[Senate Hearing 115-176] [From the U.S. Government Publishing Office] S. Hrg. 115-176 VIRTUAL CURRENCIES: THE OVERSIGHT ROLE OF THE U.S. SECURITIES AND EXCHANGE COMMISSION AND THE U.S. COMMODITY FUTURES TRADING COMMISSION ======================================================================= HEARING before the COMMITTEE ON BANKING,HOUSING,AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED FIFTEENTH CONGRESS SECOND SESSION ON EXAMINING THE GROWING WORLD OF VIRTUAL CURRENCIES AND THE OVERSIGHT CONDUCTED BY THE U.S. SECURITIES AND EXCHANGE COMMISSION AND THE U.S. COMMODITY FUTURES TRADING COMMISSION __________ FEBRUARY 6, 2018 __________ Printed for the use of the Committee on Banking, Housing, and Urban Affairs [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Available at: http://www.govinfo.gov/ ______ U.S. GOVERNMENT PUBLISHING OFFICE 28-854 PDF WASHINGTON : 2018 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Publishing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS MIKE CRAPO, Idaho, Chairman RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio BOB CORKER, Tennessee JACK REED, Rhode Island PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey DEAN HELLER, Nevada JON TESTER, Montana TIM SCOTT, South Carolina MARK R. WARNER, Virginia BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada JERRY MORAN, Kansas DOUG JONES, Alabama Gregg Richard, Staff Director Mark Powden, Democratic Staff Director Elad Roisman, Chief Counsel John O'Hara, Chief Counsel for National Security Policy Kristine Johnson, Economist Elisha Tuku, Democratic Chief Counsel Dawn Ratliff, Chief Clerk Cameron Ricker, Deputy Clerk James Guiliano, Hearing Clerk Shelvin Simmons, IT Director Jim Crowell, Editor (ii) C O N T E N T S ---------- TUESDAY, FEBRUARY 6, 2018 Page Opening statement of Chairman Crapo.............................. 1 Prepared statement........................................... 36 Opening statements, comments, or prepared statements of: Senator Brown................................................ 2 WITNESSES Jay Clayton, Chairman, U.S. Securities and Exchange Commission... 4 Prepared statement........................................... 36 Responses to written questions of: Senator Brown............................................ 138 Senator Sasse............................................ 143 Senator Reed............................................. 146 Senator Schatz........................................... 151 J. Christopher Giancarlo, Chairman, U.S. Commodity Futures Trading Commission..................................................... 6 Prepared statement........................................... 101 Responses to written questions of: Senator Brown............................................ 156 Senator Sasse............................................ 160 Senator Schatz........................................... 161 (iii) VIRTUAL CURRENCIES: THE OVERSIGHT ROLE OF THE U.S. SECURITIES AND EXCHANGE COMMISSION AND THE U.S. COMMODITY FUTURES TRADING COMMISSION ---------- TUESDAY, FEBRUARY 6, 2018 U.S. Senate, Committee on Banking, Housing, and Urban Affairs, Washington, DC. The Committee met at 10:04 a.m., in room SD-538, Dirksen Senate Office Building, Hon. Mike Crapo, Chairman of the Committee, presiding. OPENING STATEMENT OF CHAIRMAN MIKE CRAPO Chairman Crapo. The Committee will come to order. This morning we will receive testimony from SEC Chairman Jay Clayton and CFTC Chairman Chris Giancarlo on the growing world of virtual currencies and the oversight conducted by their two agencies. And welcome, gentlemen. Virtual currencies are meant to act as a type of money that can be traded on online exchanges for conventional currencies, such as dollars, or used to purchase goods or services, predominantly online. Additionally, developers, businesses, and individuals are selling virtual coins or tokens through initial coin offerings, also known as ICOs, to raise capital. Over the last year, many Americans have become increasingly interested in virtual currencies, especially given the meteoric rise in valuation and recent fall of Bitcoin. Just for perspective, on January 2 of last year, Bitcoin broke the $1,000 barrier, then peaked in December of 2017 at almost $20,000, and as of this morning is trading at roughly $6,900. Today the market capitalization of Bitcoin is roughly $115 billion. This is an incredible rise given that in 2013, when this Committee had subcommittee hearings on the topic, the total value of Bitcoin in circulation was approximately $5 billion. As virtual currencies have become more widespread, financial regulators and heads of financial institutions have noticed and voiced their opinions. Regulators and heads of industry have tried to educate investors so that they make informed decisions and ensure that the markets they oversee and participate in are working appropriately. For its part, the SEC has put forth many statements and guideposts to help the markets and investors. Namely, the SEC has issued investor bulletins on initial coin offerings; issued an investigative report on what characteristics make an ICO a security offering; issued several statements by Chairman Clayton on the issue; brought enforcement actions against fraudsters; and issued joint statements with the CFTC about enforcement of virtual currency-related products. The CFTC has also been helping inform the markets by launching a dedicated website on virtual currencies to educate investors; bringing enforcement actions against individuals involved in cryptocurrency-related scams; issuing several statements by Chairman Giancarlo and other Commissioners on the issue; and scheduling hearings on the topic. Much of the recent news about virtual currencies has been negative. Between the enforcement actions brought by your agencies, the hack of the international Coincheck exchange, and the concerns raised by various regulators and market participants, there is no shortage of examples that increase investor concerns. It is also important to note that the technology, innovation, and ideas underlying these markets present significant positive potential. These aspects underpinning virtual currencies have the ability to transform for investors the composition of, and the ability to access, the financial landscape, thus changing and modernizing capital formation and transfer of risk. Technology is forward-looking, and we look to our regulators to continue carrying out their mandates, including investor protection, as markets evolve. I look forward to hearing more and learning more about virtual currency oversight from our two witnesses today, including what their agencies are doing to ensure appropriate disclosures and safeguards for investors. Senator Brown. OPENING STATEMENT OF SENATOR SHERROD BROWN Senator Brown. Thank you, Chairman Crapo, and welcome to Chair Clayton and Chair Giancarlo. Good to have you both here. Virtual currencies, and Bitcoin specifically, have captured the attention of investors and speculators and computer programmers and regulators all over the world. I do not know how many people imagined how quickly and broadly Bitcoin, and the technology it is based on, would spread. To most of us, it is nothing short of remarkable. To be sure, it is critical for our regulators to understand innovation and technology so that markets can grow and evolve while investors and consumers are protected. Understanding the risks of emerging technologies is no easy task, but we are relying on you to maintain the integrity of these new markets and minimize the risks to Americans who want to participate in them. The volatility of Bitcoin has also been remarkable, defying attempts to think of it as a traditional currency. Bitcoin's 1,000-percent rise last year and 60-percent decline last month makes yesterday's Dow Jones record point drop look almost like a rounding error. But that growth has shown us the intersection of ingenuity and, too often, greed. Sometimes it appears that scam artists and hackers may understand more about the technology than most market participants. That should concern all of us. I hope our witnesses today can help us understand the evolution of the markets related to virtual currencies, raise awareness of the many threats involved, and identify the regulatory gaps. Each of you has made several public statements recently explaining the threats to investor protection and the potential for abuses in virtual currency markets. I understand that neither the SEC nor the CFTC has sufficient authority to police all aspects of virtual currencies, but you must make the most of the authority you have. As you both noted in the Wall Street Journal, Bitcoin mania has some analogies to the dot-com bubble of the late 1990s. I hope there are lessons from that era that you draw on to do your job to protect investors. In addition to the investment risk, virtual currency may be used to fund illicit activity, especially outside the United States. I know the regulatory framework in many other countries is still in development. I am pleased that the U.S., and FinCEN in particular, has been a leader. But we can do more. I hope the Chairman agrees with me that the Committee needs to look closely at the gaps in regulation in this area and to review your agencies' ability to get ahead of the curve. As you begin to adapt to the unique enforcement and regulatory demands posed by virtual currencies, I call on both of you not to forget your day jobs--as Chair Clayton and I talked the other day--not to forget your day jobs: to pursue and punish misconduct, more traditional misconduct but very serious misconduct, wherever it might appear. That means Main Street; it also means Wall Street. I am concerned that it is business as usual when it comes to violations by the big banks. Just last week the CFTC imposed penalties on three big banks for market manipulation--good--but then decided those firms deserved waivers from bad actor provisions under the securities laws. That might make sense if this were an isolated incident, but the banks in question have something like 68 violations over the last 10 years. So it is very, very serious. Too often we see big banks pay fines and move right along, with little contrition and, frankly, no serious punishment. Recidivist violators will not stop breaking the law if your agencies serve as sanctuaries. I have raised the issue of waivers over the years. I am disappointed in your unwillingness to pursue every avenue available. It is clear that virtual currencies bring us into a new age, but that does not mean we overlook the basic principles of going after the bad guys and being tough when they are repeat offenders. Thank you, Mr. Chairman. Chairman Crapo. Thank you. Senator Brown. Now we will turn to the testimony of our witnesses, and first today we will receive testimony from the Honorable Jay Clayton, Chairman of the U.S. Securities and Exchange Commission. Following him, we will then hear from the Honorable Chris Giancarlo, Chairman of the U.S. Commodity Futures Trading Commission. Gentlemen, again, we welcome both of you here, appreciate you coming to share your knowledge and understanding on this issue with us. And, Chairman Clayton, you may proceed. STATEMENT OF JAY CLAYTON, CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION Mr. Clayton. Thank you. Chairman Crapo, Ranking Member Brown, distinguished Senators of the Committee, thank you for the opportunity to testify before you today on the important topic of cryptocurrencies, initial coin offerings, and related trading activities. The total market capitalization of all cryptocurrencies was estimated at $700 billion earlier this year. In 2017, ICOs-- initial coin offerings--raised nearly $4 billion. These markets are local, national, and international. Today I will attempt to level-set where we stand from a market regulatory perspective. My remarks may be viewed by some as overly simplistic, but they reflect how I present these issues to Main Street investors. For ease of analysis, I break this space into three categories: First, a promising new technology referred to as distributed ledger technology or blockchain. Proponents of this technology assert that it will bring great efficiencies to our national and global economies, including our capital markets. I hope that it does. And the Commission looks forward to working with market participants who seek to bring efficiencies, including more effective oversight, to our markets. The second and third categories are cryptocurrencies and ICOs, which are subsets of the products seeking to take advantage of the commercial opportunities presented by blockchain technology. One is promoted to be a replacement for dollars. The other is like a stock offering. Cryptocurrencies: Some of the more widely known cryptocurrencies were introduced as substitutes for traditional currencies, such as the U.S. dollar or the euro. Those who promote these so-called virtual currencies have asserted that they will make it easier and cheaper to buy and sell goods, particularly across borders. They have asserted that transaction and verification fees and costs will be eliminated or reduced. To date, these assertions have proved elusive in many areas. ICOs: From what I have seen, initial coin offerings are securities offerings. They are interests in companies, much like stocks and bonds, under a new label. Promoters use the term ``coin'' based on the fact that the security being offered is represented by a digital entry or ``coin'' on an electronic ledger, as compared with a stock certificate and a related entry in a company's records. You can call it a coin, but if it functions as a security, it is a security. Also, importantly, an ICO may have nothing to do with distributed ledger technology beyond the coin itself. Buying an ICO does not mean you are investing in blockchain-related ventures. There are many problems with the way cryptocurrency and ICO markets are operating, but two are worth particular attention. First, the markets for these products have substantially less oversight than our traditional securities markets. To be blunt, if you are trading cryptocurrencies on a platform that looks like a stock exchange, do not take any comfort from that look. Our stock exchanges have extensive rule sets, and they are required to conduct surveillance. Also, broker-dealers who facilitate securities trading have capital and conduct requirements. These requirements, and others, without a doubt are necessary to protect those markets and our investors. Second, many ICOs are being conducted illegally. Their promoters and other participants are not following our securities laws. Some say this is because the law is not clear. I do not buy that for a moment. The analysis is simple. Are you offering a security? If so, you have a choice: follow our private placement rules or conduct a public offering registered with the SEC. A note for professionals in these markets: Those who engage in semantic gymnastics or elaborate structuring exercises in an effort to avoid having a coin be a security are squarely within the crosshairs of our Enforcement Division. So what are we doing about these problems? I look forward to discussing with you that question in more detail, but will start with a comment on jurisdiction and a comment on enforcement. We--the SEC and the CFTC--do not have direct jurisdiction over the popular markets that trade true cryptocurrencies. This is not an oversight. It is the result of a new product and market. The traditional currency markets did not need direct regulation by market regulators such as the SEC or the CFTC. They are sovereign- backed and regulated with a long history. Cryptocurrencies, on the other hand, have no sovereign backing or oversight and, again, to be blunt, are currently functioning as assets for trading and investment much more than as mediums for exchange. Please do not view this description as a request for expanded SEC jurisdiction. If asked, we will work with other regulators to evaluate and address this issue, including our friends at the Fed, our friends at the CFTC, and the State regulators. They all have a keen interest in this market. I will close. I know my time is short. To the extent that digital assets like ICOs are securities--and I believe every ICO I have seen is a security--we have jurisdiction and our Federal securities laws apply. We will enforce these laws. Many of these laws also include private rights of action. We are working with the DOJ and other regulators to enforce these laws. Thank you for the opportunity to testify before you today. I stand ready to work with Congress on these issues and look forward to your questions. Chairman Crapo. Thank you, Chairman Clayton. Chairman Giancarlo. STATEMENT OF J. CHRISTOPHER GIANCARLO, CHAIRMAN, U.S. COMMODITY FUTURES TRADING COMMISSION Mr. Giancarlo. Thank you, Chairman Crapo, Ranking Member Brown, and distinguished Members of the Committee. I have submitted a written statement for the record that details the CFTC's work and authority over virtual currencies, but with your permission, I would like to begin briefly with a slightly different perspective, and that is as a Dad. I am the father of three college-age children: a senior, a junior, and a freshman. During their high school years, we tried to interest them in financial markets. My wife and I set up small brokerage accounts with a few hundred dollars that they could use to buy stocks. Yet other than my youngest son, who owns shares in a video game company, we have not been able to pique their interest in the stock market. I guess they are not much different than most kids their age. Well, something changed in the last year. Suddenly they were all talking about Bitcoin. They were asking me what I thought and should they buy it. One of their older cousins, who owns Bitcoin, was telling them about it, and they got all excited. And I imagine that maybe Members of this Committee may have had some similar experiences in your own families of late. It strikes me that we owe it to this new generation to respect their enthusiasm about virtual currencies with a thoughtful and balanced response, not a dismissive one. And yet we must crack down hard on those who try to abuse their enthusiasm with fraud and manipulation. We must thoroughly educate ourselves and the public about this new innovation, and we must make good policy choices and put in place sound regulatory frameworks to reduce risks for consumers. Putting my CFTC hat back on, I suggest that the right regulatory response to virtual currencies has at least several elements, and the first is to learn everything we can. At the CFTC we have launched a new initiative called ``LabCFTC'' to engage with these innovators and inform the agency about virtual currencies and other financial technology. Next is to put things in perspective. As of 8 a.m. this morning, the total value of all outstanding Bitcoin is about $113 billion. We have a slightly different figure than you have, Chairman, but close. But the point is that that is less than the market cap of one large publicly traded company-- McDonald's. The total value of all virtual currency in the world is around $313 billion. In comparison, global money supply is around $7.6 trillion. And because Bitcoin is sometimes compared to gold as an investment asset, the value of all the gold in the world is around $8 trillion, which dwarfs the size of the virtual currency market. The next task is to tell the public what we learn and educate consumers. There is a lot of noise around virtual currency, and regulators must help set the record straight. The CFTC has produced a large amount of consumer education materials on virtual currencies, including written statements, podcasts, webinars, and a dedicated Bitcoin website. We have even scheduled visits to libraries and briefings for seniors. We have never conducted this much outreach for any other financial product. Another element is regulatory coordination. Because no one agency has direct authority over virtual currencies, we have to work together. That includes us, the SEC, the Fed, the IRS, the Treasury's FinCEN network, and even State banking officials. And the next element is to exercise our legal authority over derivatives on virtual currencies while clarifying our statutory limitations. To be clear, the CFTC does not regulate the dozens of virtual currency trading platforms here and abroad. We cannot require them to meet requirements like trade reporting and market surveillance, standards for conduct, capital requirements, or even cyberprotections or platform safeguards. But these are all standard regulations in the futures markets we oversee. Yet through our authority over commodity derivative markets, we do have enforcement power over spot coin markets. And with newly launched Bitcoin futures, the CFTC can now obtain trading data and analyze it for fraud and manipulation in five underlying spot markets. And that leads to the final element, and that is tough enforcement. Led by the CFTC's Virtual Currency Enforcement Task Force, we have launched several civil actions over the past few weeks cracking down on fraudsters and manipulators, and more will follow. In closing, I want to quote something that Chairman Clayton and I wrote recently in the Wall Street Journal: ``These markets are new, evolving, and international. They require us to be nimble and forward-looking, and coordinated with State, Federal, and international colleagues, and engaged with important stakeholders, including Congress.'' I am glad to be with you today, and I hope my kids are listening. Thank you very much. Chairman Crapo. Thank you, Chairman Giancarlo. I will begin the questioning. First I will say I have had those dinner conversations with my own children, and you are right, this is an incredibly interesting but growing new area of financial challenge, particularly among our--at least my children and yours. Both of you have said in one way or another that neither of you, neither of your agencies have complete jurisdiction over cryptocurrencies. The question I have is whether you have sufficient jurisdiction, and I would like both of you to address that question. Should Congress address revising and refining our financial law so that one agency or a group of agencies have complete jurisdiction? Or if you look at the jurisdiction of all agencies today, do we have sufficient jurisdiction in place today? Chairman Clayton? Mr. Clayton. Well, thank you, and in my position you are always cautious about speaking for other agencies, so I thank you---- Chairman Crapo. Understood. Mr. Clayton. --for saying that we should all come to--to be very direct, we should all come together, the Federal banking regulators, the CFTC, the SEC--there are States involved as well--and have a coordinated plan for dealing with the virtual currency trading market. I think our Main Street investors look at these virtual currency trading platforms and assume that they are regulated in the same way that a stock exchange is regulated. And as I said, it is far from that. And I think we should address that issue. Chairman Crapo. So am I hearing you say that you do not think we need to have additional legislative authorities? Mr. Clayton. I think we may. I think we may. Chairman Crapo. So first you should get together and tell us what you can and cannot do and then advise us. Mr. Clayton. I think that is a very good way to put it, Senator. Chairman Crapo. Chairman Giancarlo. Mr. Giancarlo. I think that is exactly right. I think the first step is to recognize where the gap is. So as we both said in different ways, what we call the spot market for Bitcoin is not a regulated marketplace. For us at the CFTC, we are familiar with that because we generally do not have regulatory supervision over the spot markets for which derivatives apply. That is a longstanding basis. We regulated derivative markets. The underlying markets we surveil, and we will take enforcement action for fraud and manipulation. But we do not have the ability to set the standards on those markets, and that is what we have today in Bitcoin. And unless it is an ICO, then, as Chairman Clayton described, he also does not have the jurisdiction. So there is that gap, and I think the starting point for an informed conversation is there is that. Now, there are other elements to it. There are other agencies that come to bear on this. So State regulators, there is a patchwork of State regulation across the Nation. Some States have been very assertive in this area, other States less so, and some States have nothing. FinCEN, as you referenced, has also been active in the area in terms of anti-money laundering and Know Your Customer requirements. So there is a patchwork here, but there is not a comprehensive structure, and that is something that I think is a policy discussion and an important one to be had. Chairman Crapo. All right. Thank you. And you have led to my next question. Much of the activity in the virtual currency markets is cross-border and international, so that raises obviously the question of what challenges does that present and what is the appropriate role for FinCEN. I would like both of you to respond. I only have about a minute left so take about 30 seconds each, if you would. Mr. Clayton. I will try to be quick. The international nature of this market is why a patchwork is probably not sufficient if it is going to continue to develop as a significant market and one that our Main Street investors access. From FinCEN's perspective, there are reports that we all have heard that these cryptocurrencies are used for illicit activity. I think FinCEN has been stepping up in that regard, and I encourage them to continue to do so. And this challenge of global markets is a challenge that I think we face now in many regards. In the 21st century with the dawn of the Internet, markets have become truly global and not just in virtual currencies but so many things. And it does become a challenge as we think about regulation. We certainly have had that challenge working with overseas regulators in the area of derivatives regulation as a result of the Dodd-Frank Act. The challenge of bringing these regulations together in a comprehensive whole is really a tremendous challenge for all of us. So in this area, it requires a lot of new thinking. Chairman Crapo. Well, thank you. I appreciate your remarks from both of you on these issues, and I would encourage you to form that work group, get together between yourselves, State regulators, other appropriate Federal regulators, and evaluate exactly what our regulatory structure should like in America to deal with this and let us know your thoughts, your further thoughts on that. I would appreciate that. Mr. Clayton. Thank you. Chairman Crapo. Senator Brown. Senator Brown. Thank you, Mr. Chairman. Chair Clayton, again, nice to see you. Last year initial coin offerings raised about $4 billion globally. You have testified that the SEC is focused on policing these transactions to protect investors. How much of that $4 billion was raised in the U.S.? Mr. Clayton. It is not clear. It is hard to get a number on that because this has been conducted on largely an unregulated basis, but I imagine, Senator, a significant enough portion where we should be paying attention. Senator Brown. And my understanding is that during the last few months the SEC has taken four enforcement actions targeting coin offers for serious violations of law. That speaks volumes about the work that--the challenges in front of you. In response to the Chair's question, you both talked, leading with you, Chair Clayton, about agencies working together and the importance of that on this and other issues. Your testimony highlights cooperation between the SEC and CFTC, Chair Clayton, regulating Bitcoin and other virtual currencies. It does not mention any cooperation with the Consumer Financial Protection Bureau. Hundreds of consumers have filed complaints with the Bureau about virtual currencies. How have you been coordinating your work specifically on this but in other areas, too, with CFPB? Mr. Clayton. On this area, largely through the FSOC. At the FSOC I believe I have made very clear my views in this area and that this is an area that we should all be on the lookout for, on the lookout from each of our perspectives. The CFPB is a member of FSOC, and they have heard my comments there. From an enforcement perspective, we are in the securities area. We do not see the CFPB on the securities side of this. I am not aware of any direct coordination on a particular enforcement action, but I could check on that. Senator Brown. OK. In the past few months, Deutsche Bank, Credit Suisse, UBS, and HSBC have been fined over $300 million by other regulators for various forms of market manipulation. But SEC has been quiet under your watch. One study by a Georgetown law professor found that SEC has ``virtually stopped enforcement actions against large entities, often referred to as `Wall Street firms'. '' How do we have confidence, Mr. Chairman, that the SEC is willing to hold Wall Street accountable when the trend in penalties and actions is going the wrong way? Mr. Clayton. I actually saw that report. That probably does not come as a surprise to you that someone sent it to me. I found it annoying, to be honest, because it did not reflect the fact that the gestation period for the cases we bring is roughly 22 to 24 months. So any type of statistics necessarily have a latency period to them. Our Enforcement Division put out a report that talks about the numbers in a comprehensive way. I am happy with that report. I am also confident that the people who are in our Enforcement Division and leading it, many of them former Federal prosecutors, two of them former heads of the Securities Task Force in the Southern District of New York, are pursuing our securities laws vigorously. I have no doubt. They come to work every day and they have my full confidence. Senator Brown. I hear you say that, and I believe you when you say that. I remember the last SEC--and it was not you--the last SEC under a Republican President, how they were asleep at the switch. So as the Governor of the Richmond Federal Reserve used to tell me, ``Watch us, and let us know you are watching us.'' But I am further troubled by a statement by one of the SEC's enforcement codirectors last fall that SEC might lose 100 of its enforcement staff by not replacing those who leave. Compared to 2016 figures, this would reflect a 7-percent reduction in enforcement head count. So how are you going to stay on top of developments in virtual currencies and the other enforcement in all the other areas that we just talked about to be able to fight traditional misconduct? How are you going to do that when you are not replacing them, if, in fact, that is the case? Mr. Clayton. Senator Brown, personnel is my biggest challenge at the moment. We have a hiring freeze as a result of natural increases in costs and people retiring or taking other jobs has reduced the size of the workforce at the SEC. I could use more people in Enforcement. I could use more people in Trading and Markets. Those are the two areas where I think the American people would get the greatest return for additional bodies. Senator Brown. So when you come in front of us--and I appreciate your candor. When you come in front of us and tell us that you are having trouble filling those jobs and---- Mr. Clayton. No trouble. I just cannot. Senator Brown. OK, I guess trouble that way, all right, because of the freeze. Isn't that message to those who want to game the system and those who want to defraud the system, isn't the message that the SEC is not the cop on the beat that even the new Chair wants it to be? Mr. Clayton. Do I want more bodies to do more? Yes. Is the message that somehow we are asleep at the switch? Absolutely not. Senator Brown. And with your budget that is coming out, our understanding is the budget--I hope the freeze is lifted. I hope the budget is enough. And I hope that you will speak to us and ask particularly people on the other side of the aisle for the dollars you need and the flexibility you need to put those cops on the beat. Mr. Clayton. I think I have been very straight about an incremental amount of money and where I think value can be added. Senator Brown. Thank you. Chairman Crapo. Senator Shelby. Senator Shelby. Thank you. Thank you, Mr. Chairman. Chairman Clayton, you and Chairman Giancarlo, you are Chairmen of two powerful regulatory bodies, but you have different jurisdictions. Anything that smacks of security comes somewhere in your range, does it not? Dealing with a commodity, something that could be deemed a commodity clearly comes in your range. The Federal Reserve is the biggest bank regulator we have and also the--and Treasury is involved in this. How are you going to put together a task force, can you do it on your own through the Administration, to deal with the cryptocurrencies--because you have got the Fed, you have got the Treasury, you have got the commodities, you have got the securities, perhaps some others that we have not thought about--before this gets out of control somewhere in the world? Mr. Clayton. Let me start, and then Chris can---- Senator Shelby. Yes, sir, go ahead. Mr. Clayton. ----by recognizing the Treasury Secretary. He has brought us together---- Senator Shelby. That is good. Mr. Clayton. ----the CFTC, the SEC, and