In three recent speeches, SEC Commissioner Hester Peirce continued to proclaim her support for technological innovation and freedom in capital markets. On September 12, 2018, Ms. Peirce gave a speech at the Cato Institute’s FinTech Unbound Conference which she titled Motherhood and Humble Pie, on September 24 she spoke at the University of Michigan Law School titling her speech Wolves and Wolverines, and then on October 2 she spoke at the Financial Planning Association 2018 Major Firms Symposium, calling that speech Pickups and Put Downs. Besides the great titles, I applaud her content and perspective.
Motherhood and Humble Pie
A prevailing theme in all three speeches centered on her dissent to the SEC’s rejection of an exchange traded product or mutual fund. As an aside, since I wrote this blog on the SEC’s published concerns related to a cryptocurrency-related exchange traded product or mutual fund, HERE, the SEC has continued to deny several more applications for such a product.
As the title of her first speech in the series indicates, she uses motherhood as a metaphor to express her view that the SEC has been acting like a helicopter mother as opposed to a free-range mother, by refusing to let its “children” take risks by exploring new financial products that involve cryptocurrencies. In one of my favorite lines in her speech, she states, “[B]etter, we naturally think, not to allow the investor to leave the house, even for a quick trip down the street, unless properly helmeted, swaddled in regulation protective gear, and strapped into a vaguely European-branded car seat that is secured exactly in the center of the back seat of the largest SUV that an upper-middle class professional’s salary can buy.”
Certainly there is risk that investors will lose money and that there will be backlash against the regulatory body for failing to put proper protections in place, but Ms. Peirce thinks that the free-market environment should support such risk. Regardless of the level of regulatory protection, there will always be investor losses. Companies will fail, fraudsters will cheat and markets will downturn. Furthermore, capital markets are, by nature, risky. As Ms. Peirce notes, “[A] key purpose of financial markets is to permit investors to take risks, commensurate with their own risk appetites and circumstances, to earn returns on their investments.”
Ms. Peirce opines that the protection against the risk of cryptocurrency investments could go beyond the SEC’s actual authority. Congress has not empowered the SEC with eliminating risk or substituting the SEC’s investment judgment for that of an investor. The SEC also does not have the authority to regulate or require regulation of assets underlying securities, including digital assets. As I’ve written about in my blogs several times, the SEC regulatory framework centers around disclosure and not a merit review. For example, the SEC does not have the power to prohibit a registration statement from going effective if the disclosures are complete and compliant with Regulations S-K and S-X, regardless of how terrible the investment may be.
Specifically, the SEC’s high-level mandates are to protect investors, facilitate capital formation and maintain fair, orderly and efficient markets. For more on the SEC’s purpose, see HERE. Ms. Peirce believes this mandate requires the SEC to ensure that investors have access to products to allow them to create their own investment portfolios, including with new and expanding asset classes such as cryptocurrencies.
People already invest in cryptocurrencies, but they must do so through direct purchases on various exchanges, outside of their regular investment accounts. The individual investor is charged with keeping records and having a certain technical know-how to play in this marketplace. It is clear that there is a strong interest among investors to access this new type of investment, and for it to be available via exchange traded products, thus the consistent new applications by industry institutions.
Ms. Peirce lists five lessons that the SEC should learn when considering cryptocurrency products and technological innovation. In particular:
- The SEC should avoid supplanting its own judgment with that of investors’ and avoid attempting to ascertain the viability of new technology in advance of its release in the marketplace as long as proper disclosures are in place.
- The SEC’s efforts to protect investors from the risks of innovation will not change the desire for the marketplace to have access to these products and instead will cause investors to seek investment opportunities in other countries and markets that may be even less regulated than the US markets.
- The SEC must be more accessible and willing to engage with entrepreneurs and market participants seeking to bring cryptocurrency products to market. Furthermore, the SEC needs to provide clear and reasonable rules for innovators.
