for centralized finance.  As one commentator observed, "So, every time they say 'the platform must do this' 'the platform must do that' -- [what] does it mean?! Implicitly, the only way of understanding these comments is an interpretation of securities market regs as being about what kind of software is allowed to be written-this won't fly."[30]  

As it turns out, lots of people want to deal with centralized intermediaries in the crypto space.  We can regulate those entities if they engage in securities activities (assuming, of course, we make it possible for them actually to do business within our regulatory framework), but DeFi protocols with which people choose to interact ought to be viewed through a different lens.  Treating DeFi differently would, in the words of attorney Collins Belton, make "[t]he SEC [] probably the best motivator of making something truly decentralized."[31]  And that would not be a bad thing for crypto, which, after all, prides itself on decentralization.

VI. Are We Catching Bad Actors or Creating a Catch 22?

The good actors want to know which digital assets are securities so they can figure out how to comply with the securities laws, but we have done little during my nearly four years on the Commission to explain what that would look like.  I lay the blame on myself and my colleagues on the Commission.  We simply have not allowed staff the latitude to consider the hard questions around how crypto can operate within the securities framework.  The way forward is not to drag entities in to the Commission through enforcement actions and brute force them into a regulatory regime that is not actually well-suited for them.  Rather, we should take a methodical approach, one that provides answers to the key questions to which market participants need answers. 

In a dissent in an enforcement action against crypto trading platform Poloniex, I laid out a paradox-deeming digital assets to be securities means that platforms that trade them and entities that intermediate them have to register with us, but they cannot operate as a registered entity under our existing rules so they would not be able to register.[32]  In that dissent, I called for answers to a number of questions, which I think bear repeating here because they give a sense of the complexity that arises once at least one digital asset trading on a platform is deemed to be a security:

1. Can the platform custody client assets, a feature typical of centralized crypto trading platforms?  If so, how, given our concerns about custody of digital asset securities?
2. If not, could a sufficient number of broker-dealers navigate the registration process to make a liquid market?
3. Would the conditions placed on their registration permit them to function as market makers or to facilitate trading on behalf of retail investors?
4. Can the platform trade non-securities alongside securities? If not, how can the platform, using two entities-a broker-dealer entity for digital asset securities, and an affiliated non-broker-dealer entity for non-securities, offer a seamless, or at least serviceable, trading platform to customers, who are likely, for example, to want to trade both digital assets and digital asset securities and pay for transactions in digital asset securities using non-security digital assets?
5. How can a trading platform and its customers determine whether a particular digital asset is a security?
6. If a token was sold in a securities offering as part of an investment contract, how long must secondary transactions in that token be deemed to be securities transactions by platforms trading the tokens?
7. What are the mechanics of registering tokens sold as part of an investment contract as a class of "equity security" under the Exchange Act?

And there are others that I did not mention in that dissent.  For example: How can a broker-dealer or trading venue work with digital asset securities alongside non-security digital assets and non-digital securities?[33]  How does Securities Investor Protection Act coverage work when a broker-dealer engages in digital assets?  What is the appropriate role, if any, of a transfer agent with respect to digital asset securities?  Who can custody digital assets consistent with the securities laws?  Should the Financial Accounting Standards Board address crypto accounting issues?  How does a platform that finds itself trading securities, due to new definitional clarity around digital asset securities (assuming that clarity comes at some point), finds itself trading digital asset securities come into compliance? 

If we intend to demand registration of entities in the crypto space, we have to give our staff the permission to do the hard work of figuring out how the rules will apply given the unique aspects of the business and to seek broad public input through a transparent regulatory (not enforcement) process in doing so. 

Conclusion

These questions are intended to spur a deeper cross-government commitment to searching for sensible regulatory solutions.  The stakes are high because the government is riding into crypto town with the promise that it can do a better job than the existing informal disciplinary mechanisms.  We do have regulatory experience that we can bring to bear here, but we have to do so carefully.  As government agencies consider how to regulate, they ought to take their lead from Congress, work collaboratively with one another, and actively consult the public who will be subject to and protected by the rules.  I might approach this whole endeavor with a less strict hand than some of my fellow regulators, but the real question is not what I or any other regulator wants, but what you the people-the intended beneficiaries of this regulation-want.  I am eager to see what you accomplish on the crypto frontier once we set some sensible, clear regulatory parameters.

To paraphrase the standard closing words of a popular crypto podcast, which follow an appropriate warning about the riskiness of the space, "[You] are headed West.  This is the frontier.  It's not for everyone. . ."[34]  Thank you for allowing me to drop in on your journey West.

