What is the SEC?
The U.S. Securities and Exchange Commission (SEC) is an independent federal government regulatory agency responsible for protecting investors, maintaining fair and orderly functioning of the securities markets, and facilitating capital formation. It was created by Congress in 1934 as the first federal regulator of the securities markets. The SEC promotes full public disclosure, protects investors against fraudulent and manipulative practices in the market, and monitors corporate takeover actions in the United States. It also approves registration statements for bookrunners among underwriting firms.
The U.S. Securities and Exchange Commission (SEC) is often referred to as the Watchdog of Wall Street, but it wouldn’t be too much of a stretch to think of it as the “Capital Markets Cop.” Two of the SEC’s main objectives are to protect investors and maintain fair, orderly, and efficient markets, similar to a regular police force’s primary goals of protecting the public and maintaining law and order. The SEC also has a third key objective in its three-pronged mission—facilitating the capital formation that is necessary to sustain economic growth.
The SEC interprets and enforces the federal laws that govern the U.S. securities industry, which are based on two basic principles:
- Investors should have access to all pertinent information about a security prior to making an investment decision. Companies offering securities to the public must therefore disclose comprehensive and accurate information about their businesses, the securities offered for sale, and the risks involved in investing in them.
- People engaged in securities sales and trading must put investors’ interests first and treat them fairly and honestly. The SEC ensures this by overseeing the key players in the securities industry, including exchanges, broker/dealers, advisers, funds, and rating agencies.
Generally, issues of securities offered in interstate commerce, through the mail or on the Internet, must be registered with the SEC before they can be sold to investors. Financial services firms—such as broker-dealers, advisory firms and asset managers, as well as their professional representatives—must also register with the SEC to conduct business. An example: they would be responsible for approving any formal crypto exchange.
- Division of Corporate Finance: Ensures investors are provided with material information (that is, information relevant to a company’s financial prospects or stock price) in order to make informed investment decisions.
- Division of Enforcement: In charge of enforcing SEC regulations by investigating cases and prosecuting civil suits and administrative proceedings.
- Division of Investment Management: Regulates investment companies, variable insurance products, and federally registered investment advisors.
- Division of Economic and Risk Analysis: Integrates economics and data analytics into the core mission of the SEC.
- Division of Trading and Markets: Establishes and maintains standards for fair, orderly, and efficient markets.
The SEC is allowed to bring only civil actions, either in federal court or before an administrative judge. Criminal cases fall under the jurisdiction of law enforcement agencies within the Department of Justice; however, the SEC often works closely with such agencies to provide evidence and assist with court proceedings.
In civil suits, the SEC seeks two main sanctions:
- Injunctions, which are orders that prohibit future violations. A person or company that ignores an injunction is subject to fines or imprisonment for contempt.
- Civil money penalties and the disgorgement of illegal profits. In certain cases, the SEC may also seek a court order barring or suspending individuals from acting as corporate officers or directors. The SEC may also bring a variety of administrative proceedings, which are heard by internal officers and the commission. Common proceedings include cease and desist orders, revoking or suspending registration, and imposing bars or suspensions of employment.
The SEC also serves as the first level of appeal for actions sought by the securities industry’s self-regulatory organizations, such as FINRA or the New York Stock Exchange
What is the CFTC?
The Commodity Futures Trading Commission (CFTC) is an independent federal agency that regulates the derivatives markets, including futures contracts, options, and swaps, in the United States. Its goals include the promotion of competitive and efficient markets and the protection of investors against manipulation, abusive trade practices, and fraud. The Commodity Futures Trading Commission Act established the CFTC in 1974. The Commodity Exchange Act regulates the trading of commodity futures in the U.S. Passed in 1936 and amended several times since the act establishes the statutory framework under which the CFTC operates. Under the act, the CFTC has the authority to establish regulations that are published in Title 17, Chapter I, of the Code of Federal Regulations.
The CFTC regulates the U.S. derivatives markets. This includes the commodity futures, options, and swaps markets as well as over-the-counter (OTC) markets. In order to sufficiently oversee these markets, the CFTC regulates the following organizations: trading organizations such as designated contract markets which are the exchanges that host futures trading, and swap execution facilities, which are platforms that allow participants to buy and sell swaps.
The Division of Clearing and Risk of the CFTC is solely responsible for monitoring derivatives clearing organizations (DCO) such as the options clearing corporation. The OCC is the largest DCO in the world and operates under the jurisdiction of the CFTC.
