Protecting Investors and Savers: Understanding Scams and Risks in Crypto and Securities Markets (U.S. Senate Committee on Banking, Housing, and Urban Affairs)

Hearing	Protecting Investors and Savers: Understanding Scams and Risks in Crypto and Securities Markets
Committee	U.S. Senate Committee on Banking, Housing, and Urban Affairs
Date	July 28, 2022

 

Hearing Takeaways:

• Scams and Frauds within the Cryptocurrency Market: The hearing focused on how an increasing number of financial scams and frauds were being applied to the cryptocurrency space. Committee Members and the hearing’s witnesses suggested that cryptocurrency-related scams and frauds might be more enticing to potential victims because they leveraged new technology to promise quick and outsized returns. They also noted how digital assets often lacked proper disclosures, which made it easier for bad actors to perpetrate scams and frauds within this space.
  • Underreporting of Cryptocurrency-Related Scams and Frauds: Committee Members and the hearing’s witnesses raised concerns over how cryptocurrency-related scams and frauds often went unreported, which made it easier for bad actors to pray upon new victims. They noted how these scams and frauds could go unreported because victims often blamed themselves for the scams and frauds, victims were often embarrassed about being involved in scams and frauds, and/or victims held out hope that their promised returns would materialize.
  • Scams and Frauds Aimed at Affinity Groups: Full Committee Chairman Sherrod Brown (D-OH), Ms. Lubin, and Ms. Walsh noted how bad actors often engaged in affinity frauds, which involved the exploitation of trusted relationships and community ties. Ms. Lubin noted how digital assets companies often emphasized financial inclusion concerns to communities of color and commented that this pitch tended to resonate with these communities. She stated however that digital assets have failed to democratize investing thus far and asserted that the promise of financial inclusion from digital assets was therefore making communities of color more susceptible to fraud.
  • Scams and Frauds Aimed at the Elderly: Sen. Chris Van Hollen (D-MD) and Ms. Lubin expressed concerns over scams and frauds being targeted at older Americans. They expressed support for the Empowering States to Protect Seniors from Bad Actors Act, which would establish a grant program at the U.S. Securities and Exchange Commission (SEC) to support state securities and insurance regulators in combatting scams aimed at seniors.
  • Scams and Frauds Employing Social Media Platforms: Sen. Robert Menendez (D-NJ) and Ms. Walsh expressed concerns over how bad actors were employing social media to perpetrate scams and frauds. Sen. Menendez criticized large social media platforms (including Facebook, Instagram, and WhatsApp) for failing to curb the spread of misinformation.
  • Importance of Financial Education: Ms. Walsh remarked that increasing investor knowledge would help to prevent harm and mentioned how the Financial Industry Regulatory Authority (FINRA) provided free and unbiased resources covering numerous topics, including investment basics, complex products and strategies, and scams and financial pitfalls. She testified that FINRA worked with the SEC, state regulators, and national non-profit organizations to disseminate these resources widely.
  • Proposal to Support the Establishment of Investor Advocacy Clinics: Sen. Catherine Cortez Masto (D-NV) and Ms. Walsh discussed the important role that investor advocacy clinics could play in working to help the victims of low-dollar scams and frauds. They noted how bad actors often sought out these victims because they were less able to defend themselves. Sen. Cortez Masto mentioned how she was introducing the Investor Justice Act of 2022, which would have the SEC establish a grant program to support law schools in operating investor advocacy clinics.
  • Involvement of Institutional Investors within the Digital Assets Space: Sen. Elizabeth Warren (D-MA) and Sen. Jack Reed (D-RI) expressed concerns over how large institutional investors were becoming heavily involved within the digital assets space. Sen. Warren asserted that large institutional investors were supporting and profiting from cryptocurrency companies that perpetrated scams on retail investors. Sen. Reed expressed concerns that private equity firms were targeting less sophisticated investors to fund their cryptocurrency investments.  
• U.S. Regulation and Oversight of the Digital Assets Market: The hearing also addressed the U.S.’s current regulation and oversight of digital assets. Committee Members and the hearing’s witnesses made several proposals to reform this system for regulation and oversight.
  • Current Regulation of Cryptocurrency Platforms: Sen. Jack Reed (D-RI) discussed how cryptocurrency trading platforms operated using state money-transmitter licenses. He indicated that these platforms were not registered with the SEC or with states as either broker-dealers or securities exchanges. He remarked that this regulatory approach was “untenable” given how these platforms most likely had securities listed on them. Ms. Walsh asserted that bringing cryptocurrencies and digital assets into the regulatory regimes for securities could benefit consumers and the markets themselves.
  • Role of State Securities and Insurance Regulators: Ms. Lubin called it important for state securities and insurance regulators to have the authority to pursue bad actors that perpetrated scams and frauds. She noted that these regulators possessed anti-fraud authority that applied to any person in connection with the offer and sale of securities, that commits a fraudulent act, or that makes material misrepresentations. She expressed opposition to federal policies that would preempt the ability of state regulators to investigate and pursue financial schemes.
  • Role of Self-Regulatory Organizations (SROs): Ms. Walsh noted how FINRA served as an SRO for the broker-dealer industry and testified that FINRA was currently monitoring the “limited” broker-dealer activity within the digital assets space. She testified that this oversight involved the monitoring of deceptive advertising materials from broker-dealers. She stated that while FINRA had not taken a public position as to whether there should exist an SRO for overseeing digital assets, she expressed FINRA’s willingness to advise Congress on features of self-regulatory models as they contemplated new laws and policies. 
  • Criticism over the Lack of Regulatory Clarity for the Digital Assets Market: Full Committee Ranking Member Patrick Toomey (R-PA) and Sen. Cynthia Lummis (R-WY) criticized the U.S.’s current lack of regulatory clarity for digital assets. Ranking Member Toomey characterized the SEC’s approach to digital assets as “regulation by enforcement” and criticized the SEC for failing to publish guidance as to when digital assets or services constituted securities. He contended that the tests for determining if assets were securities under SEC v. W.J. Howey Co. and Reves v. Ernst & Young (known as the Howey and Reves tests) were not straightforward. He stated that the SEC’s approach created compliance challenges, hampered innovation, promoted risky behaviors among digital asset companies, and was ineffective.
  • Recent Bankruptcies of Cryptocurrency Lending Platforms: Committee Members and Ms. Lubin highlighted recent high-profile bankruptcies of cryptocurrency lending platforms, including the Celsius and Voyager platforms. They suggested that these platforms may have fraudulently enticed customers through false claims that the funds on the platforms were fully insured by the U.S. Federal Deposit Insurance Corporation (FDIC). They noted that the retail investors that lent their cryptocurrencies on the platforms had their holdings frozen and were unlikely to fully recover their assets through the bankruptcy process. Full Committee Ranking Member Toomey contended that the SEC should have provided clarity as to whether these cryptocurrency products and services constituted securities. He commented that such clarity might have dissuaded people from becoming involved with cryptocurrency lending products in the first place.
  • U.S. Regulation Oversight of Stablecoins: Sen. Mark Warner (D-VA) and Full Committee Ranking Member Toomey expressed concerns over the U.S.’s regulation and oversight of stablecoins, which are cryptocurrencies that have their values pegged to reference assets (such as the U.S. dollar). They specifically expressed concerns that stablecoin issuers did not provide enough disclosure and transparency regarding the reference assets backing the stablecoins. They stated that this made it difficult for consumers to evaluate the claims made by the issuers. Full Committee Ranking Member Toomey mentioned how he was developing a legislative proposal to address stablecoins and expressed his desire to make the proposal bipartisan. He indicated that his proposal would require stablecoin issuers to fully disclose the assets being used to back their stablecoins. He also noted that this legislation would require the U.S. Office of the Comptroller of the Currency (OCC) to regulate stablecoin issuers.
  • Proposal to Clarify the Definition of Insider Trading: Sen. Reed also mentioned how he had introduced the Insider Trading Prohibition Act, which would define the practice of insider trading. Ms. Lubin expressed NASSA’s support for the Insider Trading Prohibition Act and remarked that it was important for there to exist a clear definition of insider trading. She stated that this legislation would provide clarity to regulators, prosecutors, and the industry about what types of trading activities would be permitted.
  • Proposal to Increase the Penalties for Fraud and Scams: Sen. Reed further mentioned how he had introduced the Stronger Enforcement of Civil Penalties Act of 2021, which would increase the size of the penalties that the SEC may impose. He also noted that the legislation would authorize the SEC to triple the penalty cap for repeat offenders. Ms. Lubin stated that enhanced penalties and greater fines for recidivists would provide regulators with an additional tool for discouraging bad behavior. She contended that higher penalties could serve as an effective deterrent against bad behavior.

