July 14, 2023

Good morning and welcome back to Congress in session. And how about that Judge Torres opinion?

Top Points

• Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced a revised Responsible Financial Innovation Act, covering a broad swath of policy issues and adding consumer protections to last year's version.
• Rep. Kat Cammack's (R-FL) NDAA amendment to establish a blockchain technology working group at the Department of Defense cleared the House Rules Committee and may pass the House later today.

Lummis-Gillibrand Responsible Financial Innovation Act 2.0

On Wednesday, Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) unveiled the most comprehensive crypto package to date. The bill aims to strengthen consumer protections, clarify legal obligations for crypto issuers and middle men, combat illicit finance, regulate stablecoins, and address various tax issues, and more.

Here's the full text. Below is a summary of key provisions.

Jurisdiction over Digital Assets

The bill clarifies that the SEC has jurisdiction over crypto securities and the CFTC has jurisdiction over crypto commodities.

Like last year’s bill, the RFIA would define a new category of assets, called "ancillary assets."

Ancillary assets would include digital assets sold pursuant to investment contracts (i.e., that satisfy the Howey test), but that don’t provide holders with a financial interests in a business entity (e.g., rights to dividends) associated with traditional securities.

• Ancillary assets whose value is “primarily determined” by an issuer and whose trading volume exceeds $5 million would be subject to periodic tailored disclosure requirements administered by the SEC.
  • Disclosures would be related to the issuer's business and the assets themselves.
• Ancillary assets in compliance with these periodic disclosures would be presumed commodities, not securities—thus relieving issuers and the intermediaries dealing with them from the full weight of securities laws.
  • But note: the commodity presumption could be rebutted in the U.S. Court of Appeals for the D.C. Circuit.
• The SEC may terminate an issuer's disclosure obligations if and when the issuer can certify:
  • (a) the ancillary asset's value is no longer primarily determined by the entrepreneurial or managerial efforts of the issuer or another the entity or
  • (b) the average daily trading volume is $5 million or less. See § 501.

Crypto Exchanges (Title IV)

The bill would require crypto asset exchanges to register with the CFTC and comply with certain core principles under the Commodity Exchange Act, including:

• ensure listed assets are not readily susceptible to manipulation,
• monitor trading to prevent fraud and manipulation,
• segregate customer assets,
• minimize and resolve conflicts of interest,
• keep adequate books and records, and
• share information with regulators as appropriate.

Exchanges would also have to confirm ancillary assets traded on the exchange are in compliance with their periodic reporting obligations.

As for custody, the bill would require exchanges to hold customers' crypto assets with a third-party custodian.

If a crypto asset exchange conducts trading through (or directs orders to) a decentralized exchange ("DEX"), the exchange must analyze and verify the DEX's code to mitigate risks relating to money laundering, sanctions evasion, fraud and manipulation, operations, and cybersecurity.

Consumer Protections Applying to All Crypto Intermediaries

All crypto asset intermediaries would be required to:

• Maintain proof of reserves subject to annual verification. § 203.
• Comply with new advertising standards. § 208.
• Clearly disclose to customers: whether their assets are segregated, how their assets would be treated in bankruptcy, the time and manner in which their assets would be returned upon request, and applicable fees. § 205.

Importantly, Title VI of the bill would also authorize the SEC and CFTC to register a self-regulatory organization whereby a "Market Integrity Authority" would write and enforce rules for crypto intermediaries aimed at protecting customers.

This authority would be governed by a board of 13 directors, including:

• representatives from the CFTC, SEC, FinCEN,
• four independent directors appointed by the president,
• six directors appointed by members of the authority,
• with the President designating the chair. § 601.

Combatting Illicit Finance (Title III)

The bill aims to combat illicit finance involving crypto by:

• increasing the penalty for willful violations of the Bank Secrecy Act ("BSA"),
• directing Treasury, CFTC, and the SEC to establish standards for examining financial institutions' efforts to police money laundering and sanctions evasions,
• establishing a working group on illicit finance,
• directing FinCEN to report to Congress on the use of crypto asset mixers and tumblers,
• providing that crypto asset exchanges are subject to the BSA.

Stablecoins (Title VII)

In contrast to the House proposed stablecoin bills, Lummis-Gillibrand would only allow insured depository institutions (i.e., banks or credit unions) to issue payment stablecoins.

Stablecoin issuers would have to:

• hold highly-liquid assets to back stablecoins on a 1:1 basis,
• publicly disclose reserve asset information,
• redeem stablecoins upon request, and
• comply with capital and liquidity requirements set by the appropriate federal or state regulator.

The bill would also prohibit algorithmic stablecoins from using the term "stablecoin" or "payment stablecoin" in advertising materials.

Tax

Title VIII addresses various outstanding tax issues. Specifically, the bill would:

• exempt income from crypto transactions of $200 or less,
• clarify the definition of broker for digital asset tax reporting purposes,
• prohibit wash sales of crypto assets (expected to generate revenue),
• require certain crypto intermediaries to use the mark-to-market accounting method at year end (expected to generate revenue),
• provide that crypto assets received via forks or airdrops are not recognized as gross income until the taxpayer exercises control over the asset,
• provide that crypto assets received from mining or staking are not treated as gross income until disposition.

