SEC Beefs Up its Enforcement Division, But to What Effect?

On May 3, 2022, the Securities and Exchange Commission (“SEC”) announced that it will add twenty positions to the newly renamed Crypto Assets and Cyber Unit within its Division of Enforcement. (Securities and Exchange Commission). This unit’s previous name was simply the “Cyber Unit,” but this new renaming indicates the SEC’s increased focus on crypto assets. Id. Since the SEC created this unit in 2017, it has brought more than 80 enforcement actions related to fraudulent and unregistered crypto asset offerings and has levied more than $2 billion dollars in fees, fines, and penalties. Id. While these numbers may seem impressive, they pale in comparison to just how large the crypto assets market is; indeed, even with the recent bear market, the global crypto asset market cap still hovers close to $1 trillion dollars. (CoinMarketCap).  Furthermore, in 2017, the Satis Group, a blockchain consulting firm, estimated that  80% of the 966 offerings of crypto assets were fraudulent. (Bedil Karimov & Piotr Wojcik, Frontiers; Mercer). Therefore, the 80 enforcement actions brought are only a drop in the bucket. However, the SEC’s previous team only consisted of 30 members. (Id.; Thomas Franck, CNBC). This new influx of investigative staff attorneys, trial lawyers, and fraud analysts theoretically should help the SEC keep pace with such a rapidly growing industry. However, it is unlikely that this team will be effective in bringing sufficient enforcement actions because adding a small number of personnel simply isn’t enough for the unit to keep up with such a large industry. In a worst case scenario, this team would simultaneously be (1) too small to bring enough enforcement actions to deter bad actors and (2) discourage well-intentioned innovators from participating in the industry. (MacKenzie Sigalos, CNBC; Thomas Franck, CNBC).

            Simply increasing staff or creating a task force to handle certain issues does not necessarily mean an increase in enforcement efforts. For example, in 2021, the SEC created an enforcement group focused on climate and ESG issues. (Securities and Exchange Commission). This division initially consisted of 22 members and sought to develop initiatives to proactively identify ESG-related misconduct. Id. However, it took one year for this newly created group to even bring its first ESG-related enforcement action against Vale S.A. (Kevin B. Muhlendorf, Holly Wilson, and Martha E. Marrapese, Wiley). Just like this ESG group, the SEC formed this Crypto Assets and Cyber Unit to focus on certain types of issues. The ESG group’s lackluster results thus do not bode well for the Crypto Assets and Cyber Unit.

            There are two main schools of thought when it comes to crypto assets. Chairman Gensler opines that the industry is currently the “wild west” and needs to be reigned in, and Commissioner Peirce states that too much regulation may stifle innovation. (Thomas Franck, CNBC; Hester Peirce, Securities and Exchange Commission). Since Chairman Gensler was appointed in February of 2021, he has consistently advocated for increased regulation of the crypto asset industry to the extent that many declare him to be “anti-crypto.”  (Paul Jossey, Coindesk). Commissioner Peirce, on the other hand, claims that the U.S. has “dropped the ball” on crypto regulation and criticizes the SEC for not “allowing innovation to develop and experimentation to happen in a healthy way.”  (MacKenzie Sigalos, CNBC). Both of these viewpoints are compelling. However, rampant fraud and an overabundance of “shitcoins”—crypto assets that have no value and bring nothing new to the crypto space—can strangle innovation just as much as strict regulations. (Kevin Leyes, Entrepreneur). Therefore, at least some level of regulation is necessary.

            Congress took a major step in creating a much-needed regulatory system in June, 2022, when 2 senators introduced a “comprehensive” bill regulating crypto assets, especially stablecoins. (Thomas Franck, CNBC; Connor Dovevan and Patrick Jarenwattananon, NPR). This bill includes tax requirements for different digital assets, provisions regarding cybersecurity, disclosure requirements, and the creation of a self-regulatory organization. (Connor Dovevan and Patrick Jarenwattananon, NPR). However, the most important piece of this bill is that it would place the responsibility for regulating crypto assets with the Commodity Futures Trading Commission (“CFTC”) rather than with the SEC. Id. Proponents cite Chairman Gensler’s assertion that Bitcoin is a commodity rather than a security and state that crypto assets “don’t function like securities.”  Id. Upon its introduction, this bill received major support from significant players such as the Crypto Council for Innovation and the Blockchain Association. Id. Nevertheless, critics claim that giving responsibility to the CFTC is the same as deregulating the entire industry because the CFTC is ill-equipped, both financially and in terms of personnel, to police such a large industry. (Id.; Thomas Franck, CNBC). This proposed regulatory structure is still in its infancy and it is unclear if it will gain significant traction. (Connor Dovevan and Patrick Jarenwattananon, NPR).

On the other hand, as it stands, the new addition of staff is unlikely to  have an outsized effect on the crypto industry’s regulatory environment. Indeed, the prior iteration of the unit only brought 80 enforcement actions since 2017 with a staff of 30. Consequently, adding 20 new personnel is unlikely to make a major difference in the number of enforcement actions because the unit is still too small to focus on anything but the most egregious offenders.  (Securities and Exchange Commission).  Nevertheless, even though it is a fairly small step, these additions still serve to put the industry on notice that the SEC is watching and more measures are likely on the way. However, the combination of a market downturn and—even if negligible—increased enforcement could force just as many bad actors as innovators out of the industry if these innovators become too fearful of enforcement actions. (Andrew Chow, Time; Stefania Palma and Miles Kruppa, Financial Times). Thus, Commissioner Peirce’s approach is the most compelling because she sees the importance of a regulatory system that stops the bad actors while fostering innovation. (MacKenzie Sigalos, CNBC). Indeed, given the market downturn, the crypto asset industry may need more help than ever. These newly proposed regulations are a significant step in the right direction because simply punishing noncompliance through enforcement actions, rather than by publishing and approving clear guidelines, may only serve to smother innovation even further.