Hearing Witnesses:

1. Ms. Melanie Senter Lubin, President, North American Securities Administrators Association
2. Ms. Gerri Walsh, Senior Vice President of Investor Education, Financial Industry Regulatory Authority

Member Opening Statements:

Full Committee Chairman Sherrod Brown (D-OH):

• He discussed how financial frauds and schemes were now being applied to the cryptocurrency space.
  • He commented that cryptocurrency-related frauds and schemes might be more enticing to potential victims because they leveraged new technology to promise quick and outsized returns.
• He remarked that there had occurred “spectacular blow ups” in the cryptocurrency markets within the previous two months and stated that these issues had exposed the “alarming” interconnectedness and “enormous” risks among cryptocurrency firms.
  • He suggested that recent marketing campaigns from cryptocurrency firms could have made consumers more willing to purchase cryptocurrencies, which in turn could have made consumers more susceptible to cryptocurrency-related frauds and schemes.
• He stated that these issues within the cryptocurrency space had undermined the perception that these investments were stable.
• He discussed how state securities regulators and SROs were already working to combat fraud and risks within the cryptocurrency markets.
  • He asserted that this work was especially critical during periods of market volatility and economic uncertainty because consumers were more tempted to pursue new investments when their investment portfolios were performing poorly.
• He noted how cryptocurrency-related frauds and schemes often involved promises of double-digit investment returns and false claims about FDIC coverage and Securities Investor Protection Corporation (SIPC) protection.
• He also mentioned how the hearing would examine schemes and frauds that target vulnerable groups and/or close-knit communities.
  • He highlighted how bad actors often targeted senior citizens, military service members, and military families in their frauds and schemes.
• He noted how schemes and frauds often went unreported because victims often blamed themselves for the schemes and frauds or did not want to admit that they were victims of schemes and frauds.
• He then mentioned how the U.S. Federal Bureau of Investigation (FBI) had recently issued a warning for financial institutions about cybercriminals creating fraudulent cryptocurrency investment applications.
  • He indicated that the FBI had found hundreds of victims that had collectively lost tens of millions of dollars.
• He remarked that U.S. financial markets were the envy of the world because of their investor and consumer protections.
• He stated that the Committee must work to ensure that U.S. financial and banking regulators were enforcing these protections, especially considering the growing activity within the cryptocurrency space.

