SEC’s Path to Registration - Part I

Due to SEC Inaction, Registration is Not a Viable Path for Crypto Projects

March 23, 2023 | Rodrigo Seira, Justin Slaughter, Katie Biber

See Part II here.
See Part III here.

Getting a startup off the ground involves preparing and filing a lot of documents and forms, most of which are relatively easy and straightforward. For example, a founder will have to file a certificate of incorporation with the Secretary of State’s office in order to form a new corporation. They will also need to file Form SS-4 with the IRS in order to get an employee identification number (EIN).

While many founders work with lawyers on this process, it’s simple enough that they could do it themselves. As a result, thousands of U.S. small businesses are formed each day.

SEC Chair Gary Gensler would like the American public to believe that it is just as simple and easy for crypto founders to register tokens or crypto products with the SEC.

It’s not.

Yet in a recent nationally televised interview, Gensler admonished crypto exchange Kraken over the company’s failure to register its staking product, which resulted in a settlement with the SEC pursuant to which Kraken had to pay damages and shut down the program. “These firms, Kraken knew how to register. Others know how to register, it’s just a form on our website,” he said, without providing further detail. “They know how to do it. They are just choosing not to do it,” he added later on.

Gensler elaborated on his message in an opinion piece a few days following, lamenting that “Frankly, though, crypto intermediaries aren’t exactly lining up to register with the SEC and comply with the laws enacted by Congress. Maybe it’s simply that their business models rely on being noncompliant.”

And yesterday, after years of failing to provide guidance or regulatory certainty to Coinbase, the SEC sent the Company  a Wells notice. According to Coinbase, the SEC threatened the company for listing tokens it considered securities (but it won’t say which ones) without registering as a securities exchange and offering an unregistered staking product (but it won’t say how to register).

Chair Gensler’s public comments and actions are self-serving in two ways: they attempt to justify an unconstitutional expansion of the SEC’s jurisdiction over crypto by wrongly implying that most crypto products and tokens are securities and should therefore register with the SEC, while also painting the crypto industry as composed of willful lawbreakers who actively chose not to follow simple rules and, like boundary pushing toddlers, are deserving of punishment by the SEC.

Yet, even putting aside the question of whether securities laws apply in the first place, the “forms” representing the “clear” path for crypto projects to “comply” cannot be completed on Legal Zoom or DIY’ed with free online resources.  For example, Form S-1, which is used by the most mature private companies when they want to go public or conduct an “IPO,” typically takes an army of lawyers and millions of dollars to completeHere it is: try making sense of it yourself.

In fairness to the Chair, he never explicitly said that filing a registration form would be easy or cheap. But his suggestion that crypto companies can register by “filling out a form online” fails for a much more straightforward reason: until the SEC adapts the registration framework to the unique aspects of digital assets, it is impossible to “come in and register.” The current registration forms rely on a set of disclosures that are inadequate for crypto’s unique aspects and leave investors vulnerable. Registration also entails a host of additional regulations for the token, the reporting company, and other participants in the ecosystem that makes the functioning of most crypto protocols impossible.

Indeed, the reason there are virtually no registered token offerings in the US is because the SEC has failed to provide any  actionable guidance, issue a single rule or constructively engage with anyone in the crypto industry to provide a workable regulatory framework for security tokens.

The example of Coinbase is illustrative.  An SEC registered company itself, Coinbase submitted a rulemaking petition to the SEC in summer of 2022 that asked for clarity regarding many unresolved issues needed for a functioning market in digital assets, including registration as an exchange and staking. That petition went unanswered. Instead, yesterday the SEC continued its pattern of regulation by enforcement by sending Coinbase a Wells notice covering activities the company was actively seeking clarity on through their public rulemaking.

The claim that crypto projects can “just come in and register” with the SEC today is a fabrication - much more is needed from them if the SEC genuinely wants to provide appropriate investor protection in the crypto asset space.

Our hope is that building consensus on the viability of crypto projects registering with the SEC under the current regime can spur a true, honest discussion about how this industry should be regulated, with Capitol Hill as the locus of engagement. That, and only that, offers the crypto industry, crypto skeptics, policymakers, interest groups, and the American public a path to addressing/regulating crypto.

Part II starts with a general background on the SEC registration process and then reviews the history of the crypto projects that have attempted to register, either as part of an SEC settlement or on their own accord. Understanding the struggles and resulting failures of the majority of these projects illustrates how the “path to registration” is not currently a viable one.

Part III will analyze the current SEC disclosure regime by focusing on  Form S-1. We will argue that the current disclosure framework is fundamentally misaligned with most tokens, as it presumes an issuer-security relationship that does not exist in decentralized systems. We will discuss various gaps in the disclosures required by the form and places where clarity is needed to make registration a viable path and adequately inform investors.

Finally, Part IV will underscore how the SEC’s current position, which claims most crypto projects need to be registered, while at the same time making the registration impossible, amounts to a regulatory ban of crypto which exceeds the SEC’s authority.

Special thanks to Mike Selig for his review.