Originally published by Capitol Account
Cromwell Coulson runs the OTC Markets Group, where about 12,000 over-the-counter securities trade. The job has made him a scholar of financial regulation, especially the deep-in-the-weeds SEC (and self-regulator FINRA) rules governing broker-dealers and secondary markets. Among his bona fides, he’s been the chairman of FINRA’s Market Regulation Advisory Committee. OTC Markets also operates SEC-registered Alternative Trading Systems. Today, we’re running an op-ed (the first in Capitol Account) he’s written about an issue that’s been dominating the news lately, and one he’s thought a lot about: how to regulate cryptocurrencies. His expertise merits listening to, especially as federal agencies and Congress try to sort out this complex issue.
Several of the biggest digital asset trusts, including funds of Grayscale, Bitwise and Osprey, trade on the OTC markets, as do all sorts of stocks – and not all are blue chips. (This is not so dissimilar from many of the tokens out there). To protect investors, Coulson has become a strong proponent of disclosure. Most important, he says, is giving potential investors information about the shares a company has issued to owners and affiliates, as well as providing details about insider sales. “Our whole view is that regulation shouldn’t be one-size-fits-all,” he says. “The goal is to be able to get companies to provide the right amount of disclosure to level the playing field and reduce information asymmetries.”
In the crypto arena, Coulson argues, that means using the existing broker-dealer regulatory framework for platforms that sell digital assets. And, he points out, there is already a longstanding set of rules that exist. Brokers have to follow anti-money laundering rules, for example. They have to keep clients’ funds segregated. There’s the Securities Investor Protection Corp. to help customers if their cash or securities goes missing.
As you’ll see in his article below, Coulson sees this regime as the best way to bring digital tokens into the regulatory system. That means crypto should be considered a security, and that investors’ trading should be done through broker-dealers. The big crypto exchanges – Coinbase, Gemini and others – should really be considered brokers with an alternative trading system attached, he says. Then the SEC and FINRA rules would apply. “If crypto was consistently regulated as securities, we’d solve all these investor protection issues,” Coulson says.
The plan seems destined to be opposed by most of the crypto industry, which has spent a lot of time (and lobbying money) arguing that securities laws developed in the 1930s shouldn’t apply to a new and rapidly changing technology. It also conflicts with the bipartisan legislation that was introduced this week by the Senate Agriculture Committee, which sets up the CFTC as crypto’s main regulator. (Of course this is the panel essentially talking its own book, since it oversees the commodities watchdog. And it reflects some big industry players’ desire to be monitored by the much smaller agency.)
The SEC may be wise to take a close look at Coulson’s proposal. He points out that the agency needs to make an effort to bring the token universe under its umbrella. Regulated broker-dealers like Robinhood offer crypto trading, but through subsidiaries. The SEC needs to adjust some of its rules so firms are comfortable moving the business to their brokerage arms, Coulson notes.
There’s one other advantage to the proposal – most of it can be done without Congress. Though he does say Congress could speed the process and provide some clarity if lawmakers want to weigh in. Here’s Coulson’s plan, in his own words:
It’s Time to Dot the “I’s” and Create Regulatory Clarity for Crypto Investors
By Cromwell Coulson
We had the boom. Now comes the bust. Major U.S.-based crypto investing platforms are freezing customer assets and filing for bankruptcy. Whether you call it Crypto Winter or a crisis of confidence, it’s time to bring in crypto from the wild. Washington must define the rules of the road, protect the public’s interests, and establish baseline operational standards for continued digital investment and innovation.
At OTC Markets Group, we have seen the growing investor demand for crypto investment products. We operate the public markets for some of the world’s largest digital asset trusts. These securitized products help investors gain exposure through broker-dealers and investment advisors that operate within a robust framework of state and federal securities laws. At the same time, issuers provide current disclosure, and their insiders are subject to anti-fraud rules.
Most crypto investing takes place outside any federal regulatory framework. Congress has not determined what makes digital assets a security or a commodity. This inaction has created a lack of clarity on what rules will apply and whether the CFTC or the SEC should lead oversight of market participants.