Full Committee Ranking Member Patrick Toomey (R-PA):

• He criticized SEC leadership for its failure to appear at the hearing and stated that the SEC needed to explain its response to the recent collapses of several cryptocurrency lending platforms (including Celsius and Voyager).
  • He also expressed interest in how the SEC was currently working to provide the cryptocurrency industry with regulatory clarity.
• He suggested that the SEC could have helped to prevent the recent cryptocurrency lending platform issues had it provided clarity regarding its application of securities laws to novel digital assets and services.
• He specifically stated that the SEC could have provided clarity as to how it would apply the tests under SEC v. W.J. Howey Co. and Reves v. Ernst & Young (known respectively as the Howey and Reves tests).
  • He explained that the SEC used these tests as a primary mechanism for determining whether an asset constitutes a security (and therefore falls under the SEC’s jurisdiction).
• He noted how the Howey test contains four basic prongs for determining whether an asset constitutes a security.
  • He indicated that the first prong of the Howey test was that there must be an investment of money.
  • He indicated that the second prong of the Howey test was that this investment be in a common enterprise.
  • He indicated that the third prong of the Howey test was that this investment has a reasonable expectation of profits.
  • He indicated that the fourth prong of the Howey test was that these investment profits would be derived from the efforts of others.
• He asserted that the aforementioned cryptocurrency lending products fulfilled all four of the prongs of the Howey test.
  • He commented that the SEC likely shared this view given how the SEC had investigated BlockFi in February 2022 for offering a similar lending product.
• He stated that the SEC’s refusal to publish guidance as to when digital assets or services constitute securities was resulting in an ad hoc approach to consumer protection.
  • He referred to this approach as “regulation by enforcement.”
• He remarked that there were four main problems with the SEC’s “regulation by enforcement” approach.
  • He stated that the first problem with this approach was that it created challenges for well-meaning innovators seeking to comply with existing laws and regulations.
  • He stated that the second problem with this approach was that it stifled innovation as it could make innovators reluctant to develop novel products.
  • He stated that the third problem with this approach was that it created legal uncertainty that allowed for companies with higher legal risk tolerances to offer products that might harm consumers.
  • He stated that the fourth problem with this approach was that it was ineffective.
• He called for the adoption of a more thoughtful approach to regulating digital assets and expressed optimism that the Committee could work in a bipartisan fashion to develop a regulatory framework for stablecoins.
  • He commented that there was bipartisan agreement that stablecoins should have consumer protections and mentioned how he had proposed a regulatory framework for these assets.
  • He added that he was currently engaged in discussions with several Committee Members to make his proposal bipartisan.

Witness Opening Statements:

Ms. Melanie Senter Lubin (North American Securities Administrators Association):

• She remarked that the top threats to retail investors were currently fraudulent investments tied to digital assets, fraudulent offerings related to promissory notes, scams offered through social media, scams otherwise offered online, and financial schemes connected to self-directed individual retirement accounts (SIDRAs).
  • She expressed concerns over the recent bankruptcies and collapses of several digital asset businesses.
• She stated that there existed a “concerning” amount of distrust in the U.S.’s regulated capital markets.
  • She mentioned how a recent survey had found that trust in Wall Street amongst Generation Z, Millennial, Generation X, and Baby Boomer respondents ranged between 32 percent and 36 percent.
  • She also mentioned how a March 2021 survey had found that 56 percent of stock market investors believed that the markets were rigged against individual investors.
• She further noted how distrust in the U.S.’s regulated capital markets was even higher within communities of color.
• She warned that the U.S. might be at a “tipping point” regarding its capital markets and asserted that decisions made within the next few years will impact the long-term sustainability of these markets.
  • She commented that the U.S. must promote lasting trust in and informed use of the regulated capital markets.
• She expressed support for the Empowering States to Protect Seniors from Bad Actors Act and noted how this bill would establish a grant program at the SEC for state securities and insurance regulators.
• She also remarked that the U.S. must ensure that regulators had the necessary tools and resources to provide investor protections.
  • She commented that legislative efforts to weaken regulatory oversight would not serve the best interests of investors in either traditional or emerging markets.
• She then called on Congress to oppose rushed digital assets legislation that would only offer special treatment to certain market participants and that would weaken the importance of state and federal securities regulators.
• She testified that her organization, the North American Securities Administrators Association (NASSA), was participating in efforts associated with President Biden’s recent Executive Order (EO) on Ensuring Responsible Development of Digital Assets.
  • She indicated that NASSA engaged “regularly” with SEC Chairman Gary Gensler’s staff on digital asset issues.
• She also discussed how NASSA served as a forum for its member regulators to share their experiences with their policy frameworks for digital assets.

Ms. Gerri Walsh (Financial Industry Regulatory Authority):

