Clarity Act Fails in Senate: What the SEC and CFTC Can Do Now

De Silva Law Offices, LLC

On September 15 the Senate declined to take up the Digital Asset Market Clarity Act. The motion to end debate failed 49 to 50, eleven votes short of the sixty it needed. The bill had passed the House more than a year earlier, and it would have been the first federal market-structure statute for crypto: most crypto trading would have moved out of the securities laws, the CFTC would have gained authority over spot markets in digital commodities, and the line between the two agencies would have been written into the statute rather than argued over in court.

Every Democrat voted no. So did four Republicans, after negotiations over the bill's ethics provisions and over bank objections to stablecoin rewards failed to close.[1] The Senate leaves in early October for the midterms. Senator Lummis said before the vote that failure would mean "it's over," and at least one research analyst now puts the next realistic window at 2030.[2]

The industry's answer, and the administration's, is that the agencies will do by rule what Congress would not do by statute. SEC Chairman Paul Atkins said on September 14 that "with or without that legislation, this Administration will deliver." CFTC Chairman Michael Selig said in August that if the bill stalled the CFTC "will utilize its existing authorities to begin establishing a regime for crypto asset markets."[3] Neither statement is wrong. There is, however, a good deal of daylight between what an agency says it will do and what its statute lets it do, and that gap is what a firm making decisions this fall needs to understand. This article goes through what each agency has actually proposed, where its authority stops, and how much of the result would survive a lawsuit or a change of administration. We have followed the bill since the House committees released the discussion draft last year; that analysis is here.

What the SEC has proposed

The SEC did not wait for the vote. On August 18 it proposed Regulation Crypto Assets, a set of offering rules for investment contracts that involve crypto assets.[4] There are two new exemptions from registration. The first is for startups and would let an issuer raise up to $5 million over four years on streamlined disclosure. The second is modeled on Regulation A and would allow up to $75 million in any twelve-month period, subject to financial statements and continuing reports. Disclosure under both is principles-based, and neither takes an issuer outside the antifraud provisions of the securities laws.[5]

The proposal, in outline:

The dollar limits are not the interesting part. The more important feature is the safe harbor, which tells a token when it stops being a security. Under the Howey test, a token sold to fund a project is treated as part of an investment contract because buyers are relying on the issuer's work to make it valuable. The proposed rule would let the issuer end that treatment by certifying that the work it promised is finished, or that it has permanently abandoned it. From that point the token could trade without being treated as part of the original investment contract.[6] That is as close as the SEC can get to the statutory taxonomy the Clarity Act would have supplied. The other significant piece is preemption. Offerings under the new exemptions, and secondary trading in the resulting tokens, would be exempt from state registration and qualification, which is further than Regulation D or Regulation Crowdfunding goes.[7] Comments are due October 20.[8]

Atkins has said two more proposals are coming under the agency's Project Crypto initiative, one modernizing the transfer-agent rules and one allowing investment advisers to self-custody crypto assets, with rules for tokenized securities expected to follow.[9] All of it sits on top of the interpretation the SEC issued on March 17 explaining how it will apply the Howey test to crypto assets.[10]

What the CFTC has said it will do

The CFTC has published less and promised more. Selig said in August that the agency's digital-asset rule proposals are drafted, that it intends to proceed with or without the Clarity Act, and that it wants them final before the end of the administration.[11] He has told staff to build a market-structure regime out of the authority the Commodity Exchange Act already gives the agency. As of this writing, that proposal has not been published.

What the CFTC has done under existing authority over the past four months is more concrete. On May 29 it issued a policy statement treating crypto perpetual contracts as futures, a question we urged the agency to resolve through formal rulemaking when it first asked for comment. In June it proposed its rule on prediction markets, and later that month it joined the SEC in a request for comment on the definition of a swap.[12] Each of those actions stakes out a position the agency would rather have had from Congress, and each is already being tested. CME Group's challenge to the perpetuals policy statement is pending in the District of Columbia, and the prediction-markets rule sits in the middle of the state litigation that has now reached the Supreme Court.[13]

Where the authority runs out

The CFTC's problem is the statute. The Commodity Exchange Act lets the agency police fraud and manipulation in spot commodity markets. It lets the agency regulate retail commodity transactions that involve leverage or margin. And it gives the agency complete authority over the entities it registers: designated contract markets, futures commission merchants and clearinghouses.[14] What the statute does not do is let the CFTC register or supervise a spot crypto exchange as such. That authority was the Clarity Act's central grant, and it went down with the bill.

