Former Securities and Exchange Commission Chairman Jay Clayton took over the regulator in May 2017, just as the ICO craze was coming into full swing. He started out by trying to reign in the sector, and in this interview expresses astonishment at the number of people he observed trying to get around regulations by calling digital assets tokens or coins when they were clearly securities in his opinion.
However, many readers may be surprised on his bullishness for the industry. He expects blockchain to play a critical role in capital markets infrastructure moving forward, and most recently he joined multibillion dollar crypto custodian Fireblocks as an advisor.
In this interview we also discuss why he thinks that his successor Gary Gensler prefers a futures bitcoin ETF over a spot market offering, why the Howey Test is not the only way to determine whether a token is a security, and what all of this means for the future of DeFi and stablecoins.
This interview is excerpted from Forbes CryptoAsset and Blockchain Advisor. Subscribe today for breaking news, detailed research, and commentary on the industry.
Forbes: Could you please explain why the SEC cares about crypto?
Clayton: The SEC cares about securities. To the extent that crypto overlaps with the offering or trading of securities, then the SEC cares about it. Now we go back to ICOs (initial coin offerings). Few people doubt that most ICO offerings were securities within the SEC’s remit. So that is a clear historical example of where it was absolutely appropriate, necessary and for the benefit of the public for the SEC to be involved in crypto.
Forbes: What would you say was the first major crypto issue that came across your desk? What do you remember?
Clayton: The first major crypto issue that caught my attention was the ICO boom. I remember anecdotes of lots of money being raised in what was clearly a public securities offering and actually being astonished. I was quite surprised that anybody would think that because you called it a coin or a token as opposed to a security, somehow it was outside of the SEC’s remit. I was also quite astonished that the professionals around those offerings, the lawyers and others, had thought that somehow this was different from a securities offering because the substance was exactly the same.
Forbes: Many ICO projects employed lawyers drafting opinions and letters arguing why a certain project is not a security. I imagine that you saw some of those legal opinions. What did you make of them?
Clayton: The drafters of the 33 Act made it very clear that the definition of security was very broad. An investment contract, which is the focus of the Howey Test, is just one of dozens of elements of what constitutes a security. When you look across that spectrum of elements, what you see is a principle. And that principle is that when an individual or group of individuals organized as a corporation, or as anything else, are raising money for a venture, and they have information about that venture, and they have the management authority over that venture, and they’re raising money from the public, there’s a big information asymmetry. And what they decided was that in those circumstances, you are going to have to provide the public with sufficient information to judge whether the investment was appropriate for them, as well as protection around whether that information was in fact, true in all material respects. That’s the broad concept underlying our securities laws. Now, if you raise money privately, there’s a lower standard, but once you go out to the public, that’s the standard you have to live by. And it was just a surprise to me that people would think that with labels or other mechanisms you could have that capital raising activity going on from the public, and not be subject to the security status.
Forbes: Decentralized finance (DeFi) has become popular today and there’s also a big discussion about whether stablecoins should be considered securities. What are your opinions on those issues?
Clayton: My view is that if you look at the function that the product is providing and compare that to the incumbent space, you have a very good handle on the regulation that applies or is likely to apply. Stablecoins are a good example. A stablecoin that promises $1 back to you, in exchange for the coin, and is backed by cash is one item. Such a coin that is backed by commercial paper, whether it’s 30, 60 or 90 days, sure looks like a money market mutual fund to me. So the second element really looks like a security. We have decided that a pooled vehicle of commercial paper that you use for daily liquidity is a money market mutual fund and should be regulated as such.
Forbes: When current SEC Chairman Gary Gensler testified in front of the banking committee, I guess it was two or three weeks ago, he was asked by Senator Pat Toomey (R-PA) how a stablecoin could be a security if there was no expectation of profit. It sounds like the Howey Test is not the only test applied to a case like this.
Clayton: Like I said, the definition of a security is much broader than just an investment contract. The Howey Test applies to an investment contract. It would be anomalous, if you had a stablecoin that essentially functioned as a money market mutual fund, and it was not treated in the same way.
Forbes: Turning to DeFi, there’s a lot of governance tokens that purport to essentially decentralize lending and exchange protocols. What are your thoughts on their regulatory status?
Clayton: This is an area where in some cases, you can map to an incumbent function. And in some areas, it may be that this is new. In our regulatory system, we tend to regulate what I would call hubs, because it’s more efficient. We regulate money transfers by regulating the financial institutions that facilitate the transfer. DeFi may be removing some of those hubs, and therefore, we have to think about whether new regulation is required.