• She testified that her organizations, FINRA and the FINRA Foundation, had dedicated “significant” resources to combating financial fraud.
• She noted how bad actors often sought to capitalize on trendy investment practices and vehicles when carrying out fraud.
  • She highlighted how social media could serve as a popular vector for fraudulent activity.
• She stated that the number of bad actors that exploited the hype around cryptocurrencies and digital assets had “surged” in recent years.
  • She noted how the U.S. Federal Trade Commission (FTC) had found that fraud involving cryptocurrencies as the payment vehicle had increased five-fold between 2020 and 2021.
• She called on Congress to provide greater direction on cryptocurrency regulatory issues and expressed interest in the responses from federal agencies to President Biden’s recent EO on Ensuring Responsible Development of Digital Assets.
  • She testified that FINRA was currently monitoring the “limited” broker-dealer activity within the digital assets space.
• She remarked that while cryptocurrency products could be reasonable choices for certain investors, she contended that clear regulatory oversight was needed in this space given how this area’s market history was “thin.”
• She then discussed how fraud was very heterogeneous in nature and noted that fraud was often perpetrated beyond FINRA’s jurisdiction and often came from outside of the U.S.
  • She stated that equipping investors to identify and avoid the persuasion tactics of scammers would be beneficial.
• She remarked that increasing investor knowledge would help to prevent harm and mentioned how FINRA provided free and unbiased resources covering numerous topics, including investment basics, complex products and strategies, and scams and financial pitfalls.
  • She testified that FINRA worked with the SEC, state regulators, and national non-profit organizations to disseminate these resources widely.
• She also mentioned how the FINRA Foundation spent “significant” resources on research and shared this research with the public.
  • She commented that these datasets empowered researchers to explore financial behaviors, attitudes, and knowledge across multiple demographics.
  • She further noted how FINRA had researched scam susceptibility and had tested interventions to protect against frauds.

Congressional Question Period:

Full Committee Chairman Sherrod Brown (D-OH):

• Chairman Brown asked the witnesses to elaborate on why crypto assets were so attractive to scammers and so risky for investors.
  • Ms. Lubin remarked that the crypto asset market’s lack of transparency made it attractive to scammers. She noted how crypto assets did not have disclosures that would enable investors to understand the risks associated with the products. She also discussed how scammers often tailored their schemes to capitalize on current fads.
• Chairman Brown noted how bad actors often engaged in affinity frauds, which involved the exploitation of trusted relationships and community ties. He asked Ms. Walsh to discuss how affinity frauds have evolved in recent years.
  • Ms. Walsh stated that while fraudsters were very nimble in terms of adjusting their pitches, she remarked that the fundamentals of fraud were constant. She noted how fraudsters often tried to gain trust through infiltrating communities and building social consensus. She remarked that it was important for regulators to engage in community outreach so that they could raise awareness about the potential for fraud.
• Chairman Brown noted how financial fraud victims were often blamed for the losses that they experienced. He asked Ms. Walsh to provide recommendations for shifting the focus on financial frauds away from the victims and toward the perpetrators.
  • Ms. Walsh remarked that the blaming and shaming of financial fraud victims would discourage future victims from reporting the frauds. She stated that it was very important for financial fraud victims to report frauds. She noted how these frauds involved both financial costs and non-financial costs. She indicated that these non-financial costs could include lack of sleep, loss of job, and loss of spouse. She mentioned how the FINRA Foundation was working with the AARP and a research firm to better understand the problem of financial fraud victim blaming and shaming and ways to combat it. She indicated that the FINRA Foundation had recently issued a report on this issue.
• Chairman Brown then noted how many cryptocurrency proponents often contended that the technology underlying cryptocurrencies would promote financial inclusion. He highlighted however that the recent collapses of cryptocurrency platforms had caused “significant” losses for investors and communities of color. He asked Ms. Walsh and Ms. Lubin to address whether cryptocurrency-supported financial inclusion was a realistic goal.
  • Ms. Walsh remarked that the FINRA Foundation was working to advance financial inclusion through investor education. She stated however that education was not a panacea. She asserted that there needed to exist clear and consistent regulation that allowed for disclosures so that cryptocurrency investors could understand the risks associated with these investments and obtain information about the cryptocurrency companies.
  • Ms. Lubin expressed concerns over the marketing strategies within the digital assets space. She noted how digital assets companies often emphasized financial inclusion concerns to communities of color and commented that this pitch tended to resonate with these communities. She stated however that digital assets have failed to democratize investing thus far and that communities of color had been disproportionately harmed by failed digital asset investments. She concluded that the promise of financial inclusion from digital assets led communities of color to be more susceptible to fraud.

Full Committee Ranking Member Patrick Toomey (R-PA):

• Ranking Member Toomey discussed how there were transactions that resembled securities involving crypto project tokens. He asserted that these transactions should be subject to securities laws and regulations. He stated however that the crypto project tokens within these transactions should not necessarily be considered securities for the purposes of regulation. He posited a hypothetical investment vehicle whose repayment was denominated in gold bullion. He noted that this type of investment vehicle would be considered a security while the gold involved in the transaction would remain a commodity. He then mentioned how there had recently occurred several collapses of cryptocurrency lending companies, which had led customers to have their funds frozen. He predicted that many of these customers would never fully recover the funds that they held on these lending platforms. He criticized the SEC for its failure to act before these cryptocurrency lending companies collapsed. He noted however that several state securities regulators had taken action against these cryptocurrency lending platforms. He asked Ms. Lubin to indicate whether a cryptocurrency lending product fell under the jurisdiction of the SEC.
  • Ms. Lubin noted how state securities regulators had overlapping jurisdiction with the SEC over many issues and types of securities. She stated that cryptocurrency lending products should be considered securities at both the federal and state levels.
• Ranking Member Toomey lamented how the SEC had failed to provide clarity as to whether cryptocurrency lending products constituted securities. He commented that such clarity might have dissuaded people from becoming involved with cryptocurrency lending products in the first place. He also highlighted how the SEC had taken actions against BlockFi for offering similar cryptocurrency lending products, which suggests that the SEC had believed these products to constitute securities. He asserted that the SEC should have issued a formal position on the topic. He then noted how SEC Chairman Gary Gensler had taken the position that most digital assets were securities. He stated however that SEC Chairman Gensler had failed to provide his justification for this position. He expressed skepticism toward the position and remarked that tokens often lacked features associated with securities. He elaborated that tokens often did not make specific claims for any returns or specific claims on the income of a project or an enterprise. He asserted that the aforementioned features were universal among securities. She asked Ms. Lubin to address how a token would satisfy the prongs of the Howey test (and therefore be considered a security) if it did not commit to providing a return or make a claim of ownership.
  • Ms. Lubin noted how one prong of the Howey test for evaluating whether a token constitutes a security was whether there existed an expectation of profits. She asserted that this expectation of profits could stem from appreciation of the value of a token.
• Ranking Member Toomey disputed Ms. Lubin’s response and noted that the token’s issuer was not claiming that their tokens would appreciate. He asked Ms. Lubin to identify a security that did not have any claims from their issuers.
  • Ms. Lubin noted that there existed numerous types of tokens and stated that these tokens needed to be evaluated on a case-by-case basis.
• Ranking Member Toomey interjected to emphasize that there existed different types of tokens with unique features. He stated that regulatory clarity would be helpful for determining whether these tokens constituted securities. He called on Congress to pass legislation to address this issue and commented that digital assets appeared to be fundamentally different from traditional assets.

