SBC Hearing on Protecting Investors and Savers: Understanding Scams and in Crypto and Securities Markets

Senate Banking Committee

Protecting Investors and Savers: Understanding Scams and in Crypto and Securities Markets

Thursday, July 28, 2022

Topline

• There was a significant focus on Securities Exchange Commission (SEC) regulatory enforcement, risks of crypto investing, financial inclusion, Congressional actions, and digital asset self-regulating organizations (SRO’s).
• Senator Toomey voiced four main issues with the SEC’s regulatory enforcement framework.
• Both Democrats and Republicans questioned witnesses about the risks of crypto investing.
• Walsh was questioned on whether FINRA believes a role for self-regulation should have a role regarding digital assets.

Witnesses

• Melanie Senter Lubin, President, North American Securities Administrators Association
• Gerri Walsh, Senior Vice President of Investor Education, Financial Industry Regulatory Authority

Opening Statements
Chairman Sherrod Brown (D-Ohio)

In his opening statement, Brown discussed how the “blowups” in the crypto markets over the last two months exposed the risks of crypto investments. He also discussed crypto investments from retirement accounts and said we must continue to help American families save for the future and asked law enforcement and regulators to be alert of potential scams.  Brown said new ways to cheat people out of their money is not the type of innovation most families want, adding that the Committee must make sure regulators enforce the law and protect families to keep the economy going and markets growing as well as push the Securities Exchange Commission (SEC) and banking regulators to do more. He concluded by saying industries should not be able to write the rules they want to play by.

Ranking Member Patrick J. Toomey (R-Pa.)

In his opening statement, Toomey discussed his frustration about the SEC being unable to attend as a witness. He also touched on the recent bankruptcy of Voyager and Celsius. He urged the SEC to provide regulatory clarity on digital assets and expressed his criticism of the SEC’s regulatory enforcement, citing four main issues: 1) it challenges innovators to comply with new interpretations of regulations, 2) it restricts innovation, 3) it creates a legal gray area favoring large firms, and 4) the enforcement policy is ineffective. Toomey concluded by discussing his advocacy on stable coin consumer protections.

Testimony

Ms. Melanie Senter Lubin, President, North American Securities Administrators Association

In her testimony, Lubin highlighted North American Securities Administrators Association (NASAA) member activity involving both registered and unregistered persons and firms as well as four key points: 1) the top threats to retail investors, 2) promoting lasting trust in and informed use of capital markets, 3) improvements in how we prevent and detect investor harm, and 4) opposing legislation that would weaken investor protection.

Ms. Gerri Walsh, Senior Vice President of Investor Education, Financial Industry Regulatory Authority

In her testimony, Walsh focused on the Financial Industry Regulatory Authority’s (FINRA) regulatory work and the research, outreach, and educational initiatives that FINRA and the FINRA Foundation have underway to help both novice and advanced investors establish sound financial practices, follow pathways to investing and retirement readiness, and avoid fraud and costly mistakes.

Question & Answer

The Securities Exchange Commission (SEC) Jurisdiction

Toomey asked if crypto lending products fall under SEC jurisdiction. Lubin said that she views crypto lending products as securities. Toomey asked how a digital token meets the Howey Test’s expectations of profits’ prong if there is no claim on the enterprise. Lubin explained that the possible appreciation of the token meets the profits requirement. Toomey asked if Lubin could think of a security where there is no claim on the issuer. Lubin explained there are various tokens, so it is a case-to-case determination.

Risks of Crypto

Sens. Kyrsten Sinema (D-Ariz.) and Brown asked what makes crypto assets so attractive to scam artist and risky for investors. Lubin said one of the reasons is because the market is not super transparent, adding that there is no disclosure given to investors to explain the risks of purchasing the product. She also discussed how scam artist tailor their pitches based on what is on the news. Brown asked how crypto scams have evolved over the years. Walsh said the sale pitches have changed, but the fundamentals of fraud have remained the same, which is to build trust in future victims. Brown also asked what could be done to shift the focus on the perpetrators rather than blaming the victim. Walsh said blaming victims can discourage them to come forward, adding that regulatory agencies need victims to come forward to explain how they were defrauded so that agencies can have a better understanding of how to combat future crimes.