Funding

To fund implementation, the bill authorizes the CFTC to collect registration fees from crypto intermediaries (not to exceed $30,000,000). See § 411.

Title X also appropriates over five years:

• $25 million for Office of Science and Technology Policy and National Economic Council to hire staff specializing in crypto, AI, and other FinTech issues,
• $150 million for FinCEN to prevent money laundering in crypto,
• $500 million for the CFTC to implement the bill,
• $500 million for the SEC to implement the bill, but not to be used for enforcement purposes,
• $150 million for the FTC to conduct consumer education and enforcement related to crypto, and
• $12.5 million to fund the Advisory Committee on Financial Innovation.

So What?

That Senators Gillibrand and Lummis reached bipartisan agreement on such a broad swath of crypto policy issues is in itself significant. Up to this point, however, Senate Committee leaders haven’t expressed interest in moving any crypto legislation.

Yesterday’s decision in SEC v. Ripple Labs Inc. may shake things up. There, the Court ruled Ripple’s XRP sales to institutional investors, like hedge funds, were investment contract securities. But Ripple's XRP sales over exchanges, which were largely purchased by retail investors, were not investment contract securities.

If the Court's logic were applied more broadly to the crypto market, institutional investors would effectively have more investor protections (e.g., disclosures required by securities laws) than retail investors buying the very same asset on exchanges (as there's currently a regulatory gap for non-security digital assets traded on the spot market). Many in Congress will find this result troubling.

Thus, Democrats in particular may be more willing to work on legislation—like Lummis-Gillibrand or McHenry-Thompson—that aim to clarify the law, fill regulatory gaps, and ensure basic consumer protections, rather than continue to rely on the courts.

Crypto in House NDAA

As background, the National Defense Authorization Act ("NDAA") authorizes defense funding and lays out defense priorities for the upcoming fiscal year. Because the bill ensures continuous funding for troops and operations, it is often viewed as a "must pass" bill, and thus a prime vehicle for attaching targeted pieces of legislation that might otherwise stall out in Congress.

At least one crypto-related amendment is expected to be considered.

Rep. Kat Cammack (R-FL) filed an amendment that would establish a working group to identify ways blockchain technology might improve efficiencies at the Department of Defense ("DoD"). See Amend. 730.

On Tuesday, House Rules Committee voted to allow the amendment to be considered on the House floor, where it may receive a vote or get rolled into an en bloc package with other non-controversial amendments today.

Report Language

The Committee Report accompanying the bill also mentions crypto briefly. Under a section directing the DoD to report to Congress on financial advice programs for servicemembers, the report raises concerns over a DoD financial advisor recommending "meme stocks" and crypto to a recent DoD widow. The report adds:

• "These 'investments' are known to be high-risk and underperforming and are not in keeping with the nature of the [Servicemember Group Life Insurance Program]." See Report at 188.

So what?

The Senate is working on its own NDAA bill, which, in its current form, does not include any crypto-related provisions. Once both chambers pass their respective versions, leaders will negotiate a final "conferenced" bill. It is unclear whether Rep. Cammack's amendment would be included in the final bill.

Look Ahead

• House Financial Services Committee is tentatively scheduled to markup stablecoin and market structure bills on July 19.

Quick Hits

• Judge Torres says XRP itself is not a security; holds Ripple's XRP sales to institutional clients ("Institutional Sales") were investment contracts, but sales to public on exchanges or provided to employees as compensation did not constitute investment contracts; denies Ripple's fair notice defense; says trial needed to determine whether Larsen and Garlinghouse aided and abetted Ripple's securities violations (i.e., the Institutional Sales).
  • ​Opinion.
• Senator Tommy Tuberville (R-AL) leads letter urging Attorney General Merrick Garland and SEC Chair Gensler to review inconsistencies between Prometheum's statements to Congress and recent SEC filings regarding the extent of the company's ties to a Chinese based firm.
  • ​Letter.
• Rep. Torres calls for investigation into SEC's decision to grant a special-purpose broker-dealer license to Prometheum.

• Senate Finance Chairman Ron Wyden (D-OR) and Ranking Member Mike Crapo (R-ID) request public input on how digital assets should be taxed.
  • ​Letter.
  • ​Report on Selected Issues Regarding the Taxation of Digital Assets.
  • ​Press Release.

Use Case of the Week

"Opscientia (OpSci) is an open source DeSci project leveraging the power of Web3 to grow, sustain, and continuously improve a decentralized science movement to drive progress in scientific research, making it easier for scientists around the world to share data."

More here.

Trivia

June 30 Q/A:

• Q: Which U.S. President was born on the Fourth of July?
• A: John Calvin Coolidge.

This Week's Q: Which 3 Presidents died on the Fourth of July?

Thanks for reading and enjoy your weekend.

Sincerely,

GSL

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