representatives of the Federal Reserve to talk about this because, Senator, you are exactly right. The funny thing about these cryptocurrencies is they only work for their purported purpose if they are integrated with the financial system. And so, therefore, it necessarily touches on all of our regulation. Senator Shelby. Chairman. Mr. Giancarlo. I would just reinforce that. The Treasury Secretary has been out front on this. He has formed a Virtual Currency Working Group of ourselves, the SEC, the Fed, and FinCEN. We have had a number of preliminary conversations and work streams developed. I have had a number of bilateral conversations with the Treasury Secretary on virtual currencies, and we are going to be coordinating our various responses. It has begun with just some broad conversations establishing our different jurisdictions so that we are all clear as to what we are doing, but also what we are not doing, where the gaps are. Senator Shelby. Do you need additional legislation in this area, to both of you, or do you think you can work a task force together to get your arms around this without that? Mr. Clayton. I cannot give you a definitive answer to that question because we should work together, but, Senator, we may be back with our friends from Treasury and the Fed to ask for additional legislation. Senator Shelby. You know, we live in a virtual world. We go to the doctor, and they give you a virtual examination, you know? We can go here and it is virtual, and this was not my world. I started out with pencil and paper in school, as you can imagine, in my day. But at the same time, this currency, these cryptocurrencies, they lack intrinsic value, it seems to me. They lack liquidity. I am sure people have probably made a lot of money going up, and a lot of them made money or lost money going down. But I do not know where the bottom is, if the bottom was ever reached, as opposed to a sovereign-issued currency. Do you disagree? Mr. Giancarlo. No, Senator. I do not know where the natural equilibrium point is in this, but I will tell you there are some economists who posit that there is a relationship between Bitcoin value and the difficulty or the cost of mining, which is a process of electronically producing these, and that there are some charts I have seen that have plotted that correlation that seemed to be readily correlated until last summer when the price broke free of that correlation and that it came back into correlation late at the end of the year last year. Now, I am not an economist. I find those things fascinating, but I am not an expert in it. But the point the economists are making is that there is some sort of floor, that the level set is not zero, that there is some floor there tied into the cost of mining of Bitcoin. And I am not endorsing that point of view. I am just sharing that with you. Senator Shelby. Chairman Clayton, do you have any comment? Mr. Clayton. Look, there are a lot of smart people who think there is something to the value of the cryptocurrency in the international exchange, and I am not seeing those benefits manifesting themselves in the marketplace yet. And from the perspective of--look, I look at this as protecting Main Street investors. They should understand that. Senator Shelby. How do you put a value on cryptocurrencies? Does the market put a value on it, or does it go straight up, then straight down, or what? Mr. Clayton. Well, that is what is something worth? It is worth what somebody is willing to pay you for it. But in our world, the securities world, you know, there are rules that dictate how much you have to tell somebody about what it is you are selling them. Senator Shelby. But part of your mandate, the Securities and Exchange Commission, is to protect the investor. Is that right? Mr. Clayton. That is right. Senator Shelby. And the Chairman of the Commodity Futures Trading Commission, he has seen obviously commodities just go wild at times, and your mandate is to watch the commodities, right? Mr. Giancarlo. Market integrity is generally perceived to be our core mandate. Senator Shelby. You also mentioned personnel, you know, you need personnel. There is a hiring freeze on. We talked the other day about--this gets into the realm of appropriations and so forth. I am hoping that we will give you every tool you need to do your job and to hire the people that you need to execute that. Mr. Clayton. Thank you very much. Thank you. Senator Brown [presiding]. Senator Reed. Senator Reed. Thank you very much. Thank you, gentlemen, for your testimony. Following on the questions of Senator Brown and Senator Shelby, you do need more personnel, but very specifically, do you have the technologists, the computer experts that can begin to understand how these cryptocurrencies work, the cryptologists, and not just sort of on a day-to-day basis, you know, to give you the Thompson, but look ahead and say this is the direction it is going, which could have very significant deleterious effects? Do you have anyone like that on the staff? Mr. Clayton. The answer to your question is we formed a Distributed Ledger Technology Working Group, a cybergroup. They have done an exceptional job getting up to speed on this in a short amount of time and identifying some of the very issues you talk about. You know, in an emerging area like this, could you use more horsepower? Always. But you make a very good point, Senator, on looking out across the international nature of this and trying to understand where it is going to land and do the things that people say add up. That is a very important---- Senator Reed. Where are the technologists located? If you do not have them--and I presume you do not--is it---- Mr. Clayton. What we have, I would say it is a combination of economists and technologists. It is a question of, you know, here is what the technology is and does it make economic sense. We have those people in our Division of Economic and Risk Analysis, DERA, and we also have some of them in Enforcement, and they work together. Senator Reed. But you need more. I will take that as a yes. Mr. Giancarlo, the same question. Do you have the technologists? Are you working together? Mr. Giancarlo. Thank you, Senator Reed. We have done a couple of things in 2017, as Senator Brown said, to get ahead of the curve. We hired the agency's first-ever Chief Innovation Officer, someone who comes with a deep background in a lot of these new financial technology innovations. We also created something called ``LabCFTC'', which is our innovation hub, and you asked where is it located. It is actually located in New York City because so much of this innovation is taking place there and we wanted to be close to these innovators to learn from them. But in terms of protecting consumers, we also formed a Virtual Currency Enforcement Task Force. It was actually that task force that recently brought three civil actions against Bitcoin fraudsters. And as I said in my testimony, there is more to come. And as to the resource questions, we do need more resources. I used our bypass authority last year to put forward a budget request of 13 percent over our budget. We had been flat-funded for 3 years, and we do need additional resources. And built into those resources are additional resources for FinTech generally and cyber and cryptocurrencies specifically. Senator Reed. Let me just elaborate a bit. We continue to refer to Bitcoin. That is just one cryptocurrency. They seem to be proliferating, that every day there is a new variety of cryptocurrency, some of them out-and-out fraudulent, some of them based on the Bitcoin technology or processes. But just the sheer expansion of these cryptocurrencies is an issue, one. And, two--because my time is short and I have one other slightly unrelated question to Chairman Clayton--are you tracking all these different daily emerging currencies, one? And, two--again, it goes back to my sort of step-back question--is someone looking long term at the systemic effects? You know, where are we going to be? This is eerily reminiscent of the late 1990s in derivatives which were nominally small parts of the market that were esoteric, et cetera, and then, of course, 10 years later, exploded. So why don't you start, Mr. Giancarlo? And I will finish up with the Chairman. Mr. Giancarlo. Thank you very much. So you are absolutely right. Bitcoin is one of many. However, of the many, there is really a handful that have gotten significant traction. Senator Reed. Right. Mr. Giancarlo. And so that is important, though, for listeners to know because so many of these are fraudulent, as you said. We went after one--and I just mention it because I think it is interesting--called ``My Big Coin'', which became known as ``My Big Con'' by people that were defrauded by it. It was people that really were taking--it was a Ponzi scheme. They were taking consumers' money and using it to buy houses and furniture and jewelry. And we went after them and went after them hard, and we will continue to do that. In terms of systemic risk, right now this is still a relatively small market just by ratio. But as you say, we have to watch it and watch it carefully. Senator Reed. Mr. Chairman. Mr. Clayton. So as I mentioned, the SEC does not have direct jurisdiction over pure cryptocurrencies, but we have had to watch them because, of course, they are integrated with the markets that we do oversee. And to your question of does 10 make sense or 15 or 20 make sense, I have a hard time getting my head around that because if it is an efficient medium of exchange, 15 of them fluctuating different places probably does not make a lot of sense to me. That is where I am at. On systemic effects, I agree with Chairman Giancarlo, but if people are getting ripped off, that presents reputational risks that can have systemic effects. Senator Reed. We can go into a raft of questions, money laundering, evading, et cetera, but just changing gears one second, I will make a comment and then follow up with a written question. There is some consideration, I have heard, of the SEC allowing in public offering, initial public offering, borrowers to sue, i.e., forced arbitration. I think that would be a very bad idea, and I will make the argument and---- Mr. Clayton. I am happy to address the question. Chairman Crapo [presiding]. Well, we are out of time on that right now, so we will have to do it in writing. Senator Reed. We will talk. Chairman Crapo. Senator Rounds. Senator Rounds. Thank you, Mr. Chairman. Gentlemen, I am just curious. I go back to where I learned with a pen and pencil to begin with as well, and we did not have a quill at that time, but we did have No. 2 lead. And as I get into this and learn more about this thing, it is fascinating to see how quickly things are moving, and yet everything that we talk about seems to translate back into dollars and cents yet. That has not changed--until now, and suddenly we are talking about a new type of exchange, and it sounds almost like bartering to me. And it is a bartering which could avoid the determination of a value in dollars and cents. Which brings up the question of how do you tax it if you need to, how do you recognize income? But, also, in this particular case, I notice both of you identified that you have additional--or you have existing resources and regulatory oversight capabilities that you are utilizing today. And while I question whether or not there are seams that have to be filled, it would appear that there are some basics that maybe a lot of us do not quite understand that still have to be answered. I just want to start out, because I think, Mr. Clayton, you started with this discussion, with regard to the issue of whether or not you had control over an ICO and the fact that if they were issuing in this particular case Bitcoin or the opportunity to market it, you had identified it as a stock or at least a value of something. What is in this particular case that thread that you utilize once again? And can you delve into that a little bit more about how your agency responds to the regulatory need in this particular case? What is the specific item that you look at as being an item which is subject to your review, a security in what? Mr. Clayton. The definition of a security is broad, and it includes--I am not going to use the technical terms. There are Supreme Court cases and things like that. But it includes situations where if you are offering me a security--or offering me something, a coin, and I give you money, and the purpose of me giving you that money is to profit from your efforts going forward. So if I give you money, you give me a coin and you say, ``I am going to take the money and I am going to grow a business, and that is going to increase the value of that coin. And, by the way, Chairman Clayton, you can trade it to somebody else. So you may be able to get value for it tomorrow. In fact, you probably will get value for it tomorrow. Buy now so you can get more value for it in a few days.'' That is a security. Senator Rounds. So commodity-wise, if we are looking at trading commodities, you would not have an interest in the subject of investigating or reviewing whether or not the trading of an ag. commodity was something, and yet when we talk about the CFTC, we are talking about a different story where commodities most certainly are an item of interest to you. Is Bitcoin or are these as currently being traded, are they a commodity or are they a security? Or are they both? Mr. Giancarlo. So what is so challenging about Bitcoin is it has characteristics of multiple different things. One of the phrases that is often used is that Bitcoin is a medium of exchange, a store of value, or a means of account. Well, those three things have different connotations to them. If it is a medium of exchange, then it is a currency-like instrument. And yet, as we have seen, a number of means of exchanges have been closed to Bitcoin. There was recently a Bitcoin conference that stopped accepting Bitcoin from registrants because they could not process the payments. But yet it is still spoken of as perhaps a means of account. And in that case, it has implications from the Fed and currency. From our point of view, when it is used as a store of value, then it is very much like an asset, like a commodity. And, in fact, what we hear a lot of is people buying and holding. If you go on to the Twitter universe, you will see a phrase, ``HODL,'' which means hold on for dear life. And the thinking is that they buy it and hold it. In fact, I mentioned in my opening remarks my 30-year-old niece, who bought Bitcoin years ago, and she is an HODL. She says, ``I am going to own it. I do not know what is going to come of it, but I want to hang onto it.'' And she is not a fraudster or a manipulator. She is just a kid and believes in it. You know, I was fascinated talking to her, and I think she represents a lot of folks that think there is something in this I want to hold onto it. And so in that regard, from our point of view, it is a commodity. And if there is a derivative on that, we regulate it. The problem is in the cash market we do not have regulatory authority. It means we cannot set the standards. But what we will do and we are doing is looking for fraud and manipulation, and we intend to be very aggressive, if nothing else so that people like my niece can have some security that there are not fraudsters and manipulators out there, and there are far too many of them. Senator Rounds. Thank you, Mr. Chairman. Your suggestion earlier that we bring them both back in at a later date after they have had an opportunity to look at the differences would be very appropriate. Thank you, gentlemen. Thank you, Mr. Chairman. Chairman Crapo. Thank you. Senator Warren. Senator Warren. Thank you, Mr. Chairman. Chairman Clayton, on January 26th, Bloomberg published an article entitled, ``SEC Weighs a Big Gift to Companies: Blocking Investor Lawsuits''. Now, as you know, class action lawsuits are how investors can hold companies accountable when they defraud people, and the article says the SEC is thinking about letting companies sell shares in initial public offerings while at the same time allowing those companies to prohibit investors from bringing class action lawsuits against them. Wow, I mean, forcing investors to give up class actions when they have been defrauded. The SEC has never allowed corporations to bar investors who get cheated from bringing class action lawsuits. So I just want to get a straight yes-or-no answer from you on this. Do you support this enormous change in SEC policy? Mr. Clayton. So I think you know that I cannot prejudge an issue that may come before the SEC, but I would be happy to talk to you about this, and let me get to the bottom line. I cannot dictate whether this issue comes before us or not because of the way it has come before the SEC in the past. But I am not anxious to see a change in this area. Senator Warren. OK. So I am reading tea leaves here. Mr. Clayton. I am not---- Senator Warren. I mean, you run this agency. The change cannot happen without your approval. I think it is fair for the---- Mr. Clayton. That is actually not right. If it came up before the agency, I am only one of five votes. Senator Warren. I am going to guess there are going to be at least two votes against that and that you at best will be the deciding vote. Mr. Clayton. Senator, I do not want to prejudge the issue. If this issue--I want to be practical. If this issue were to come up before the agency, it would take a long time for it to be decided because it would be the subject of a great deal of debate. And like I said, in terms of where we can do better, this is not an area that is on my list for where we can do better. Senator Warren. OK. So I will tell you what. Chairman Clayton, I am going to let you get away with that, because what I am reading is real skepticism about a rule like this. The SEC's mission is to protect investors, not throw them under the bus. And I cannot think of anything that would do more harm to investors than saying they have to pre-waive their rights to sue a company in a class action when that company cheats them. So---- Mr. Clayton. Like I said, it is not a change that is on---- Senator Warren. I hear you. So let me ask you about something else, and that is the fiduciary rule. Financial advisers who put the high fees, the commissions, the kickbacks, the prizes they can get for recommending a specific product ahead of the interests of their clients cost hardworking Americans trying to save for their retirements about $17 billion every year. And that is why President Obama and the Department of Labor put the fiduciary rule in place to eliminate these conflicts of interest in retirement accounts like 401(k)s and IRAs. Now, less than a month after you were sworn in as Chairman of the SEC, you issued a Request for Information asking for public comment on rulemaking related to the standards of conduct for investment advisers and broker-dealers. Can you state to this Committee that any rulemaking you do on this topic will not weaken the existing protections for retirement savers? Mr. Clayton. Making an absolute statement like that---- Senator Warren. Yeah, an absolute statement that you are not going to weaken rules for people who are trying to save for their retirement. Mr. Clayton. From what baseline--let me---- Senator Warren. Well, we have a rule from the Department of Labor. Now you could strengthen the rule, you could pass the same rule, or you could weaken the rule. I want to know that you are not going to weaken the rule. That is all I am asking you. Mr. Clayton. Here is what I am trying to do. Let me tell you what I am trying to do. The relationship between an investment adviser or a broker-dealer and their client in a very simple area--they have a 401(k), they have an annuity, and they have a few stocks--is regulated--throw out the banking regulators. It is regulated by no less than five people. And they all have different standards. My main objective is to bring clarity to that without jeopardizing investor protections. That is how I am---- Senator Warren. Well, but that is the question I am asking you, about whether or not you are jeopardizing the protection that people are trying to save for their retirement get. I get that you could bring clarity. Clarity could be do whatever you want. Clarity is what right now has cost American investors saving for their retirement $17 billion a year. Mr. Clayton. I think it is a combination of an insufficient standard in some places, which we are looking to increase---- Senator Warren. Glad to hear that. Mr. Clayton. --a lack of clarity and also the standard is only as good as the remedy available. And one of the things that I am also looking at, believe me, I spend a lot of time in this space trying to get it right. One of the things we are looking at is what dollars do you actually collect when somebody has done you harm, because you could have a really strong standard, but if there are no dollars there, that is a problem. Senator Warren. So I agree with you, Mr. Chairman, if you want to strengthen enforcement of this rule or strengthen the rule itself, count me in. But that is what the American people look to the SEC for. Thank you. Mr. Clayton. I do. Senator Warren. Thank you. Thank you, Mr. Chairman. Chairman Crapo. Senator Perdue. Senator Perdue. I want to go change the subject a little bit back to Bitcoin here or to cryptocurrencies. You know, we see in IPOs and tax jurisdictional arbitrage. Do you guys see that today in this developing cryptocurrency and also in ICOs? Chairman Clayton, do you want to start with that? Mr. Clayton. Well, yeah---- Senator Perdue. And, by the way, who pays for frivolous class action lawsuits? Who pays for that? Mr. Clayton. Shareholders. Senator Perdue. Yeah, and investors, I would argue customers, employees, all of the above, right? Mr. Clayton. Yes. Senator Perdue. Would you answer the other question for me, please? Mr. Clayton. So regulatory arbitrage is one of many issues that I see in this market. To be frank, tax loss and things like that are there. Of course they are because it is recordkeeping, it is difficult to trace. Senator Perdue. South Korea and China are the ones that predominantly play in this world. You said before most of the current investment comes from the U.S. I am not sure--I do not know if we all know enough yet to know that, right? South Korea and China are really heavily invested. In fact, South Korea has a new rule that says you have to use real name bank accounts in order to trade in this. Those are the kinds of things I am asking for. Is the arbitrage really going on around the world here? Mr. Clayton. There is certainly regulatory arbitrage, but you are making a great point because this was a largely unregulated space across the world. And now what you are seeing is each country taking a perspective, a view, action, et cetera, which also goes to how functional is this asset class and how would we regulate it and how does it work. There is a lot happening that is beyond the kind of understanding of your average investor. How would you know how---- Senator Perdue. So how can we and two agencies here--I understand there is interaction between all of our regulatory agencies, but there is also another axis here that you have to coordinate, and that is the other country regulators as well. Mr. Clayton. Correct. Senator Perdue. So I am asking both of you, what are you seeing and what are you anticipating we need to do, either legislatively or rulemaking, to combat that? Mr. Clayton. Chris, do you want to---- Mr. Giancarlo. Sure, let me jump in. I will just identify two areas of arbitrage we are seeing. One is regulatory, which I want to come to, but actually we are also seeing price arbitrage as well. There is something known as the ``kimchi premium'' for Bitcoin traded in South Korea because there is so much interest there that it drives the price up there slightly higher, so price arbitrage. But, you know, in the early days of many markets, every American city had a cotton exchange and the prices were different there before you developed a national market. So here we have different regional and international markets and perhaps as this market matures, if it matures, a single price may develop. In terms of regulation, unfortunately I think that some time ago, perhaps the middle of last year, there was this perception that Bitcoin was off the regulatory grid. And one of the things that Chairman Clayton and I have been working so hard to do is to disabuse that notion. Now, we are limited in our regulatory authority to set regulatory standards on these underlying platforms. But when it comes to enforcement, when it comes to ICOs, we are using our full authority to drive the message, and other countries are doing that as well, and we have had frequent conversations. I spoke recently or had communication recently with the head of the Japan financial service agency about some things that were going on there. Jay Clayton spoke very eloquently at the FSB meeting recently in Basel, Switzerland. We are beginning our communication with other regulators. And I think the message is getting through that this is not off the grid, and I think part of that is now you are seeing it in the Bitcoin price. As the word is getting out that we will go after misconduct, I think you are starting to see that reflect in the price, and I think that is an important step. Senator Perdue. Well, with what little time we have left, I would like both of you to respond to the pump-and-dump efforts that are underway right now. You see this beginning to develop. I know you are both involved in this. Can you both address what your agencies are doing to combat that? Mr. Clayton. Senator Perdue, this is one of the things that I am worried that investors do not understand, which is when you have---- Senator Perdue. Me, too. Mr. Clayton. When you have an unregulated exchange, the ability to manipulate prices increases significantly. And, you know, just a few coordinated sales can change a price. Senator Perdue. Or an email, a fraudulent email. Mr. Clayton. Correct. Mr. Giancarlo. I have mentioned we formed this Virtual Currency Enforcement Task Force. We have got some really good people on this, and we have brought three actions in the last few weeks. I said there are more to come. There are more to come. We are digging deep and learning a lot and seeing a lot. And I do not want to get ahead of that other than to say that we are working the beat hard right now. Senator Perdue. And you have a jurisdictional right to do that, right? Mr. Giancarlo. We have enforcement jurisdiction. Yes, we do. Senator Perdue. Great. Thank you, Mr. Chairman. Chairman Crapo. Senator Donnelly. Senator Donnelly. Thank you, Mr. Chairman. Thanks to both the witnesses. This would be to both of you. Now that the SEC and the CFTC have asserted jurisdiction and warned the public of the risks posed by virtual currency operators, what other ways can your agencies prevent retail investors from falling victim to fraud and manipulation? Mr. Giancarlo. I am happy to take this question, Senator. Earlier Ranking Member Brown mentioned what do we do with the CFPB. We have actually formed a partnership with the CFPB to consumer education in the area of Bitcoin. One of the things I have learned recently is that America's libraries are a place where a lot of people go and research Bitcoin. In fact, they use the library computers. One of the most frequently searched items from a library computer is Bitcoin. And so we are teaming up with CFPB to go out to America's libraries, to educate librarians who often get some of the questions asked, to be able to direct library patrons to use our resources, our Bitcoin website and our other resources. So we are really getting very creative in the area of consumer education. I had mentioned we have got several podcasts on this subject with thousands of downloads. We are working as hard as we ever were. We have never done as much work on consumer education as we have done with virtual currency. Mr. Clayton. We also have an Office of Investor Education and Advocacy that has been engaged with a number of groups on this, and I think they have done a terrific job getting the word out. In terms of getting the word out, though, there are financial intermediaries and other actors that we are counting on to act responsibly in this area. Senator Donnelly. OK. Well, let me ask you a follow-up, and it goes to the point you just made about the libraries and others. Are you concerned that retail investors will remain vulnerable to fraudulent and manipulative online solicitations that are sometimes more difficult for you guys to pick up? Mr. Giancarlo. Senator, in the broad range of marketplaces, seniors seem to be the prey of choice for fraudsters and manipulators. Whether it is in precious metals, whether it is in foreign exchange, whether it is in a whole range of products, we see and we prosecute continuously fraudsters who seek to prey on either the less sophisticated seniors who maybe do not quite have the retirement nest egg that they believe they need and fall prey to get-rich-quick schemes or schemes that say we will guarantee 100 percent returns and all kinds of nonsense like that. And it is a big part of our enforcement effort at the agency. Senator Donnelly. Let me ask you this, and this goes to perspective and to hopes and dreams. But what warnings would you give? There was an article in the Washington Post yesterday, and it was about good, hardworking Americans, people who have worked really hard and want to have a pension. It was about a group of our friends and neighbors from Kentucky, and the title of the article was, ``Bitcoin Is My Potential Pension''. What would you say to them to help protect them from winding up in a situation a few years from now where it did not quite work out the way they were hoping? Mr. Giancarlo. It is such a troubling development, Senator, unquestionably, which is why we are putting out so much materials. But what I would say to them is--it is the same advice I would give my children. If it sounds too good to be true, it is. If they are promising ridiculous returns, they are ridiculous. If you are going to give them money, you had better be prepared to lose it. Mr. Clayton. I agree with everything that Chairman Giancarlo said. I also would say this to them, which is there are things like disruptive technologies that come along, but they should not disrupt the way you look at markets or the way you look at investing. Pumping all of your money into a disruptive technology has a very high likelihood of not working out for you as an individual. When we see disruptive technologies come along, you know, there will be winners, but there will be many losers. Senator Donnelly. OK. Mr. Clayton. That is the way it works. Senator Donnelly. Let me ask you one other question. How can both of you best assist law enforcement and Federal authorities to ensure these virtual currencies are not used by terrorist groups or Nations like North Korea to evade sanctions? Mr. Giancarlo. So we work very closely with law enforcement. We recently commenced a program with the FBI where we actually had FBI agents on secondment with our agency in order to look at this. At the end of the day, the use of these cash markets for that, it is going to require cooperation amongst multiple agencies, especially with FinCEN, who often because of their anti-money-laundering operation may see some of these issues before we can, and then bring our expertise to bear and coordinate with our law enforcement agencies. Mr. Clayton. Same here. I would supplement that with we also have a Dark Web Working Group that tries to monitor what is going on in that space in order to identify these types of issues. Senator Donnelly. Thank you, Mr. Chairman. Senator Brown [presiding]. Senator Kennedy. Senator Kennedy. Thank you, Mr. Chairman. Welcome, gentlemen. I think you are both doing a terrific job. Chairman Giancarlo, when is the last time you bought a stock exchange-traded fund, mutual fund, or a bond? Mr. Giancarlo. So I hold generally traded funds---- Senator Kennedy. Yes, but when is the last time you bought one? Mr. Giancarlo. Well, probably before I--I pretty much put my investing---- Senator Kennedy. A year ago? Mr. Giancarlo. Well, probably before I started at the Commission. Senator Kennedy. Two years ago? Mr. Giancarlo. Yes. Senator Kennedy. OK. When you bought it, what did you buy? Equity or bond? Mr. Giancarlo. Index funds mostly. Senator Kennedy. Index funds, OK. When you bought it, did you sit down and read the prospectus for the index fund? Mr. Giancarlo. Well, you know, I am not supposed to say this---- Senator Kennedy. Cover to cover? Mr. Giancarlo. As a lawyer, I am not supposed to say that I probably did not read it cover to cover. [Laughter.] Mr. Giancarlo. But I will confess that I did not read it cover to cover. Senator Kennedy. How many investors do you think do that, do not read it? Mr. Giancarlo. I think most. Senator Kennedy. OK. So what is the point? I mean, we are talking about all the dangers and the risks of cryptocurrencies like Bitcoin. I am putting aside the shyster fraud issue. I mean, what is the point of all this over disclosure if nobody is reading it? Mr. Giancarlo. Well, I---- Senator Kennedy. And why do we want to do the same thing with Bitcoin? Mr. Giancarlo. I