On June 7, 2022, US Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced S. 4356 - the Responsible Financial Innovation Act (RFIA), which aims to establish a US regulatory regime for digital assets. The much-anticipated bill seeks to resolve the long-standing uncertainty about the jurisdiction of financial regulators over digital assets, clarify the taxation of digital assets and decentralized autonomous organizations (DAOs), and establish disclosures and consumer protection obligations on issuers and service providers of digital assets.
Why the RFIA Matters
The RFIA has garnered significant attention because it is the first major bipartisan legislation that, if signed into law, would govern the regulation of digital assets. Under the RFIA, "digital assets" are defined as natively electronic assets that confer economic, proprietary, or access rights or powers and are recorded using cryptographically secured distributed ledger technology or similar means. Notably, the RFIA's sponsors are members of the relevant congressional committees—the Senate Committee on Agriculture, Nutrition, & Forestry (of which Senator Gillibrand is a member), which oversees the Commodity Futures Trading Commission (CFTC), and the Senate Committee on Banking, Housing, and Urban Affairs (of which Senator Lummis is a member), which oversees the Securities and Exchange Commission (SEC). Although referred to the Senate Committee on Finance due to its tax provisions, the bill addresses the regulation of digital assets by the SEC, the CFTC, and federal banking agencies and, therefore, will help frame the Agriculture and Banking Committees' consideration of digital asset legislation going forward.
While the RFIA is not on course to be enacted into law this year, its introduction demonstrates the movement in Congress to modernize federal law to account for the advent and growth of digital assets. Given the Biden administration's recent report on stablecoins and support for enacting regulatory requirements for stablecoin issuers, an opportunity may exist for a bill focused on stablecoins to be enacted into law this year—though with less than six months before the end of the 117th Congress, the legislative clock will be a significant obstacle. Regardless of what happens this year with stablecoins, the RFIA's comprehensive approach will likely extend its influence into the 118th Congress when Representative Patrick McHenry (R-NC), who is in line to chair the House Financial Services Committee if Republicans take control of the House of Representatives in the mid-term elections, is expected to advance legislation on the federal regulation of digital assets generally. Accordingly, the RFIA should be carefully examined by any participants in the digital asset markets to understand how the regulation of digital assets could evolve in the near future.
In this Legal Update, we highlight six key aspects of the RFIA.
1. The CFTC would be the primary regulator of most digital assets.
- The RFIA grants exclusive jurisdiction to the CFTC over digital assets, subject to several exclusions. In particular, the CFTC would not have jurisdiction over digital assets that provide the holder with any of the following rights with respect to a business entity: (i) a debt or equity interest, (ii) liquidation rights, (iii) an entitlement to an interest or dividend payment, (iv) a profit or revenue share derived solely from the entrepreneurial or managerial efforts of others, or (v) any other financial interest. In addition, the CFTC would not have jurisdiction over digital collectibles and other unique (i.e., non-fungible) digital assets, including NFTs.
- To the extent that the CFTC has jurisdiction with respect to a particular digital asset, that digital asset is included within the definition of "commodity," which clarifies the regulatory status of the digital asset (i.e., that it is not a "security").
- The RFIA introduces an important term to digital asset regulation—"ancillary asset"—as part of its effort to settle the current ambiguous and overlapping jurisdiction of the CFTC and SEC in respect of many digital assets.
- An ancillary asset includes any "intangible, fungible asset that is offered, sold, or otherwise provided to a person in connection with the purchase and sale of a security through an arrangement or scheme that constitutes an investment contract" but, importantly, does not include assets that have debt or equity-like characteristics (more on that below).
- The CFTC has jurisdiction over ancillary assets that fall within the definition of "digital asset," but the disclosure requirements that the RFIA imposes on issuers of ancillary assets would be subject to the SEC's jurisdiction.
- Exchanges or facilities trading digital assets could register with the CFTC to become a registered digital asset exchange, but registration as a digital asset exchange would be voluntary. Any registered digital asset exchange would be subject to requirements on trading, treatment of customer assets, permitted investments, reporting and recordkeeping, conflicts of interest, financial condition, and governance.
- Any registered digital asset exchange also would be required to be registered with the Treasury Department as a money service business.
2. Issuers of digital assets would be subject to SEC periodic disclosures.
- An issuer of a security that provides holders of the security with an ancillary asset would be required to provided initial and ongoing periodic disclosures related to the ancillary asset if (1) the average aggregate value of all ancillary assets provided by the issuer is greater than $5 million, and (2) the issuer or any person owning not less than 10 percent of any class of equity securities of the issuer engaged in entrepreneurial or managerial efforts that primarily determine the value of the ancillary asset.
- On a semi-annual basis, the issuer would be required to
- Basic corporate information on the issuer related to the
ancillary asset (including risk factors and statements about the
issuer's financial resources to continue business as a going
concern) and information on the ancillary asset, including:
- A description of the uses, market for, and supply of the ancillary asset;
- The identity of recipients of more than 5 percent of the total amount of ancillary assets in any distribution;
- The risk factors that may limit demand for the ancillary asset;
- A description of the technology underlying the ancillary asset; and
- Any other material information that may impact the value of the ancillary asset.