= = = = =

 

[1] See, e.g., Chair Gary Gensler, Remarks Before the Aspen Security Forum, SEC (Aug. 3, 2021), https://www.sec.gov/news/public-statement/gensler-aspen-security-forum-2021-08-03 ("Right now, we just don't have enough investor protection in crypto. Frankly, at this time, it's more like the Wild West.").

[2] Wild West, merriam-webster (11th ed. 2003).

[3] See, e.g., @Petrarch1603, A Map of the Connecticut Western Reserve (1798), Reddit (Mar. 10, 2019), https://www.reddit.com/r/Ohio/comments/azglji/
a_map_of_the_connecticut_western_reserve_1798/.

[4] Harlan Hatcher, The Western Reserve: The Story of New Connecticut in Ohio 73 (1949).

[5] The City of Cleveland bears his name minus the extraneous "a".

[6] Hatcher, supra note 4, at 307.

[7] Id. at 307-8.

[8] David McCullough, The Pioneers: The Heroic Story of the Settlers Who Brought the American Ideal West 8-9 (2019).

[9] John Bartlett, Bartlett's Familiar Quotations 554 (15th ed. 1980).

[10] Id.; Go West, young man, Wikipedia, https://en.wikipedia.org/wiki/Go_West,_young_man (last modified June 30, 2021) (attributing "Go west, young man" to Horace Greeley, New-York Daily Tribune, July 13, 1865).

[11] Andrew P. Morriss, Hayek and Cowboys: Customary Law in the American West, 1 N.Y.U. J. of L. & Liberty 35, 46 (2005).

[12] Id. at n.52 (citing J. Evetts Haley, The XIT Ranch of Texas and the Early Days of the Llano Estacado 116 (1953)).

[13] Terry L. Anderson & P.J. Hill, An American Experiment in Anarcho-Capitalism: The -Not So Wild, Wild West, 3 The J. of Libertarian Stud. 9, 27 (1979).

[14] Morriss, supra note 11, at 63.

[15] Id.

[16] Id. at 62.

[17] Commissioner Hester M. Peirce, Token Safe Harbor Proposal 2.0, SEC (Apr. 13, 2021), https://www.sec.gov/news/public-statement/peirce-statement-token-safe-harbor-proposal-2.0.

[18] Custody of Digital Asset Securities by Special Purpose Broker-Dealers, 17 C.F.R. §240 Release No. 34-90788 (Apr. 27, 2021), https://www.sec.gov/rules/policy/2020/34-90788.pdf.

[19] See e.g., Letter from Charles De Simone, Securities Industry and Financial Markets Association (May 20, 2021) ("The Statement places a burden on SPBDs to find evidence or arguments for why a digital asset is or is not a security where there is unlikely to be a definitive answer, as the SEC has acknowledged by not itself providing unequivocal guidance as to how determine when a digital asset is a security."), https://www.sec.gov/comments/s7-25-20/s72520-8819436-238123.pdf; Letter from Ron Quaranta, The Wall Street Blockchain Alliance (Apr. 27, 2021) ("We encourage the SEC to formally propose rulemaking that would clarify for all participants engaged in digital asset securities, the role of marketing activities in determining whether a product is in fact a security, and which would provide further guidance on the treatment and classification of digital assets."), https://www.sec.gov/comments/s7-25-20/s72520-8734174-237103.pdf; Letter from Benjamin Kaplan, Prometheum (Apr. 26, 2021) ("As a result, we believe clarity is needed for Special Purpose Broker-Dealers, issuers, ATS' and other market Participants . . . to understand the regulatory framework they must comply with. Therefore, we respectfully request that the Commission provide further clarification on the definition of digital asset securities.), https://www.sec.gov/comments/s7-25-20/s72520-8734178-237104.pdf.

[20] See Reves v. Ernst & Young, 494 U.S. 56 (1990); SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[21] See SEC v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020); SEC v. Telegram Grp. Inc., 448 F. Supp 3d. 352 (S.D.N.Y. 2020).

[22] Commissioner Hester M. Peirce & Commissioner Elad L. Roisman, In the Matter of Coinschedule, SEC (July 14, 2021), https://www.sec.gov/news/public-statement/peirce-roisman-coinschedule.

[23] For a discussion of these issues, see George Selgin, The Fable of the Cats, Alt-M (July 6, 2021), https://www.alt-m.org/2021/07/06/the-fable-of-the-cats/; David Beckworth, Larry White on Stablecoins, Money Market Funds, and the History of Free Banking, Mercatus Ctr. (Aug. 2, 2021),  https://www.mercatus.org/bridge/podcasts/08022021/larry-white-stablecoins-money-market-funds-and-history-free-banking. 