will say historically it has been one of the foundational principles of our securities laws that adequacy of disclosure, full disclosure, is one of the building blocks. I will tell you, having been in business, that most business people will tell you they study the prospectus only to see what they can sue on if they need to sue on something if something goes wrong. Senator Kennedy. I think you see where I am going. I am going to ask you both a philosophical question in a second about how far you think we ought to go to protect people from themselves. But I do not think the disclosure we have right now works. I think it is good for the lawyers, and it is good for the financial advisers. But I think we overdisclose, and I think you can--I will bet you each have a smart lawyer on your staff. You could go to them and say, ``Write me a good disclosure for Bitcoin.'' And you would get it back and look at it and then pick 50 names from the Washington, DC, phone book and ask them to come in and say, ``Read this and tell me if it makes sense to you.'' I mean, what is the point? How far do you think we ought to go here in terms of a cryptocurrency--I am separating this from the blockchain technology. China outlawed it. I think South Korea has, too. What are you suggesting, that we just go after the shysters and fully disclose? I mean, is that what you think we ought to do? Chairman Clayton. Mr. Clayton. Well, I think that is exactly the question we are here to pose and take forward, which is, you know, what is the right way to deal with this new thing? As just a person watching it, I am not satisfied when I see people thinking that these trading platforms of cryptocurrencies have the same kind of protections that a stock exchange would. And I am very unhappy that people are conducting ICOs like public offerings of stock when they should know that they should be following the private placement rules unless they are registering with us. Those two things make me unhappy. To figure out how to deal with them is why we are here. I agree with you that we should be careful not to go too far. But just to be clear, for me in this ICO space, it is pretty clear that our securities laws work pretty well. Disclosure can be improved. It can really be improved. Senator Kennedy. Well, let me make this suggestion, because I do not want to go over. The last time I asked questions, I got a little carried away. I think I went over 3 minutes, and our Ranking Member put me on double secret probation. [Laughter.] Senator Kennedy. So I am not going to do that today. Senator Brown. Like I have the power to do that. [Laughter.] Senator Kennedy. He does. The disclosure, I mean, you can extend the disclosure we have now to Bitcoin, and you have not done anything. I am not suggesting we should not have disclosure, but you have got to have disclosure that makes sense and helps people other than the lawyers. Mr. Clayton. I agree, Senator. Senator Brown. Senator Warner. Senator Warner. I usually agree with my friend from Louisiana. I think we may be on top of something that is transformational, and I do not think you can separate the underlying distributed ledger or blockchain from some of these crypto assets. And if we had the same rate of increase the next 2 years that we have had the last couple years--we are talking now a couple hundred billion--we would be north of $20 trillion caught up in this area by 2020. And I think you--I remember back, I was lucky enough to get in the cell phone business back in the early 1980s, and everybody thought it was going to be a small business, and they were wrong and I got rich. I think we are looking at the same kind of transformation about to take place, and we are going to have to wrap our arms around it. We have talked about some of the consumer protection issues, but we have got money-laundering issues, we have got cybersecurity issues. A third of the Bitcoin exchanges have been cyber-hacked between 2009 and 2015. I am not exactly sure what the right regime ought to be, but I would argue that--while I commend the Treasury Secretary for putting a working group together, I would argue this is the reason we created FSOC in the first place, that this rises potentially to the level of a systemically relevant event, and I would just be curious whether you believe--and I commend what both of you are trying to do, but whether this ought to elevate to an FSOC-level analysis. Mr. Clayton. So, Senator, I had the same question you had, which is: There is a big rise here; if it does keep going is this a systemic issue? Which is one of the reasons we brought it up at FSOC, talked about it at FSOC. Again, I commend the Treasury Secretary for forming the working group. I want to go back to separating ICOs and cryptocurrencies. ICOs that are securities offerings, we should regulate them like we regulate securities offerings. End of story. Senator Warner. I have a couple more points I want to make. Mr. Giancarlo. Thank you, Senator. Just real quickly, on the issue of disclosure, sometimes what we are seeing is not a problem of absence of disclosure. It is false disclosure. False disclosure is often fraud, and I think we need to step in there. But just in terms of discussion, as Chairman Clayton mentioned, we have begun discussions at FSOC. In addition, there have also been discussions led by Chairman Clayton at the Financial Stability Board and also at IOSCO, which is the International Organization of Securities Commissions. So these discussions are taking place at the right levels of debate, but there is so much more to be done. Senator Warner. Again, to my friend from Louisiana, we have got this--we are focusing a lot on Bitcoin and crypto assets, cryptocurrencies, and I think there are even definitional issues here. But you have got a whole new platform called ``Ethereum'' where they are creating, you know, file sharing or extra computer time. I am not sure what kind of assets those fall into? Are they potentially regulated within your realm or if there is a trading exchange, a tokenization exchange between excess computer time? I am not sure where that fits at this point. Mr. Clayton. The definition of a security I believe--the people who wrote the 1934 Act and the 1933 Act, they were smart. They did it on a principled basis. They basically said if you are giving people money in exchange for a future development of a business with the hope of a return--and whether that return comes in the form of server time or your ability to sell server time--it is a security. Senator Warner. I concur with the approach you have taken in terms of the ICOs, and I think there has been some very bad behavior. Yet certain ICOs the SEC has not stopped; others they have stopped. Are you going to go back and re-review the ones that have gone forward? Mr. Clayton. Let me say another thing about the 1933 and 1934 Acts. When they were written, there was a great recognition that there was a tremendous amount of securities activity in this country, and that we were going to rely on gatekeepers to help us enforce those rules and they would be liable if they did not help us enforce those rules-- accountants, lawyers, underwriters, sellers, and the like. I am counting on those people to do their job, and I have made that clear. Senator Warner. Let me ask, Chairman Giancarlo, what we did--and one of the things I am concerned about was that I think we may have moved too fast on allowing, for example, futures trading on Bitcoin. And I just wonder. You know, you have allowed future trading contracts on Bitcoin, yet the SEC has not allowed ETFs. I am just worried that we need a much more coordinated effort, because I think the potential, writ large, amongst crypto assets and the underlying blockchain could be as transformational as wireless was years ago, and I think we are going to need a much more coordinated effort. I know my time has expired, but if you could both quickly comment on that, I would appreciate it. Mr. Giancarlo. Well, so I believe it is critically important that we coordinate on this. I believe that we are all both individually and collectively understanding our authorities, understanding this new technology, working around it. There was communication among myself, Chairman Clayton, the Treasury Secretary, and others in connection with Bitcoin futures. And, you know, Bitcoin future are quite different than the Bitcoin market. Bitcoin is an anonymous area. Bitcoin futures is fully transparent to the regulator. Bitcoin, retail. Bitcoin futures, mostly institutional and high net worth. Bitcoin futures, regulated. Bitcoin futures, regulated. Bitcoin, unregulated. And with Bitcoin futures we are now having visibility into underlying spot markets and data from those markets we would not otherwise have. Mr. Clayton. I completely agree on coordination. Like I said, I break it down into three areas. There is this great technology that I agree with you has promise. There are these pure cryptocurrencies, which we need to take a look at across FinCEN, Treasury, CFTC, the Fed. And then there are securities offerings that are called ICOs that should be undertaken as securities offerings consistent with our regulatory regime. Chairman Crapo [presiding]. Senator Cotton. Senator Cotton. Thank you, and thank you, gentlemen, for your appearance today. I want to continue on the line of questioning that Senator Warner began. Putting aside Bitcoin or other kinds of cryptocurrencies that are based on blockchain or distributed ledger technology, what are your thoughts on the potential value of that underlying technology, of blockchain and distributed ledger technology, both to enterprises and consumers and perhaps to Government agencies? Mr. Giancarlo. It is important to remember that if there were no Bitcoin, there would be no distributed ledger technology. It grew out of that technology initiative. And the potential applications--and, by the way, I am no pie-in-the-sky dreamer. I just report what I read. But the applications range from enormous potential in the financial services industry, in the banking industry, but right down to the way charity dollars are spent, the way perhaps refugees are accounted for across the globe. There was an article just this morning about use of distributed ledger technology for 2.5 billion people around the world who do not have access to banking services. One of the areas that--in our own area of agriculture futures, 66 million tons of American soybeans were just handled through a blockchain transaction by the Dreyfus Company for sale to China. So Bitcoin is now being used--it is used in our American transportation logistics system, and, most importantly, the potential of distributed ledger technology for regulators to be able to do really close market surveillance, and if it had been available in 2008, if we had been able to see the counterparty credit exposure of one bank to another bank in real time with precision, that would have enabled much more precise policy choices that had to be made in a rush without good data. So I think distributed ledger technology has got enormous potential. Now, how it will be realized, when it will be realized, what are the other challenges in it, those we cannot say. But the potential seems extraordinary. Senator Cotton. Thank you. Mr. Clayton. Mr. Clayton. I agree that the potential seems very significant, and just look around anywhere in our economy where verification and recordkeeping has cost that is potentially reduced, that is an opportunity for this technology. That is just one of them, and I hope people pursue it vigorously. Senator Cotton. Thank you. Let us turn our attention now to cryptocurrency and to Bitcoin, since it is the most prominent. Yesterday, the Dow Jones had its single largest decline in a point scale, 4.6 percent as a percent, which is high--not the highest ever. That obviously generated a lot of news coverage. The dollar has faced 2-percent inflation or less now for many years. Bitcoin, however, has seen a 32,000-percent increase in its value over the last 5 years. It has declined by some 60 percent, I think, in just the last 30 days. What are the factors driving that kind of extreme price volatility in Bitcoin relative to securities in publicly traded companies or the U.S. dollar? Mr. Giancarlo. Well, just recently the volatility you see in Bitcoin was not as large as volatility we have seen in some other assets classes, such as the VIX product, which is known as the fear index or volatility gauge. And so we have seen extraordinary volatility in Bitcoin, but, you know, in our world, in commodity derivatives, we are used to volatility in asset classes, and that is one of the things the emergence of a futures product is meant to do, is to provide those who are exposed to that volatility means of hedging and mitigating the risk to that volatility. Senator Cotton. Mr. Clayton. Mr. Clayton. I do not really know what is driving the volatility in Bitcoin and cryptocurrencies. They are not correlated with sovereign currencies, so it must be something different from what would drive the dollar. But that is one of the issues before us, there does appear to be a lot of volatility compared to the medium they are supposed to be a substitute for. Senator Cotton. So what does that kind of volatility portend for a cryptocurrency's future as a potential alternative to legal tender of Nation States or, in the EU's case, a transnational organization? Mr. Clayton. You raise a great point. Now, maybe that volatility tamps down to a stable currency--but an asset that is highly volatile is not a very effective means of exchange because you do not know how much you are getting by the time you receive it or how much you are paying at the time you have to pay it. If you agree to a price on day one but have to source it on day ten, you expose yourself to significant risk. Senator Cotton. Thank you. My time has expired. I do want to associate myself with the remarks of Senator Donnelly at the end of his remarks about the risks that cryptocurrencies are currently posing as a way for rogue Nations, terrorist organizations, criminal organizations to evade sanctions, not just in trading but in hacking as well, as we have seen in media reports on North Korea. So I am glad to hear that you are working closely with our law enforcement and intelligence agencies, and I hope that continues. Thank you. Chairman Crapo. Senator Menendez. Senator Menendez. Thank you, Mr. Chairman. Thank you to both of you. It is good to welcome a fellow New Jerseyan in your role, Mr. Chairman. I have been actively following both Venezuela's and Russia's interest in developing virtual currencies for the purposes of evading U.S. sanctions. Last month I sent a letter to Secretary Mnuchin on this subject, and I asked Under Secretary Mandelker about this a few weeks ago when she was here before the Committee. Under what circumstances would the SEC and the CFTC have a role in engaging or regulating the proposed new petro or crypto ruble currencies? More broadly, does the SEC and CFTC have a role to play in preventing the use of digital currencies by foreign Governments to evade U.S. sanctions? Mr. Giancarlo. Our jurisdiction would be very limited in that area, Senator. As I have spoken about before, we do have enforcement authority for fraud and manipulation, and so if we thought that that instrument was being used for fraudulent purposes, manipulation purposes, we would not hesitate to take authority. But you are probably touching on an area where the jurisdictional lapse is probably greatest for the two agencies sitting before you today. Senator Menendez. And so let me ask you, manipulation, what if you are manipulating to avoid U.S. sanctions? Mr. Giancarlo. You know, I would have to speak to our enforcement counsel to see how that fits in, but we would certainly look at it, and if---- Senator Menendez. I would like to have you do so, and I would love to hear back through the Committee. Mr. Giancarlo. Thank you. Senator Menendez. Are you interacting with FinCEN to the extent that you may have limited jurisdiction? Are you adequately integrated into the financial regulatory network that watches for illicit activities? Or are there gaps that could create vulnerabilities? Mr. Giancarlo. So as we mentioned before, Senator, Chairman Clayton and I are part of a Virtual Currency Task Force that has been put together by the Treasury Secretary that includes the Fed and FinCEN, and we have already had our first meeting, a beginning meeting to set up some work streams. We will have more to come. It just so happens that I am actually meeting with FinCEN's virtual currency team this week on a previously scheduled meeting to get some introductory discussions started of cooperation between our agencies, and so I look forward to actually asking them this question as well. Senator Menendez. OK. And I would just say to both of you, to the extent that you have a role to play and you lack the present authorities to do so, I would love to know about that if you determine that is necessary, because my sense of cryptocurrency is largely driven to evade U.S. sanctions and to undermine sovereign currencies. Both of them are a challenge to the national interest of the United States. Let me ask you this: We have seen a dramatic increase in the number of initial coin offerings where private companies are using digital tokens to raise money instead of going through the capital markets. The Wall Street Journal reported that initial coin offerings grew from about 96 million in 2016 to over 4 billion in 2017. Many of these ICOs are relying on celebrity promoters to gin up the sales. For example, last year Floyd Mayweather, the boxer, used Instagram to promote the purchase of Centra tokens. Now, I have done extensive work on consumer protections in the prepaid card space where we have seen celebrities like the Kardashians use their status to sell products that come at a steep cost to consumers, and this feels eerily similar to that, just the next avenue of exploitation. And I worry about unsuspecting investors that do not have the resources to understand the true risks. What can the SEC do to better protect investors who may be persuaded by celebrity promoters to purchase tokens offered in initial coin offerings without fully understanding the risks? Mr. Clayton. Senator, I am not going to comment on a specific instance, but---- Senator Menendez. I am talking about broadly. Mr. Clayton. Some time ago we put out an alert that said if you are promoting securities, you are taking on securities law liability. I believe that that has tamped down some of this endorsement activity. I will say it again right here: If you are promoting securities, you are potentially taking on securities law liability. Senator Menendez. Well, let me ask you--I appreciate that, and I hope that you will think about doing more to protect consumers. Can you walk us through why the SEC at this point is not comfortable with approving ETFs with significant investments in cryptocurrencies? Mr. Clayton. Our ETF product space is largely a retail product space, and we have made it clear to the marketplace that there are a couple of issues with having an ETF that is based on a cryptocurrency. They go to price discovery, custody, and, you know, some other issues around volatility. We have let the industry know that those are issues that are of concern to us and that we do not want to approve an ETF product with a cryptocurrency underlier until we can get comfortable with those issues. Senator Menendez. Thank you, Mr. Chairman. Chairman Crapo. Thank you. Senator Moran. Senator Moran. Mr. Chairman, thank you very much. I am sorry you both have to crane your necks to the left so hard to have a conversation with me. But I am delighted to be back on the Committee, Mr. Chairman. Thank you very much. Let me first start by suggesting to you that if you have suggestions, I will probably not have the chance to see you in the Financial Services Appropriations Subcommittee before we take a look at fiscal year 2019. Assuming that we are successful in the next few days on fiscal year 2018 and budget caps, we will have an opportunity to reconsider spending levels for fiscal year 2018. You have made your request through the budgetary process and an appearance before our subcommittee, but if there are priorities in which as we go back to potentially increase funding and any levels of jurisdiction within FSGG, I would welcome your input as to what is the highest priority. I heard the commentary earlier in regard to one of the questions, I think, of Senator Reed that the hiring freeze has created challenges. I do not know that we can overcome that. But if it is personnel in a particular way or other things, it would be useful for me to know. Mr. Clayton. Thank you very much. And I did not want to get ahead of the process. Our fiscal year 2019 request reflects the sentiment I have expressed today. Senator Moran. I do not know that we will see the fiscal year 2019 request before we are taking a look at the potential increase in funding for fiscal year 2018, depending on when the President's budget is released. But I would offer that--it does not need to be today--if there are any suggestions you would like to convey to me. You may have answered this question just now with Senator Menendez, Chairman Clayton, but doesn't--you indicated why you were reluctant or unwilling at the moment to approve an ETF proposal. But doesn't ETF, just as options do on its exchange, reduce the--mitigate the concerns, reduce the volatility and increase price discovery and reduce risk? So additional products--my question really is: Don't additional products help alleviate some of the challenges that we face? Or is Bitcoin or cryptocurrency so unique that it is different than other items that are traded on exchanges? Mr. Clayton. Yes, I think that the CFTC product has that effect. It is largely an institutional product, and you can take both sides of the market and, you know, it gives people a chance. As for ETFs, you can take both sides of an ETF, but predominantly they are offered for a long investor, someone who wants exposure to the rise and fall of Bitcoin or other currencies, and that is a different dynamic than a futures product. And we have long taken an investor protection view of approving those types of products, which is embodied in our liquidity, custody, and pricing rules. If we get comfortable with those rules, then we can move forward. Senator Moran. Very good. Let me raise a different topic than cryptocurrency. One of the things that I have tried to pay attention to and often in cooperation with the Senator from New Mexico, Senator Udall, is trying to modernize our IT system, particularly within the Federal Government. And you indicated, Chairman Clayton, about the $500 million loss in a Japanese cryptocurrency in your written testimony. We have now passed as part of the national defense authorization bill what has been labeled as ``MGT Act''. It is the Modernizing Government Technology Act, and what it does is create a fund for Federal agencies to rid themselves of their legacy technologies and have access to dollars to replace that legacy. It encourages moving to the cloud, again, with the opportunities for us to have better technologies and safer technology systems to reduce our vulnerabilities. I just would encourage you, you have a lot at risk in the safety and security of the data that you hold, and I would welcome your reassurances that--I am sure you will tell me that you are spending many millions of dollars and working diligently and you have the right personnel in place. But I would guess if we ask agencies of the Federal Government who have been hacked themselves and whose data has been released, they would have told us the same thing prior to that occurring to them. I would be, first of all, delighted to be reassured that we will not be reading in tomorrow's paper or next month's papers that there has been a hack at CFTC or SEC. Then, second, I just would offer you the opportunity to take a look at that legislation and see how it might be of benefit to your agencies and to suggest any ideas that you would have for what Congress can do to further strengthen cybersecurity within your worlds. Mr. Clayton. Thank you. Senator Moran. You are welcome. Mr. Clayton. Thank you very much. Senator Moran. Mr. Chairman, thank you. Chairman Crapo. Thank you. Senator Cortez Masto. Senator Cortez Masto. Thank you. Gentlemen, thank you. I apologize. I have had another Committee hearing going on at the same time, but I appreciate your written comments and the conversation today. It is so important. And as somebody who was Attorney General of the State of Nevada and worked on consumer protection issues, obviously weeding out any type of fraud is important in this space as well. Let me start with a couple of questions that I have. I understand that companies that originated outside the cryptocurrency space like Kodak and Burger King have recently jumped into the cryptocurrency space. However, some critics have warned that companies are using blockchain as an opportunistic venture to pump up stock prices without having a clear business plan. One company, Long Island Iced Tea, I understand changed its name to Long Blockchain and watched its stock soar. So are you concerned that companies may be utilizing blockchain as a scheme to pump up their stock prices? I am going to just open it up to both of you. Mr. Clayton. The short answer is yes. The longer answer is I have put out a warning in this space, and I have put out a warning to securities lawyers as well, which is nobody should think it is OK to change your name to something that involves blockchain when you have no real underlying blockchain business plan and try to sell securities based on the hype around blockchain. Senator Cortez Masto. And when you say you put out a warning, what does that mean specifically? Mr. Clayton. I made a speech regarding this, which is published on the SEC website. But this is an area of concern to us. Anytime there is something new that people seek to raise the value of their securities without the underlying goods being there is problematic. Senator Cortez Masto. Right. Mr. Giancarlo. Thank you, Senator. So as you know, the jurisdiction of the CFTC and the SEC is slightly different in this regard, and so Chairman Clayton is rightfully concerned with initial coin offerings that are misrepresenting the affiliation, whether it be with Kodak or otherwise. We focus on fraud and manipulation broadly in instruments where there is wild claims for them, and I mentioned earlier a case we recently brought on a Long Island firm called ``My Big Coin'', which turned out to be My Big Con. There was nothing there. They were taking people's money and not investing in anything other than their own jewelry and houses and fancy cars and this kind of thing. We have been very aggressive in using our enforcement authority. We have recently brought three cases just last month alone. I have said there will be more, and we are looking into this and monitoring markets very carefully. We believe that our big task is bringing enforcement cases and letting people see that, as well as consumer education, which I have also---- Senator Cortez Masto. Yeah, because it has a deterrent effect. You hope it does, right? Mr. Clayton. Yes. Senator Cortez Masto. OK. Thank you. It has also been reported that more than 3 million Bitcoins have been stolen. That is about 14 percent of the Bitcoins or one in seven Bitcoins stolen. And on January 26th, Coincheck, a Japanese currency exchange, was hacked. In minutes, $430 million was lost to hackers. This follows another theft of more than $500 million from another exchange, Mt. Gox. If people put money into a stock or bond and it was stolen, they would have help. For example, the Federal Government is still trying to help investors recover the money stolen by Bernie Madoff. When virtual currencies are stolen by hackers, what can buyers do to get their money back, if anything? Mr. Clayton. This is a very good point, and it is one that we have emphasized in our investor alerts, that when you engage in investing online with an offshore entity, the chances that we can do anything practical to get your money back are very, very low. Mr. Giancarlo. In our futures market, for example, we have what we call ``system safeguards,'' requirements that futures exchanges have cyberprotections in place and they adopt best practices. For these underlying spot markets, which we do not regulate, we do not have the authority to require them to have cybersafeguards in place. Senator Cortez Masto. Right. Mr. Giancarlo. And, you know, a lot of these companies are young, they are startups. They are focused on putting what resources they have into developing their technology. And in the case of some of the cases you mentioned, what I understand was the cyberprotections just were not there. Now, I know that the JFSA has been aggressive on this. We have had some conversations with them. We have asked questions. What are they doing about it? But, unfortunately, the theft has already happened. Senator Cortez Masto. Right. Mr. Giancarlo. And so this is a problem, that these underlying stages, while we do have enforcement authority, we do not have the same regulatory authority that we have in the markets that we oversee. That is our day job, as one of your colleagues mentioned earlier, and so, therefore, this is a gap. Mr. Clayton. Or the same kind of protection rules like custody. Senator Cortez Masto. Right. Mr. Clayton. It was gone. Senator Cortez Masto. Yeah, so it is the old axiom, ``Buyer beware.'' So around this space, a lot of education is important, I would imagine, from all the Federal agencies to buyers so they know until something else can be done, which I think we are still trying to figure that out I notice my time is up. Thank you very much. Thank you. Chairman Crapo. Thank you, Senator. I had not planned on having a second round, but I have agreed to allow Senator Shelby and Senator Warren to each have one brief question. Senator Shelby. Senator Shelby. I want to get in the area of what is on a lot of people's minds today, and I know you do not control the stock market. You know, what goes up comes down, as we all know, and we do not know when and so forth. Is this perhaps more than an ordinary correction, or do you have a judgment on that at all? Chairman Clayton. Mr. Clayton. So your question is exactly the question I asked my staff and some of my colleagues across the Federal Government. Senator Shelby. OK. Mr. Clayton. Because we should be asking those questions. By this morning, there was nothing to indicate that any of our systems did not function as they were expected to function yesterday. This was the largest volume since November 2016. There was a significant price change. We have two types of limits. We have single stock limits, and then we have market limits, the circuit breakers. Neither one of those were hit in any great detail. The single stock was nine; the circuit breakers did not get hit. So as I sit here today, there is nothing that came out of this that concerns me from a functioning standpoint. But days like yesterday, our job is to look at them. Senator Shelby. From a regulatory standpoint, are you saying that you do not see anything amiss? Mr. Clayton. Yes. Senator Shelby. From a regulatory standpoint. Mr. Clayton. Yes. Senator Shelby. You cannot control what goes up and what goes down. But what spooked the markets? Is it profit taking perhaps? Is it a whiff of maybe inflation out there? Because people that watch the markets and participate in the markets see that the Fed is beginning to raise interest rates, dealing with price stability as they see it. And the Fed has information perhaps we do not have. The economy is hot, unemployment is low, and so forth. Is it a combination of all, or can we really say? Mr. Clayton. Well, I cannot really say because I--you know, there are a lot of opinions on those things. Our job is to look at the functioning---- Senator Shelby. Absolutely. Mr. Clayton. --and look at the systemic risks. Senator Shelby. That is right. Mr. Clayton. And I am asking myself, is there anything that happened yesterday that gives me a different view of systemic risk than I had the day before? And so far, no. But that is a question I ask myself almost every day. Senator Shelby. Of course, we all know that when the market is going up, people are elated. That is natural. When it is going down, some people profit, but not a lot of people are elated. Is that fair? Mr. Clayton. That is fair. Senator Shelby. Do you have any comment, Mr. Chairman? Mr. Giancarlo. Well, I am just smiling because of just a recollection of a saying that a mentor of mine who actually was my introduction in to the financial markets used to say. When I would ask him--and he was an old hand in the markets--what drove the market up yesterday, or down, he would say, ``Oh, it was up? More people bought than sold. Oh, it was down? More people sold than bought.'' And we laugh, but what he said to me, he said, you know, ``When you listen to the pundits and they say, `Well, the market was up yesterday because of this,' that may have been why or it may not have been why.'' But the reporters or the pundit needed a reason, so they pick something out and that becomes the reason for the day. I do not mean to be facetious, but