On June 7, 2022, Senator Cynthia Lummis (R-WY) and Senator Kirsten Gillibrand (D-NY) introduced the Responsible Financial Innovation Act (RFIA), which seeks to create a complete regulatory framework for digital assets. This is the second in a series of blogs on this groundbreaking bipartisan legislation. Click here for a general overview of the bill and a summary of the tax provisions included in the RFIA.
The RFIA attempts to create a clear standard for determining which digital assets are securities and which are commodities, and draws clear jurisdictional lines between the SEC and CFTC. The SEC would retain jurisdiction over the sale of investment contracts, while the CFTC would gain jurisdiction over the digital asset spot markets. CFTC Chairman Rostin Benham quickly declared his support of the proposed division of labor, while SEC Chairman Gary Gensler has expressed concerns that the legislation may undermine existing market regulations for stock exchanges, mutual funds, and public companies. The policy debate over which of the two agencies is best situated to regulate the crypto markets will likely grow louder in the wake of this proposal.
With respect to securities laws, the RFIA seeks to solve the long-standing problem of the application of the Howey test to digital assets: how long does the security label attach to a digital asset that was initially sold as an investment contract? Application of the full panoply of securities laws to every transaction in a digital asset can stifle the growth of a network and create headaches for entities seeking to comply with complex rules that don’t always fit the underlying conduct.
This update provides a summary of the securities law provisions and obligations placed upon the SEC in the RFIA.
Title III – Responsible Securities Innovation
Section 301 – Securities Offerings Involving Certain Intangible Assets
The bill would create a new Section 41 to the Securities Exchange Act of 1934 and add a definition of “ancillary asset.” An “ancillary asset” is defined as “an intangible, fungible asset that is offered, sold, or otherwise provided to a person in connection with the purchase and sale of a security through an arrangement or scheme that constitutes an investment contract.” This definition would mean that tokens wouldn’t be “tainted” with security status simply because they were sold pursuant to an investment contract or as part of a private offering to investors that also included equity or other securities. The definition excludes assets with “security-like” rights in a business entity, such as voting rights and rights to profits.
The bill explains two significant consequences of a digital asset qualifying as a “ancillary asset.”
First, the issuer of the investment contract, pursuant to which the ancillary asset was sold, would incur tailored semi-annual disclosure obligations for at least one year under two conditions: (i) if the “average daily aggregate value” of all trading in the ancillary asset in spot markets open to the public in the US is greater than $5 million and (ii) if the issuer, or any person owning 10% or more of any class of equity securities of the issuer, “engaged in the entrepreneurial or managerial efforts that primarily determined the value of the ancillary asset.” Foreign private issuers, as defined in the bill, would not be able to avail themselves of the provisions of new Section 41 of the Exchange Act. The bill lists more than thirty specific disclosure requirements relating to (i) basic corporate information regarding the issuer, and (ii) information relating to the ancillary asset.
Second, the bill codifies a rebuttable presumption that the ancillary asset is a commodity and not a security. Accordingly, transactions in the ancillary asset would not be subject to the securities laws and the CFTC would have jurisdiction over spot markets in the ancillary asset. The bill makes it clear that a person who is not an issuer, an entity controlled by the issuer, or a person acting at the direction or on behalf of an issuer will not be required to treat an ancillary asset as a security.
The bill also contains provisions permitting voluntary disclosure and a mechanism by which the SEC may exempt an ancillary asset from the disclosure obligations.
Section 302 – Termination of Specified Periodic Disclosure Requirements
The bill creates a mechanism by which an issuer can end its reporting obligations by certifying to the Commission that, during the 12-month period preceding the certification, either (i) “average daily aggregate value” was not greater than $5 million or (ii) neither the issuer, nor any entity controlled by the issuer, “engaged in the entrepreneurial or managerial efforts that primarily determined the value of the ancillary asset.” An issuer would be required to support its certification “by reasonable evidence, based on the knowledge of the issuer filing the certification, after due inquiry.”
After notice and opportunity for a hearing, a Commission vote to deny a certification may occur if the Commission finds that the certification “is not supported by substantial evidence.” An issuer would retain the ability to re-file a certification no earlier than 180 days after the denial.