Sen. Catherine Cortez Masto (D-NV):

• Sen. Cortez Masto noted how more than 46,000 Americans have reported losing more than $1 billion in cryptocurrencies to scams since January 2021. She also highlighted how it was difficult for scam victims to recover their stolen funds, especially for investors with less than $100,000 in losses. She mentioned how FINRA had provided startup grants to law schools beginning in 2009 to establish investor advocacy clinics in high need areas. She expressed interest in identifying actions to help these scam victims. She expressed particular interest in helping victims with losses under $100,000 and noted how these victims often faced challenges in terms of accessing legal services. She asked Ms. Walsh to identify the lessons that FINRA had learned from operating investor advocacy clinics.
  • Ms. Walsh recounted how one of the FINRA Foundation’s earliest grants was to the law school at Northwestern University to establish a securities arbitration clinic in 2004. She stated that this experience had informed their 2009 grant program to help law schools to establish investor advocacy clinics. She indicated that the FINRA Foundation had ceased this grant program in 2015. She remarked that securities arbitration clinics provided an important vehicle for individuals with low dollar securities claims to pursue their claims. She also stated that these clinics provided financial counseling to people that experience financial losses that were not the result of financial misconduct. She further noted how these clinics provided outreach services and education to communities. She mentioned how the FINRA Foundation provided these clinics with its materials to support these outreach and education efforts.
• Sen. Cortez Masto thanked the FINRA Foundation for its support of investor advocacy clinics and noted how law schools in her state of Nevada were interested in setting up such clinics. She mentioned how she was introducing the Investor Justice Act of 2022, which would have the SEC establish a grant program to support law schools in operating investor advocacy clinics. She then asked the witnesses to provide recommendations for how Congress could enhance the ability of regulators to pursue Ponzi schemes.
  • Ms. Lubin called it important for financial regulators to possess sufficient resources so that they could pursue Ponzi scheme cases. She noted how state regulators worked with their federal counterparts and FINRA to pursue these cases. She highlighted how the Empowering States to Protect Seniors from Bad Actors Act currently under consideration would establish a grant program at the SEC for state securities and insurance regulators. She commented that this bill would support the efforts of regulators to pursue matters involving seniors and vulnerable adults. She also called it important for state regulators to have the authority to pursue bad actors. She expressed opposition to federal policies that would preempt the ability of state regulators to investigate and pursue financial schemes. She commented that having more regulators observe the financial space would help to protect investors.
  • Ms. Walsh expressed agreement with Ms. Lubin’s call for providing more resources to financial regulators. She stated that it was also important to support research regarding fraud mechanisms and the personality characteristics that led to scam susceptibility. She further called for fostering networks across federal and state governments to support the sharing of this research on fraud and fraud susceptibility.

Sen. Mark Warner (D-VA):

• Sen. Warner first highlighted how the Wall Street Journal had recently reported several incidences of cryptocurrency scams and frauds. He then expressed confusion as to how stablecoins could make money. He elaborated that it would be difficult for a stablecoin that was fully backed by reference assets to afford their float through merely relying upon fees. He asked the witnesses to address how fully backed stablecoins could be profitable. He also asked the witnesses to indicate whether stablecoin issuers were providing sufficient disclosures regarding their fees.
  • Ms. Lubin remarked that there was a “tremendous” lack of transparency associated with stablecoins and noted how every level of a stablecoin transaction had fees. She also suggested that stablecoin issuers could derive revenue from the excess reserves backing their stablecoins. She reiterated that stablecoins lacked transparency and stated that stablecoins did not have the same levels of disclosures present in securities investments. She commented that this lack of transparency created uncertainty surrounding the business models of stablecoin issuers.
  • Ms. Walsh expressed agreement with Ms. Lubin’s comments. She asserted that more disclosures and greater clarity were necessary for digital assets. She noted how market forces could drive up the value of various securities and stated that having disclosures and clarity would enable investors to make more informed decisions.
• Sen. Warner reiterated his doubts regarding the feasibility of stablecoin business models that claimed to be fully backed by reference assets. He asserted that these business models required additional review. He also stated that the stablecoin space remained too nascent to have effective SROs.