markets are very, very complex. Very, very complex. Senator Shelby. Very much. Mr. Giancarlo. And sometimes it is oversimplifying, and you hear it on the news, you hear it by people that are stock pickers, and they say, ``Well, it was because of this.'' Well, I do not know how anybody really knows. Now, if there are fundamental moves, fundamental changes, that is where we have to do--and I share Chairman Clayton's view. Our job is to look at the structural underpinnings and see whether there is anything that is not functioning. Senator Shelby. See if the fundamentals are sound. Mr. Giancarlo. See if the fundamentals are sound. So you will not be surprised to know that we had a late night last night and an early morning this morning, checking in with our exchanges to make sure that things are in order, making sure that the margin levels held, to make sure there was no significant margin breaches. And I can say that the system held. The system worked as it was designed to do. The margin levels worked as they were designed to work. And so the right systems and the right policies are in place. But the markets are always evolving, always organic, and that is why we need to stay very close to them. Senator Shelby. The market always corrects. The question is: Is this an ordinary--maybe not an ordinary correction, but is it a correction, the market will correct itself, and we go from there? Is that fair? Mr. Giancarlo. Yes. Senator Shelby. Thank you, Mr. Chairman. Chairman Crapo. Senator Warren. Senator Warren. Thank you, Mr. Chairman. So I want to go back to virtual currency, and I want to ask about initial coin offerings, ICOs. Some ICOs raise money for legitimate companies, but others we know are just Ponzi schemes. And many of the investors in ICOs are just everyday Americans lured by aggressive marketing promising very high returns. In fact, it is now so bad that Facebook recently banned all ads for virtual currency-related products and ICOs because there were so many ``deceptive and misleading'' advertising that targeted regular consumers. So I just want to ask a little question around how we make ICOs safer. Chairman Clayton, the SEC evidently recognized the risk, so it announced last summer that it would consider certain coins to be securities under the Securities Act, meaning that they have to be registered with the Commission and comply with disclosure requirements. In 2017, companies raised more than $4 billion in ICOs. How many of those companies registered their ICO with the SEC? Mr. Clayton. Not one. Senator Warren. Not one. And as of today, how many companies have registered for upcoming ICOs? Mr. Clayton. Not one. Senator Warren. Not one, so we are still at zero. Can you just say a word about why that is so? Mr. Clayton. Yes. I do not think the gatekeepers that we rely on to assist us in making sure our securities laws are followed have done their job. We have made it clear what the law is. As I have said many times, there are thousands and thousands of private placements that go on every year in the U.S. We want them to go on. We want people to raise capital. But we want them to do it right. Senator Warren. Right. Mr. Clayton. What ICOs do is they take the disclosure-like benefits of a private placement and then add to it the public general solicitation and retail investor promise of a secondary market without registering with us. And folks somehow got comfortable that this was new and it was OK and it was not a security, it was just some other way to raise money. Well, I disagree with them. Senator Warren. So it is not new, it is--or it is new, but it is not OK and it is not another way to raise money. Mr. Clayton. Correct. Senator Warren. I am understanding you to say it is a violation of the law. Mr. Clayton. Yes. Senator Warren. Registration really matters. When companies do not register their tokens as securities, they can hide information, and the SEC does not have the information it needs to monitor this market. Mr. Clayton. I am perfectly happy for these people to do private placements, but do them right. Do not try and do it as a private placement but get all the benefits of a public---- Senator Warren. And then lever over into a public---- Mr. Clayton. Yeah, and do all the other shenanigans that are---- Senator Warren. Well, good. So should I take today as you are sounding a warning bell for people, maybe they better pay a little closer attention to the law or the SEC is going to pay closer attention to them? Mr. Clayton. Yes, and it is not the first time. But I really appreciate the opportunity to do it today. Senator Warren. Thank you. Thank you, Mr. Chairman. Chairman Crapo. Thank you, Senator. And thank you to our witnesses. We appreciate not only your testimony today but the work that you are doing in this critical area. I would ask you to get back to me on recommendations as you refine your evaluation of our current financial legislative system and whether we need to provide further clarification from Congress. With that, this hearing is adjourned. [Whereupon, at 11:54 a.m., the hearing was adjourned.] [Prepared statements and responses to written questions supplied for the record follow:] PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO This morning, we will receive testimony from SEC Chairman Jay Clayton and CFTC Chairman Chris Giancarlo on the growing world of virtual currencies and the oversight conducted by their two agencies. Virtual currencies are meant to act as a type of money that can be traded on online exchanges for conventional currencies, such as dollars, or used to purchase goods or services, predominantly online. Additionally, developers, businesses and individuals are selling virtual coins or tokens through initial coin offerings, also known as ICOs, to raise capital. Over the last year, many Americans have become increasingly interested in virtual currencies, especially given the meteoric rise in valuation and recent fall of Bitcoin. Just for perspective, on January 2 of last year, Bitcoin broke the $1,000 barrier, then peaked in December of 2017 at almost $20,000 and as of this morning is trading at roughly $6,900. Today, the market capitalization of Bitcoin is roughly $115 billion. This is an incredible rise given that in 2013, when this Committee had subcommittee hearings on the topic, the total value of Bitcoin in circulation was approximately $5 billion. As virtual currencies have become more widespread, financial regulators and heads of financial institutions have noticed and voiced their opinions. Regulators and heads of industry have tried to educate investors so that they make informed decisions, and ensure that the markets they oversee and participate in are appropriately working. For its part, the SEC has put forth many statements and guideposts to help the markets and investors. Namely, the SEC has: issued investor bulletins on initial coin offerings; issued an investigative report on what characteristics make an ICO a security offering; issued several statements by Chairman Clayton on the issue; brought enforcement actions against fraudsters; and issued joint statements with the CFTC about enforcement of virtual currency related products. The CFTC has also been helping inform the markets by: launching a dedicated website on virtual currencies to educate investors; bringing enforcement actions against individuals involved in cryptocurrency related scams; issuing several statements by Chairman Giancarlo and other Commissioners on the issue; and scheduling hearings on the topics. Much of the recent news about virtual currencies has been negative; between the enforcement actions brought by your agencies, the hack of the international Coincheck exchange, and the concerns raised by various regulators and market participants, there is no shortage of examples that increase investor concerns. It is also important to note that the technology, innovation, and ideas underlying these markets present significant positive potential. These aspects underpinning virtual currencies have the ability to transform for investors the composition of, and ability to access, the financial landscape, thus changing and modernizing capital formation and transfer of risk. Technology is forward looking, and we look to our regulators to continue carrying out their mandates, including investor protection, as the markets evolve. I look forward to learning more about virtual currency oversight from the two witnesses, including what their agencies are doing to ensure appropriate disclosures and safeguards for investors. ______ PREPARED STATEMENT OF JAY CLAYTON Chairman, U.S. Securities and Exchange Commission February 6, 2018 Chairman Crapo, Ranking Member Brown, and distinguished senators of the Committee, thank you for the opportunity to testify before you today. \1\ I am pleased that the Committee is holding this hearing to bring greater focus to the important issues that cryptocurrencies, initial coin offerings (ICOs) and related products and activities present for American investors and our markets. --------------------------------------------------------------------------- \1\ The views expressed in this testimony are those of the Chairman of the Securities and Exchange Commission and do not necessarily represent the views of the President, the full Commission, or any Commissioner. --------------------------------------------------------------------------- I am also pleased to join my counterpart, Commodity Futures Trading Commission (CFTC) Chairman Christopher Giancarlo, for our second time testifying together before Congress. Since I joined the Commission in May, Chairman Giancarlo and I have built a strong relationship. Cryptocurrencies, ICOs and related subjects are the latest in a host of market issues on which we and our staffs have been closely collaborating to strengthen our capital markets for investors and market participants. \2\ --------------------------------------------------------------------------- \2\ See Jay Clayton and J. Christopher Giancarlo, ``Regulators Are Looking at Cryptocurrency'', Wall St. J. (Jan. 24, 2018), available at https://www.wsj.com/articles/regulators-are-looking-at-cryptocurrency- 1516836363?mod=searchresults&page=1&pos=2. --------------------------------------------------------------------------- The mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets and facilitate capital formation. We do so through our enforcement of the Federal securities laws and our oversight of the securities markets and their participants including (1) approximately $75 trillion in securities trading annually on U.S. equity markets; (2) the disclosures of approximately 4,100 exchange- listed public companies with an approximate aggregate market capitalization of $31 trillion; and (3) the activities of over 26,000 registered entities and self-regulatory organizations, including investment advisers, broker-dealers, transfer agents, securities exchanges, clearing agencies, mutual funds, exchange-traded funds (ETFs), the Financial Industry Regulatory Authority (FINRA), and the Municipal Securities Rulemaking Board (MSRB), among others. For those who seek to raise capital to fund an enterprise, as many in the ICO space have sought to do, a primary entry into the SEC's jurisdiction is the offer and sale of securities, as set forth in the Securities Act of 1933. \3\ As I will explain in greater detail below, determining what falls within the ambit of a securities offer and sale is a facts-and-circumstances analysis, utilizing a principles-based framework that has served American companies and American investors well through periods of innovation and change for over 80 years. --------------------------------------------------------------------------- \3\ Under Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Exchange Act, a security includes, among other items, ``an investment contract.'' See 15 U.S.C. 77b-77c. An investment contract is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. See SEC v. Edwards, 540 U.S. 389, 393 (2004); SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946); see also United Housing Found., Inc. v. Forman, 421 U.S. 837, 852-53 (1975). --------------------------------------------------------------------------- The cryptocurrency and ICO markets, while new, have grown rapidly, gained greater prominence in the public conscience and attracted significant capital from retail investors. We have seen historical instances where such a rush into certain investments has benefited our economy and those investors who backed the right ventures. But when our laws are not followed, the risks to all investors are high and numerous--including risks caused by or related to poor, incorrect or nonexistent disclosure, volatility, manipulation, fraud, and theft. To be clear, I am very optimistic that developments in financial technology will help facilitate capital formation, providing promising investment opportunities for institutional and Main Street investors alike. From a financial regulatory perspective, these developments may enable us to better monitor transactions, holdings and obligations (including credit exposures) and other activities and characteristics of our markets, thereby facilitating our regulatory mission, including, importantly, investor protection. At the same time, regardless of the promise of this technology, those who invest their hard-earned money in opportunities that fall within the scope of the Federal securities laws deserve the full protections afforded under those laws. This ever-present need comes into focus when enthusiasm for obtaining a profitable piece of a new technology ``before it's too late'' is strong and broad. Fraudsters and other bad actors prey on this enthusiasm. The SEC and the CFTC, as Federal market regulators, are charged with establishing a regulatory environment for investors and market participants that fosters innovation, market integrity and ultimately confidence. To that end, a number of steps the SEC has taken relating to cryptocurrencies, ICOs and related assets are discussed below. Message for Main Street Investors Before discussing regulation in more detail, I would like to reiterate my message to Main Street investors from a statement I issued in December. \4\ Cryptocurrencies, ICOs and related products and technologies have captured the popular imagination--and billions of hard-earned dollars--of American investors from all walks of life. In dealing with these issues, my key consideration--as it is for all issues that come before the Commission--is to serve the long term interests of our Main Street investors. My efforts--and the tireless efforts of the SEC staff--have been driven by various factors, but most significantly by the concern that too many Main Street investors do not understand all the material facts and risks involved. Unfortunately, it is clear that some have taken advantage of this lack of understanding and have sought to prey on investors' excitement about the quick rise in cryptocurrency and ICO prices. \5\ --------------------------------------------------------------------------- \4\ In December, I issued a statement that provided my general views on the cryptocurrency and ICO markets. The statement was directed principally at two groups: (1) Main Street investors and (2) market professionals--including, for example, broker-dealers, investment advisers, exchanges, lawyers, and accountants--whose actions impact Main Street investors. See ``Statement on Cryptocurrencies and Initial Coin Offerings'' (Dec. 11, 2017), available at https://www.sec.gov/ news/public-statement/statement-clayton-2017-12-11. \5\ In one instance, the SEC brought an enforcement action against a purported Bitcoin mining company that claimed to have a product ``so easy to use that it is `Grandma approved.' '' In this case, in less than 6 months, the company allegedly raised more than $19 million from more than 10,000 investors. The SEC charged that company with operating a Ponzi scheme. See Press Release 2015-271, ``SEC Charges Bitcoin Mining Companies'' (Dec. 1, 2015), available at https://www.sec.gov/ news/pressrelease/2015-271.html; ``SEC Obtains Final Judgment Against Founder of Bitcoin Mining Companies Used To Defraud Investors'' (Oct. 4, 2017), available at https://www.sec.gov/litigation/litreleases/2017/ lr23960.htm. --------------------------------------------------------------------------- There should be no misunderstanding about the law. When investors are offered and sold securities--which to date ICOs have largely been-- they are entitled to the benefits of State and Federal securities laws and sellers and other market participants must follow these laws. Yes, we do ask our investors to use common sense, and we recognize that many investment decisions will prove to be incorrect in hindsight. However, we do not ask investors to use their common sense in a vacuum, but rather, with the benefit of information and other requirements where judgments can reasonably be made. This is a core principle of our Federal securities laws and is embodied in the SEC's registration requirements. Investors should understand that to date no ICOs have been registered with the SEC, and the SEC also has not approved for listing and trading any exchange- traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies. If any person today says otherwise, investors should be especially wary. Investors who are considering investing in these products should also recognize that these markets span national borders and that significant trading may occur on systems and platforms outside the U.S. Investors' funds may quickly travel overseas without their knowledge. As a result, risks can be amplified, including the risk that U.S. market regulators, such as the SEC and State securities regulators, may not be able to effectively pursue bad actors or recover funds. Further, there are significant security risks that can arise by transacting in these markets, including the loss of investment and personal information due to hacks of online trading platforms and individual digital asset ``wallets.'' A recent study estimated that more than 10 percent of proceeds generated by ICOs--or almost $400 million--has been lost to such attacks. \6\ And less than 2 weeks ago, a Japanese cryptocurrency market lost over $500 million in an apparent hack of its systems. \7\ --------------------------------------------------------------------------- \6\ See ``EY Research: Initial Coin Offerings (ICOs)'' (Dec. 2017), available at http://www.ey.com/Publication/vwLUAssets/ey- research-initial-coin-offerings-icos/%24File/ey-research-initial-coin- offerings-icos.pdf. \7\ See Reuters, ``Japan Raps Coincheck, Orders Broader Checks After $530 Million Cryptocurrency Theft'', Jan. 28, 2018, available at https://www.reuters.com/article/us-japan-cryptocurrency/japan-raps- coincheck-orders-broader-checks-after-530-million-cryptocurrency-theft- idUSKBN1FI06S. --------------------------------------------------------------------------- In order to arm investors with additional information, the SEC staff has issued investor alerts, bulletins and statements on ICOs and cryptocurrency-related investments, including with respect to the marketing of certain offerings and investments by celebrities and others. \8\ If investors choose to invest in these products, they should ask questions and demand clear answers. I would strongly urge investors--especially retail investors--to review the sample questions and investor alerts issued by the SEC's Office of Investor Education and Advocacy. \9\ --------------------------------------------------------------------------- \8\ ``Statement on Potentially Unlawful Promotion of Initial Coin Offerings and Other Investments by Celebrities and Others'' (Nov. 1, 2017), available at https://www.sec.gov/news/public-statement/ statement-potentially-unlawful-promotion-icos; ``Investor Alert: Public Companies Making ICO-Related Claims'' (Aug. 28, 2017), available at https://www.sec.gov/oiea/investor-alerts-and-bulletins/ ia_icorelatedclaims; ``Investor Bulletin: Initial Coin Offerings'' (July 25, 2017), available at https://www.sec.gov/oiea/investor-alerts- and-bulletins/ib_coinofferings; ``Investor Alert: Bitcoin and Other Virtual Currency-Related Investments'' (May 7, 2014), available at https://www.investor.gov/additional-resources/news-alerts/alerts- bulletins/investor-alert-bitcoin-other-virtual-currency; ``Investor Alert: Ponzi Schemes Using Virtual Currencies'' (July 23, 2013), available at https://www.sec.gov/investor/alerts/ ia_virtualcurrencies.pdf. \9\ See ``Sample Questions for Investors Considering a Cryptocurrency or ICO Investment Opportunity'' (Dec. 2017), available at https://www.sec.gov/news/public-statement/statement-clayton-2017-12- 11#_ftnref8. --------------------------------------------------------------------------- These warnings are not an effort to undermine the fostering of innovation through our capital markets--America was built on the ingenuity, vision, and spirit of entrepreneurs who tackled old and new problems in new, innovative ways. Rather, they are meant to educate Main Street investors that many promoters of ICOs and cryptocurrencies are not complying with our securities laws and, as a result, the risks are significant. With my remaining testimony, I would like to provide the Committee an overview of the Commission's ongoing work on cryptocurrencies and ICOs. Cryptocurrencies and Related Products and Trading Speaking broadly, cryptocurrencies purport to be items of inherent value (similar, for instance, to cash or gold) that are designed to enable purchases, sales, and other financial transactions. Many are promoted as providing the same functions as long-established currencies such as the U.S. dollar but without the backing of a Government or other body. While cryptocurrencies currently being marketed vary in different respects, proponents of cryptocurrencies often tout their novelty and other potential beneficial features, including the ability to make transfers without an intermediary and without geographic limitation and lower transaction costs compared to other forms of payment. Critics of cryptocurrencies note that the purported benefits highlighted by proponents are unproven and other touted benefits, such as the personal anonymity of the purchasers and sellers and the absence of Government regulation or oversight, could also facilitate illicit trading and financial transactions, as well as fraud. The recent proliferation and subsequent popularity of cryptocurrency markets creates a question for market regulators as to whether our historic approach to the regulation of sovereign currency transactions is appropriate for these new markets. These markets may look like our regulated securities markets, with quoted prices and other information. Many trading platforms are even referred to as ``exchanges.'' I am concerned that this appearance is deceiving. In reality, investors transacting on these trading platforms do not receive many of the market protections that they would when transacting through broker-dealers on registered exchanges or alternative trading systems (ATSs), such as best execution, prohibitions on front running, short sale restrictions, and custody and capital requirements. I am concerned that Main Street investors do not appreciate these differences and the resulting substantially heightened risk profile. It appears that many of the U.S.-based cryptocurrency trading platforms have elected to be regulated as money-transmission services. Traditionally, from an oversight perspective, these predominantly State-regulated payment services have not been subject to direct oversight by the SEC or the CFTC. Traditionally, from a function perspective, these money transfer services have not quoted prices or offered other services akin to securities, commodities and currency exchanges. In short, the currently applicable regulatory framework for cryptocurrency trading was not designed with trading of the type we are witnessing in mind. As Chairman Giancarlo and I stated recently, we are open to exploring with Congress, as well as with our Federal and State colleagues, whether increased Federal regulation of cryptocurrency trading platforms is necessary or appropriate. We also are supportive of regulatory and policy efforts to bring clarity and fairness to this space. The SEC regulates securities transactions and certain individuals and firms who participate in our securities markets. The SEC does not have direct oversight of transactions in currencies or commodities, including currency trading platforms. While there are cryptocurrencies that, at least as currently designed, promoted, and used, do not appear to be securities, simply calling something a ``currency'' or a currency-based product does not mean that it is not a security. To this point I would note that many products labeled as cryptocurrencies or related assets are increasingly being promoted as investment opportunities that rely on the efforts of others, with their utility as an efficient medium for commercial exchange being a distinct secondary characteristic. As discussed in more detail below, if a cryptocurrency, or a product with its value tied to one or more cryptocurrencies, is a security, its promoters cannot make offers or sales unless they comply with the registration and other requirements under our Federal securities laws. \10\ --------------------------------------------------------------------------- \10\ It is possible to conduct an offer and sales of securities, including an ICO, without triggering the SEC's registration requirements. For example, just as with a Regulation D exempt offering to raise capital for the manufacturing of a physical product, an ICO that is a security can be structured so that it qualifies for an applicable exemption from the registration requirements. --------------------------------------------------------------------------- In this regard, the SEC is monitoring the cryptocurrency-related activities of the market participants it regulates, including brokers, dealers, investment advisers, and trading platforms. Brokers, dealers and other market participants that allow for payments in cryptocurrencies, allow customers to purchase cryptocurrencies (including on margin) or otherwise use cryptocurrencies to facilitate securities transactions should exercise particular caution, including ensuring that their cryptocurrency activities are not undermining their anti-money-laundering and know-your-customer obligations. \11\ As I have stated previously, these market participants should treat payments and other transactions made in cryptocurrency as if cash were being handed from one party to the other. --------------------------------------------------------------------------- \11\ I am particularly concerned about market participants who extend to customers credit in U.S. dollars--a relatively stable asset-- to enable the purchase of cryptocurrencies, which, in recent experience, have proven to be a more volatile asset. --------------------------------------------------------------------------- Finally, financial products that are linked to underlying digital assets, including cryptocurrencies, may be structured as securities products subject to the Federal securities laws even if the underlying cryptocurrencies are not themselves securities. Market participants have requested Commission approval for new products and services of this type that are focused on retail investors, including cryptocurrency-linked ETFs. While we appreciate the importance of continuing innovation in our retail fund space, there are a number of issues that need to be examined and resolved before we permit ETFs and other retail investor-oriented funds to invest in cryptocurrencies in a manner consistent with their obligations under the Federal securities laws. These include issues around liquidity, valuation, and custody of the funds' holdings, as well as creation, redemption, and arbitrage in the ETF space. Last month, after working with several sponsors who ultimately decided to withdraw their registration statements, the Director of our Division of Investment Management issued a letter to provide an overview of certain substantive issues and related questions associated with registration requirements and to encourage others who may be considering a fund registered pursuant to the Investment Company Act of 1940 to engage in a robust discussion with the staff concerning the above-mentioned issues. \12\ Until such time as those questions have been sufficiently addressed, I am concerned about whether it is appropriate for fund sponsors that invest substantially in cryptocurrencies and related products to register. We will continue engaging in a dialogue with all interested parties to seek a path forward consistent with the SEC's tripartite mission. --------------------------------------------------------------------------- \12\ See ``Staff Letter: Engaging on Fund Innovation and Cryptocurrency-Related Holdings'' (Jan. 18, 2018), available at https:/ /www.sec.gov/divisions/investment/noaction/2018/cryptocurrency- 011818.htm. --------------------------------------------------------------------------- ICOs and Related Trading Coinciding with the substantial growth in cryptocurrencies, companies and individuals increasingly have been using so-called ICOs to raise capital for businesses and projects. Typically, these offerings involve the opportunity for individual investors to exchange currency, such as U.S. dollars or cryptocurrencies, in return for a digital asset labeled as a coin or token. The size of the ICO market has grown exponentially in the last year, and it is estimated that almost $4 billion was raised through ICOs in 2017. Note that this number may understate the size of the ICO market (and the potential for loss) as many ICOs ``trade up'' after they are issued. These offerings can take different forms, and the rights and interests a coin is purported to provide the holder can vary widely. A key question all ICO market participants--promoters, sellers, lawyers, officers, and directors and accountants, as well as investors--should ask: ``Is the coin or token a security?'' As securities law practitioners know well, the answer depends on the facts. But by and large, the structures of ICOs that I have seen involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our Federal securities laws. As noted above, the foundation of our Federal securities laws is to provide investors with the procedural protections and information they need to make informed judgments about what they are investing in and the relevant risks involved. In addition, our Federal securities laws provide a wide array of remedies, including criminal and civil actions brought by the DOJ and the SEC, as well as private rights of action. The Commission previously urged market professionals, including securities lawyers, accountants, and consultants, to read closely an investigative report it released. On July 25, 2017, the Commission issued a Report of Investigation pursuant to Section 21(a) of the Securities Exchange Act of 1934 \13\ regarding an ICO of DAO Tokens. \14\ In the Report, the Commission considered the particular facts and circumstances presented by the offer and sale of DAO Tokens and concluded that DAO Tokens were securities based on longstanding legal principles, and therefore that offers and sales of the DAO Tokens were subject to the Federal securities laws. The Report also explained that issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption from registration applies, and that platforms that provide for trading in such securities must register with the SEC as national securities exchanges or operate pursuant to an exemption from such registration. --------------------------------------------------------------------------- \13\ Section 21(a) of the Exchange Act authorizes the Commission to investigate violations of the Federal securities laws and, in its discretion, to ``publish information concerning any such violations.'' The Report does not constitute an adjudication of any fact or issue addressed therein, nor does it make any findings of violations by any individual or entity. \14\ Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (July 25, 2017), available at https://www.sec.gov/litigation/investreport/34-81207.pdf. --------------------------------------------------------------------------- The Commission's message to issuers and market professionals in this space was clear: those who would use distributed ledger technology to raise capital or engage in securities transactions must take appropriate steps to ensure compliance with the Federal securities laws. The Report and subsequent statements also explain that the use of such technology does not mean that an offering is necessarily problematic under those laws. The registration process itself, or exemptions from registration, are available for offerings employing these novel methods. The statement I issued in December that was directed to Main Street investors and market professionals provided additional insight into how practitioners should view ICOs in the context of our Federal securities laws. Certain market professionals have attempted to highlight the utility or voucher-like characteristics of their proposed ICOs in an effort to claim that their proposed tokens or coins are not securities. Many of these assertions