Section 303 – Guidance Relating to Satisfactory Control Location
The bill would require the SEC to issue guidance relating to the designation of a satisfactory control location for digital assets under Rule 15c3-3 of the Exchange Act, also known as the Customer Protection Rule. The RFIA sets parameters around the guidance: it must permit the requirement to designate a satisfactory control location to be satisfied by the use of commercially reasonable cybersecurity practices to maintain control of sufficient private key material to transfer control of the digital asset, including by means of a smart contract.
Section 304 – Custody and Customer Protection Rules
The RFIA would require the SEC to complete its ongoing studies relating to (i) the Customer Protection Rule and (ii) Rule 206(4)-2 of the Investment Advisers Act, also known as the Custody Rule, within 18 months of the legislation being enacted. The bill lists specific concepts that must be addressed in the rulemakings, including investor protection, facilitating regulatory compliance, market structure, and custody of digital assets.
Additionally, within 270 days of enactment of the legislation, the bill would require the Commission to adopt guidance permitting a broker to engage in trading and custodial activities for digital assets, digital asset securities, and traditional securities within the same legal entity.
Title VIII – Responsible Interagency Coordination
The bill would require the SEC to change the way in which it interacts with the public and other agencies in certain respects.
Sec. 801 – Timeline for Interpretive Guidance
The bill would place a timeline of 180 days for the SEC, along with other federal financial regulators, to respond to a written request for individualized interpretive guidance with respect to the application of a statute, rule, or policy under the SEC’s jurisdiction.
Sec. 805 – Analysis of Decentralized Finance Markets and Technologies
The bill would require the Secretary of the Treasury to consult with the SEC, CFTC, and private sector participants in DeFi protocols before submitting a report relating to a variety of DeFi topics.
Sec. 806 – Analysis of Energy Consumption in Digital Asset Markets
The bill would require the Federal Energy Regulatory Commission to consult with the SEC and CFTC in order to conduct a study analyzing energy consumption in digital asset markets.
Sec. 807 – Analysis of Self-Regulation and Registered Digital Asset Associations
The bill would require the SEC and CFTC to consult with digital asset intermediaries to issue a report setting forth principles for self-regulation for digital asset markets and a proposal for the establishment of a self-regulatory organization for digital asset markets based on delegated authority from both agencies.
Sec. 808 – Cybersecurity Standards for Digital Asset Intermediaries
The bill would require the SEC and CFTC to consult with the Secretary of the Treasury and Director of the National Institute of Standards and Technology to develop comprehensive, principles-based guidance relating to cybersecurity for digital asset intermediaries.
Sec. 809 – Advisory Committee on Financial Innovation
The bill would establish the Advisory Committee on Financial Innovation that would provide annual reports to the President and Congress and provide recommendations for legislation, regulation, and supervision relating to innovation in a variety of matters including digital assets, market structure, financial inclusion, and reduction of systemic risk. The bill would require a SEC commissioner to participate.
 See Al Barbarino, CFTC Chief Says Crypto Bill Gets Regulatory Balance Right, Law360 (June 8, 2022), available at https://www.law360.com/securities/articles/1500741/cftc-chief-says-crypto-bill-gets-regulatory-balance-right?nl_pk=802f8cdd-c1db-4bf5-a44f-b2867a2cf581&utm_source=newsletter&utm_medium=email&utm_campaign=securities&utm_content=2022-06-09; Paul Kiernan, Crypto Legislation Could Undermine Market Regulations, Gensler Says (June 14, 2022), available at https://www.wsj.com/articles/crypto-legislation-could-undermine-market-regulations-gensler-says-11655231512?mod=markets_lead_pos10.
 See Custody of Digital Asset Securities by Special Purpose Broker-Dealers, Rel. No. 34-90788 (Dec. 23, 2020), available at https://www.sec.gov/rules/policy/2020/34-90788.pdf; Staff Statement on WY Division of Banking’s “NAL on Custody of Digital Assets and Qualified Custodian Status” (Nov. 9, 2020), available at https://www.sec.gov/news/public-statement/statement-im-finhub-wyoming-nal-custody-digital-assets.