SEC’s Proposed ‘Dealer’ Definition: A Shadow Ban On DeFi? – Technology

On March 28, 2022, buried within a 200-page proposed rule ostensibly meant to
redefine “dealer” and “government securities
dealer” under Sections 3(a)(5) and 3(a)(44) of the Securities
Exchange Act of 1934, the Securities and Exchange Commission
(“SEC”) published a seemingly innocuous footnote:

“Proposed Rule 3a5-4 would apply to securities as defined
by Section 3(a)(10) of the Exchange Act, and proposed Rule 3a44-2
would apply to government    securities as defined by
Section 3(a)(42) of the Exchange Act, including any digital
asset that is a security or a government security within the
meaning of the Exchange Act.”

The security status of digital assets is currently evaluated on
a case-by-case basis, typically by applying the Howey Test. This footnote clarifies
the staff’s position: They are keeping an eye on digital
assets, and building a regulatory framework around the possibility
that some, if not all, digital assets will fall within their
purview.

If a broad swath of digital assets, including any number of
crypto and blockchain-based assets, are deemed to be securities,
and, accordingly, those in the decentralized finance (DeFi)
industry are deemed to be participating in activities that avail
themselves to categorization as “dealers” for purposes of
federal securities regulation, it could amount to a shadow ban on
the industry as it currently exists.

Under the proposed rule, if a DeFi exchange satisfies the
proposed rule’s proposed thresholds (i.e., large trading firms
that employ automated, algorithmic trading strategies to execute
trades, and have or control more than $50 million in total assets
under management) and doesn’t register with the SEC, it would
then be deemed an unregistered dealer, which is potentially a
felony offense.

The question remains: Is the SEC opening the door to proactive
registration by DeFi exchanges, or anyone else who might be touched
by the expanding reach of the staff? Is this an invitation to
“come in and register”? If not, the fear of a potential
shadow ban will remain. Hopefully, this means that proactive market
participants can avail themselves of regulatory infrastructure and
that this expansion of definitions will lead to clarity.

The comment period for this proposed rule is expected to extend
until at least May 27, 2022.

Dinsmore attorneys are closely monitoring these developments,
and are available to assist any DeFi market participant or exchange
looking to proactively position themselves to minimize long-term
risk exposure, or to facilitate making an official comment on the
proposed rule.

www.dinslaw.com

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