that the Federal securities laws do not apply to a particular ICO appear to elevate form over substance. The rise of these form-based arguments is a disturbing trend that deprives investors of mandatory protections that clearly are required as a result of the structure of the transaction. Merely calling a token a ``utility'' token or structuring it to provide some utility does not prevent the token from being a security. \15\ Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law. It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens, i.e., the ability to sell them on an exchange at a profit. In short, prospective purchasers are being sold on the potential for tokens to increase in value--with the ability to lock in those increases by reselling the tokens on a secondary market--or to otherwise profit from the tokens based on the efforts of others. These are key hallmarks of a security and a securities offering. --------------------------------------------------------------------------- \15\ See SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351 (1943) (``[T]he reach of the [Securities] Act does not stop with the obvious and commonplace. Novel, uncommon, or irregular devices, whatever they appear to be, are also reached if it be proved as matter of fact that they were widely offered or dealt in under terms or courses of dealing which established their character in commerce as `investment contracts,' or as any interest or instrument commonly known as a `security'.''); see also Reves v. Ernst & Young, 494 U.S. 56, 61 (1990) (``Congress' purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.''). --------------------------------------------------------------------------- On this and other points where the application of expertise and judgment is expected, I believe that gatekeepers and others, including securities lawyers, accountants and consultants, need to focus on their responsibilities. I have urged these professionals to be guided by the principal motivation for our registration, offering process and disclosure requirements: investor protection and, in particular, the protection of our Main Street investors. \16\ --------------------------------------------------------------------------- \16\ See ``Opening Remarks at the Securities Regulation Institute'' (Jan. 22, 2018), available at https://www.sec.gov/news/ speech/speech-clayton-012218. --------------------------------------------------------------------------- I also have cautioned market participants against promoting or touting the offer and sale of coins without first determining whether the securities laws apply to those actions. Engaging in the business of selling securities generally requires a license, and experience shows that excessive touting in thinly traded and volatile markets can be an indicator of ``scalping,'' ``pump and dump,'' and other manipulations and frauds. Similarly, my colleagues and I have cautioned those who operate systems and platforms that effect or facilitate transactions in these products that they may be operating unregistered exchanges or broker-dealers that are in violation of the Securities Exchange Act of 1934. I do want to recognize that recently social media platforms have restricted the ability of users to promote ICOs and cryptocurrencies on their platforms. I appreciate the responsible step. Enforcement A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation. The ability of bad actors to commit age-old frauds with new technologies coupled with the significant amount of capital--particularly from retail investors--that has poured into cryptocurrencies and ICOs in recent months and the offshore footprint of many of these activities have only heightened these concerns. In September 2017, the Division of Enforcement established a new Cyber Unit focused on misconduct involving distributed ledger technology and ICOs, the spread of false information through electronic and social media, brokerage account takeovers, hacking to obtain nonpublic information and threats to trading platforms. \17\ The Cyber Unit works closely with our cross-divisional Distributed Ledger Technology Working Group, which was created in November 2013. We believe this approach has enabled us to leverage our enforcement resources effectively and coordinate well within the Commission, as well as with other Federal and State regulators. --------------------------------------------------------------------------- \17\ See Press Release 2017-176, ``SEC Announces Enforcement Initiatives To Combat Cyber-Based Threats and Protect Retail Investors'' (Sept. 25, 2017), available at https://www.sec.gov/news/ press-release/2017-176. --------------------------------------------------------------------------- To date, we have brought a number of enforcement actions concerning ICOs for alleged violations of the Federal securities laws. In September 2017, we brought charges against an individual for defrauding investors in a pair of ICOs purportedly backed by investments in real estate and diamonds. \18\ According to the SEC's complaint, investors provided approximately $300,000 in funding and were told they could expect sizeable returns despite neither company having real operations. In December 2017, we obtained an emergency asset freeze to halt an alleged ICO fraud that purportedly raised up to $15 million from thousands of individual investors beginning in August 2017. \19\ According to the complaint, the scam was operated by a recidivist securities law violator and promised investors a more than 1,300 percent profit in under 29 days. As another example, after being contacted by the SEC last December, a company halted its ICO to raise capital for a blockchain-based food review service, and then settled proceedings in which we determined that the ICO was an unregistered offering and sale of securities in violation of the Federal securities laws. \20\ Before tokens were delivered to investors, the company refunded investor proceeds after the SEC intervened. --------------------------------------------------------------------------- \18\ Press Release 2017-185, ``SEC Exposes Two Initial Coin Offerings Purportedly Backed by Real Estate and Diamonds'' (Sept. 29, 2017), available at https://www.sec.gov/news/press-release/2017-185-0. \19\ Press Release 2017-219, ``SEC Emergency Action Halts ICO Scam'' (Dec. 4, 2017), available at https://www.sec.gov/news/press- release/2017-219. \20\ Press Release 2017-227, ``Company Halts ICO After SEC Raises Registration Concerns'' (Dec. 11, 2017), available at https:// www.sec.gov/news/press-release/2017-227. --------------------------------------------------------------------------- And most recently, we halted an allegedly fraudulent ICO that targeted retail investors promoting what it portrayed as the world's first decentralized bank. \21\ We were able to freeze some of the allegedly ill-gotten cryptocurrency assets and obtained a receiver to try to marshal these assets back to harmed investors. --------------------------------------------------------------------------- \21\ Press Release 2018-8, ``SEC Halts Alleged Initial Coin Offering Scam'' (Jan. 30, 2018), available at https://www.sec.gov/news/ press-release/2018-8. --------------------------------------------------------------------------- I also have been increasingly concerned with recent instances of public companies, with no meaningful track record in pursuing distributed ledger or blockchain technology, changing their business models and names to reflect a focus on distributed ledger technology without adequate disclosure to investors about their business model changes and the risks involved. A number of these instances raise serious investor protection concerns about the adequacy of disclosure especially where an offer and sale of securities is involved. The SEC is looking closely at the disclosures of public companies that shift their business models to capitalize on the perceived promise of distributed ledger technology and whether the disclosures comply with the Federal securities laws, particularly in the context of a securities offering. With the support of my fellow Commissioners, I have asked the SEC's Division of Enforcement to continue to police these markets vigorously and recommend enforcement actions against those who conduct ICOs or engage in other actions relating to cryptocurrencies in violation of the Federal securities laws. In doing so, the SEC and CFTC are collaborating on our approaches to policing these markets for fraud and abuse. \22\ We also will continue to work closely with our Federal and State counterparts, including the Department of Treasury, Department of Justice, and State attorneys general and securities regulators. --------------------------------------------------------------------------- \22\ See Joint Statement by SEC and CFTC Enforcement Directors Regarding Virtual Currency Enforcement Actions (Jan. 19, 2018), available at https://www.sec.gov/news/public-statement/joint-statement- sec-and-cftc-enforcement-directors. --------------------------------------------------------------------------- Conclusion Through the years, technological innovations have improved our markets, including through increased competition, lower barriers to entry and decreased costs for market participants. Distributed ledger and other emerging technologies have the potential to further influence and improve the capital markets and the financial services industry. Businesses, especially smaller businesses without efficient access to traditional capital markets, can be aided by financial technology in raising capital to establish and finance their operations, thereby allowing them to be more competitive both domestically and globally. And these technological innovations can provide investors with new opportunities to offer support and capital to novel concepts and ideas. History, both in the United States and abroad, has proven time and again that these opportunities flourish best when pursued in harmony with our Federal securities laws. These laws reflect our tripartite mission to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation. Being faithful to each part of our mission not in isolation, but collectively, has served us well. Said simply, we should embrace the pursuit of technological advancement, as well as new and innovative techniques for capital raising, but not at the expense of the principles undermining our well- founded and proven approach to protecting investors and markets. Thank you for the opportunity to testify before you today and for your support of the Commission and its workforce. I stand ready to work with Congress on these issues and look forward to answering your questions. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] PREPARED STATEMENT OF J. CHRISTOPHER GIANCARLO Chairman, U.S. Commodity Futures Trading Commission February 6, 2018 Introduction: Virtual Currency Thank you, Chairman Crapo, for the invitation to testify before the Committee. Thank you, Ranking Member Brown, and all the Members of the Committee for this opportunity to discuss virtual currencies. At the outset, I would like to note that this hearing is timely, even fortuitous. Emerging financial technologies broadly are taking us into a new chapter of economic history. They are impacting trading, markets and the entire financial landscape with far ranging implications for capital formation and risk transfer. They include machine learning and artificial intelligence, algorithm-based trading, data analytics, ``smart'' contracts valuing themselves and calculating payments in real-time, and distributed ledger technologies, which over time may come to challenge traditional market infrastructure. They are transforming the world around us, and it is no surprise that these technologies are having an equally transformative impact on U.S. capital and derivatives markets. The more specific topic for today's hearing, however, is virtual currency. Broadly speaking, virtual currencies are a digital representation of value that may function as a medium of exchange, a unit of account, and/or a store of value. Virtual currencies generally run on a decentralized peer-to-peer network of computers, which rely on certain network participants to validate and log transactions on a permanent, public distributed ledger, commonly known as the blockchain. Supporters of virtual currencies see a technological solution to the age-old ``double spend'' problem--that has always driven the need for a trusted, central authority to ensure that an entity is capable of, and does, engage in a valid transaction. Traditionally, there has been a need for a trusted intermediary--for example a bank or other financial institution--to serve as a gatekeeper for transactions and many economic activities. Virtual currencies seek to replace the need for a central authority or intermediary with a decentralized, rules- based and open consensus mechanism. \1\ An array of thoughtful business, technology, academic, and policy leaders have extrapolated some of the possible impacts that derive from such an innovation, including how market participants conduct transactions, transfer ownership, and power peer-to-peer applications and economic systems. \2\ --------------------------------------------------------------------------- \1\ See generally, CFTC Talks, Episode 24, Dec. 29, 2017, Interview with Coincenter.org Director of Research, Peter Van Valkenburgh, at http://www.cftc.gov/Media/Podcast/index.htm. \2\ See Marc Andreessen, ``Why Bitcoin Matters'', New York Times DealBook (Jan. 21, 2014), https://dealbook.nytimes.com/2014/01/21/why- bitcoin-matters/; Jerry Brito and Andrea O'Sullivan, ``Bitcoin: A Primer for Policymakers'', George Mason University Mercatus Center (May 3, 2016), https://www.mercatus.org/publication/bitcoin-primer- policymakers; Christian Catalini and Joshua S. Gans, ``Some Simple Economics of the Blockchain'', Rotman School of Management Working Paper No. 2874598, MIT Sloan Research Paper No. 5191-16 (last updated Sept. 21, 2017), https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2874598; Arjun Kharpal, ``People Are `Underestimating' the `Great Potential' of Bitcoin, Billionaire Peter Thiel Says'', CNBC (Oct. 26, 2017), https://www.cnbc.com/2017/10/26/ bitcoin-underestimated-peter-thiel-says.html; Hugh Son, ``Bitcoin `More Than Just a Fad,' Morgan Stanley CEO Says'', Bloomberg (Sept. 27, 2017), https://www.bloomberg.com/news/articles/2017-09-27/bitcoin-more- than-just-a-fad-morgan-stanley-ceo-gorman-says; Chris Brummer and Daniel Gorfine, ``FinTech: Building a 21st-Century Regulator's Toolkit'', Milken Institute (Oct. 21, 2014), available at http:// www.milkeninstitute.org/publications/view/665. --------------------------------------------------------------------------- Others, however, argue that this is all hype or technological alchemy and that the current interest in virtual currencies is overblown and resembles wishful thinking, a fever, even a mania. They have declared the 2017 heightened valuation of Bitcoin to be a bubble similar to the famous ``Tulip Bubble'' of the 17th century. They say that virtual currencies perform no socially useful function and, worse, can be used to evade laws or support illicit activity. \3\ Indeed, history has demonstrated to us time-and-again that bad actors will try to invoke the concept of innovation in order to perpetrate age-old fraudulent schemes on the public. Accordingly, some assert that virtual currencies should be banned, as some Nations have done. \4\ --------------------------------------------------------------------------- \3\ Virtual currencies are not unique in their utility in illicit activity. National currencies, like the U.S. Dollar, and commodities, like gold and diamonds, have long been used to support criminal enterprises. \4\ Countries that have banned Bitcoin include Bangladesh, Bolivia, Ecuador, Kyrgyzstan, Morocco, Nepal, and Vietnam. China has banned Bitcoin for banking institutions. --------------------------------------------------------------------------- There is clearly no shortage of opinions on virtual currencies such as Bitcoin. In fact, virtual currencies may be all things to all people: for some, potential riches, the next big thing, a technological revolution, and an exorable value proposition; for others, a fraud, a new form of temptation and allure, and a way to separate the unsuspecting from their money. Perspective is critically important. As of the morning of February 5, the total value of all outstanding Bitcoin was about $130 billion based on a Bitcoin price of $7,700. The Bitcoin ``market capitalization'' is less than the stock market capitalization of a single ``large cap'' business, such as McDonalds (around $130 billion). The total value of all outstanding virtual currencies was about $365 billion. Because virtual currencies like Bitcoin are sometimes considered to be comparable to gold as an investment vehicle, it is important to recognize that the total value of all the gold in the world is estimated by the World Gold Council to be about $8 trillion which continues to dwarf the virtual currency market size. Clearly, the column inches of press attention to virtual currency far surpass its size and magnitude in today's global economy. Yet, despite being a relatively small asset class, virtual currency presents novel challenges for regulators. SEC Chairman Clayton and I recently wrote: The CFTC and SEC, along with other Federal and State regulators and criminal authorities, will continue to work together to bring transparency and integrity to these markets and, importantly, to deter and prosecute fraud and abuse. These markets are new, evolving, and international. As such they require us to be nimble and forward- looking; coordinated with our State, Federal, and international colleagues; and engaged with important stakeholders, including Congress. \5\ --------------------------------------------------------------------------- \5\ Jay Clayton and J. Christopher Giancarlo, ``Regulators Are Looking at Cryptocurrency: At the SEC and CFTC We Take Our Responsibility Seriously'', Wall Street Journal, Jan. 24, 2018, https:/ /www.wsj.com/articles/regulators-are-looking-at-cryptocurrency- 1516836363. --------------------------------------------------------------------------- It is this perspective that has guided our work at the CFTC on virtual currencies. Introduction: The Mission of the CFTC The mission of the CFTC is to foster open, transparent, competitive, and financially sound derivatives markets. \6\ By working to avoid systemic risk, the Commission aims to protect market users and their funds, consumers, and the public from fraud, manipulation, and abusive practices related to derivatives and other products that are subject to the Commodity Exchange Act (CEA). --------------------------------------------------------------------------- \6\ See CFTC, ``Mission and Responsibilities'', http:// www.cftc.gov/About/MissionResponsibilities/index.htm. --------------------------------------------------------------------------- The CFTC was established as an independent agency in 1974, assuming responsibilities that had previously belonged to the Department of Agriculture since the 1920s. The Commission historically has been charged by the CEA with regulatory authority over the commodity futures markets. These markets have existed since the 1860s, beginning with agricultural commodities such as wheat, corn, and cotton. Over time, these organized commodity futures markets, known as designated contract markets (DCMs) regulated by the CFTC, have grown to include those for energy and metals commodities, collectively including crude oil, heating oil, gasoline, copper, gold, and silver. The agency now also oversees these commodity futures markets for financial products such as interest rates, stock indexes, and foreign currency. The definition of ``commodity'' in the CEA is broad. It can mean a physical commodity, such as an agricultural product (e.g., wheat, cotton) or natural resource (e.g., gold, oil). It can mean a currency or interest rate. The CEA definition of ``commodity'' also includes ``all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt in.'' In the aftermath of the 2008 financial crisis, President Obama and Congress enhanced the CFTC's regulatory authority. With passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the agency now also oversees most of the U.S. swaps market in addition to exchange traded futures markets. Futures, swaps and other derivatives markets are essential means for commercial and financial risk mitigation and transfer. These markets allow the risks of variable production costs, such as the price of raw materials, energy, foreign currency, and interest rates, to be transferred from those who cannot afford them to those who can. They are the reason why American consumers enjoy stable prices in the grocery store, whatever the conditions out on the farm. But derivatives markets are not just useful for agricultural producers. They impact the price and availability of heating in American homes, the energy used in factories, the interest rates borrowers pay on home mortgages, and the returns workers earn on their retirement savings. More than 90 percent of Fortune 500 companies use derivatives to manage commercial or market risk in their worldwide business operations. In short, derivatives serve the needs of society to help moderate price, supply and other commercial risks to free up capital for economic growth, job creation, and prosperity. To ensure the integrity of U.S. derivatives markets, the CFTC regulates derivatives market participants and activities. The agency oversees a variety of individuals and organizations. These include swap execution facilities, derivatives clearing organizations, designated contract markets, swap data repositories, swap dealers, futures commission merchants, commodity pool operators, and other entities. The CFTC also prosecutes derivative market fraud and manipulation, including misconduct in underlying spot markets for commodities. I. CFTC Authority and Oversight Over Virtual Currencies In 2015, the CFTC determined that virtual currencies, such as Bitcoin, met the definition of ``commodity'' under the CEA. Nevertheless, the CFTC does NOT have regulatory jurisdiction under the CEA over markets or platforms conducting cash or ``spot'' transactions in virtual currencies or other commodities or over participants on such platforms. More specifically, the CFTC does not have authority to conduct regulatory oversight over spot virtual currency platforms or other cash commodities, including imposing registration requirements, surveillance and monitoring, transaction reporting, compliance with personnel conduct standards, customer education, capital adequacy, trading system safeguards, cybersecurity examinations, or other requirements. In fact, current law does not provide any U.S. Federal regulator with such regulatory oversight authority over spot virtual currency platforms operating in the United States or abroad. However, the CFTC DOES have enforcement jurisdiction to investigate through subpoena and other investigative powers and, as appropriate, conduct civil enforcement action against fraud and manipulation in virtual currency derivatives markets and in underlying virtual currency spot markets. In contrast to the spot markets, the CFTC does have both regulatory and enforcement jurisdiction under the CEA over derivatives on virtual currencies traded in the United States. This means that for derivatives on virtual currencies traded in U.S. markets, the CFTC conducts comprehensive regulatory oversight, including imposing registration requirements and compliance with a full range of requirements for trade practice and market surveillance, reporting and monitoring and standards for conduct, capital requirements, and platform and system safeguards. II. Assertion of CFTC Authority The CFTC has been straightforward in asserting its area of statutory jurisdiction concerning virtual currencies derivatives. As early as 2014, former CFTC Chairman Timothy Massad discussed virtual currencies and potential CFTC oversight under the Commodity Exchange Act (CEA). \7\ And as noted above, in 2015, the CFTC found virtual currencies to be a commodity. \8\ In that year, the agency took enforcement action to prohibit wash trading and prearranged trades on a virtual currency derivatives platform. \9\ In 2016, the CFTC took action against a Bitcoin futures exchange operating in the U.S. that failed to register with the agency. \10\ Last year, the CFTC issued proposed guidance on what is a derivative market and what is a spot market in the virtual currency context. \11\ The agency also issued warnings about valuations and volatility in spot virtual currency markets \12\ and launched an unprecedented consumer education effort (detailed in Section IV herein). --------------------------------------------------------------------------- \7\ Testimony of CFTC Chairman Timothy Massad before the U.S. Senate Committee on Agriculture, Nutrition, and Forestry (Dec. 10, 2014), http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-6. \8\ In re Coinflip, Inc., Dkt. No. 15-29 (CFTC Sept. 17, 2015), http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/ legalpleading/enfcoinfliprorder09172015.pdf. \9\ In re TeraExchange LLC, Dkt. No. 15-33 (CFTC Sept. 24, 2015), http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/ legalpleading/enfteraexchangeorder92415.pdf. \10\ In re BXFNA Inc. d/b/a Bitfinex, Dkt. No. 16-19 (CFTC June 2, 2016), http://www.cftc.gov/idc/groups/public/@lrenforcementactions/ documents/legalpleading/enfbfxnaorder060216.pdf. \11\ CFTC, Retail Commodity Transactions Involving Virtual Currency, 82 FR 60335 (Dec. 20, 2017), www.gpo.gov/fdsys/pkg/FR-2017- 12-20/pdf/2017-27421.pdf. \12\ CFTC, A CFTC Primer on Virtual Currencies (Oct. 17, 2017), http://www.cftc.gov/idc/groups/public/documents/file/ labcftc_primercurrencies100417.pdf. --------------------------------------------------------------------------- a. Enforcement The CFTC Division of Enforcement is a premier Federal civil enforcement agency dedicated to deterring and preventing price manipulation and other disruptions of market integrity, ensuring the financial integrity of all transactions subject to the CEA, and protecting market participants from fraudulent or other abusive sales practices and misuse of customer assets. Appendix A hereto summarizes recent CFTC enforcement activities. The CFTC has been particularly assertive of its enforcement jurisdiction over virtual currencies. It has formed an internal virtual currency enforcement task force to garner and deploy relevant expertise in this evolving asset class. The task force shares information and works cooperatively with counterparts at the SEC with similar virtual currency expertise. In September 2017, the CFTC took enforcement action against a virtual currency Ponzi scheme. \13\ Over the past few weeks, the CFTC filed a series of civil enforcement actions against perpetrators of fraud, market manipulation and disruptive trading involving virtual currency. These include: --------------------------------------------------------------------------- \13\ On September 21, 2017, the CFTC filed a complaint in Federal court in the Southern District of New York against Nicholas Gelfman and Gelfman Blueprint, Inc., see http://www.cftc.gov/idc/groups/public/ @lrenforcementactions/documents/legalpleading/ enfgelfmancomplaint09212017.pdf. i. My Big Coin Pay Inc., which charged the defendants with commodity fraud and misappropriation related to the ongoing solicitation --------------------------------------------------------------------------- of customers for a virtual currency known as My Big Coin; ii. The Entrepreneurs Headquarters Limited, which charged the defendants with a fraudulent scheme to solicit Bitcoin from members of the public, misrepresenting that customers' funds would be pooled and invested in products including binary options, and instead misappropriated the funds and failed to register as a Commodity Pool Operator; and iii. Coin Drop Markets, which charged the defendants with fraud and misappropriation in connection with purchases and trading of Bitcoin and Litecoin. These recent enforcement actions confirm that the CFTC, working closely with the SEC and other fellow financial enforcement agencies, will aggressively prosecute bad actors that engage in fraud and manipulation regarding virtual currencies. b. Bitcoin Futures It is important to put the new Bitcoin futures market in perspective. It is quite small with open interest at the CME of 6,695 bitcoin \14\ and at Cboe Futures Exchange (Cboe) of 6,695 bitcoin (as of Feb. 2, 2018). At a price of approximately $7,700 per Bitcoin, \15\ this represents a notional amount of about $94 million. In comparison, the notional amount of the open interest in CME's WTI crude oil futures was more than one thousand times greater, about $170 billion (2,600,000 contracts) as of Feb 2, 2018, and the notional amount represented by the open interest of Comex gold futures was about $74 billion (549,000 contracts). --------------------------------------------------------------------------- \14\ Each CME contract represents 5 bitcoin. \15\ The price changes day to day. --------------------------------------------------------------------------- Prior to the launch of Bitcoin futures, the CFTC closely observed the evolution of virtual currencies over the past several years. One exchange, CME Group, launched a Bitcoin Reference Rate in November 2016. And, another exchange, CBOE Futures Exchange (Cboe), first approached the CFTC in July 2017. The CFTC anticipated receiving proposals for the launch of Bitcoin futures products in late 2017. Under CEA and Commission regulations and related guidance, futures exchanges may self-certify new products on 24-hour notice prior to trading. In the past decade and a half, over 12,000 new futures products have been self-certified. \16\ It is clear that Congress and prior Commissions deliberately designed the product self-certification framework to give futures exchanges, in their role as self-regulatory organizations, the ability to quickly bring new products to the marketplace. The CFTC's current product self-certification framework has long been considered to function well and be consistent with public policy that encourages market-driven innovation that has made America's listed futures markets the envy of the world. --------------------------------------------------------------------------- \16\ Prior to the changes made in the Commodity Futures Modernization Act of 2000 (CFMA) and the Commission's subsequent addition of Part 40, exchanges submitted products to the CFTC for approval. From 1922 until the CFMA was signed into law, less than 800 products were approved. Since then, exchanges have certified over 12,000 products. For financial instrument products specifically, the numbers are 494 products approved and 1,938 self-certified. See http:// www.cftc.gov/IndustryOversight/ContractsProducts/index.htm. --------------------------------------------------------------------------- Practically, both CME and Cboe had numerous discussions and exchanged numerous draft product terms and conditions with CFTC staff over a course of months prior to their certifying and launching Bitcoin futures in December 2017. This type of lengthy engagement is not unusual during the self-certification process for products that may raise certain issues. The CFTC staff undertook its review of CME's and Cboe's Bitcoin futures products with considered attention. Given the emerging nature and heightened attention of these products, staff conducted a ``heightened review'' of CME's and Cboe's responsibilities under the CEA and Commission regulations to ensure that their Bitcoin futures products and their cash-settlement processes were not readily susceptible to manipulation, \17\ and the risk management of the associated Derivatives Clearing Organizations (DCOs) to ensure that the products were sufficiently margined. \18\ --------------------------------------------------------------------------- \17\ See CEA Section 5(d)(3), 7 U.S.C. 7(d)(3); Section 5(d)4), 7 U.S.C. 7(d)(4); 17 CFR 38.253 and 38.254(a), and Appendices B and C to Part 38 of the CFTC's regulations. \18\ CEA Section 5b(c)(2)(D)(iv), 7 U.S.C. 7a-1(c)(2)(D)(iv) (``The margin from each member and participant of a derivatives clearing organization shall be sufficient to cover potential exposures in normal market conditions.''). --------------------------------------------------------------------------- Staff obtained the voluntary cooperation of CME and Cboe with a set of enhanced monitoring and risk management steps. 