Jonathan Cartu Announces: House Financial Services Committee Considers Implications…


Withholding Service Contracts Not Unlawful

On July 17, 2019, members of the U.S. House Committee on Financial Services considered testimony on the potential impact of Facebook’s proposed Libra cryptocurrency on consumers, investors and the global financial system. The Committee also heard testimony on a draft bill, the “Keep Big Tech Out of Finance Act,” that would (i) block large platform utilities (defined generally as online marketplaces with over $25 billion in annual revenue) from being affiliated with a financial institution (including money service businesses), and (ii) prohibit large platform utilities from offering digital assets that are designed to serve a function similar to that of money.

The witnesses and the substance of their testimonies included the following:

Chris Brummer, Agnes N. Williams Research Professor Director at the Institute of International Economic Law, Georgetown University Law Center

Mr. Brummer criticized the ambiguity of a Libra white paper and the argument that the Libra coin is not a security and, therefore, not subject to securities rules and regulations. Mr. Brummer stated that the white paper failed to:

  • clearly state that potential users could lose money and that “runs on the coin are possible”;

  • confirm that users will be exposed to counterparty risk due to the potential mismanagement of reserve investments;

  • disclose governance risks, such as how Libra coins may be negatively affected by the Libra Association’s decision-making and conflicts of interest;

  • explain how the decentralized application interface may affect the proposed “secure, scalable, and reliable blockchain”; and

  • address the potential systemic risk of Libra.

Additionally, Mr. Brummer argued, even if Libra coins are not securities, they do have “securities-like” characteristics that would require them to comply with securities rules and regulations. Such characteristics include:

  • consumers risking capital in a common enterprise;

  • significant information asymmetries between Libra and Facebook;

  • operational and value-preservation control of the Libra Association;

  • users seeking profit from coin holder participation; and

  • similarities to pooled funds, which are subject to securities rules and regulations.

Katharina Pistor, Edwin B. Parker Professor of Comparative Law at Columbia Law School

Ms. Pistor stated that the Libra white paper brought to the forefront an ongoing debate about the benefits and challenges of “fast-moving innovations in technology.” Ms. Pistor highlighted several key takeaways, such as that:

  • Libra is designed to be a “new global currency” and a “for-profit “currency of currencies””;

  • Libra’s reserve of “safe” assets rely on public backstopping mechanisms for which Libra sponsors are not paying;

  • all interests and dividends will be delivered to Libra Association and/or Libra Token investors – not holders of Libra coins;

  • it is not clear how or when the Libra Association will move away from its current “club-like or permissioned system to a permission-less system”;

  • the Libra Association is accountable only to itself; and

  • current legal and regulatory frameworks are incomplete both domestically and internationally and allow both legal and digital arbitrage that will be exacerbated by Libra’s introduction.

The Honorable Gary Gensler, Professor of the Practice of Global Economics and Management, MIT Sloan School of Management, Senior Advisor to the Director, MIT Media Lab, and CoDirector of MIT’s Fintech @ CSAIL

Mr. Gensler warned that Libra introduces serious public policy considerations. According to Mr. Gensler, Libra Reserve is a pooled investment vehicle, which means that it should be regulated by the SEC, and the Libra Association should be registered as an investment advisor. Mr. Gensler acknowledged other arguments that Libra Reserve could be regulated as a bank, but emphasized that it should not be allowed to make loans. Additionally, Mr. Gensler highlighted the privacy and consumer protection considerations raised by Facebook’s new subsidiary Calibra, which is a digital wallet. Given Facebook’s recent issues with the misuse of consumer data, Mr. Gensler warned, further regulation is needed based on the “potential to commercialize private consumer financial transaction data” in addition to data on Facebook’s vast social media and information network.

Based on these concerns, Mr. Gensler stated, he approved of the draft bill as one alternative way to both promote competition and lower potential risks posed by big tech affiliations.

Robert Weisman, President of Public Citizen

Mr. Weisman asserted that Facebook cannot be allowed to create a private global currency, and warned policymakers not to rely on Facebook’s representations of how Libra and Calibra will operate. Mr. Weisman warned that:

  • Libra will both deepen Facebook’s social media dominance and extend that dominance into global payment markets;

  • Libra will be systemically important but will operate without the required controls to protect against systemic risk;

  • it will be difficult to ensure customer protections are met, since Libra is a private and borderless currency;

  • there is no historical precedent for this type of corporate surveillance;

  • it may pose a “fundamental threat” to sovereign nations’ ability to maintain distinct monetary policies and responses to currency crises; and

  • fraudsters will “rush to take advantage of Libra.”

Mr. Weisman “strongly endorse[d]” the draft bill, expressing support for either a “legislated prohibition or . . . a lengthy moratorium on privatized, global currencies.”

Meltem Demirors, CEO of CoinShares

Ms. Demirors asked policymakers and regulators to treat Bitcoin and other cryptocurrencies, such as Libra, as “open, permission-less technologies that will support American growth.” Ms. Demirors stated that:

  • bitcoin and “decentralized, open, permission-less cryptocurrency networks” are beneficial and “foster innovation, economic growth and the development of new industries”;

  • bitcoin and Libra are fundamentally different; and

  • regulators should continue to “allow and encourage Bitcoin and the innovation happening here in America . . . to flourish” and to distinguish between “fact and marketing fiction.”

Commentary

The reaction to Facebook’s announcement of Libra was, to put it mildly, negative from all hands. The story, published last July is illustrative of:

The announcement of Libra and the ruckus that followed also illustrated the technology company’s lack of sophistication as to the details of financial regulation. Had Facebook chosen to market a “stablecoin” backed by U.S. dollars held at a U.S. bank, Facebook could have created a legally straightforward and feasible blockchain product. In other words, Facebook could have designed a technology product with the same bang per currency unit (and then it could have created a similar Euro and Yen blockchain product for sale in other jurisdictions). 

Instead, it tried to create a novel product that not only created a political firestorm, but violated pretty much every U.S. financial statute: the Investment Company Act, the Advisers Act, the Securities Act, the Exchange Act, possibly the Commodity Exchange Act, and certainly the tax laws. In short, Libra was a legal nonstarter. Technology firms that seek to provide financial services must become as sophisticated with financial regulation as they are with rules governing intellectual property.  

Vivion TLG

Leave a Reply