- The SEC needs to commit to expanding investor access to financial markets, including through innovative technology. Innovation does not just mean cryptocurrency products but includes mobile access to investment products, online disclosures, and all fintech.
- The SEC has to consider the resources it requires in meeting regulatory burdens, including financial, coding and data analytics. These regulatory burdens take away resources that could be used on customer-serving innovation and stifle smaller businesses from pursuing technological innovation.
Ms. Peirce ends with calling for an SEC Office of Innovation, a request that was granted. On October 18, 2018, the SEC launched its new Strategic Hub for Innovation and Financial Technology (FinHub), which is a topic for an upcoming blog.
Wolves and Wolverines
Commissioner Peirce’s September 24 speech at the University of Michigan Law School focused on arbitration between public companies and their shareholders and my favorite topic, digital assets. Solidifying me as a fan even more, Ms. Peirce begins by pointing out that corporate law is a form of public interest law, noting that “[T]he hunt for profit drives companies to strive to identify and meet people’s needs using as few resources as possible.” The corporate ecosystem, including dealing with customers, supplies, creditors, shareholders, employees and communities, requires mutual responsibility and an obligation to exercise sound judgment and respectable ethics.
This sentiment, however, acted as a segue to discuss the fact that failures in corporate ethics, such as the Enron scandal, have resulted in a more conservative SEC and regulatory regime. Repeating her earlier speech, Ms. Peirce conveys her views that the SEC should not be substituting its judgment for that of the investment community. Rather, the SEC should be ensuring that the regulatory framework requires proper disclosure so that investors can make an informed decision, whether it be to trade in particular stocks or products on the public markets, or invest in a private company with “world-changing ideas.”
In addition to her views on access to cryptocurrency, Ms. Peirce has been targeted by pro-regulatory enthusiasts for her statement on mandatory arbitration in the corporate context. In particular, in response to a reporter’s question, she answered that she supports mandatory arbitration since shareholder litigation is expensive and costs all shareholders regardless of the merits of the claims. Arbitration can be more effective, quicker and less costly. Despite the fact that the topic of arbitration between corporations and their shareholders is within the jurisdiction of state corporate law, the SEC could exert its influence by using public policy to affect the ability of a company to register securities if it has an offending policy. Ms. Peirce is consistent with her conviction that on this topic, as with others, the SEC should not impose its judgment on such free-market matters but rather leave it to supply, demand and the investors’ own due diligence.
Ms. Peirce then turned to the topic of cryptocurrency-related exchange traded products and mutual funds. She reiterated much of her sentiment from her prior speech, spending even more time on her concern that the regulatory treatment of cryptocurrencies will stifle all technological innovation in the capital markets, not just those related to digital assets.
Ms. Peirce also impressively took on the question as to whether she thinks all ICOs involve the offering of securities and whether a token security can become a non-security (utility) thereafter. Although months earlier William Hinman, the Director of the SEC Division of Corporation Finance, had expressed his views that a token can become a utility or non-security (see HERE), Commissioner Peirce hedged on the answer but left the impression that she may lean toward continuing to view cryptocurrencies as securities over the long term. Interestingly, although she is very clear that she does not support any merit review, no matter how veiled behind investor protection, she also seems to support some new regulatory structure that would cover digital assets through a longer period of time, while fostering and allowing development and market testing.
Pickups and Put Downs
On October 2, Commissioner Peirce spoke at the Financial Planning Association 2018 Major Firms Symposium. Although Commissioner Peirce stays true to her belief in a more technology- and innovation-friendly SEC, this speech was geared towards its audience and concentrated on the fund management marketplace.
Of course, she could not resist expressing her disappointment with the SEC for denying cryptocurrency-related exchange traded products, stating that “[T]he regulatory process can be a formidable roadblock to the development of new products that could provide investors with more diversity and protection in their investment portfolios.” Ms. Peirce believes the SEC should be less concerned with the volatility and risk associated with a cryptocurrency investment, which involves an investor’s personal decision as long as they have proper disclosure, and instead consider.
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