1. Designated contract markets (DCMs) setting exchange large trader reporting thresholds at five bitcoins or less; 2. DCMs entering direct or indirect information sharing agreements with spot market platforms to allow access to trade and trader data making up the underlying index that the futures contracts settle to; 3. DCMs agreeing to engage in monitoring of underlying index data from cash markets and identifying anomalies and disproportionate moves; 4. DCMs agreeing to conduct inquiries, as appropriate, including at the trade settlement and trader level when anomalies or disproportionate moves are identified; 5. DCMs agreeing to regular communication with CFTC surveillance staff on trade activities, including providing trade settlement and trader data upon request; 6. DCMs agreeing to coordinate product launches to enable the CFTC's market surveillance branch to monitor developments; and 7. DCOs setting substantially high initial \19\ and maintenance margin for cash-settled instruments. --------------------------------------------------------------------------- \19\ In the case of CME and Cboe Bitcoin futures, the initial and maintenance margins were ultimately set at 47 percent and 44 percent by the respective DCOs. By way of comparison that is more than 10 times the margin required for CME corn futures products. The first six of these elements were used to ensure that the new product offerings complied with the DCM's obligations under the CEA core principles and CFTC regulations and related guidance. The seventh element, setting high initial and maintenance margins, was designed to ensure adequate collateral coverage in reaction to the underlying volatility of Bitcoin. In crafting its process of ``heightened review'' for compliance, CFTC staff prioritized visibility, data, and monitoring of markets for Bitcoin derivatives and underlying settlement reference rates. CFTC staff felt that in gaining such visibility, the CFTC could best look out for Bitcoin market participants and consumers, as well as the public interest in Federal surveillance and enforcement. This visibility greatly enhances the agency's ability to prosecute fraud and manipulation in both the new Bitcoin futures markets and in its related underlying cash markets. As for the interests of clearing members, the CFTC recognized that large global banks and brokerages that are DCO clearing members are able to look after their own commercial interests by choosing not to trade Bitcoin futures, as some have done, requiring substantially higher initial margins from their customers, as many have done, and through their active participation in DCO risk committees. After the launch of Bitcoin futures, some criticism was directed at the self-certification process from a few market participants. Some questioned why the Commission did not hold public hearings prior to launch. However, it is the function of the futures exchanges and futures clearinghouses--and not CFTC staff \20\--to solicit and address stakeholder concerns in new product self-certifications. The CFTC staff's focus was on how the futures contracts and cash settlement indices are designed to bar manipulation and the appropriate level of contract margining to meet CEA and Commission regulations. --------------------------------------------------------------------------- \20\ Unlike provisions in the CEA and Commission regulations that provide for public comment on rule self-certifications, there is no provision in statute or regulation for public input into CFTC staff review of product self-certifications. It is hard to believe that Congress was not deliberate in making that distinction. --------------------------------------------------------------------------- Interested parties, especially clearing members, should indeed have an opportunity to raise appropriate concerns for consideration by regulated platforms proposing virtual currency derivatives and DCOs considering clearing new virtual currency products. That is why CFTC staff has added an additional element to the Review and Compliance Checklist for virtual currency product self-certifications. That is, requesting DCMs and SEFs to disclose to CFTC staff what steps they have taken in their capacity as self-regulatory organizations to gather and accommodate appropriate input from concerned parties, including trading firms and FCMs. Further, CFTC staff will take a close look at DCO governance around the clearing of new virtual currency products and formulate recommendations for possible further action. The CFTC's response to the self-certification of Bitcoin futures has been a balanced one. It has resulted in the world's first federally regulated Bitcoin futures market. Had it even been possible, blocking self-certification would not have stopped the rise of Bitcoin or other virtual currencies. Instead, it would have ensured that virtual currency spot markets continue to operate without effective and data- enabled Federal regulatory surveillance for fraud and manipulation. It would have prevented the development of a regulated derivatives market that allowed participants to take ``short'' positions that challenged the 2017 rise of Bitcoin prices. III. Adequacy of CFTC Authority The CFTC has sufficient authority under the CEA to protect investors in virtual currency derivatives over which the CFTC has regulatory jurisdiction under the CEA. As noted above, the CFTC does NOT have regulatory jurisdiction over markets or platforms conducting cash or ``spot'' transactions in virtual currencies or over participants on those platforms. For such virtual currency spot markets, CFTC only has enforcement jurisdiction to investigate and, as appropriate, conduct civil enforcement action against fraud and manipulation. Any extension of the CFTC's regulatory authority to virtual currency spot markets would require statutory amendment of the CEA. \21\ The CFTC is an experienced regulator of derivatives markets that mostly serve professional and eligible contract participants. Such extension of regulatory authority would be a dramatic expansion of the CFTC's regulatory mission, which currently does not give the CFTC regulatory authority (distinct from enforcement authority) over cash commodity markets. --------------------------------------------------------------------------- \21\ The CFTC has jurisdiction over retail foreign currency markets and retail commodity transactions that use leverage, margin, or financing with some exceptions. Congress responded to concerns in the regulation of leveraged retail FX by providing the CFTC oversight responsibilities for Retail Foreign Exchange Dealers (RFEDs). The CFTC Re-authorization Act of 2008 amended the CEA to create a new registration category for RFEDs that include disclosure requirements and leverage limitations to customers. --------------------------------------------------------------------------- IV. Educating Investors and Market Participants The CFTC believes that the responsible regulatory response to virtual currencies must start with consumer education. Amidst the wild assertions, bold headlines, and shocking hyperbole about virtual currencies, there is a need for much greater understanding and clarity. Over the past 6 months, the CFTC has produced an unprecedented amount of consumer information concerning virtual currencies (listed in Appendix B hereto). These consumer materials include an information ``primer'' on virtual currencies (Appendix C hereto), consumer and market advisories on investing in Bitcoin and other virtual currencies (Appendix D hereto), a dedicated CFTC ``Bitcoin'' webpage, several podcasts (available on the Commission's website and from various streaming services) concerning virtual currencies and underlying technology, weekly publication of Bitcoin futures ``Commitment of Traders'' data and an analysis of Bitcoin spot market data. In addition, the CFTC's Office of Consumer Education and Outreach (OCEO) is actively engaging with responsible outside partners to better educate consumers on Bitcoin and other virtual currencies. The OCEO is currently partnering with:
The Consumer Finance Protection Bureau (CFPB) to train U.S. public library staff to identify and report consumer in virtual currencies; the American Association of Retired Persons (AARP) to distribute a virtual currency ``Watchdog Alert'' to 120,000 AARP members; North American Securities Administrators Association (NASAA) Investor Educators, who are responsible for conducting outreach to the public on avoiding investment fraud, including in virtual currencies; the National Attorneys General Training and Research Institute (NAGTRI), which is the research and training arm of the National Association of Attorneys General (NAAG), to inform State AGs about the availability of CFTC's virtual currency resources; and The Federal Reserve Bank of Chicago to help consumers manage their finances better, OCEO will again coordinate with NFA, FINRA, and SEC to hold a webinar on fraud prevention in virtual currencies. V. Interagency Coordination As noted, the CFTC's enforcement jurisdiction over virtual currencies is not exclusive. As a result, the U.S. approach to oversight of virtual currencies has evolved into a multifaceted, multi- regulatory approach that includes: The Securities and Exchange Commission (SEC) taking increasingly strong action against unregistered securities offerings, whether they are called a virtual currency or initial coin offering in name. State Banking regulators overseeing certain U.S. and foreign virtual currency spot exchanges largely through State money transfer laws. The Internal Revenue Service (IRS) treating virtual currencies as property subject to capital gains tax. The Treasury's Financial Crimes Enforcement Network (FinCEN) monitoring Bitcoin and other virtual currency transfers for anti-money-laundering purposes. The CFTC actively communicates its approach to virtual currencies with other Federal regulators, including the Federal Bureau of Investigation (FBI) and the Justice Department and through the Financial Stability Oversight Council (FSOC), chaired by the Treasury Department. The CFTC has been in close communication with the SEC with respect to policy and jurisdictional considerations, especially in connection with recent virtual currency enforcement cases. In addition, we have been in communication with overseas regulatory counterparts through bilateral discussions and in meetings of the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO). VI. Potential Benefits I have spoken publicly about the potential benefits of the technology underlying Bitcoin, namely Blockchain or distributed ledger technology (DLT). \22\ Distributed ledgers--in various open system or private network applications--have the potential to enhance economic efficiency, mitigate centralized systemic risk, defend against fraudulent activity and improve data quality and governance. \23\ --------------------------------------------------------------------------- \22\ J. Christopher Giancarlo, Keynote Address of Commissioner J. Christopher Giancarlo before the Markit Group, 2016 Annual Customer Conference, New York, May 10, 2016, http://www.cftc.gov/PressRoom/ SpeechesTestimony/opagiancarlo-15. \23\ Id. --------------------------------------------------------------------------- DLT is likely to have a broad and lasting impact on global financial markets in payments, banking, securities settlement, title recording, cybersecurity, and trade reporting and analysis. \24\ When tied to virtual currencies, this technology aims to serve as a new store of value, facilitate secure payments, enable asset transfers, and power new applications. --------------------------------------------------------------------------- \24\ See, e.g., Larry Greenemeier, ``Can't Touch This: New Encryption Scheme Targets Transaction Tampering'', Scientific American, May 22, 2015, http://www.scientificamerican.com/article/can-t-touch- this-new-encryption-scheme-targets-transaction-tampering/. --------------------------------------------------------------------------- Additionally, DLT will likely develop hand-in-hand with new ``smart'' contracts that can value themselves in real-time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default. \25\ --------------------------------------------------------------------------- \25\ See Massimo Morini and Robert Sams, ``Smart Derivatives Can Cure XVA Headaches'', Risk Magazine, Aug. 27, 2015, http:// www.risk.net/risk-magazine/opinion/2422606/-smart-derivatives-can-cure- xva-headaches; see also Jeffrey Maxim, ``UBS Bank Is Experimenting with `Smart-Bonds' Using the Bitcoin Blockchain'', Bitcoin Magazine, June 12, 2015, https://bitcoinmagazine.com/articles/ubs-bank-experimenting- smart-bonds-using-bitcoin-blockchain-1434140571; see also Pete Harris, ``UBS Exploring Smart Bonds on Block Chain'', Block Chain Inside Out, June 15, 2015, http://harris-on.typepad.com/block_chain_io/2015/06/ubs- exploring-smart-bonds-on-block-chain.html; See, generally, Galen Stops, ``Blockchain: Getting Beyond the Buzz'', Profit & Loss, Aug.-Sept. 2015, at 20, http://www.profit-loss.com/articles/analysis/technology- analysis/blockchain-getting-beyond-the-buzz. --------------------------------------------------------------------------- DLT may enable financial market participants to manage the significant operational, transactional, and capital complexities brought about by the many mandates, regulations, and capital requirements promulgated by regulators here and abroad in the wake of the financial crisis. \26\ In fact, one study estimates that DLT could eventually allow financial institutions to save as much as $20 billion in infrastructure and operational costs each year. \27\ Another study reportedly estimates that blockchain could cut trading settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion. \28\ Moving from systems-of-record at the level of a firm to an authoritative system-of-record at the level of a market is an enormous opportunity to improve existing market infrastructure. \29\ --------------------------------------------------------------------------- \26\ See, e.g., ``Oversight of Dodd-Frank Act Implementation'', U.S. House Financial Services Committee, http:// financialservices.house.gov/Dodd-Frank/ (last visited Mar. 2, 2016). \27\ Santander InnoVentures, Oliver Wyman, and Anthemis Group, ``The FinTech Paper 2.0: Rebooting Financial Services'' 15 (2015), http://santanderinnoventures.com/wp-content/uploads/2015/06/The- Fintech-2-0-Paper.pdf. \28\ Telis Demos, ``Bitcoin's Blockchain Technology Proves Itself in Wall Street Test'', Apr. 7, 2016, Wall Street Journal, http:// www.wsj.com/articles/bitcoins-blockchain-technology-proves-itself-in- wall-street-test-1460021421. \29\ Based on conversations with R3 CEV, http://r3cev.com/. --------------------------------------------------------------------------- Outside of the financial services industry, many use cases for DLT are being posited from international trade to charitable endeavors and social services. International agricultural commodities merchant, Louis Dreyfus, and a group of financing banks have just completed the first agricultural deal using distributed ledger technology for the sale of 60,000 tons of U.S. soybeans to China. \30\ Other DLT use cases include: legal records management, inventory control and logistics, charitable donation tracking and confirmation; voting security and human refugee identification and relocation. \31\ --------------------------------------------------------------------------- \30\ Emiko Terazono, ``Commodities Trader Louis Dreyfus Turns to Blockchainhttps'', Financial Times, Jan. 22, 2018, www.ft.com/content/ 22b2ac1e-fd1a-11e7-a492-2c9be7f3120a. \31\ Frisco d'Anconia, ``IOTA Blockchain To Help Trace Families of Refugees During and After Conflicts'', Cointelegraph.com, Aug. 8, 2017, https://cointelegraph.com/news/iota-blockchain-to-help-trace-families- of-refugees-during-and-after-conflicts. --------------------------------------------------------------------------- Yet, while DLT promises enormous benefits to commercial firms and charities, it also promises assistance to financial market regulators in meeting their mission to oversee healthy markets and mitigate financial risk. What a difference it would have made on the eve of the financial crisis in 2008 if regulators had access to the real-time trading ledgers of large Wall Street banks, rather than trying to assemble piecemeal data to recreate complex, individual trading portfolios. I have previously speculated \32\ that, if regulators in 2008 could have viewed a real-time distributed ledger (or a series of aggregated ledgers across asset classes) and, perhaps, been able to utilize modern cognitive computing capabilities, they may have been able to recognize anomalies in marketwide trading activity and diverging counterparty exposures indicating heightened risk of bank failure. Such transparency may not, by itself, have saved Lehman Brothers from bankruptcy, but it certainly would have allowed for far prompter, better-informed, and more calibrated regulatory intervention instead of the disorganized response that unfortunately ensued. --------------------------------------------------------------------------- \32\ See supra n. 22. --------------------------------------------------------------------------- VII. Policy Considerations Two decades ago, as the Internet was entering a phase of rapid growth and expansion, a Republican Congress and the Clinton administration established a set of enlightened foundational principles: the Internet was to progress through human social interaction; voluntary contractual relations and free markets; and Governments and regulators were to act in a thoughtful manner not to harm the Internet's continuing evolution. \33\ --------------------------------------------------------------------------- \33\ The Telecommunications Act of 1996 (See Telecommunications Act of 1996 (Pub. L. No. 104-104, 110 Stat. 56 (1996))) and the ensuing Clinton administration ``Framework for Global Electronic Commerce'' (See Clinton administration, Framework for Global Electronic Commerce, http://clinton4.nara.gov/WH/New/Commerce/) established a simple and sensible framework: (a) the private sector should play the leading role in innovation, development, and financing; and (b) Governments and regulators should ``do no harm'' by avoiding undue restrictions, supporting a predictable, consistent, and simple legal environment and respecting the ``bottom-up'' nature of the technology and its deployment in a global marketplace. --------------------------------------------------------------------------- This simple approach is well-recognized as the enlightened regulatory underpinning of the Internet that brought about such profound changes to human society. During the almost 20 years of ``do no harm'' regulation, a massive amount of investment was made in the Internet's infrastructure. It yielded a rapid expansion in access that supported swift deployment and mass adoption of Internet-based technologies. Internet-based innovations have revolutionized nearly every aspect of American life, from telecommunications to commerce, transportation and research and development. This robust Internet economy has created jobs, increased productivity and fostered innovation and consumer choice. ``Do no harm'' was unquestionably the right approach to development of the Internet. Similarly, I believe that ``do no harm'' is the right overarching approach for distributed ledger technology. Virtual currencies, however, likely require more attentive regulatory oversight in key areas, especially to the extent that retail investors are attracted to this space. SEC Chairman Clayton and I recently stated in a joint op-ed, that: Our task, as market regulators, is to set and enforce rules that foster innovation while promoting market integrity and confidence. In recent months, we have seen a wide range of market participants, including retail investors, seeking to invest in DLT initiatives, including through cryptocurrencies and so-called ICOs . . . initial coin offerings. Experience tells us that while some market participants may make fortunes, the risks to all investors are high. Caution is merited. A key issue before market regulators is whether our historic approach to the regulation of currency transactions is appropriate for the cryptocurrency markets. Check-cashing and money-transmission services that operate in the U.S. are primarily State-regulated. Many of the internet-based cryptocurrency trading platforms have registered as payment services and are not subject to direct oversight by the SEC or the CFTC. We would support policy efforts to revisit these frameworks and ensure they are effective and efficient for the digital era. \34\ --------------------------------------------------------------------------- \34\ See supra n. 5. As the Senate Banking Committee, the Senate Agriculture Committee and other Congressional policymakers consider the current state of regulatory oversight of cash or ``spot'' transactions in virtual currencies and trading platforms, consideration should be given to shortcomings of the current approach of State-by-State money transmitter licensure that leaves gaps in protection for virtual currency traders and investors. Any proposed Federal regulation of virtual currency platforms should be carefully tailored to the risks posed by relevant trading activity and enhancing efforts to prosecute fraud and manipulation. Appropriate Federal oversight may include: data reporting, capital requirements, cybersecurity standards, measures to prevent fraud and price manipulation and anti-money laundering and ``know your customer'' protections. Overall, a rationalized Federal framework may be more effective and efficient in ensuring the integrity of the underlying market. Conclusion We are entering a new digital era in world financial markets. As we saw with the development of the Internet, we cannot put the technology genie back in the bottle. Virtual currencies mark a paradigm shift in how we think about payments, traditional financial processes, and engaging in economic activity. Ignoring these developments will not make them go away, nor is it a responsible regulatory response. The evolution of these assets, their volatility, and the interest they attract from a rising global millennial population demand serious examination. With the proper balance of sound policy, regulatory oversight, and private sector innovation, new technologies will allow American markets to evolve in responsible ways and continue to grow our economy and increase prosperity. This hearing is an important part of finding that balance. Thank you for inviting me to participate. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM JAY CLAYTON Q.1. When I asked you how much of the $4 billion raised by initial coin offerings (ICOs) last year was raised in the United States, you said that it was unclear and hard to estimate ``because this has been conducted largely on an unregulated basis,'' but there is enough to make it worth paying attention. Later, when asked why no ICOs were registered with the SEC, you stated that you do not think gatekeepers ``have done their job,'' even though you have made the law clear. You also explained that you want private placements to happen, but you ``want them to do it right,'' and ICOs have taken ``the disclosure-like benefits of a private placement'' but used general solicitation and the promise of secondary trading among retail investors without registering with the SEC. Based on these responses, you seem to share my concern that ICOs are evading the registration requirements of the securities laws and failing to satisfy private-placement requirements. Accordingly, I have several follow-up questions and requests about the SEC's efforts to police ICOs: Please describe the strategy, policies, and procedures that the SEC is using to track and monitor ICOs and secondary trading of ``tokens'' issued in ICOs. A.1. I do share your concern that a number of initial coin offering (ICO) participants are evading the registration requirements of the Securities Act of 1933 by failing to either register the token offering or to qualify for an exemption from the registration requirements. With the support of my fellow Commissioners, I have asked the SEC's Enforcement staff to continue to police these markets vigorously and recommend enforcement actions against those who conduct or facilitate ICOs or engage in other actions relating to digital assets in violation of the Federal securities laws. Last year, the SEC announced two initiatives to build on the Enforcement Division's ongoing efforts to address cyber- based threats and protect retail investors. One such effort was to create a Cyber Unit to focus on targeting cyber-related misconduct, including in the insider trading and ICO spaces. The other was to establish a Retail Strategy Task Force to implement initiatives that directly affect retail investors. The Cyber Unit and Retail Strategy Task Force are helping to build upon and leverage the expertise already developed by the cross-divisional Distributed Ledger Technology Working Group, formed in 2013, to address violations of the Federal securities laws. I want to emphasize that our efforts are not limited to the offerings of coins or tokens. The number of broker-dealers and investment advisers engaged in this space has grown, and we are reviewing their activities as well. The SEC's National Examination Program announced in its public priorities that it will continue to monitor the sales of ICOs and cryptocurrencies, and where the products are securities, will conduct examinations of investment advisers and broker-dealers to assess regulatory compliance. Areas of focus include, among other things, whether financial professionals maintain adequate controls and safeguards to protect these assets from theft or misappropriation, and whether financial professionals are providing investors with disclosure about the risks associated with these investments, including the risk of investment losses, liquidity risks, price volatility, and potential fraud. Through these various functions, the SEC staff surveils publicly available data sources; receives and reviews tips, complaints and referrals, which can be submitted to the SEC via https://www.sec.gov/whistleblower/submit-a-tip; and liaises with domestic and international regulatory and law enforcement partners and with members of the public to gather information. The staff also established a dedicated email address at [email protected] to centralize communications from the public on FinTech issues to engage with issuers and other market participants about these issues. I have made cross-border awareness of and attention to these issues a priority, including in connection with our participation in the Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO). With respect to secondary trading of tokens, because token trading platforms by and large are not registered as national securities exchanges or operating pursuant to the Regulation ATS exemption, and certain of them appear to operate overseas, the SEC's direct knowledge of the nature and full extent of trading by those platforms has been limited. The SEC's Divisions of Enforcement and Trading and Markets recently issued a joint statement on potentially unlawful online platforms for trading digital assets. The statement emphasizes that investors should use a platform or entity registered with the SEC to get the protections offered by the Federal securities laws and SEC oversight. \1\ Notwithstanding the fact that these platforms largely have not registered with us or operated pursuant to an exemption, the SEC staff has continued to monitor publicly available sources; review tips, complaints and referrals, and work with regulatory partners, members of the public, and members of the industry to obtain information on secondary trading as described above. The Commission has brought enforcement actions against online platforms for operating as unregistered national securities exchanges and will continue to do so where appropriate. --------------------------------------------------------------------------- \1\ If those tokens are securities and the platforms on which they trade register as national securities exchanges or operate as alternative trading systems (ATSs), those exchanges and ATSs are required to report information about their operations and trading to the SEC. For example, ATSs file quarterly reports on Form ATS-R to disclose to the SEC their trade volume, the securities traded, and trading participants, which augments the SEC's oversight to monitor the activities of these markets. Q.2. Please provide statistics on ICOs tracked by the SEC and/ or any third-party data obtained and used by the SEC to follow ICOs. Please provide: the total number of offerings and monetary value, and the exemptions used and/or purported to be used for those ICOs, by number of offerings and monetary value. A.2. Although a number of public data sources purport to track ICOs, we do not have definitive data on their number or value. In this regard, it is noteworthy that many of the platforms that facilitate trading in digital assets are not regulated and do not provide information that is subject to regulatory review. In addition, much of the information found in public data sources is unaudited. In addition, while the SEC possesses offering data with respect to registered offerings, data with respect to ICOs purporting to qualify for an exemption from registration is more spotty (e.g., with respect to offerings conducted under Regulation D, which requires the provision of only limited data to the Commission and does not require the issuer to designate whether the offering is an ICO), or non-existent (e.g., with respect to offerings relying on statutory exemptions rather than Commission rules). In connection with the efforts described above, the SEC staff reviews third-party data sources to examine market data for ICOs. Publicly reported numbers from third-party data sources indicate on a worldwide basis more than $6.2 billion has been raised in 2018; $3.9 billion in 2017; and $95 million in 2016. Q.3. I am concerned that the anonymity afforded by blockchain technology may allow issuers to evade the geographic and accredited-investor restrictions that they claim to impose on ICOs. How is the SEC ensuring that ICOs do not evade these requirements? In answering this question, please address: o How is the SEC ensuring that issuers in ICOs that are restricted to non-U.S. investors do not sell securities to U.S. investors through blockchain or other technology? How is the SEC ensuring that issuers in ICOs that are restricted to accredited investors do not sell securities to nonaccredited investors through blockchain or other technology? How is the SEC ensuring that securities issued in unregistered ICOs are not sold to U.S. investors in secondary trading in violation of the securities laws through blockchain or other technology? A.3. The Federal securities laws provide that all offers and sales of securities to persons within the United States must be registered or qualify for an exemption. These laws apply to protect United States investors regardless where the issuer is located. Just as with any other offer and sale of securities, the SEC will bring enforcement actions where appropriate for violations of the registration provisions of the Federal securities laws. The Federal securities laws provide certain exemptions from registration for both primary offerings of securities and resales of securities, notably concerning accredited investors. Failure to comply with the conditions for such exemptions can result in violations of the registration provisions of the Federal securities laws. To the extent offering participants are able to qualify for an exemption from registration, our efforts will examine whether the procedures they are following are designed to ensure compliance with an appropriate exemption, and we are aware of issues raised by anonymity and other aspects of ICOs that make compliance with private placement exemptions more difficult on a relative basis. The SEC will continue to review information related to individual ICOs, ask for additional information from issuers and trading platforms, and bring enforcement actions where appropriate for violations of the registration provisions of the Federal securities laws. The SEC already has brought enforcement actions alleging violations of the registration and anti-fraud provisions of the Federal securities laws. See SEC v. REcoin Group Foundation, LLC et al. (E.D.N.Y.) (Sep. 29, 2017); SEC v. PlexCorps et al., 17-cv-7007 (E.D.N.Y.) (Dec. 1, 2017); SEC v. AriseBank et al., 3:28-cv-0186 (N.D. Tex.) (Jan. 25, 2017); see also In re Munchee, Inc., Admin. File No. 3-18304 (Dec. 11, 2017) (settled administrative action alleging registration violations). Additionally, the SEC has brought enforcement actions against virtual currency-denominated platforms operating as unregistered securities exchanges. See SEC v. Jon E. Montroll and Bitfunder, 18-cv-1582 (S.D.N.Y.) (Feb. 21, 2018); In re BTC Trading, Corp. and Ethan Burnside, Admin. File No. 3-16307 (Dec. 8, 2014). This is the same approach--clarifying the application of longstanding law, then prosecuting violations--that the SEC has taken for any offers and sales of securities for many years. The SEC will continue to police these markets vigorously-- including through the use of our investigatory tools, such as issuing document requests and administrative subpoenas, conducting witness interviews, and taking sworn testimony--and staff will recommend enforcement actions against those who conduct ICOs or engage in other actions relating to digital assets in violation of the Federal securities laws. Q.4. What is the SEC doing to ensure that gatekeepers are doing their jobs? Without commenting on any specific ongoing investigations, has the SEC considered taking enforcement actions against any accountants, securities