A lot of securities lawyers will nod, “Yes, I saw this coming,” in response to today’s settlement with BlockFi Lending LLC (“BlockFi”).  A company taking in crypto from a wide range of investors and promising returns could implicate the securities laws in several ways.  Today’s settlement tags that arrangement as both an investment contract under Howey[1] and a note under Reves.[2]  On top of that, the settlement deems BlockFi an unregistered investment company.  Lurking behind the legal analysis, however, is an important question:  Is the approach we are taking with crypto lending the best way to protect crypto lending customers?  I do not think it is, so I respectfully dissent.

As an initial matter, it is difficult to understand how the civil penalty will protect investors.  BlockFi will pay the SEC $50 million, and will pay another $50 million in connection with state settlements for the same conduct.  While penalties this size are intended to deter bad conduct, here there is no allegation that BlockFi failed to pay its customers the money due them or failed to return the crypto lent to it.  BlockFi’s misrepresentations about over-collateralization are serious, but the combined $100 million penalty nevertheless seems disproportionate. 

The piece of the settlement aimed at getting important information to customers is more understandable from a retail protection standpoint.  Customers who lend crypto assets to a company in exchange for a promised return should get the information they need to assess the risks against the rewards.  A company offering crypto lending services could offer that information voluntarily as a way to gain and retain customers.  For those companies that do not provide the information on their own, a self-regulatory or government regulatory framework might make sense.  Securities law is one regulatory framework through which one could force transparency.  This settlement seeks to do just that.  The Order Instituting Proceedings states that BlockFi’s parent company has announced that it “confidentially submitted a draft registration statement on Form S-1.”[3]  If this registration statement becomes effective, it will afford BlockFi customers helpful transparency.  But it is still worth asking whether a framework other than the securities regulatory framework might be better suited to getting customers transparency around the terms and risks of crypto lending products.

Applying the securities regulatory framework has consequences, some of which may be unfortunate.  Rather than forcing transparency around retail crypto lending products, today’s settlement may stop them from being offered to retail customers in the United States.  BlockFi will not be allowed to take in any additional crypto from retail investors until the company has registered a new crypto lending product on Form S-1.  Getting an S-1 to the point where staff will declare it effective is often a months-long, iterative process.  When crypto is at issue, the timeframe is likely to be longer than it would be for more traditional filings.  

Even assuming BlockFi perseveres and prevails in the S-1 registration process, before it can restart its lending program, it has to leap through another regulatory hoop—the Investment Company Act.  The Commission has found that BlockFi operated as an unregistered investment company.[4]  Yet BlockFi cannot register as an investment company since it issues debt securities,[5] and so it needs an exemption or exclusion from registration.  The Order Instituting Proceedings also specifically discusses the market intermediary exclusion.[6]  If BlockFi seeks refuge in this rarely used exclusion, it has a challenging path to prove that it qualifies, particularly with the Commission staff’s typical heightened scrutiny for crypto companies.[7]   The Commission’s lack of experience with the market intermediary exclusion combined with the nature of BlockFi’s business suggests that the sixty-day timeframe (even if extended an additional 30 days) allocated for BlockFi to “provid[e] the Commission staff with sufficient credible evidence that it is no longer required to be registered under the Investment Company Act”[8] is extremely ambitious.  

More importantly, what ends does this Investment Company Act exercise serve?  The Form S-1 already should satisfy the information disclosure objective at the heart of this settlement.  Finding a way not to be subject to the Investment Company Act would not seem to serve an additional protective purpose.  If the Commission believes that additional protections are needed to make up for not being covered by the Investment Company Act protections, then we could work with BlockFi under our Section 6(c) exemptive authority to craft a bespoke set of conditions that make sense in this context.[9]  The Section 6(c) process also lends itself better to public input, which seems appropriate given that today’s settlement will reverberate beyond just the settling entity and will affect competing crypto lenders and their customers as well.

We often tell companies wanting to offer products that could implicate the securities laws to “come in and talk to us.”  To make that invitation meaningful, however, we need to commit to working with these companies to craft sensible, timely, and achievable regulatory paths.  Working with an earnest desire to reach a prudent, properly calibrated regulatory outcome is important for a number of reasons.  First, these products matter to people.  A program that allows people—and not just affluent people—to keep their crypto assets, while still earning a return is valuable to many Americans, as evidenced by the programs’ popularity in the United States to date.  The investor protection objective of today’s settlement will be poorly served if retail investors are ultimately shut out from participation in these products.  Second, our process speaks volumes about our integrity as a regulator.  Inviting people to come in and talk to us only to drag them through a difficult, lengthy, unproductive, and labyrinthine regulatory process casts the Commission in a bad light and thus makes us a less effective regulator.  Third, a company that tries to do the right thing should be met across the table by a regulator that tries to get to a sensible result in a reasonable timeframe.  For the sake of the American public, our own reputation, and the companies that heed our call to come in and talk to us, we need to do better than we have so far at accommodating innovation through thoughtful use of the exemptive authority Congress gave us.