Swap data repositories, which were created by the Dodd-Frank Act to provide a central facility for swap data reporting and recordkeeping are also regulated by the CFTC. The CFTC also regulates all intermediaries—entities that act as agents for other people when dealing with futures, swaps, and options. Some of these intermediaries include:
- The operators of commodity pools, which are funds that combine investor contributions to trade on the futures and commodities markets.
- Commodity trading advisors, those who provide investment advice for the commodity and futures markets.
- Futures commission merchants, who accept the order to purchase or sell any commodity for future delivery.
- Introducing brokers, who have a direct relationship with a client, but delegates the work of the floor operation and trade execution to another futures merchant.
- Swap dealers, individuals, or entities that serve as swaps brokers, make markets in swaps or enter into swaps contracts with counterparties.
There are five main divisions of the CFTC: Division of Clearing and Risk, Market Participants Division, Division of Market Oversight, Division of Data, and the Division of Enforcement:
The role of the Division of Clearing and Risk (DCR) is to enable the CFTC to meet its statutory responsibility to ensure the financial integrity of all transactions subject to the Commodity Exchange Act (CEA) and the avoidance of systemic risk in the derivatives markets. The DCR oversees all operations of derivative clearing operations (DCOs) and is divided into four branches itself:
- Clearing Policy
- Examinations
- Risk Surveillance
- International & Domestic Clearing Initiatives
According to the CFTC website, some of the DCR’s main responsibilities include:
- Preparing regulations, orders, guidelines, and other regulatory work product on issues pertaining to DCOs, including the protection of customers in the bankruptcy or insolvency of an FCM or DCO
- Reviewing DCO applications for registration, petitions for regulatory relief or exemption, and rule submissions, and making recommendations to the Commission regarding such matters
- Reviewing DCO recovery plans and wind-down plans for consistency with Commission regulations and engaging with the FDIC and other financial regulators, both domestically and internationally, regarding planning for the potential resolution of a DCO
- Conducting risk assessments on an annual basis to determine which DCOs to examine and the topics that should be included in the risk-based examination
- Examination of DCOs for compliance with all relevant requirements of the CEA and Commission regulations, including examining each systemically important DCO (SIDCO) at least once a year
- Analyzing notifications regarding hardware or software malfunctions, cyber-security intrusions, or threats that have or may have a material impact on clearing
What is the Difference?
The SEC and CFTC were created by different laws, have different responsibilities, and use different methods to fulfill those responsibilities. The most basic difference between the two entities is that the SEC regulates the securities market and the CFTC regulates the derivatives market.
- security v. commodity/derivative: securities are certificates of interest, participation or collateral in any profit-sharing agreement, while commodities futures include certificates and contracts for the future delivery of said goods. This means that anything where there is a market for future delivery is a commodity, and that this market of future delivery contracts can be securitized or made into derivatives. This gets really complicated where the contracts for future delivery of securities, a common
- at a high level, the SEC regulates investments in businesses, and the CFTC regulates investments in things and services to be delivered in the future.
- Are cryptos commodities or securities? —> the devil is in the details; L1s like BTC/ETH have already been declared by the SEC to be commodities and outside of their purview of regulation, but other L1s like XRP have run afoul of the Howey rest according to the SEC. This is why methods of distribution matter, why token mechanics matter, and why you need a lawyer if you’re looking to ICO and/or establish an incentives program for your DAO…
What’s the Beef?
Memorandum of understanding (inter-agency vibe check): https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/cftc-sec-mou030608.pdf
This memo outlines several ways that the organizations are supposed to interact and coordinate their investigative and enforcement actions, and how they promise to notify each other for particular examinations, and to avoid giving each other red tape wherever possible.
In practice, there are inter-agency rivalries (more remit means more funding) when it comes to regulating ‘grey-area’ financial instruments like certain securities, and crypto-assets. An increased scope of regulation generally results in an agency getting more funding to do this regulation, which is why both are jockeying to be the preeminent regulators for cryptos, and why it will lead to arguments from both agencies regarding whether a particular financial blockchain application is a security, or a commodity/derivative.