lawyers, consultants, or other gatekeepers in connection with ICOs? A.4. Our securities laws are based in substantial part on, and in many ways require, market professionals holding themselves to high standards. In December, I issued a public statement on cryptocurrencies and ICOs directed in part to market professionals. I have since made other public statements that these professionals, especially gatekeepers, need to act responsibly and hold themselves to high standards. I have made it clear that gatekeepers need to focus on their responsibilities, keeping in mind the principal motivation for our registration, offering process and disclosure requirements--to protect retail investors. I'm counting on them to do their jobs. We have encouraged market professionals to contact our staff for assistance and have set up a dedicated email address, [email protected], for this very purpose. Within the SEC, a group of staff across the agency has been tasked with focusing on these issues and are exploring the best ways to message our expectations to professionals. SEC staff is examining approaches to ICOs that may be contrary to our securities laws and the professional obligations of the securities bar. In this regard, staff is focusing on professional advisers and other gatekeepers, and, as with other areas of the securities laws, the SEC will consider bringing enforcement actions where appropriate. Q.5. Do you believe a virtual currency exchange or platform utilized in an ICO could have liability under the securities laws for an illegal unregistered ICO? A.5. The SEC's Report of Investigation Pursuant to Section 21(a) of the Securities Act of 1934: The DAO (The DAO Report), issued on July 25, 2017, reminded entities that engage in exchange activity, including with respect to the trading of tokens that meet the definition of ``security,'' regarding their obligation to register as a national securities exchange or operate pursuant to an exemption from such registration. More recently, the Divisions of Enforcement and Trading and Markets issued a statement with information for investors and market participants about the applicability of the Federal securities laws to online trading platforms that operate as an ``exchange'' for securities trading. As The DAO Report and the statement make clear, a platform can be found to have violated Section 5 of the Exchange Act by effecting trades in a token that is a security without registering as a national securities exchange or operating pursuant to an exemption from such registration. In addition, as The DAO Report addresses, those who participate in an unregistered offer and sale of securities not subject to a valid exemption can be liable for violating the registration provisions of the Federal securities laws. Accordingly, such a platform could also be found to have violated Section 5 of the Exchange Act to the extent it participated in the offer or sale of the token in the ICO itself, including (for example) by soliciting offers to buy the securities for value. The SEC will bring enforcement action against unregistered securities token exchanges as the facts and circumstances warrant. Q.6. In response to my questions about how the SEC is handling a reported reduction in its enforcement staff headcount by 100, you stated that ``personnel'' is your ``biggest challenge at the moment,'' with ``a hiring freeze'' and attrition having reduced SEC staff headcount. You then said you ``could use more people'' in the Divisions of Enforcement and Trading and Markets, adding that ``[t]hose are the two areas where I think the American people would get the greatest return for additional bodies.'' Please explain the hiring freeze, i.e., how and when it was authorized, when it was implemented, staffing levels at the time of implementation, and when or under what conditions you expect it to be lifted. A.6. In late Fiscal Year (FY) 2016, the SEC implemented a general freeze on external hiring, with limited exceptions. As a result, the filling of 365 total positions was suspended. Limited backfills of vacancies have been allowed for specific needs. Recently, I submitted the SEC's budget request for FY 2019 seeking $1.658 billion in support of 4,628 positions. The funds will allow us to restore 100 positions, approximately one-quarter of the total reduction resulting from the hiring freeze, to address critical priority areas and enhance the agency's expertise in key areas. These key areas include cybersecurity and risk management, protecting Main Street investors, facilitating capital formation, and effective oversight of our capital markets. I expect that a significant number of these positions would be in or related to our Trading and Markets and Enforcement Divisions. Q.7. As noted in Question 2, you stated the SEC is under a ``hiring freeze''. The day following the hearing, The Wall Street Journal reported that former Representative Scott Garrett plans to take a position as your advisor at the SEC. Is this report accurate? Assuming it is: What is, or will be, Mr. Garrett's role at the SEC? Please explain if this is a new role. Specifically, please state (i) his title; (ii) the division where he works or will work; (iii) his responsibilities; (iv) who he reports to (and, if applicable, who that individual reports to), and (v) who, or how many staff, he supervises or will supervise, if any. Has Mr. Garrett started work at the SEC yet? If not, when will Mr. Garrett start work at the SEC? Why does the hiring freeze not appear to apply to Mr. Garrett? Did you consider any other individuals for Mr. Garrett's role? If so, what were these other individuals' backgrounds and qualifications? A.7. Mr. Garrett began working at the SEC on March 5, 2018, as a senior advisor to the General Counsel in the Office of the General Counsel. He is not acting as my advisor. Mr. Garrett has an important, specialized, and narrowly tailored role. He will be working primarily on projects involving other Federal financial regulators that oversee our capital markets (e.g., the CFTC, Federal Reserve, and the Treasury Department). Information sharing, and in particular, sharing information regarding market operations, is important to the SEC. Mr. Garrett will focus on matters where we need to seek greater information sharing and regulatory cooperation. As a former member of Congress with many years of experience interacting with and overseeing Federal financial regulatory agencies, Mr. Garrett is well positioned to help ensure that appropriate protocols are in place to foster information sharing and regulatory coordination that improve our ability to oversee the capital markets and its participants. Our current plan for FY2018 allows for limited external hiring, including the position Mr. Garrett occupies. This hiring action is consistent with our prioritization of hiring professionals to assist the agency in fulfilling its mission generally and the specific needs discussed above. The agency hired Mr. Garrett as an attorney, an ``excepted-service'' position, which means that the position was excepted from competitive hiring procedures. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM JAY CLAYTON Q.1. We've heard a lot about the potential for fraud with ICOs. What are the potential benefits of ICOs? For example, do ICOs have the potential to expand access to capital for small businesses? A.1. If done in conformance with our securities laws, ICOs may allow small businesses to raise capital in an efficient and cost-effective manner. At the same time, these ICOs could provide investors with additional investment opportunities. Importantly, though, when offering these investment opportunities to investors in the form of an ICO, issuers must be sure to comply with our securities laws, including with respect to providing adequate disclosures to investors about the risks of the investment and how the money raised will be used. We should embrace the pursuit of technological advancement, as well as new and innovative techniques for capital raising, but not at the expense of the principles undermining our well-founded and proven approach to protecting investors and markets. Q.2. According to your testimony, ICOs raised nearly $4 billion in 2017. While the SEC has filed enforcement actions that argue that certain ICOs should have been registered with the SEC, your testimony states that no ICOs have yet to be registered with the SEC. Why have no ICOs been registered with the SEC? Is one possible explanation for the lack of ICO registrations that the registration requirements are too stringent and not adapted to the unique nature of an ICO? A.2. I am not aware of unique features of ICOs that would prevent and further complicate compliance, as opposed to other types of securities offerings, with the Federal securities laws. The SEC has assisted numerous issuers in registering novel and unusual products over the years, utilizing a principles-based framework that has served American companies and American investors well through periods of innovation and change. While I will not speculate as to why no issuer to date has chosen to conduct an ICO as a registered offering, we have received inquiries about registering ICOs with the SEC and will continue to work with parties that seek to do so. The staff has held itself out as ready and willing to engage with would-be issuers and other market participants who would like to conduct offerings in compliance with the Federal securities laws but may need compliance assistance or exemptive, no-action, or other forms of regulatory relief in order to comply with our rules and regulations that may have been written with a more traditional offering in mind. Unfortunately, too few have sought to take us up on that offer. Q.3. What guidance has the SEC provided to companies as to whether their ICO should be registered with the SEC? Does the SEC intend to provide more guidance as to when ICOs should be registered with the SEC? For example, beyond enforcement actions, the SEC could issue no action letters, put out a concept release or proposed rule, or otherwise provide further written guidance as to what constitutes a security. How--if at all--has the SEC tried to work with companies that want to register their ICOs with the SEC? A.3. The SEC and its staff have issued a number of statements, investor alerts and bulletins, and press releases. \2\ The Commission also issued The DAO 21Report and has brought a number of enforcement actions consistent with the requirements of the Federal securities laws. We have made clear that, for decades, we have applied a flexible, principles-based analysis to determine whether an instrument is a security. This analysis has served our markets and our investors well for many years as investment opportunities and market structures have changed. In short, where purchasers make an investment of money with an expectation of profits derived from the entrepreneurial and managerial efforts of others, there is an investment contract and therefore a security. The focus is not on form, but on the economic realities of the transaction and relationship. --------------------------------------------------------------------------- \2\ See testimony appendix --------------------------------------------------------------------------- Again, we have been clear on this issue. We have applied our securities law framework to a number of different ICOs and shown each time that the ICO was a security. I worry that many have sought to make this analysis more complicated than it really is, in the hopes of coming to a conclusion that the securities laws should not apply and, as a result, they are free to seek investments from the general public without regard to disclosure and procedural rules that have served our markets so well. That said, to the extent additional guidance in this area would be appropriate or helpful, we will continue to be open to providing it. We also stand ready to engage with issuers seeking to register ICOs or to discuss potential ICO structures. We have established a [email protected] email address dedicated to FinTech-specific inquiries. I have encouraged market participants, including issuers and their advisers, to engage with the SEC staff to aid in their analysis under the Federal securities laws. Through the [email protected] email address, and in-person meetings, the SEC staff regularly communicates with dozens of individuals and practitioners regarding the Federal securities laws and regulations thereunder, and to date, the staff has had numerous potential issuers seeking guidance on how to register or qualify an ICO. Q.4. Does the SEC intend to evaluate whether all of the registration requirements for a securities offering should also apply to registering an ICO? A.4. The SEC staff has substantial experience in assisting issuers in registering novel and unusual products, making appropriate accommodations to adapt to particular circumstances of each offering. While I am not aware of unique features of ICOs that would prevent and further complicate compliance with the Federal securities laws, SEC staff stand ready to engage with interested issuers and market participants on issues related to securities offerings involving ICOs and other cryptocurrency-related products. Q.5. Are you concerned about the potential for bitcoin and other cryptocurrencies to facilitate money laundering by criminals such as human traffickers, gangs like MS-13, or terrorists like Hezbollah? What--if any--role does your agency have in addressing this problem, including through cooperation with other agencies? A.5. Several characteristics of cryptocurrencies can facilitate efforts to evade our money-laundering laws and regulations and, as a result, facilitate criminal and other illicit activity. For example: Anonymity/Tracing money. Many of the cryptocurrencies are specifically designed to be pseudonymous or truly anonymous. Attribution of a specific private key to an individual or entity could be difficult or impossible, especially where tools such as digital tumblers and misers are used to make tracing and attribution difficult. Traditional financial institutions (such as banks) often are not involved with cryptocurrency transactions, again making it more difficult to follow the flow of money. International scope. Cryptocurrency transactions and users span the globe. Although the SEC has methods for obtaining information from abroad (including through cross-border agreements), there may be restrictions on how the SEC can use the information, and it may take more time to get the information than in the case of domestic activity. In many cases, the SEC may be unable to obtain relevant information located overseas. No central authority. As there is no central authority that collects cryptocurrency user information, the SEC generally must rely on other sources, such as cryptocurrency exchanges or users, for this type of information. Seizing or freezing cryptocurrency. Law enforcement officials may have difficulty seizing or freezing illicit proceeds held in cryptocurrencies. Cryptocurrency wallets may be encrypted and, unlike money held in a bank or brokerage account, cryptocurrencies may not be held by a third-party custodian. New technologies. Cryptocurrencies involve new and developing technologies, ever evolving. The SEC staff collaborates regularly with other agencies (Federal, State, and international) on matters of mutual interest and has frequent communications with other financial regulators. In particular, the SEC's Division of Enforcement has long-standing and on-going cooperation efforts with a number of Federal law enforcement and regulatory partners, such as the DOJ, FBI, IRS, and CFTC, to name a few, in addition to State and international regulators. In matters of mutual interest, SEC Enforcement staff will collaborate as appropriate with these partners through, among other ways, information sharing arrangements, access grants, and memoranda of understanding. In addition, SEC staff participates in forums organized within the law enforcement and regulatory communities. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED FROM JAY CLAYTON Q.1. On January 26th, Bloomberg reported that the SEC is considering breaking with its prior position, and permitting issuers to slip forced arbitration clauses into initial public offerings, which would bar investors from suing issuers for wrongdoing, such as fraud. During your testimony, you said that you ``cannot prejudge an issue that may come before the SEC,'' but added that you are ``not anxious to see a change in this area.'' Isn't it the case that the SEC has previously opposed barring investors in initial public offerings from pursuing legal remedies against issuers for offenses like fraud? If so, what--if anything--has changed? Does your comment during your testimony that you are ``not anxious to see a change'' in this area reflect your belief that investors should not be barred from suing issuers for fraud and other securities violations? A.1. This matter is complex. It involves our securities laws, matters of other Federal and State law, an array of market participants and activities, as well as matters of U.S. jurisdiction. It also involves many public policy considerations. Further, this issue has come before the Commission in a variety of ways and contexts and may do so in the future. Views of market participants on this issue, particularly in the case of an initial public offering (IPO) of a U.S. company, are deeply held and, in many cases, divergent. In response to the recent heightened interest from Congress and others relating to the inclusion of mandatory arbitration provisions in the charters or bylaws of U.S. companies contemplating an IPO, I have (1) made several statements \1\ and (2) more recently, asked the Division of Corporation Finance (the Division) to review how this issue has arisen in the past, and may arise in the future, in connection with filings made by companies with the Division. --------------------------------------------------------------------------- \1\ See, e.g., Remarks before the SEC Investor Advisory Committee (March 8, 2018), available at https://www.sec.gov/news/public- statement/statement-clayton-2018-3-8. --------------------------------------------------------------------------- A summary provided by the Division of its prior approach to this issue, as well as how the Division would expect to proceed if the issue were presented in the context of an IPO of a U.S. company, is below. The summary reflects the Division's view that should a U.S. company pursue a registered IPO with a mandatory arbitration clause in its governing documents, the decision about whether to declare the filing effective should be made by the Commission, not the Division by delegated authority. I agree with the Division's view on process and, in particular, that this would be a decision for the Commission. Although I have made several prior statements on this issue, for reasons of clarity and completeness, I summarize my perspective on the issue below. As a threshold matter, and recognizing the complexity and importance of this issue, I reiterate my personal view that any analysis of this issue or decision making by the Commission in the context of a registered IPO by a U.S. public company should be conducted in a measured and deliberative manner. The Federal securities laws provide a basis for private rights of action by investors in the event of material misstatements as part of securities offerings. There is a long history of claims of this type being brought against U.S. publicly traded companies in our Federal and State courts, including as class actions. The Division's summary notes that, in the case of foreign private issuers that have conducted registered offerings in the United States and U.S. companies that are not listed, direct and indirect limitations on such actions have been prevalent for many years. In addition, and beginning several years prior to my arrival at the Commission, certain U.S. companies conducting exempt Regulation A offerings have included mandatory arbitration clauses in their governing documents or subscription agreements. The Division's summary discusses these and other matters in more detail. It is my view that if we are presented with this issue in the context of a registered IPO of a U.S. company, I would expect that any decision would involve Commission action (and not be made through delegated authority) and that the Commission would give the issue full consideration in a measured and deliberative manner. Such a review would take into account various considerations, including developments in applicable law and any other relevant considerations. Since this hearing, I have reiterated these views and sought to appropriately frame this issue and my preference for such a process in my public statements. These statements have not only addressed my perspective on the appropriate procedure for analyzing this matter but also its relative priority. With respect to priority, generally speaking, my view is that the Commission should allocate its limited rulemaking and other related resources to a portfolio of matters that (1) present currently pressing and significant issues for investors and our markets, (2) are central to our mission, (3) are ripe for consideration, and/or (4) are addressable through a reasonable share of Commission and staff time. To me, such matters currently include, among others and in no particular order, (1) standards of conduct for investment professionals, (2) Congressionally-mandated rulemaking, (3) the regulation of investment products, including ETFs, (4) the impact of distributed ledger technology (including cryptocurrencies and ICOs), (5) FinTech developments, (6) the elimination of burdensome regulations that do not enhance investor protection or market integrity with an eye toward facilitating capital formation, (7) an examination of equity and fixed income market structure, and (8) of course, inevitable issues that we have not yet identified but will emerge as pressing. These statements have made it clear that I have not formed a definitive view on whether or not mandatory arbitration for shareholder disputes is appropriate in the context of an IPO for a U.S. company. I believe any decision would be facts and circumstances dependent and could inevitably divert a disproportionate share of the Commission's resources from the priorities I noted above. In short, this issue is not a priority for me. Although the issue is not a priority for me, it does not mean that it is not worthwhile to analyze, and I have encouraged those with strong views to support their position with robust, legal and data driven analysis. If this matter does come before the Commission, such analysis will assist the Commission in its deliberative process. Summary Provided by the Division of Corporation of Finance The Division of Corporation Finance (the Division) oversees periodic filings by reporting companies and filings of issuers seeking to raise money in the capital markets through, for example, initial public offerings. The Federal securities laws generally focus on requiring companies to provide full and fair disclosure of material information to investors and the Division's oversight of filings is intended to facilitate compliance with those laws. State laws generally provide the parameters for companies to establish their corporate governance through their organizational documents, such as their charter or bylaws. The Commission does not have rules permitting or prohibiting companies from using arbitration provisions. The Commission's processes with respect to arbitration provisions have been and may in the future be implicated through the Division's role in overseeing and processing filings by companies. The most often identified channel for this issue to arise is if a U.S. company sought to include a mandatory arbitration provision in its governing documents when it filed an initial registration statement to offer and sell securities publicly. Following is an overview of circumstances in which mandatory arbitration provisions have been and could be present in the governance documents of companies that make filings with the Commission. Registered Offerings by U.S. Companies A company may not sell securities in the United States unless (1) it has an effective registration statement on file with the SEC or (2) an exemption from registration is available. Section 8(a) of the Securities Act of 1933 (Securities Act) provides that a registration statement will become effective 20 days after it is filed and authorizes the Commission to accelerate the effective date of a registration statement after taking into account the adequacy of the disclosure and certain other considerations. \2\ This authority to accelerate the effective date has been delegated to the Division by the Commission. By statute, registration statements become effective with the passage of time. As a matter of practice, a company will nearly always include in any pre- effective registration statement a legend, referred to as a ``delaying amendment,'' in order to prevent the registration statement from becoming effective automatically following the passage of time and to better control the timing of its offering. During this time, the Division staff may review the filing. In the course of a filing review, Division staff will evaluate the company's disclosure and may issue comments to elicit better compliance with disclosure requirements, and the company will amend its registration statement to address the comments as appropriate. Following this review and comment process, the company submits a request to accelerate the effective date of the registration statement. --------------------------------------------------------------------------- \2\ In its entirety, Section 8(a) states that ``The effective date of a registration statement shall be the twentieth day after the filing thereof or such earlier date as the Commission may determine, having due regard to the adequacy of the information respecting the issuer theretofore available to the public, to the facility with which the nature of the securities to be registered, their relationship to the capital structure of the issuer and the rights of holders thereof can be understood, and to the public interest and the protection of investors [emphasis added].'' --------------------------------------------------------------------------- When this issue last arose in the context of an initial public offering (IPO) of a U.S. company in 2012, the Division took the position, based on a consideration of relevant Federal laws and case law, that it would not use its delegated authority to accelerate the effective date of a U.S. company's registration statement when the company's governing documents contained a mandatory arbitration provision covering disputes arising under Federal securities laws. In that context, the Division was unable to conclude that such provisions are consistent with ``the public interest and protection of investors'' as required by Securities Act Section 8(a) in light of, among other things, the anti-waiver provision in Section 14 of that Act. \3\ More specifically, at that time, the Division advised a company that it did not anticipate exercising its delegated authority to accelerate the effective date of the registration statement if such a provision was included in the company's governing documents and that the Commission would need to make any decision on a request for acceleration. In that situation, the company decided not to include the mandatory arbitration provisions in its governing documents in connection with its IPO. --------------------------------------------------------------------------- \3\ Section 14 states that ``Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title or of the rules and regulations of the Commission shall be void.'' --------------------------------------------------------------------------- If this issue were to come before the Division in a U.S. company's registration statement for an IPO today, as discussed in more detail below, the Division would not use its delegated authority to accelerate the effective date of the registration statement. Instead, the Division would refer a request for acceleration to the full Commission. The historical treatment of this issue in other circumstances, such as in the qualification of Regulation A offerings and in the processing of registration statements filed by foreign private issuers, is described below. Other Circumstances For many years, U.S. and non-U.S. companies have made other types of filings with the Commission that have included mandatory arbitration provisions for shareholder disputes in their governing or offering documents. These circumstances and the relevant considerations are described further below. In these circumstances, the relevant statutes and rules generally require appropriate disclosure regarding material risks to the issuer or of the offering, which would include risks relating to mandatory arbitration provisions and any impact on holders of the offered securities. Regulation A: Some companies utilizing the exemption from registration available under Regulation A have included mandatory arbitration clauses in their governing documents or subscription agreements. Under Regulation A, a company may not sell its securities until the Division has qualified its offering statement. In these exempt offerings, neither the Federal securities laws nor the Commission's rules require the Division to make the same public interest determination as is required when accelerating the effective date of a registration statement in the context of an IPO. In 2015, after reviewing the relevant law and regulations, the Commission staff concluded that there would not be grounds to withhold qualification of a Regulation A offering on the basis that the issuer had included a mandatory arbitration provision in its governing documents. Since then, in light of the Commission staff's 2015 determination, certain offerings that have included a mandatory arbitration clause have been qualified under Regulation A, provided that the material risks of such a dispute resolution approach had been disclosed and the issuer otherwise qualified for the exemption. Foreign Private Issuers: For many years, a number of foreign companies with securities listed or traded in the United States have included mandatory arbitration and other analogous provisions in their filings. Registration statements of foreign private issuers offering and selling securities in the United States also generally include disclosures regarding limitations investors may face as a result of the issuer's foreign status and home country laws and regulations. These disclosures have typically included a risk factor informing investors that due to jurisdictional issues it may be difficult for them to obtain or enforce judgments or bring original actions, including actions styled as class actions, against the company. In these instances and in situations where mandatory arbitration has been required, either due to local law requirements or otherwise, the Division staff has focused on the disclosure of the material risks related to these limitations and has declared these filings effective. Exchange Act Reporting Companies: There are several other ways a company could be in the Securities Exchange Act of 1934 (Exchange Act) reporting regime and have a mandatory arbitration provision in its governing documents. For example, a registration statement for a class of securities pursuant to Exchange Act Section 12(g) becomes effective automatically 60 days after filing. As another example, a public reporting company could amend its bylaws or seek shareholder approval of a charter amendment or to include an arbitration provision (assuming that the applicable State law allows for the enforceability of such a provision). \4\ In any of these situations, the Commission's rules would require appropriate disclosures to investors. --------------------------------------------------------------------------- \4\ See Claudia H. Allen, ``Bylaws Mandating Arbitration of Stockholder Disputes'', 39 Del. J. of Corp. Law 751, 779 782 (2015) (discusses circumstances where arbitration clauses included in public issuers' filings) (Allen). --------------------------------------------------------------------------- Considerations Mandatory arbitration clauses involve complexities beyond the Commission and its rules. For example, they raise issues under the State corporate laws under which the issuers are organized. In addition, Federal case law regarding mandatory arbitration continues to evolve. Since 2012, when this issue was last presented to the Division in the context of an IPO of a U.S. company, the Supreme Court has affirmed the strong Federal interest in promoting the arbitration of claims under Federal laws. \5\ Over the last several years, commentators have observed that there is uncertainty as to whether the Commission would have a basis to deny an acceleration request in these circumstances. \6\ If a U.S. company were to file for an IPO with governing documents that included a mandatory arbitration provision, the Commission would need to evaluate the specific facts and circumstances in the context of not just the Federal securities laws but also State corporate and other Federal law. This is a complex legal and