We sit at the intersection of crypto and the traditional capital markets. In our experience, the SEC’s broad anti-fraud, investor protection and market integrity rules are particularly well-suited to provide a robust and trusted regulatory framework. Here’s why:
Unlike commodities futures trading, crypto is decentralized. Investors use competing intermediaries offering fractional interests in the same fungible product. This is akin to securities trading, where investors trade at competitive prices through any registered broker-dealer.
The SEC’s Exchange Act and associated FINRA SRO rules robustly regulate secondary markets. These regulations aim to ensure intermediaries, insiders, and issuers treat investors fairly. The core principles and procedures embedded within these rules could solve many of crypto’s current problems.
The SEC and FINRA ensure market integrity by regulating intermediaries. Retail brokers can only make investment recommendations in the customer’s best interest, must obtain best execution, and meet net capital requirements. Brokers acting as custodians have strict processes to safeguard and segregate customer funds. Markets in turn must provide fair and equitable access to all participants and adhere to security and system integrity requirements. The SEC has a proven track record, including robust inspection regimes that would benefit reputable crypto market participants.
Under the securities framework, digital asset intermediaries would register as broker-dealers. Regulators could then provide exemptions to fit digital assets into established brokerage, clearing and custody operations. In 2008, FINRA issued guidance reminding member firms that market regulation rules apply to “all of the business of a broker-dealer, not only to its securities and investment banking business.” Trading digital assets through regulated broker-dealers would immediately benefit crypto investors with these same protections.
Crypto markets have recently seen allegations of insider trading and secondary market distributions by insiders. Lack of regulatory clarity on crypto control person and affiliate responsibilities has allowed instances of insider trading. Accusations include undisclosed “whales” dumping their holdings and rampant promotional schemes occurring across messaging apps and social media platforms. These are not new problems. Over the past 90 years, the SEC has developed robust insider trading and disclosure rules. Regulators aim to ensure that insiders and paid promoters cannot fly under the radar and manipulate the public market. Clear definitions of who is an affiliate, dealer or statutory underwriter provide additional clarity. FINRA-regulated broker-dealers have established KYC and AML gatekeeper processes to detect affiliate trading and prevent unregistered distributions.
The securities law framework imposes enhanced requirements on those who have the power, influence, or control to manipulate the public market, including corporate officers, directors, large shareholders and paid promoters. Under SEC regulation, large stakeholders and insiders with informational advantages must limit buying and selling activity and disclose their transactions. These rules help protect investors from pump-and-dump schemes, insider trading and other fraudulent practices.
Comprehensive intermediary and insider rules would allow securities regulators to be flexible in establishing ongoing disclosure requirements for crypto issuers. The SEC can acknowledge where the disclosure requirements for digital assets and DeFi organizations should differ from those of a traditional corporate entity. Companies and funds offering investment opportunities to the public must be truthful and transparent about their businesses and the risks involved in investing. This framework reduces information asymmetries and provides investors with a standardized baseline of information.
Unlike static commodities and currencies, many crypto projects and DeFi organizations are dynamic. The importance of ongoing insider and issuer disclosure will become clearer as projects mature, new features emerge and/or governance moves from proof of work to proof of stake. The more complex entities become, the higher the requirements for ongoing disclosure. Crypto disclosure rules need the flexibility to handle digital enterprises at all stages.
The SEC and FINRA have an opportunity to demonstrate why their regulatory framework best serves investors. Success requires a pragmatic approach to bring market participants over the regulatory wall. SEC and FINRA staff must engage with industry participants to design workable frameworks and issue regulatory relief in the form of rulemaking and no-action letters.
It’s clear Americans will continue to invest in this innovative asset class. Congress can seize this opportunity to provide additional regulatory clarity to support SEC oversight for all digital investing. Dotting the regulatory “I’s” of intermediaries, insiders, and issuers will better protect investors today and ensure the U.S. capital markets remain the envy of the world.