The consequence is practical. Whatever the agency's staff has drafted will have to bring spot trading inside the perimeter the CFTC already controls: spot contracts listed on a DCM, handled by an FCM, and cleared through a DCO. We described how that structure works when the CFTC first opened the door to spot crypto trading on registered exchanges last year. A firm that stays outside the perimeter answers to the CFTC only for fraud and manipulation. Anyone expecting a federal license for a standalone crypto exchange will not get one from a rule.

The SEC has a different limit. It can exempt an offering from registration, and it can announce how it reads the law. It cannot decide that a category of assets is no longer a security. That question is governed by the Supreme Court's Howey test, and the test stays in place no matter what the SEC says about it.

That matters for the safe harbor. The safe harbor is the SEC's opinion about when an investment contract has ended. A judge hearing a private lawsuit, or a state attorney general bringing an enforcement action, applies Howey directly and can reach a different answer.

The preemption provisions are the weakest point of the proposal. They rest on the SEC's authority under Section 18 of the Securities Act to displace state registration rules, and the state regulators and attorneys general who fought the Clarity Act are the parties most likely to challenge that authority in court.[15]

The reading of the vote that has circulated most widely is that the SEC won, since the bill existed to move spot markets to the CFTC and that did not happen. That is right about the transfer and wrong about the result. Bitcoin and ether are already commodities. The SEC has no authority over spot trading in either, and what it gains in the bill's absence is the token-offering space and the tokenization of securities.[16] The derivatives markets stay where they were, and so does the registered perimeter through which the CFTC is now routing spot activity. The parties that lost on September 15 were the unregistered spot exchanges that wanted a federal license. The registered exchange that already has one came out ahead.

How durable any of it is

That leaves the question of how long any of this lasts.

The first answer is that a rule made by notice and comment can be unmade by notice and comment. Atkins said so himself in August: legislation "remains indispensable," in his words, to keep the agency's current work from being "unwound by a future rogue regulator."[17] The last administration reversed the SEC's approach to crypto in short order after taking office, and nothing in the current proposals would stop a future Commission from reversing them again.

The second is that the courts no longer defer. After Loper Bright, a judge reads the statute for herself, and the past year has shown what that means for the CFTC in particular.[18] The Ninth Circuit used the major-questions doctrine to reject the agency's reading of the word "swap" in the sports contract cases, and CME's suit over the perpetuals policy statement gives any incumbent, or any state, a template for challenging a rule the agency builds on its existing authority.[19] The more ambitious the market-structure proposal turns out to be, the more likely it is to meet those arguments.

The industry's real wager, as Barron's put it after the vote, is that two years of building under friendly rules will create facts on the ground that a later administration finds too costly to undo.[20] That is a fair reading of the politics. It is not legal durability, and it should not be mistaken for it.

What to do now

A firm planning a token offering should treat Regulation Crypto Assets as the operating framework for the next two years, and should comment on it before October 20. The final rule will be shaped by the comment file, and an issuer that waits for the final rule has given up its only chance to influence it.

CFTC registrants should expect the market-structure and custody proposals to run through DCMs and FCMs, and should plan any spot crypto business inside that perimeter rather than outside it.

Everyone should keep one thing in mind about the agencies' policy statements. They are the agencies' current positions, not settled law. That is what they have always been, and the courts have started to say so.

The Clarity Act would have put these rules in the United States Code. Without it they live in the Federal Register and the case reporters, where they are easier to write and, as the next few years may show, easier to take back.

De Silva Law Offices, LLC advises exchange applicants, introducing brokers, fund sponsors and market participants on CFTC and NFA registration, digital asset regulation, event contracts and prediction markets, and enforcement defense. Questions about this article or the firm's practice may be directed to info@desilvalawoffices.com.

De Silva Law Offices, LLC | 110 North Wacker Drive, Suite 2500, Chicago, IL 60606 | 312-500-8424 | desilvalawoffices.com

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