Sen. Robert Menendez (D-NJ):

• Sen. Menendez remarked that cryptocurrency scams had real impacts on hard working Americans and noted how the FTC had estimated that $750 million was lost to scammers in 2021. He stated that many scam victims have attempted to contact law enforcement and were still awaiting help. He expressed concerns that these scams were not being adequately investigated. He asked Ms. Lubin to identify who the victims of cryptocurrency scams ought to contact to obtain justice.
  • Ms. Lubin recommended that scam victims first contact their state securities regulators to obtain justice. She noted how state securities regulators worked with their federal counterparts on pursuing scams. She indicated that state securities regulators had jurisdiction over both securities sold from their states and securities sold into their states. She stated that state securities regulators often worked with their federal counterparts to pursue national and international scams.
• Sen. Menendez asked Ms. Lubin to explain why it was difficult for financial regulators to prosecute cryptocurrency scams.
  • Ms. Lubin first highlighted how cryptocurrencies were very new and stated that financial regulators were currently working to develop expertise in this area. She also noted how it often took time for scam victims to report complaints to the appropriate bodies. She explained that scam victims were often unsure as to whether they were actually scam victims or just needed to wait longer to receive their returns.
• Sen. Menendez then criticized large social media platforms (including Facebook, Instagram, and WhatsApp) for failing to curb the spread of misinformation. He asked the witnesses to address how the spread of misinformation on social media platforms magnified the problem of cryptocurrency scams.
  • Ms. Walsh mentioned how state securities regulators had highlighted that bad actors often employed social media to perpetrate scams and frauds. She noted that while most of this fraud occurred outside of broker-dealers (which meant that FINRA lacked jurisdiction over the activity), she testified that FINRA was monitoring social media for scams. She mentioned how FINRA had recently looked into how broker-dealers were using social media to acquire customers.
• Sen. Menendez then noted how digital assets were quite new and commented that scammers could take advantage of this novelty to mislead investors. He asked Ms. Walsh to address whether the lack of education around digital assets was contributing to their prevalence in scams.
  • Ms. Walsh remarked that the U.S. needed more education on digital assets so that people would understand how these assets worked, which disclosures to look for, and how to obtain recourse when necessary. She noted how most digital asset transactions were occurring outside of the broker-dealer space, which meant that FINRA’s protections did not apply to these transactions. She commented that this dynamic made it difficult to obtain resource.
• Sen. Menendez noted how reported losses due to cryptocurrency scams in 2021 were nearly 60 times greater than in 2018 according to the FTC.

Sen. Cynthia Lummis (R-WY):

• Sen. Lummis remarked that the U.S. needs strong consumer protections for the digital assets space. She stated that these consumer protections would take several forms, including disclosures made by companies that create digital assets, legal segregation and protection of customer assets in bankruptcy, and disclosures made by digital asset exchanges regarding risks and permissible transactions. She asserted that her proposed legislation, the Lummis-Gillibrand Responsible Financial Innovation Act, would provide such consumer protections for digital assets. She then noted how the SEC had previously stated that digital assets could transition their legal status between securities and commodities. She also noted how the SEC had stated that digital assets may embody an investment contract depending on their specific facts. She called on the Committee to have an “honest discussion” regarding the Howey test. She asked Ms. Lubin to indicate whether there were significant investor protection issues when market participants could not effectively tell the difference between a security and a commodity.
  • Ms. Lubin stated that securities lawyers could apply the Howey test to products (including cryptocurrency products) to determine whether the products constitute securities.
• Sen. Lummis requested that Ms. Lubin provide feedback on the Lummis-Gillibrand Responsible Financial Innovation Act’s classifications of digital assets. She then asked Ms. Walsh to indicate whether the digital assets space should have some level of self-regulation.
  • Ms. Walsh testified that FINRA had not taken a public position as to whether there should exist an SRO for digital assets. She stated however that the self-regulatory model enshrined in federal securities laws had led to “robust” regulation within the broker-dealer space. She noted how FINRA and its predecessor organizations were registered with and overseen by the SEC. She commented that existing SROs were therefore regulated entities in nature. She also noted how FINRA’s Board of Governors was majority public. She stated that FINRA therefore received input from the industry that they oversee without being controlled by this industry. She commented this dynamic contributed to continued investor protections. She expressed FINRA’s willingness to advise Congress on features of self-regulatory models as they contemplated new laws and policies.
• Sen. Lummis expressed interest in receiving feedback from FINRA on the Lummis-Gillibrand Responsible Financial Innovation Act. She then asked Ms. Walsh to indicate whether FINRA should play a role in any potential digital asset self-regulatory model or if there should exist a separate SRO that was more focused on digital assets.
  • Ms. Walsh reiterated that FINRA had not taken a public position regarding the use of a self-regulatory model for digital assets. She highlighted how most of the current activity involving digital assets was occurring outside of the broker-dealer space. She stated that FINRA maintained “robust” examination mechanisms for broker-dealers, including reviews of advertising materials and customer communications. She expressed FINRA’s willingness to share these tools to Congress as they considered laws about this space.

Sen. Elizabeth Warren (D-MA):