Forbes: What types of powers or regulations would the SEC need to regulate DeFi to regulate something like a governance token used to operate a decentralized exchange (DEX)?
Clayton: Let me let me say this. What does a Securities Exchange do? It makes it so that buyers and sellers who don’t know each other have an entity that sets the rules and provides recourse and stability. The question in some of these situations is what is providing that rule set, stability and avenue of recourse? That’s where I would start the inquiry. But you’re right, these are very interesting questions. If there’s no avenue of recourse, I think we have to wonder whether it’s actually functioning in a way that people would expect.
Forbes: As I’m sure you’re very well aware, SEC Commissioner Hester Peirce is seen as someone that is friendly to the industry. And there was a lot of hope and expectation about her proposed Safe Harbor agreement, the idea that, perhaps certain tokens and products would have a certain amount of time to become sufficiently decentralized before they’re fully subject to securities rules. I believe that was introduced while you were still chairman, although it didn’t get very far. I’m curious if you have any thoughts on it, and whether or not it could see the light of day in the future?
Clayton: That is for the next for the current commission, not me to decide. I applaud Hester, for being open and also recognizing that the existing securities laws are extremely broad. If they are impeding development, and that’s an if, one way to address that is through a safe harbor. One of the questions I have is, should people be trying to comply with the securities laws? Registering with the SEC, using the safe harbors, we raise billions and billions of dollars of capital in this country in compliance with the securities laws. A good question is, why is that so difficult in this space? If it is, then maybe a safe harbor is appropriate, but that’s a threshold question to the inquiry about adding a safe harbor.
Forbes: I want to ask a few questions now about ETFs. First, why do you think there has not been any approvals yet?
Clayton: I think the SEC has been very clear about market integrity. Gensler has been very clear about market integrity and surveillance being a key threshold to approval of ETFs in the space. I think that’s appropriate.
Forbes: Gensler has recently expressed a preference for a derivatives-based ETF as opposed to one based on spot markets. From your perspective, and not in reference to any particular application or even a proposed crypto ETF, are there major differences in how a spot or a derivative-based ETF is constituted or governed?
Clayton: I don’t want to speak for the chair, but I think what Gensler was saying is that in this case, the derivatives market is surveilled and is under the jurisdiction of the CFTC, while the spot cash market is global. Surveillance to the extent that it exists is different, and it’s not under the jurisdiction of the U.S. regulatory agency.
Forbes: Coinbase was the first major crypto native company to go public on an SEC registered exchange. From your perspective, how big of a step do you think that was?
Clayton: I don’t want to speak to the regulatory elements of that, but from the perspective of public interest, public acceptance of blockchain technology, tokenization and digitization, it demonstrates a broad interest in investing in that ecosystem.
Forbes: There is an expectation that we are going to see a lot more crypto companies following Coinbase’s lead and going public. Some such as Circle or eToro have already negotiated SPAC deals, and others such as Kraken or BlockFi may take more traditional routes. What does the SEC look for when it comes to approving a company to go public? And are there any special considerations that go into evaluating a crypto firm?
Clayton: To your broad question about what the SEC is looking for in addition to compliance with financial statements and other requirements on the general disclosure, do investors have an appreciation for the opportunities and risks that are present for the company and the markets in which it operates? To the extent you’re asking about regulatory risk, that’s idiosyncratic to the types of functions that particular firm would be providing. A firm that is using distributed ledger technology to facilitate existing transactions may have a much different regulatory profile from a firm that is providing security services, particularly one that’s providing security services directly to retail investors.
Forbes: If Coinbase does end up having to register with the SEC, as Gary Gensler suggested it may need to in his recent testimony, what would that look like? Would it end up more or less having to potentially delist every token that could be considered a security?
Clayton: I’m not going to comment on a specific company. But to the extent someone is providing exchange services for securities, they would need to take whatever the appropriate measures to come into compliance with the ATSs or exchange rules or other rules that would allow you to provide those services.
Forbes: Last couple of questions. The NFT phase really picked up after you left office. That said, I’m interested in whether any NFT-related project cases came before you during your tenure at the SEC.
Clayton: There is a wide spectrum of products being offered under the label NFT. Some may go all the way to being quite similar to ICOs, while others are different. But the label and the underlying assets of NFT largely came after my time there.
Forbes: Anything else that you would like to share?
Clayton: I would like to see America lead in the study and development of this technology. Whether that’s in the cash market, Treasury market, equities market, fixed income market or new markets. I think we should be open to the study and adaptation of this technology provided that in addition to adding efficiency, it’s at least as good, if not better, from the perspective of our regulatory goals.
Forbes: Thank you for your time.