- Basic corporate information on the issuer related to the ancillary asset (including risk factors and statements about the issuer's financial resources to continue business as a going concern) and information on the ancillary asset, including:
3. Digital asset service providers also would be required to provide disclosures.
- A provider of a digital asset service, which is defined very broadly to include any intermediary, would be required to provide notice to and obtain acknowledgment from customers regarding material source code changes, whether digital assets are segregated or pooled, what happens in bankruptcy, the procedure for returning digital assets upon customer request, any applicable fees, and the dispute resolution process. This will, in many cases, take the form of a "terms of service."
- The customer agreements would also address how the digital asset service provider intends to address forks, airdrops, and other rewards; any lending arrangements the provider may enter into relating to the digital assets; and any rehypothecation of the digital assets. While many centralized providers already provide these types of disclosures and the information regarding these types of activities are available in public-facing smart contracts for decentralized providers, these requirements are intended to make digital asset services more legible and transparent for everyday consumers.
- Digital asset service providers would be required to agree on terms of settlement finality for all transactions, including the conditions under which a digital asset may be deemed fully transferred. This is intended to help clarify when risk of loss transfers.
4. Issuers of payment stablecoins would be subject to new prudential regulations.
- Issuers of payment stablecoins would be required to:
- Maintain reserves of high-quality liquid assets valued at 100 percent of the face value of all outstanding payment stablecoins;
- Publicly disclose the assets backing the stablecoin and their respective values; and
- Have the ability to redeem all outstanding payment stablecoins at par in legal tender.
- Payment stablecoins issued by a depository institution (such as a bank or credit union) would not be considered either a commodity or a security.
- The Office of the Comptroller of the Currency would be
expressly authorized to issue limited-purpose bank charters to
issuers of payment stablecoins.
- Holding companies of such banks and similar state-chartered institutions would be subject to highly tailored (limited) supervision under the Bank Holding Company Act;
- Such banks and similar state-chartered institutions would be able to apply to become members of the Federal Reserve System and have capital requirements that are not constrained by the Collins Amendment; and
- Such banks and similar state-chartered institutions could be subject to insolvency proceedings under the Federal Deposit Insurance Act even if they are not insured by the Federal Deposit Insurance Corporation.
- The Federal Reserve would be required to provide payment, clearing, and settlement services and, upon request, a segregated balance account to any depository institution, including a federally or state-chartered issuer of payment stablecoins. The RFIA does not mention this explicitly, but this provision is likely targeted at the Wyoming special purpose depository institutions (SPDIs) that have applied for—but not yet received—Federal Reserve master accounts. 1
5. DAOs would be classified by default as "business entities."
- To date, many DAOs have chosen to operate without adopting a formal legal entity or organization, such as a LLC. As a result, a number of legal issues surrounding DAOs—including the potential responsibility of DAO members for actions and liabilities of the DAO—have remained unclear.
- The bill creates a default tax classification for a DAO as a "business entity" that is not a disregarded entity for US federal tax purposes.
6. The taxation of digital assets would be adjusted to facilitate the use of cryptocurrencies.
- Digital assets lending agreements would generally not be taxable events, similar to securities lending transactions.
- Digital assets obtained from staking or mining activities would not form part of a taxpayer's gross income until the disposition of those assets.
- A de minimis amount of up to $200 per transaction would be exempt from a taxpayer's gross income for use of virtual currency for payment for goods and services.
- The IRS would be required to adopt guidance on several long-standing tax issues related to digital assets, including for example, disposition of forks and airdrops, merchant acceptance of digital assets, digital asset mining and staking, and charitable contributions of digital assets.
- Like most tax rules, these proposals are nuanced and subject to certain conditions, but, conceptually, these provisions seek to encourage greater use of cryptocurrency as a form of payment and medium of value transfer.
What Do the Regulators Think?
Following the introduction of the RFIA, the chairs of the two agencies that would be most impacted by the legislation expressed divergent views on its merits, signaling that the legislation will still be the subject of debate going forward. CFTC Chair Rostin Behnam has indicated that he believes that the legislation represents the appropriate balance of regulatory responsibilities between the CFTC and the SEC and that the CFTC stands ready to accept the responsibilities afforded to it under the legislation. In contrast, SEC Chair Gary Gensler has expressed concern that the bill could undermine investor protections. This lack of agreement on the RFIA by these key financial regulators suggests that the debate over how Congress should regulate digital assets is far from over.
The authors would like to thank Dominique A. Nikolaidis for her help writing this Legal Update.
1 See our Legal Update on proposed guidelines for access to master accounts: https://www.mayerbrown.com/en/perspectives-events/publications/2022/03/us-federal-reserve-re-proposes-guidelines-for-evaluating-access-requests-for-federal-reserve-bank-services.
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