After much anticipation, the House passed House Financial Services Chairman Patrick McHenry (R-NC) and House Agriculture Chairman GT Thompson’s (R-PA) crypto regulatory legislation, the Financial Innovation and Technology for the 21st Century Act (FIT 21) (H.R. 4763). At a high level, the measure seeks to establish a clearer division of jurisdiction between the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) with regard to oversight of the digital assets ecosystem, establishing the first framework for regulating the digital asset markets. The floor vote marked the first true barometer for crypto support in the House; 71 Democrats voted for the measure, representing significant bipartisan support for a crypto regulatory framework. The better-than-expected vote is a legacy-making moment for Chairman McHenry, who is retiring at the end of the year. However, Senate consideration remains unlikely due to opposition from Senate Banking Chairman Sherrod Brown (D-OH), Sen. Elizabeth Warren (D-MA) and other senators focused on anti-money laundering (AML) provisions involving crypto.
FIT 21 Summary
While the relevant committees of jurisdiction overseeing digital assets are split, the House Financial Services and Agriculture committees have moved in lockstep. Digital asset market participants have long held that the unique characteristics of most digital assets make existing federal rules incompatible with how these tokens are distributed and traded, resulting in a great deal of regulatory uncertainty. The 200-page bill would address these concerns by establishing new criteria to help digital asset developers determine whether a given token or related activity is subject to oversight by the SEC or CFTC. Specifically, the bill would empower the CFTC to conduct oversight over digital assets as a commodity if the blockchain it runs on is decentralized. The CFTC’s authorities would be expanded to allow it to solely oversee cash or spot market digital commodity transactions. Regarding conflicts of interest, the measures prohibit a digital commodity exchange from trading for their own accounts, though the bill allows the CFTC to adopt rules to allow trading for certain purposes. The bill also prohibits CFTC-registered platforms from comingling their funds with customer funds, allowing the customer to waive this for certain specified reasons.
If enacted, the bill would curtail some of the SEC’s current oversight of the digital assets ecosystem, ending what many have described as its current approach of “regulation by enforcement.” Under the bill, the SEC would regulate digital assets as a security or restricted digital asset if the blockchain is functional but not decentralized. Currently, the SEC asserts that most digital tokens are securities under the Howey test and thus must be registered under the Securities Act of 1933. The now-infamous Howey test, named for the 70-year-old case SEC v. W. J. Howey Co., has been the SEC’s main source of regulatory authority. In that case, the U.S. Supreme Court held that an investment contract is a “security” if it involves “an investment of money in a common enterprise with profits to come solely from the efforts of others.”
In applying the Howey test, the SEC’s position has evolved over recent years to clarify that most tokens must be registered under the Securities Act or offered pursuant to a specific exemption. As a result, numerous companies went from offering unregistered tokens or Initial Coin Offerings (ICO) without proper AML and know-your-customer (KYC) protocols to ensuring all offerings fit within a registration exemption and meet other anti-fraud compliance requirements. FIT 21 attempts to upend the Howey test as it relates to crypto by introducing new designations for digital assets.
FIT 21 Vote
The House Financial Services Committee, with jurisdiction over securities regulation and the SEC, passed the bill out of the committee in July 2023, with all Republicans and six Democrats voting to advance the legislation. The House Agriculture Committee, with jurisdiction over the CFTC, also marked up the bill and passed the measure out of the committee with a unanimous voice vote in July 2023. Throughout the process, House Financial Services Committee Ranking Member Maxine Waters (D-CA) opposed the bill, along with the majority of committee Democrats. Ahead of the May 22 vote, SEC Chairman Gary Gensler released a statement about the bill, criticizing many aspects of it and characterizing it as a measure that would place “investors and capital markets at immeasurable risk.” This is contrasted with CFTC Chairman Rostin Behnam, who met with House Democrats on the morning of the FIT 21 vote, in an event organized by Rep. Wiley Nickel (D-NC), a crypto supporter.
The White House also softened its tone and created separation from Gensler in its Statement of Administration Policy regarding the bill. The White House stated that it opposed the bill, although it is “eager to work with Congress to ensure a comprehensive and balanced regulatory framework for digital assets.” The statement criticized the bill but did not state that President Biden would veto the legislation should it reach his desk. House Democratic leadership also stated that it would not whip against the bill, following the White House’s lead. Additionally, Rep. Waters (D-CA), House Agriculture Ranking Member David Scott (D-GA) and other senior Democrats urged the caucus to vote against the measure.
On May 22, the measure passed the House by a 279-136 vote, with support from nearly all Republicans and 71 Democrats. Ahead of the vote, it was expected that two dozen or more Democrats would support the bill, as the previous week’s vote on H.J.Res.109, which would nullify the Securities and Exchange Commission’s (SEC) Staff Accounting Bulletin No. 121 (SAB 121) was viewed as a proxy for FIT 21’s support. Instead, 71 Democrats, including former Speaker Nancy Pelosi (D-CA), Whip Katherine Clark (D-MA) and Caucus Chairman Pete Aguilar (D-CA) voted for the measure. Following the vote, Chairman McHenry said, “this is a huge victory. I never in a million years thought we’d get that kind of outcome.” The surprise vote represents emerging bipartisan momentum on crypto and opportunities for deal-making down the line.
Next Steps
As mentioned, the proposal faces resistance from the Senate, likely stalling the bill for the rest of the 118th Congress. Senate Banking Chairman Brown has not signaled support for any digital assets legislation. Additionally, Sen. Warren has expressed major opposition to digital asset regulatory reform measures, focusing on AML requirements. However, the November elections are likely to play a role in the future dynamics around crypto. It is also expected that Chairman McHenry will push for the inclusion of crypto legislation in any year-end-package. As discussed, there are many challenges in this Congress that make a bipartisan agreement on these issues an uphill battle.
The passage of FIT 21 also comes amid continued talks between House Financial Services Chairman McHenry and Ranking Member Waters on a stablecoin regulatory framework. Although reportedly far along in the process, long-running issues regarding the balance between the regulatory powers of the Federal Reserve and state regulators remain an issue. The duo failed to have the bill included in the Federal Aviation Administration (FAA) reauthorization bill in May, with Chairman McHenry and Leader Chuck Schumer (D-NY) engaging in talks about including the measure. Additionally, Sens. Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) introduced a bipartisan stablecoin bill (S. 4155) that would establish a stablecoin regulatory framework. House Financial Services Chairman Patrick McHenry (R-NC) previously said he is “grateful” for the Gillibrand-Lummis effort, calling them “allies in the cause of creating clarity.”
While FIT 21 is unlikely to advance in 2024, there is potential for a stablecoin measure to advance in the 118th Congress during the post-election lame duck time frame. This could manifest as part of a four-corners negotiation on a must-pass bill or a financial services package focused on stablecoin regulation, with the potential for additional financial services provisions.
The Brownstein financial services practice group will continue to monitor this effort and other digital assets proposals as they develop.
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