policy issue that requires careful consideration. As such, and as discussed above, if the issue were presented to the Division in the context of an IPO for a U.S. company, the Division would decline to exercise its delegated authority to accelerate the effective date of a registration statement and instead refer the matter to the Commission for its consideration. --------------------------------------------------------------------------- \5\ See, e.g., American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013) (holding that, under the Federal Arbitration Act (FAA), courts must ``rigorously enforce'' arbitration agreements according to their terms unless the FAA's mandate has been ``overridden by a contrary congressional command''). \6\ See, e.g., Allen at 778 (fn 141). --------------------------------------------------------------------------- ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCHATZ FROM JAY CLAYTON Q.1. During your testimony you mentioned that initial coin offerings (ICO) seem to be security offerings, which would bring under the jurisdiction of your agency to regulate. One major concern that members of the committee, financial experts, and investors all share is that ICOs may actually be Ponzi schemes. How can investors discern between legitimate ICOs with legitimate value and those that are fraudulent schemes? A.1. Your question goes to the heart of the Federal securities laws--ensuring that investors, especially retail investors, have adequate information to make informed investment decisions. I believe that it is difficult for investors to make determinations whether an investment opportunity is at risk of being a Ponzi scheme or another scheme in the absence of disclosures of material information by ICO issuers. While many ICOs issue a ``White Paper'' in conjunction with the offering, many of these White Papers are, in essence, outlines of an idea, and none that I have seen provide the scope and depth of information one would find in a statutory prospectus. Many provide nothing comparable in the way of disclosure. In the absence of this critical information, I do not know how an average investor would be able to discern with a reasonable degree of confidence whether the ICO is ``legitimate'' or whether there is significant risk that it is a fraudulent scheme. As part of my December statement on cryptocurrencies and ICOs, I cautioned investors to ask clear questions and demand answers from ICO issuers and promoters. In addition to publicized enforcement actions, the SEC and its staff have issued a number of statements, investor alerts, and bulletins targeted to retail investors. Investors can access much of this information by visiting the www.investor.gov website ``Spotlight on Initial Coin Offerings and Digital Assets.'' Q.2. Do you need new statutory authority to regulate ICOs (and other areas of cryptocurrencies) or do you believe already- existing authorities sufficiently address this new area? If new statutory authority is required, what should the authority aim to achieve? A.2. The registration and disclosure requirements of the Federal securities laws provide flexibility in describing the terms of the securities, as well as the particular businesses that may be issuing these securities. Over the past 84 years, the SEC and its staff have worked with companies issuing novel types of securities and have used a principles-based approach to assure appropriate disclosure is made to investors, and this approach has worked well. In addition, the Federal securities laws have anti-fraud and other remedial provisions that are principles-based, broad, and flexible and that are aimed at protecting investors from fraud, including fraud arising from securities offerings, actions of intermediaries, and market manipulation. These provisions provide the SEC with important tools that can be applied to securities activities involving novel technologies--regardless of how those technologies are used. I believe offerings of digital assets that are securities should be treated and evaluated no differently. Nevertheless, the staff will continue monitoring developments in this area and consider the need for additional authorities. As Chairman Giancarlo and I testified, we are open to exploring with Congress, as well as with our Federal and State colleagues, whether increased Federal regulation of cryptocurrency trading platforms--or spot markets--is necessary or appropriate. We also are supportive of regulatory and policy efforts to bring clarity and fairness to this space and are conferring with our colleagues at the U.S. Department of the Treasury and the Federal Reserve Board with respect to any potential legislative suggestions. To the extent that new issues arise in our markets that the SEC is unable to address, we will alert Congress to gaps in authority and request additional authority where necessary. Q.3. In SEC v. W.J. Howey Co., the Supreme Court created the ``Howey Test'' which has since been the test for determining whether a financial transaction is a security or not. However, cryptocurrencies are not squarely compatible with the test that was designed to address more traditional instruments and contracts. Does Howey apply to cryptocurrencies? More specifically, is the ``efforts of others'' requirement met? Who should arbitrate whether a particular cryptocurrency should be considered an investment contact, commodity, or some other financial instrument? Do you believe that responsibility should belong to a specific Federal agency or should it be made in an interagency forum, such as the Financial Stability Oversight Council? A.3. Determining whether a transaction involves a security does not turn on labelling--such as the characterization of something as a ``cryptocurrency.'' Whether a token or a digital asset called a cryptocurrency is a security is determined by applying long-established law to the facts and circumstances of the particular instrument being sold. As you noted, under Supreme Court case law in SEC v W.J. Howey and its progeny, where purchasers make an investment of money with an expectation of profits derived from the entrepreneurial and managerial efforts of others, there is a security. Determining whether the Howey test results in an investment being a security requires an assessment of the facts and circumstances of each case, including the economic realities underlying a transaction. Such analysis looks to the substance of the transaction, not merely its form or other naming conventions. As is the case with any ``investment contract'' analysis, securities counsel assisting its client may exercise judgment in making an initial determination. The SEC staff may confer with counsel to express different views and explain its basis. If these differences remain unresolved and the company offers the instrument, the SEC may authorize an enforcement action on the basis that the instrument is a security. If litigated, a court would make the ultimate determination. As is the case with any instrument being offered or sold, the SEC is the agency appropriately charged with determining whether a particular instrument is an ``investment contract,'' and, thus, a security. This principles-based framework has served American companies and investors well throughout periods of innovation and change for 84 years. Such determinations have been made without recourse to an interagency forum. The SEC staff does confer, and will continue to confer, with other agencies as appropriate to discuss particular products that may raise issues under different regulatory regimes. With respect to the ``managerial efforts of others'' prong of the Howey test, the DAO Report noted that the central issue turned on ``whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.'' \1\ In the case of The DAO, its investors ``relied on the managerial and entrepreneurial efforts of Slock.it and its co-founders, and The DAO's Curators, to manage The DAO and put forth project proposals that could generate profits for The DAO's investors.'' The DAO Report further noted that The DAO's investors' expectations of future profits were primed by market efforts of The DAO and its co-founders. Whether any other particular token or cryptocurrency met this test would be a facts-and-circumstances analysis, utilizing the principles-based framework. --------------------------------------------------------------------------- \1\ SEC v. Glenn W. Turner Enters., Inc., 474 F.2d 476, 482 (9th Cir. 1973). --------------------------------------------------------------------------- With respect to a ``true'' cryptocurrency, it may well be that the Howey test leads to the conclusion that the cryptocurrency is not a security and the cryptocurrency is a commodity. Again, however, such a determination would need to be made on an individual basis based on the facts and circumstances, without regard to what the product is named. Q.4. The concept of banks is familiar to the average American. Banks comply with extensive regulations to ensure safety and protect consumer confidence and are insured by the Federal Deposit Insurance Corporation (FDIC). Cryptocurrency investments are quite different. But many retail investors do not seem to appreciate how different cryptocurrencies are from real currencies. For example, there is no FDIC-like protection for investments in cryptocurrency. Should cryptocurrency wallets and exchanges be subject to similar rules aimed at protecting consumer funds under their control? A.4. I agree with the premise in your question that banks are subject to regulations designed to ensure their safety and soundness and bank cash deposits are insured by the FDIC. In the securities industry, customers receive protection for cash and securities held at broker-dealers under the SEC's customer protection rule, which requires broker-dealers to hold customer fully paid and excess margin securities in possession or control and free of lien and to segregate the net amount of cash owed to customers. These provisions, along with the SEC's net capital rule applicable to broker-dealers, are designed to facilitate the prompt return of securities and cash to customers if the broker-dealer fails financially. Moreover, if the failed broker-dealer cannot promptly return these assets, there is a special bankruptcy regime to protect customers. Specifically, the Securities Investor Protection Act (SIPA) gives the customers a priority claim over other creditors to customer securities and cash held by the failed broker-dealer. In addition, if the amount of customer securities and cash held by the failed firm is insufficient to make each customer whole, SIPA provides up to $500,000 per customer (of which $250,000 can be used for cash claims) to make up any shortfalls. In a recent statement from the Divisions of Enforcement and Trading and Markets, SEC staff noted that there may be online trading platforms--such as digital wallet services--that, while not exchanges, directly or indirectly offer trading or other services to investors in ICOs and cryptocurrencies. To the extent these services involve securities, this would trigger certain requirements under the Federal securities laws, including registration as a broker-dealer, transfer agent, or clearing agency, among others, and the customer protections that go along with that registration. With respect to cryptocurrencies that are not securities, the question of whether wallets and exchanges should be subject to a regime that provides for consumer insurance and supervisory oversight is part of the broader questions of whether a separate regulatory regime is necessary or appropriate for those cryptocurrencies. We are discussing this question with our fellow regulators and expect to consult with the Committee on any recommendations. With these matters as context, I generally agree with your assessment that investors in cryptocurrencies and ICOs are not receiving the protections that are comparable to bank deposits and brokerage accounts. Q.5. Do you think consumers fully understand the level of inherent risk associated with investing in cryptocurrencies? A.5. I have significant concerns that Main Street investors have not been given clear disclosures that would provide a basis for understanding the material facts and risks involved when it comes to ICOs and cryptocurrencies. Worse, I have seen examples where it appears promoters are intentionally confusing ICOs with SEC-registered IPOs. Unfortunately, I believe it is clear that some have taken advantage of this lack of understanding. In response, I have urged investors, particularly retail investors, to ask questions and demand clear answers from issuers and promoters of cryptocurrencies and ICOs. The SEC staff also has taken a number of steps to alert investors to this very point and arm investors with information on these assets. For example, the SEC staff has issued a number of investor alerts, statements, and warnings. So, too, have SROs, State securities regulators, and other Federal, State, local, and international regulators. The www.investor.gov website ``Spotlight on Initial Coin Offerings and Digital Assets,'' lists a series of statements, investor alerts and bulletins, announcements of enforcement actions, and further provides contact information. It is important for investors to be informed about critical questions related to these products and for them to understand the risks involved. Q.6. Currently, States play a major role in regulating cryptocurrencies. The result has been a wide range of approaches with a patchwork of regulatory schemes that can prove difficult to navigate. o Should a formal interagency committee be created to aid financial regulatory agencies create coordinated regulation and oversight of new financial products, services, and platforms associated with cryptocurrencies? What role should States play in regulating cryptocurrencies? A.6. Federal and State regulators play an important role in protecting Main Street investors against fraudulent and illegal activities. Coordination among Federal and State regulators concerning the introduction of new types of financial products occurs through a number of long-established channels. The SEC staff has worked with a number of agencies over the years to discuss products that may raise issues under different regulatory regimes, and currently we are participating in the FSOC subcommittee formed at the direction of the Secretary of the Treasury to coordinate the regulatory approach to issues regarding cryptocurrencies, ICOs, and other digital assets. To the extent a digital asset operates as a ``true'' currency, trading in such instruments does not fall under the SEC's jurisdiction. Currency trading--such as trading in euros, dollars, or yen--implicates regulation by FinCEN and State laws regarding money transfers, among others. Traditional money- transmission services that operate in the United States are primarily State-regulated and many of the internet-based cryptocurrency trading platforms have registered as payment services that are not subject to direct oversight by the SEC or the CFTC. To the extent these financial instruments take on other characteristics or are used in particular markets, they may be subject to regulation by the SEC and/or CFTC. The SEC has been collaborating with the CFTC on our approaches to policing these markets for fraud and abuse and will continue to work closely with our Federal and State counterparts, including the Department of Treasury, Department of Justice, and State attorneys general and securities regulators to ensure appropriate oversight consistent with our respective statutory missions. Should additional legislative, regulatory, or other policy efforts be necessary to address these issues, I stand ready to work with Congress and our regulatory counterparts. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM J. CHRISTOPHER GIANCARLO Q.1. On January 18, 2018, the Director of the SEC's Division of Investment Management wrote a letter to industry raising concerns about potential ``fraud and manipulation'' that could impact prices in both cryptocurrency markets and the derivatives markets linked to them. As a result of these and other concerns, the Director wrote: ``Until the questions identified above can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products.'' This letter follows the SEC's previous denial of an application to list Bitcoin exchange-traded funds in March 2017 and reports that the SEC told other exchanges to withdraw their applications. One former SEC lawyer characterized the SEC's first application denial as ``essentially saying that until significant Bitcoin markets are regulated, the listing exchange really can't address concerns about the potential for manipulative trading,'' leading some observers to believe that the SEC would change its position after the launch of the CME and Cboe Bitcoin futures exchanges. However, between the Investment Management letter and the SEC's requests for certain exchange applicants to withdraw their applications, it appears that there are still serious concerns at the SEC about the potential for fraud and manipulation in cryptocurrency and related futures markets, even after the launch of the CME and Cboe exchanges. I have several questions related to these developments: Do you believe that the SEC's concerns about the risks of fraud and manipulation in the cryptocurrencies and related futures markets are accurate? Do you believe that the SEC is being too conservative waiting until its concerns are resolved before approving new products? A.1. There are different statutory provisions and regulatory standards for how products under the SEC's or CFTC's jurisdiction are listed to trade. With respect to the SEC, commodity-trust exchange traded products, (ETP) (e.g., the Winklevoss Bitcoin ETP submitted in 2017) are exchange rule changes. The SEC must determine whether the proposed rule change is consistent with the statutory provisions, and the rules and regulations that apply to national securities exchanges. The SEC must approve the filing if it finds that the proposed rule change is consistent with these legal requirements and it must disapprove the filing if it does not make such a finding. The proposed rule change is published in the Federal Register and subject to notice and comment. Under the Commodity Exchange Act (CEA) and Commission regulations, futures exchanges can self-certify new futures contracts on 24- hour notice prior to trading. There are limited grounds for the CFTC to ``stay'' self-certification such as filing a false statement in the certification. It is clear that Congress and prior Commissions deliberately designed the CFTC's product self-certification framework to give futures exchanges the ability to quickly bring new products to the marketplace. Q.2. If you believe that the SEC is being too conservative, or its markets and products are sufficiently different from the CFTC's, please explain how the risks in your markets are different from the risks that led the SEC to identity fraud and manipulation concerns in the cryptocurrencies and related derivatives markets. A.2. The functional role of futures and securities are also fundamentally different. Futures are risk management instruments, typically very short term in nature (hence weekly and quarterly expirations) and designed to help firms manage risk exposures, while ETPs are investment products, held by retail investors for long periods--for example, an ETP can be held as part of a retail investor's retirement investment in an IRA account. The regulatory approach to these two sets of instruments reflects these economic and functional differences. Q.3. Additionally, are there specific risks or events that would cause you to reconsider the markets underlying the Bitcoin futures and other derivatives? A.3. The CFTC's approach to Bitcoin futures was a balanced approach that took into account promoting responsible innovation and development that is consistent with its statutory mission. The information access and risk management protocols established for the Bitcoin futures contracts reflects an appropriate and thoughtful balance of flexibility provided in the statute to the exchanges to self-certify new futures contracts, and for CFTC to monitor that these contracts continue to be in compliance with the CEA's core principles. Q.4. Your written testimony mentioned that CME's and Cboe's Bitcoin futures exchanges have information-sharing agreements with the Bitcoin exchanges they rely on. Could you please submit a model or sample information- sharing agreement for the record? This would help the Committee and others in Congress understand the unique risks in these markets, how oversight is being conducted, and whether additional legislation related to virtual currencies is necessary. A.4. One purpose of the Commodity Exchange Act is to serve the public interest by providing a means for managing and assuming price risks, discovering prices, or disseminating pricing information. The CEA sets forth a series of Core Principles applicable to a board of trade designated by the Commission as a contract market. Those core principles, also adopted by the Commission in Part 38 of its Regulations, contain requirements that (core principle 3) the board of trade list contracts that are not readily susceptible to manipulation and that (core principle 4) the board of trade ``shall have the capacity and responsibility to prevent manipulation, price distortion, and disruptions of the delivery or cash settlement process through market surveillance, . . . including (A) methods for conducting real-time monitoring of trading.'' Designated contract markets that list futures contracts that are cash settled must also have, in accordance with Commission Regulation 38.253, ``rules or agreements that allow the designated contract market access to information on the activities of its traders in the reference market.'' The Commission has also published guidance and acceptable practices for contract markets to comply with these referenced core principles on an ongoing basis. In particular, the Commission's guidance for cash settled contracts provides that ``at a minimum, an acceptable program of monitoring cash-settled contracts must include access, either directly or through an information-sharing agreement, to traders' positions and transactions in the reference market for traders of a significant size in the designated contract market near the settlement of the contract.'' See Part 38, Appendix B, Core Principle 4, Section (b)(3) (Cash-settled contracts). The Cboe Futures Exchange (CFE) has entered into an information sharing agreement with the Gemini auction platform concerning the Cboe's listed Bitcoin contracts. The information sharing agreement is described starting in the last paragraph of page 5 of the CFE certification filing, continuing on to page 6, which is linked here: http://www.cftc.gov/filings/ptc/ ptc120117 cfedcm001.pdf. Specifically, the certification states that ``the Amendment modifies [CFE] Rule 216 to make clear that CFE may enter into information sharing agreements with trading venues like the Gemini Exchange. In particular, CFE is amending Rule 216 to clarify that CFE may have information sharing agreements with trading venues other than domestic or foreign self-regulatory organizations, associations, boards of trade, and swap execution facilities. CFE is also amending Rule 216 to make clear that CFE may be a direct party to any information sharing agreements under Rule 216 or be a party as a third party beneficiary to information sharing agreements entered into by CFE affiliates. In this regard, Cboe Options has entered into an information sharing agreement with Gemini that provides CFE with the ability to access Gemini Exchange trade data for regulatory purposes, including in connection with the surveillance and regulation of trading in XBT futures on CFE's market. Pursuant to this information sharing agreement, CFE Regulation (CFER) will receive on a regular basis from Gemini, order and trade detail information from the Gemini Exchange market for Bitcoin in U.S. dollars, which CFER will utilize to conduct cross market surveillance of the Gemini Exchange Bitcoin auction and the CFE XBT futures settlements. This information sharing agreement also permits CFE to share that data with the Commission. One way in which this information sharing will occur is that CFE plans to share Gemini Exchange market data with the Commission.'' The Chicago Mercantile Exchange (CME) also self-certified its Bitcoin futures contract which can be reviewed here: http:/ /www.cftc.gov/filings/ptc/ptc120117cmedcm001.pdf. The Bitcoin contract utilizes an index, referred to as the Bitcoin Reference Rate or BRR, for settlement. According to the CME's certification filing, the BRR is calculated by Crypto Facilities, a financial services firm, and the BRR is also governed by an oversight committee. In order for a trading venue to be considered a constituent exchange by the BRR, CME's certification further states at pages 4-5, that certain criteria must be met including that ``the venue cooperates with inquiries and investigations of regulators and the Calculation Agent upon request.'' In addition, the Commission is closely coordinating with other regulators who have access to cash platform data, in particular the Financial Crimes Enforcement Network (FinCEN) within the Department of Treasury. Q.5. On January 19, 2018, you said in a speech that you had directed CFTC staff to develop a ``heightened review'' process for virtual currencies derivatives, including a checklist for new products, and that you had asked the CTFC's General Counsel to discuss the statutory support for codifying these principles through rulemaking. Could you please provide an update on the process and status of these discussions? A.5. The elements of the ``heightened review'' process are publicly available on the CFTC's website in its January 4, 2018, ``Backgrounder on Oversight of and Approach to Virtual Currency Futures Markets.'' Q.6. Is the CFTC staff developing a proposed rule for notice and comment? A.6. CFTC staff is currently preparing staff-level guidance on the heightened review process that will be publicly available on the CFTC's website. Q.7. Will the full Commission vote on the rule? A.7. If a rule was proposed, it would go through the notice- and-comment process under the Administrative Procedure Act (APA) and require a Commission vote to implement. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM J. CHRISTOPHER GIANCARLO Q.1. The CFTC's backgrounder on its oversight and approach to virtual currency futures markets states that virtual currency ``self-certification under heightened review means that the CFTC not only has clear legal authority, but now also will have the means to police certain underlying spot markets for fraud and manipulation.'' How will the CFTC exercise this authority in light of your testimony that ``the CFTC does NOT have regulatory jurisdiction under the CEA over markets or platforms conducting cash or `spot' transactions in virtual currencies or other commodities or over participants on such platforms.'' A.1. In 2015, the CFTC determined that virtual currencies, such as Bitcoin, met the definition of ``commodity'' under the CEA. Nevertheless, to be clear, the CFTC does not have regulatory jurisdiction over markets or platforms conducting cash or ``spot'' transactions in virtual currencies or other commodities or over participants on such platforms. More specifically, the CFTC does not have authority to conduct regulatory oversight over spot virtual currency platforms or other cash commodities, including imposing registration requirements, surveillance and monitoring, transaction reporting, compliance with personnel conduct standards, customer education, capital adequacy, trading system safeguards, cybersecurity examinations, or other requirements. In fact, current law does not provide any U.S. Federal regulator with such regulatory oversight authority over spot virtual currency platforms operating in the United States or abroad. However, the CFTC does have enforcement jurisdiction to investigate through subpoena and other investigative powers and, as appropriate, conduct civil enforcement action against fraud and manipulation in virtual currency derivatives markets, and in underlying virtual currency spot markets just like other commodities. In contrast to its lack of regulatory authority over virtual currency spot markets, the CFTC does have both regulatory and enforcement jurisdiction under the CEA over derivatives on virtual currencies traded in the United States. This means that for derivatives on virtual currencies traded in U.S. markets, the CFTC conducts comprehensive regulatory oversight, including imposing registration requirements and compliance with a full range of requirements for trade practice and market surveillance, reporting and monitoring and standards for conduct, capital requirements, and platform and system safeguards. Q.2. Are you concerned about the potential for Bitcoin and other cryptocurrencies to facilitate money laundering by criminals such as human traffickers, gangs like MS-13, or terrorists like Hezbollah? A.2. I am very concerned about the potential for the use of cryptocurrency for illicit activity. The CFTC does not have the regulatory authority to prevent or stop the use of it for those purposes, which has to be done by law enforcement agencies, with whom we actively cooperate on cryptocurrency and other matters. We are committed to referring any illicit activity to our law enforcement partner agencies. Q.3. What--if any--role does your agency have in addressing this problem, including through cooperation with other agencies? A.3. I met recently with the new head of FinCEN, and the financial crimes unit, and they assured me that their anti- money-laundering procedures are in place for all domestic virtual currency trading platforms, which we do not regulate at the CFTC, but about which we are concerned. We are broadly concerned about the use of virtual currencies for illicit activities, and yet no Federal regulator has direct authority over these markets. I think policymakers in Congress, as well as the regulatory agencies, should focus first and foremost on developing a plan for where we go next. And, I think the industry itself has something to do in this area as well. A number of virtual currency platforms in the U.K. are banding together to develop a self-regulatory organization to clean up the industry of these problems. I think advocates for virtual currencies need to know that they have a responsibility for cleaning up this industry if they really want it to be something that bears respect and becomes part of not only our future but their future as well. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCHATZ FROM J. CHRISTOPHER GIANCARLO Q.1. Currently, States play a major role in regulating cryptocurrencies. The result has been a wide range of approaches with a patchwork of regulatory schemes that can prove difficult to navigate. Should a formal interagency committee be created to aid financial regulatory agencies create coordinated regulation and oversight of new financial products, services, and platforms associated with cryptocurrencies? A.1. The creation of a formal interagency committee to aid financial regulatory agencies to coordinate and oversee new financial products, services, and platforms associated with cryptocurrencies is an interesting idea that would have potential benefits. Currently, the CFTC actively communicates its approach to virtual currencies with other Federal regulators, including the Federal Bureau of Investigation (FBI) and the Justice Department and through the Financial Stability Oversight Council (FSOC), chaired by the Treasury Department. Q.2. What role should States play in regulating cryptocurrencies? A.2. With respect to the role of States, I believe that the States have an important role to play, at least, if not beyond, the point that a Federal regulator is designated to have regulatory jurisdiction over virtual currency platforms. Q.3. The CFTC has authorized Bitcoin options on the Chicago Mercantile Exchange and Cboe Options Exchange. What procedures and regulations are in place to ensure the volatility of Bitcoin does not spread such that it risks the stability of the more traditional financial sectors trading the future? A.3. The seventh element of the ``heightened review'' process for virtual currency product certifications provides that derivatives clearing organizations (DCOs) set substantially high initial margin and maintenance margin for cash-settled Bitcoin futures. This element was designed to ensure adequate collateral coverage in reaction to the underlying volatility of Bitcoin. Futures exchanges also have risk controls and tools to manage periods of volatility as well as unexpected spikes in volatility. CFTC regulations require futures exchanges to conduct real-time market monitoring of trading activity and market conditions, and to establish and maintain risk control mechanisms to prevent and reduce the potential risk of price distortions and market disruptions, including restrictions that pause or halt trading. See 17 CFR 38.157, 38.251, and 38.255. CFE and CME also have position limits on their Bitcoin futures, which limits the number of Bitcoin futures contracts a market participant may own.