• Sen. Warren remarked that cryptocurrencies made it faster and cheaper for bad actors to prey on consumers. She mentioned how the FTC had found that about 25 percent of money lost in scams since 2021 involved cryptocurrencies. She added that these figures were only based on reported scams and speculated that these figures would be even higher if they were to include unreported scams. She remarked that the cryptocurrency industry was built to favor scammers and asserted that many institutional investors were involved in cryptocurrency scams. She asked Ms. Walsh to indicate whether large institutional investors were becoming more prominent players within the cryptocurrency market.
  • Ms. Walsh indicated that while the FINRA Foundation’s work focused on retail investors, she noted how media reports had stated that institutional investors (including hedge funds) were making “large” investments in cryptocurrencies.
• Sen. Warren mentioned how venture capital firms had invested $33 billion in cryptocurrency-related companies in 2021, which was more than in all previous years combined. She also noted that hedge funds and large institutional investors were now the main source of cryptocurrency trading activity. She then mentioned how cryptocurrency lending platforms Voyager and Celsius had recently filed for bankruptcy protection. She discussed how these platforms had offered very high interest rates to cryptocurrency owners seeking to lend out their cryptocurrencies and had claimed to have FDIC coverage. She asked Ms. Walsh to indicate whether these lending platforms contained elements of scams.
  • Ms. Walsh noted how FINRA was empowered to investigate claims and disclosures made within the broker-dealer space. She called it important for there to exist clarity within the digital assets space regarding the claims made by digital asset companies.
• Sen. Warren interjected to assert that these cryptocurrency lending platforms had lied about their ability to offer high interest rates and not put the money of their customers at risk. She stated that large institutional investors were continuing to fund cryptocurrency-related companies that were targeting retail investors. She asked Ms. Lubin to indicate whether retail investors that used Celsius and Voyager were likely to have their claims prioritized in the bankruptcy processes of the two companies.
  • Ms. Lubin noted that if the retail investors that sued Celsius and Voyager were considered to be unsecured creditors, then they would likely have the lowest priority claims in the bankruptcy process. She commented that these retail investors would face an “uphill battle” to have their claims made whole in the bankruptcy process.
• Sen. Warren reiterated that large institutional investors were supporting and profiting from cryptocurrency companies that perpetrated scams on retail investors. She contended that Congress must address these large institutional investors. She mentioned how she would soon be introducing legislation that would regulate the cryptocurrency market and combat scams within this market.

Sen. Chris Van Hollen (D-MD):

• Sen. Van Hollen first thanked Ms. Lubin for her input during the development of the bipartisan Empowering States to Protect Seniors from Bad Actors Act. He highlighted how the U.S. Senate Special Committee on Aging had found that senior citizens lose approximately $3 billion each year to financial scams. He asked Ms. Lubin to address why it was important for the U.S. Senate to pass the Empowering States to Protect Seniors from Bad Actors Act.
  • Ms. Lubin remarked that state securities and insurances regulators constantly lacked sufficient resources to pursue scams. She commented that scam artists always tended to have more resources than regulators. She noted that the Empowering States to Protect Seniors from Bad Actors Act would establish a grant program to support state securities and insurance regulators in combatting scams aimed at seniors. She stated that these grants would help to address the aforementioned resource issues.
• Sen. Van Hollen asked Ms. Lubin to indicate whether resource constraints were currently impacting the Maryland Securities Division’s ability to pursue certain investigations.
  • Ms. Lubin stated that additional resources would enable the Maryland Securities Division to better pursue certain cases.
• Sen. Van Hollen explained that the Empowering States to Protect Seniors from Bad Actors Act would direct the SEC to establish a grant program to support state efforts to address fraud targeted at seniors. He asked Ms. Lubin to confirm that this legislation would apply to fraud involving cryptocurrencies.
  • Ms. Lubin remarked that the Empowering States to Protect Seniors from Bad Actors Act would apply to any kind of fraud involving seniors. She mentioned how NASSA had model legislation that would require financial professionals to report instances of potential financial exploitation to state securities and insurance regulators and adult protective services. She commented that the grant money from this legislative proposal would enable state securities and insurance regulators to investigate such instances of financial exploitation.
• Sen. Van Hollen then asked the witnesses to discuss whether there existed any authorities to address deceptive advertising within the cryptocurrency space.
  • Ms. Walsh remarked that FINRA took the issue of deception “very seriously.” She noted that FINRA did review advertising materials used in the sale of investment products. She emphasized that FINRA’s jurisdiction was limited to broker-dealers and indicated that FINRA provided oversight when broker-dealers became involved with cryptocurrencies. She noted that FINRA reviewed the nature of the communications being made by broker-dealers and highlighted how FINRA’s rules required that these communications be fair, full, and not misleading.
• Sen. Van Hollen asked Ms. Walsh to indicate whether FINRA had taken any actions to date against parties for deceptive advertising within the cryptocurrency space.
  • Ms. Walsh testified that she was personally unaware of FINRA taking any action against parties for deceptive advertising within the cryptocurrency space. She stated however that it was possible that FINRA had taken actions against parties for deceptive advertising within the cryptocurrency space.
  • Ms. Lubin noted how state securities and insurance regulators mostly followed statutes based on the Uniform Securities Act and commented that these statutes were “very similar” to federal law. She indicated that state securities and insurance regulators possessed anti-fraud authority that applied to any person in connection with the offer and sale of securities, that commits a fraudulent act, or that makes material misrepresentations.
• Sen. Van Hollen expressed concerns with how some advertisements falsely suggested that cryptocurrency products had FDIC coverage. He expressed hope that NASSA members and FINRA would remain vigilant against these false advertisements within the cryptocurrency space.

