What the SEC Hearing Means for Crypto and Innovation

Last week on the 18th of April, the Honourable Gary Gensler, Chair of the US Securities and Exchange Commission (SEC), appeared before the US Committee on Financial Services for a hearing entitled “Oversight of the Securities and Exchange Commission.” The purpose of this hearing was to examine ‘the regulatory developments, rulemakings, and activities undertaken by the SEC since the last hearing on the 5th of October 2021.

There is growing concern that Chair Gensler is weaponising the SEC and, in doing so, departing from the established process, precedent, and jurisdiction. Over the last week, the SEC has faced a great divide in opinions regarding how to achieve their three-part mandate effectively and efficiently without hurting other parts of the economy. The US Securities and Exchange Commission ensures that the US financial markets are fair, transparent, and efficient. However, this mission is a double-edged sword, as the SEC’s regulatory actions often have both intended and unintended consequences. Weighing the pros and cons of the SEC’s activities is extremely important as the results could outweigh the benefits and cause deeper cuts into the already bleeding global market.

1920s America was characterised by falling government debt, low bank deposit interest rates and a nation of citizens looking to capitalise on the stock market of the ‘roaring 20s’. Investors flocked to US securities hoping to make significant returns, and banks provided the credit to fuel a market boom. Consequently, speculative demand saw a rapid increase in public listings, with an estimated US$50 billion worth of new securities offered in the United States between 1921 to 1929. Inevitably, a lax regulatory environment, rampant stock fraud and years of highly speculative growth resulted in a market collapse in October 1929. The ensuing financial turmoil saw heavy losses for investors and banks, leading to a steep decline in public confidence in US markets. In response, Congress passed the Securities Act of 1933 and, in the following year, the Securities Exchange Act of 1934, paving the way for the creation of the Securities and Exchange Commission.

The SEC operates as the independent, non-partisan regulatory agency responsible for US securities laws. Its primary role is best reflected by its mission to ‘protect investors, maintain fair, orderly, and efficient markets and facilitate capital formation.’ However, a critical issue facing the SEC is balancing protecting investors and facilitating capital formation. Some argue that, in its quest to protect investors, the SEC’s regulatory burden on businesses, particularly smaller ones, has become too heavy, thus hindering capital formation.

Additionally, the SEC’s focus on disclosure-based regulation has been criticised by some, who argue that it leads to the over-disclosure of information that may not be material to investors, leading to high compliance costs for businesses. Another significant issue raised in last week’s hearing was the speed and scale of regulatory proposals being put forward by the SEC and the risk that its radical regulatory agenda may stifle innovation and market growth.

Capital formation is vital for businesses to acquire the necessary funds for expansion, such as purchasing new equipment and buildings. These funds may come from investors or the business’s resources. The US Securities and Exchange Commission (SEC) plays a critical role in ensuring equitable capital distribution to businesses while protecting investors and the economy. However, the SEC’s actions reveal a potential bias against funding from the cryptocurrency sector, possibly aimed at reducing competition with traditional fiat currencies.

These debates highlight the essential question of the appropriate role of government regulation in markets. The SEC must maintain a neutral stance and promote fairness and transparency in all market sectors, including the cryptocurrency industry. However, finding a balance between protecting investors and fostering economic growth is challenging, particularly in recent years, with the SEC under pressure to be more responsive to investors’ interests while encouraging capital formation.

Excessive regulation is causing problems for companies, especially smaller ones. The increasing regulatory burden is making it harder for businesses to meet the SEC’s requirements for disclosing information. Increased regulation is causing many companies to refrain from going public and instead rely on private investors for funding. While this allows them to avoid the costs and regulatory requirements of going public, it could be detrimental to public investors.

If fewer companies continue to go public, fewer investment opportunities will be available in the stock market, which could lead to decreased investor interest and fewer diverse investment options. Additionally, private companies may provide investors with less information about their financial health, leading to increased investment risk. Public investors may also need help to obtain accurate information about private companies, which could further increase investment risk.

The trend of smaller companies staying private could also have a negative impact on the broader economy. Smaller companies are critical to a thriving economy, and if they struggle to raise capital or choose not to go public, overall economic growth could be hindered. Slow economic growth could lead to a reduction in job creation and lower economic output.