Sen. Robert Menendez (D-N.J.) asked if the lack of education on digital assets part of crypto scams. Walsh discussed how important it is to educate people so they know what they are getting into with respect to digital assets. Sinema asked how unregulated investment spaces threaten retail investors. Lubin explained that if the space is not regulated, there will be a lack of transparency due to a lack of enforcement abilities, which would lead to more scams. Sinema asked if investors should be worried about the recent Celsius bankruptcy. Lubin said it is certainly appropriate for them to be worried and emphasized the importance of educating investors.

Sen. Cynthia Lummis (R-Wyo.) asked if there are significant investor protection issues when participants cannot differentiate between securities and commodities. Lubin expressed the importance of this distinction and explained that most security lawyers would view digital assets as an investment contract, which in turn should be regulated.

Financial Inclusion

Brown asked if financial inclusion using crypto is a realistic goal. Walsh said advancing financial inclusion is very important, adding that it is also important that we educate people about U.S. financial markets, how they work, and what the risks are so they feel comfortable engaging in the markets. Lubin discussed how communities of color have been left out of opportunities to invest based on sales pitches. Sen. Elizabeth Warren (D-Mass.) asked if institutional investors were becoming more prominent in the crypto market. Walsh discussed how there have been large investments by institutional investors in digital assets.

Congressional Actions

Sen. Catherine Cortez Masto (D-Nev.) asked how Congress could enhance the ability of regulators to pursue scammers. Lubin said it is important to make sure regulators have adequate resources to pursue these types of cases, adding that the more regulators are taken out of the oversight equation, the less effective they can be in protecting investors. Walsh said it is important to give regulators the resources they need to focus on research as well.   

Victims of Financial Crimes

Menendez asked who investors should call if they are a victim of crypto scam. Lubin said they should contact their state securities division. Warren asked if “mom and pop” investors are likely to be at the head of the line in getting their money back from bankrupt crypto platforms. Lubin said if those investors are considered unsecured creditors, then they will be at the end of the line adding that there are other things to be litigated.

Responsible Financial Innovation Act

Sen. Van Hollen (D-Md.) asked why it is important to pass the Responsible Financial Innovation Act sponsored by Senators Kirsten Gillibrand (D-N.Y) and Cynthia Lummis (R-WY). Lubin said agencies can never have too many resources when trying to keep up with bad actors. 

Regulatory Resources

Hollen asked if there are investigations that NASAA cannot pursue due to a lack of resources. Lubin said yes. Hollen asked Walsh if FINRA has practices to track and expose deceptive advertising. Walsh explained FINRA does have an advertising review team that takes actions when wrongdoing occurs specifically in the broker-dealer realm.

Registering Crypto Investors

Sen. Jack Reed (D-R.I.)  asked how would getting crypto currency trading platforms registered as broker dealers or exchanges help security regulators do their jobs and how would that help regulators increase investor protections. Walsh explained bringing crypto and digital assets into that space of regulation could have extraordinary value for consumers and the markets themselves to the extent that there is disclosure that is not misleading.

The Stronger Enforcement of Civil Penalties Act

Reed asked how the Stronger Enforcement of Civil Penalties Act would empower the SEC to protect the public from scams and bad actors. Lubin said her association believes it is important that regulators have multiple tools to protect investors, adding that the penalties need to be high enough that they deter bad actors. 

Digital Asset SRO’s

Lummis asked if FINRA believes a role for self-regulation should have a role regarding digital assets. Walsh explained FINRA has not taken a public position on the topic; however, she stated that FINRA would be happy to share their self-regulatory model and what that could look like with digital assets.

Lummis asked if FINRA would have a role in digital asset self-regulating organizations (SRO) or if SROs specific to digital assets would be better. Walsh said FINRA has not taken a position but has the appropriate tools to regulate broker-dealers. She also noted that most of the activity is coming from alternate places.

 

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