Sen. Kyrsten Sinema (D-AZ):

• Sen. Sinema mentioned how she had co-founded the Congressional Financial Innovation Caucus. She noted that while her constituents were optimistic about blockchain technology, she expressed concerns that bad actors were using the promise of this technology to perpetuate scams and frauds. She remarked that the U.S. needed to provide safeguards and information to cryptocurrency investors so that the investors could make informed financial decisions. She noted how NASSA had found that investments tied to digital assets were a top threat to investors. She commented that the digital assets investment space was “basically unregulated.” She asked Ms. Lubin to discuss how unregulated investment spaces posed threats to retail investors.
  • Ms. Lubin noted how securities regulators could not evaluate offerings before they were sold in unregulated spaces. She also stated that investors would not have access to necessary information to make informed decisions in unregulated spaces.
• Sen. Sinema then mentioned how cryptocurrency lender Celsius had recently filed for Chapter 11 bankruptcy protection. She noted how Celsius had suspended the ability for its customers to access their holdings prior to this filing. She commented that these customers were afraid that the bankruptcy process would absolve Celcius of its obligations to them. She also noted how these customers might be considered unsecured creditors in bankruptcy proceedings. She asked Ms. Lubin to address whether these concerns from Celsius customers were justified.
  • Ms. Lubin remarked that Celsius customers were “very appropriately concerned” regarding their ability to recover their funds held with Celsius. She noted that NASSA was currently working to educate investors on what to expect from an investing company or platform that files for bankruptcy protection. She stated that regulators should work to assist investors in responding to these types of bankruptcies.
• Sen. Sinema then asked Ms. Walsh to discuss the role that easily understandable consumer disclosures and a consistent regulatory framework play in terms of reducing the instances of fraud and financial abuse within cryptocurrency and securities markets.
  • Ms. Walsh noted how there existed multiple layers of regulation, including examinations, enforcement, and education. She stated that clear disclosure obligations for cryptocurrency and digital asset providers would help both consumers and the market itself. She commented that such disclosures were key to enabling market participants to make informed decisions. She then remarked that investor education was a complementary tool to required disclosures. She mentioned how FINRA worked “collaboratively” with state securities regulators, federal agencies (including the SEC), and national non-profit organizations to publicize the tactics being used in financial frauds and scams.
• Sen. Sinema highlighted how Celsius’s recent bankruptcy filing had significantly harmed many vulnerable Americans and stated that these consumers might not have fully understood the risks posed by Celsius. She added that Celsius was not alone in its failure. She lastly mentioned how she had introduced the Virtual Currency Tax Fairness Act, which would create a de minimis tax of $50 for cryptocurrency transactions.

Full Committee Ranking Member Patrick Toomey (R-PA):

• Ranking Member Toomey noted how concerns had been raised throughout the hearing about the lack of disclosures for stablecoin backing assets. He mentioned how his stablecoin legislation would require stablecoin issuers to fully disclose the assets being used to back their stablecoins. He also noted that this legislation would require the OCC to regulate stablecoin issuers.

Sen. Jack Reed (D-RI):

• Sen. Reed mentioned how he had introduced the Insider Trading Prohibition Act, which would define the practice of insider trading. He asked Ms. Lubin to address how securities regulators, professional traders, and retail investors would all benefit if Congress were to clearly define the standards for insider trading liability.
  • Ms. Lubin expressed NASSA’s support for the Insider Trading Prohibition Act and remarked that it was important for there to exist a clear definition of insider trading. She stated that insider trading made it more difficult for investors to make money because it put investors at an unfair disadvantage to connected insiders. She stated that this legislation would provide clarity to regulators, prosecutors, and the industry about what types of trading activities would be permitted.
• Sen. Reed then discussed how cryptocurrency trading platforms aimed at retail investors were operating outside of the securities regulatory structure. He noted how these platforms were not registered with the SEC or with states as either broker-dealers or securities exchanges. He indicated that these platforms instead relied upon state money transmitter licenses. He asserted that this regulatory approach was “untenable” given how these platforms most likely had securities listed on them. He asked Ms. Walsh to address how getting cryptocurrency trading platforms to register as broker-dealers or securities exchanges help securities regulators to do their jobs. He also asked Ms. Walsh to address how this registration would lead to stronger investor protections.
  • Ms. Walsh remarked that the federal and state regulatory regimes for securities had fostered investor protections and market integrity. She asserted that bringing cryptocurrencies and digital assets into these regulatory regimes could benefit consumers and the markets themselves. She stated that disclosures that were full, fair, and not-misleading would add value to the U.S.’s securities markets.
• Sen. Reed then mentioned how he had introduced the Stronger Enforcement of Civil Penalties Act of 2021, which would increase the size of the penalties that the SEC may impose. He also noted that the legislation would authorize the SEC to triple the penalty cap for repeat offenders. He stated that the recent failures of cryptocurrency companies and platforms had revealed a “shocking” number of Ponzi schemes and frauds. He commented that the scale of the damage caused by these failures was “staggering” and highlighted how Celsius now owed its users more than $4.7 billion. He added that Voyager’s liabilities were in a similar range to Celsius. He asked Ms. Lubin to address how the Stronger Enforcement of Civil Penalties Act of 2021 would empower the SEC to better protect investors from bad actors.
  • Ms. Lubin called it important for regulators to have multiple tools for protecting investors. She stated that enhanced penalties and greater fines for recidivists would provide regulators with an additional tool for discouraging bad behavior. She noted how many industry participants viewed penalties as a business cost. She contended that these penalties therefore must be raised so that they could act as a deterrent for bad behavior.
• Sen. Reed then discussed how many private equity firms were targeting the “mass affluent” market to obtain funding. He commented that this trend raised questions as to what constitutes a retail investor and had blurred the distinction between public and private markets. He asked Ms. Lubin to provide her thoughts on this development.
  • Ms. Lubin noted how private markets were significantly less transparent than public markets. She explained that private markets were allowed to provide less transparency because they were only open to accredited investors. She asserted that the threshold for becoming an accredited investor was too low and noted how this definition had not been modified for 40 years. She contended that many people that qualified to participate in the private markets would be better served in the public markets. She highlighted how public markets were more liquid, more transparent, and less complex than the private markets.