It is crucial to strike a balance between regulatory requirements and facilitating capital formation to ensure a thriving economy while protecting public investors. One of the reasons for the shift towards fewer companies going public is the increased compliance costs associated with regulatory requirements. Smaller businesses often lack the resources and personnel to comply with the extensive regulations mandated by the SEC, which makes it harder for companies to meet the heightened disclosure requirements, leading to increased compliance costs that can hinder their ability to compete in the market.

One issue with the SEC’s focus on disclosure-based regulation is that it can lead to the over-disclosure of information that may not be material to investors. The SEC’s disclosure-based regulatory framework requires companies to provide detailed information about their operations, including sensitive personal data, making them more vulnerable to data breaches and cybercrime. This further burdens companies that are already grappling with meeting the requirements. The over-disclosure of information can have severe consequences for individuals and smaller businesses, particularly with the expansion of the surveillance economy.

As the SEC works to balance investor protection and economic growth, it must also consider how to protect individuals’ privacy in an environment where surveillance and data collection are becoming more widespread. Oversight will require careful consideration of data governance, consent, and the use of surveillance technology in the workplace. Ultimately, a more nuanced approach is required that considers the needs of businesses, investors, and the economy to ensure the continued success of the US financial markets.

One of the risks of regulation via enforcement instead of having clear, unambiguous laws is the potential for inconsistent and arbitrary application of rules. When regulations are enforced based on the discretion of regulators rather than clear guidelines, the risk of unfair treatment and lack of transparency increases. Ambiguity can lead to uncertainty for businesses and investors, as it becomes difficult to predict whether their actions will be considered compliant. In addition, companies subject to enforcement actions may expend significant resources defending themselves against charges they believed were not applicable or were applied unfairly.

Furthermore, unclear regulations do inadvertently stifle innovation and growth, which limits the potential benefits that innovative new products and services could bring to the economy. Businesses that are unsure of the legal boundaries may choose to avoid new products or services altogether rather than risk regulatory action. There are also concerns that overregulation via enforcement can lead to a “chilling effect” on free speech and creativity.

These concerns are particularly relevant in industries such as the arts, where regulations can be subjective and difficult to define. Creators may self-censor or avoid certain content altogether to avoid the risk of enforcement action or negative publicity.

The crypto industry has borne the brunt of unclear guidelines, arguably orchestrated to defend the US dollar from further erosion, especially before Central Bank Digital currencies (CBDCs) are rolled out and adopted. To address these risks, regulatory agencies such as the SEC need clear and unambiguous regulations rather than relying solely on enforcement actions. Providing clarity by removing guesswork enhances innovation, with clear frameworks for investors and businesses to follow, helping to reduce uncertainty and the potential for inconsistent application of regulations.

Clear regulations also allow regulatory agencies to focus their enforcement efforts on truly egregious violations rather than minor or technical infractions. These stated suggestions would improve the efficiency of the regulatory process, reducing the burden on businesses and the cost to taxpayers.

While enforcement is essential for regulatory agencies like the SEC, clear regulations are necessary to reduce uncertainty, foster innovation, and protect free speech and creativity. By striking the right balance between regulation and enforcement, the SEC can effectively fulfil its mandate and ensure the continued success of the US financial markets.

Another issue raised is the need for the SEC’s regulatory regime to keep pace with technological developments. As technology continues to disrupt the financial markets, the SEC has a critical role in ensuring that these developments do not pose systemic risks to the markets. While the SEC has made some strides in this area, some believe that more needs to be done to keep abreast of technological changes.

In conclusion, the SEC’s mandate is crucial in ensuring that the US financial markets remain fair, transparent, and efficient. However, as recent debates have shown, it is difficult to balance competing interests properly while keeping pace with technological changes. The instability or failure of the US Dollar could cause significant harm to the global economy, especially if it fails without something of equal or better substance to replace the gap. Consequently, the SEC must continue to engage in these debates openly and thoughtfully to support the stable and sustainable growth of US financial markets and the value of the US Dollar.

Disclaimer: Please note that the information provided in this article is not to be considered as financial advice. Please seek advice for your personal or business matters from a qualified professional or make contact with myself or one of the team at Strategy Hubb to tailor custom solutions to accommodate your circumstances.