On October 12, 2017, the Securities and Exchange Commission’s (SEC) Dodd-Frank Investor Advisory Committee met to hear remarks from commissioners, review public statements, and engage in a discussion regarding blockchain technology among other matters.
As reported by ETHNews the committee seeks to identify the implications that blockchain-based technologies hold for securities markets. A slideshow presentation by Nancy Liao, Associate Research Scholar at Yale Law School, outlined the various components of blockchain technology, describing distributed systems, proof-of-work verification, hash functions, consensus, and cryptographic protocols. Jeff Bandman, principal of Bandman Advisors, also gave his testimony to the committee. This encompassed regulation, potential for real-time data gathering, enabling consumers to control their own data, and obstacles that stand before regulators. Bandman has clout, having served as the Former FinTech advisor at the US Commodity Futures Trading Commission (CFTC) and Director and Architect of LabCFTC.
Bandman's tone was one of deference to both the role of regulators and the promise of a new technology. He said:
"My perspective on blockchain and FinTech is shaped by my own experience as a regulator and supervisor of critical market infrastructure. At the CFTC I was responsible for running the division that supervises many of the world’s largest clearinghouses. At the time we formed the CFTC staff working group to monitor developments in blockchain, DLT and bitcoin, it was already being suggested that these new technologies could revolutionize clearing and settlement. The excitement of these opportunities was balanced by my awareness of the importance of the regulator’s mission – customer protection, market integrity, financial stability. These novel technologies should not be deployed into production on critical market infrastructure until we can be confident it will not jeopardize those core mission objectives, will not put investors at risk."
Bandman emphasized that regulators don’t need to pick losers and winners, but rather allow the marketplace to do so. He also said, "Regulators do not regulate 'technology' itself. They regulate the application of technology." He elaborated, "By this I mean applied technology in activities and entities and markets in the space it regulates." Bandman also stated that regulatory officials must look at both risks and opportunities. "The mission of the regulator remains constant – market integrity, customer protection, access to markets, safeguard confidential information, capital formation, financial stability, systemic risk." Bandman went on to place cybersecurity at the forefront of regulatory concerns and pointed toward an advanced cryptographic architecture, such as in distributed ledger or blockchain systems, as a means of delivering a safer data storage.
Bandman said blockchain technology has the potential to give investors control of their own data. He described traditional models by which investor data is managed through a central authority, governed by a series of requirements. He said, “Blockchain offers revolutionary potential for decentralized, distributed systems where users can own and control their own data. They can determine themselves who is or is not trusted. They can determine who has access to their data, their behavioral history and other information. This is being explored not just in financial services, but with health records and with digital rights to intellectual property."
Another merit Bandman spoke of, real-time regulation, comes to light based on blockchain technology's capability to instantly deliver information to every network participant. "This is a transformational shift from the way regulators receive data and see markets today. It may offer a completely new paradigm of the reporting regulators rely on. It presents an exciting opportunity." Such a shift in paradigms would transition regulators from "seeing events in the rear-view mirror, well after they have already occurred" toward a position from which more investor protections could be offered due to a swifter response. "When you see dangerous or suspicious activity through the windshield," Bandman said, going back to his driving analogy, "it puts you in a position to apply the brakes or turn the wheel to take action earlier, possibly to avert danger, and before further damage occurs. Thus regulators could be in a position to detect fraud or market manipulation earlier perhaps detecting and halting schemes before they have unleashed the full degree of harm that might otherwise occur."
Bandman did not mince words when it came to naming innovation’s obstacles.
“Well-intentioned rules to deter corruption and promote transparency in government are standing in the way of progress – these are rules that govern procedures for procurement, ethics rules and so on. I learned about these obstacles first-hand earlier this year during my work to design and launch LabCFTC. It was Chairman Giancarlo’s vision and our ambition to roll up our sleeves and dig deeper into these technologies ourselves. These new technologies have the potential to make regulators more effective and efficient in carrying out their jobs. Regulators need to use the technologies themselves to keep up with digital markets, to avoid being left behind in an analog world."
Bandman wanted to be crystal clear that he does not advocate removing the protections mentioned above, because they are needed "to prevent corruption and protect the taxpayer." Still, he also holds that a "greater flexibility and an approach based on proportionality is needed to embrace the potential of this transformational technology." He said that "well-intentioned" obstacles like Ethics and Procurement rules inadvertently stifle innovation and might be improved.
In conclusion, Bandman lauded the SEC's guidelines on token offerings (or initial coin offerings) that it delivered in July 2017, which he referred to as a "Digital Marbury versus Madison." He elaborated:
"By that I mean it is a true landmark in its sphere, in clarifying the SEC’s jurisdiction in this space, just as that early U.S. Supreme Court case was a landmark in establishing the principle of judicial review. And like Marbury versus Madison, it neatly established the principle without the cloudiness of further litigation or enforcement action in the particular case. It put the market on notice that these tokens can be securities, but did so without a blanket or extreme approach that some jurisdictions have applied in banning all ICOs. The SEC took a balanced approach, recognizing that one size does not fit all. A one size fits all approach would stifle innovation, and fail to distinguish the variety of facts and circumstances of a token offering or ICO – which must be reviewed under the longstanding Howey test. Where tokens are securities, if offered to U.S. persons or with a U.S. nexus they fall under the SEC’s jurisdiction. And the SEC has already started to act, with the creation of a cyber task force and the announcement at the end of last month of its first enforcement actions against ICO fraudsters."
As Bandman puts it, the marketplace has had a positive reaction to the guidelines. "I believe the markets are welcoming and adapting to greater legal certainty accompanied by robust enforcement."