[24] Randal K. Quarles, Parachute Pants and Central Bank Money, Fed. Rsrv. (June 28, 2021), https://www.federalreserve.gov/newsevents/speech/quarles20210628a.htm.

[25] See, e.g., In the Matter of Blotics Ltd. f/d/b/a Coinschedule Ltd., Securities Act Release No. 10956 (July 14, 2021), https://www.sec.gov/litigation/admin/2021/33-10956.pdf.

[26] The following podcast offers a helpful primer on the different types of pooled vehicles: Greg Xethalis, The Encrypted Economy with Eric Hess: How Are Crypto Funds Regulated In The U.S.? (Oct. 4, 2021), https://theencryptedeconomy.com/podcast/how-are-crypto-funds-regulated-in-the-u-s-greg-xethalis-general-counsel-for-multicoin-capital/.

[27] C.S. Lewis, God in the Dock: Essays on Theology and Ethics (1970) ("It would be better to live under robber barons than under omnipotent moral busybodies.  The robber baron's cruelty may sometimes sleep, his cupidity may at some point be satiated; but those who torment us for our own good will torment us without end for they do so with the approval of their own conscience.").

[28] In the Matter of Blockchain Credit Partners d/b/a DeFi Money Market, Securities Act Release No. 10961 (Aug. 6, 2021), https://www.sec.gov/litigation/admin/2021/33-10961.pdf.

[29] In the Matter of Zachary Coburn, Exchange Act Release No. 84553 (Nov. 8, 2018), https://www.sec.gov/litigation/admin/2018/34-84553.pdf.

[30] Gabriel Shapiro (@lex_node), Twitter (Sept. 1, 2021, 8:20AM), https://twitter.com/lex_node/status/1433042004984881153.

[31] Collins Belton, Unchained Podcast: How the Greatest Decentralizing Force for Crypto Projects Is the SEC (Oct. 5, 2021), https://unchainedpodcast.com/how-the-greatest-decentralizing-force-for-crypto-projects-is-the-sec/.

[32] Commissioner Hester M. Peirce, In the Matter of Poloniex, LLC, SEC (Aug. 9, 2021), https://www.sec.gov/news/public-statement/pierce-statement-poloniex-080921.   CFTC Commissioner Dawn Stump recently raised similar concerns about the need for clarity about how the rules will apply if the CFTC is going to require registration.  See Commissioner Dawn D. Stump, Concurring Statement Regarding Enforcement Action Against Payward Ventures, Inc. (d/b/a Kraken), CFTC (Sept. 28, 2021), https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement092821b ("I believe that if the Commission is going to hold an exchange liable for operating as an unregistered FCM with respect to retail commodity transactions, it is incumbent upon the Commission to explain in a transparent manner the relevant legal requirements for such an entity that seeks to register as an FCM and how the Commission will apply them in enabling the entity to conduct business with U.S. customers.").

[33] See e.g., Letter from Amy Kim, Digital Chamber of Commerce (Apr. 5, 2021)("Precluding broker-dealers from custodying non-security digital assets will impinge the ability of firms to settle trades in digital asset securities and make it more costly for them to interact with digital asset securities on-chain."), https://www.sec.gov/comments/s7-25-20/s72520-8634796-230930.pdf; Letter from Alan Konevsky, tZERO Group, Inc. (Apr. 7, 2021) ("We suggest that the Commission not create unusual and unnecessary product-specific industry silos, and, instead, permit special purpose broker-dealers to offer their customers access to traditional and digital asset securities."), https://www.sec.gov/comments/s7-25-20/s72520-8648975-231028.pdf; Letter from Charles De Simone, Securities Industry and Financial Markets Association (May 20, 2021) ("The establishment of an SPBD goes further, resulting in a trifurcated market between digital and traditional securities, and further, non-security digital assets. This trifurcation creates obstacles for broker-dealers and customers alike."), https://www.sec.gov/comments/s7-25-20/s72520-8819436-238123.pdf.

[34] Bankless: Weekly Rollup, YouTube, (Oct. 8, 2021), https://www.youtube.com/watch?v=TA_Oqoo6qWs.

[C]laimant provided significant information that prompted the opening of the investigation by the Commission staff, participated in multiple interviews with Commission staff, and continued to provide helpful information over a two year period.

• Securities Industry Commentator
• Bill Singer