So far, The CFTC claims that crypto is a currency and, therefore, a commodity regulated by the Commodity Exchange Act of 1934 (“CEA”), a law that was created long before crypto. Setting aside whether a law that was invented in the time of slide-rulers can effectively manage a digital asset, the CFTC is trying to regulate derivatives of cryptocurrencies, but not the currencies directly. The SEC is staking its claim on the definition of a “security,” which includes investment contracts as established in the 1946 Supreme Court case of SEC v. Howey (again, the days of slide rulers although some computers existed around this time). Under the Howey test, a security includes an “investment contract” under the Securities Exchange Act of 1934. The test turns any contract, scheme, or transaction into a security if there is an investment of money in a common enterprise with a reasonable expectation of profit from the work of others.
Oddly, the SEC has already said that bitcoin and Ethereum, the two largest cryptocurrencies by market size, are not securities. But as noted in a recent article in the Jurist, “the SEC has cleverly identified other aspects of the crypto ecosystem which are more similar securities and has declared those areas to be fair game for SEC regulation.” Specifically, the SEC is trying to regulate initial coin offerings (“ICOs”), which would apply to any new cryptocurrencies hitting the market, not ones already in circulation. The SEC is also going after Decentralized Finance (“DeFi”) products related to lending and borrowing crypto on decentralized platforms. Since these instruments are more akin to debt, they are more clearly in the SEC’s purview. The SEC is also going after crypto-related companies that have issued stock or other securities to investors. Those securities offerings, whether registered or unregistered, are also clearly in the SEC’s authority. As a result, it is widely accepted that established and broadly decentralized virtual currencies, like Bitcoin and Ether, are “commodities” and not currencies.
Efforts to categorize these cryptocurrencies or others as “currencies” generally will not withstand regulatory scrutiny because they are goods exchanged in a market for uniform quality and value and thus fall both within the common definition of commodity and the Commodity Exchange Act’s (CEA) definition of commodity. It is important to note that the “jurisdictional authority of CFTC to regulate virtual currencies as commodities does not preclude other agencies from exercising their regulatory power when virtual currencies function differently than derivative commodities.”
Even though the CFTC has determined that virtual currencies are commodities, the CFTC’s jurisdiction over virtual currency markets is limited to policing fraudulent and manipulative activities in interstate commerce. Beyond this type of enforcement authority, the CFTC does not generally oversee virtual currency transactions or exchanges that do not involve margin, leverage, or financing, and cannot, for example, require a spot crypto exchange to register with the CFTC. As a result of the above, the CFTC is said to have “enforcement jurisdiction” over cryptocurrency and digital assets, but not “registration jurisdiction.” A spot cryptocurrency product is generally a product that results in actual delivery of the cryptocurrency within a particular market’s spot delivery period. An example of a U.S.-based spot market is Coinbase.
Enforcement Actions
The chart below summarizes certain CFTC enforcement actions.
| Bitcoin | BitMex | Kraken | Bitfinex |
| CFTC alleged that Coinbase delivered misleading/inaccurate reports concerning bitcoin transactions | CFTC alleged that BitMax illegally offered crypto derivatives to non-eligible US Customers | CFTC alleged that (1) Kraken offered margin retail crypto products to non-eligible US Customers + (2) failed to register as an FCM | CFTC alleged that Bitfinex offered spot and leveraged bitcoin, ether, and tether trading to non-eligible US Customers |
| US$6.5 million civil monetary penalty | US$100 million civil monetary penalty + stop offering crypto commodity contracts in US until registers with CFTC + increased KYC and AML | US$1.25 million civil monetary penalty + cease and desist from further violations | US$1.5 million civil monetary penalty + implement systems to prevent unlawful retail transactions |
| “Reporting false, misleading, or inaccurate transaction information undermines the integrity of digital asset pricing… This enforcement action send the message that the Commission will act to safeguard the integrity and transparency of such information.” | “This case reinforces the expectation that the digital assets industry, as it continues to touch a broader pool of participants, takes seriously its responsibilities in the regulated financial industry and its duties to develop and adhere to a culture of compliance” | “The Commission’s finding… is informed by its Final Interpretive Guidance on retail commodity transactions involving certain digital assets issued in 2020” | “Bitcoin, ether, lifecoin, and tether tokens, along with other digital assets, are encompassed within the broad definition of “commodity” under Section 1a(9) of the Act” |
Both the CFTC and SEC are asserting their jurisdiction in this space, and in many cases, additional clarity is needed to understand whether a digital asset should be considered a commodity (subject to the CFTC’s enforcement authority), or a security (subject to the SEC’s jurisdiction). In addition, even with this clarity, a related question persists on whether the SEC and CFTC collectively have sufficient regulatory authority in order to properly regulate crypto markets, or if congressional action is needed.