How the SEC Actually Writes Crypto Rules, with SEC Commissioner Hester Peirce

Now, I'm recording this intro from my home office, but where the interview took place is by far the coolest location I've ever done an interview at. No offense to any of my prior guests, but this interview takes place on the 10th floor in the ceremonial room of the offices of the Securities and Exchange Commission. Can you imagine saying that in 2021? I'm so grateful for SEC Commissioner Hester Peirce and to Chief Counsel of the Crypto Task Force, Taylor Linman. In this episode, we talk about the rulemaking process within an agency like the Securities and Exchange Commission, how they're coordinating on joint rulemaking with the CFTC, as well as what other processes they have ongoing. Welcome to the Law of Code podcast. My mission with this podcast is to help everyone understand the rules that shape our world so we can create better ones. I'm Jacob Robinson. I'm a former securities regulatory lawyer and really my goal with this interview is to help you understand what goes on inside the agency. Commissioner Peirce and Taylor Linman are both so generous with their time. Now, we don't just cover the rulemaking process in this episode. Commissioner Peirce also shares her personal philosophy to approaching work in capital markets. I don't think anyone's really asked her that before. Taylor shares how the team at the crypto task force approaches answering the tough questions that shape our industry. Starting with a conversation about their personal philosophy towards the capital markets. Let's start with why each of you joined the Securities and Exchange Commission and what I'd love to hear you answer if you're willing is how you think about morality and the philosophy of how you approach the work that you do and especially you Hester just because I've spoken to a lot of your colleagues and people who used to work with you, people who work with you now. No one has anything but great things to say about you and the same thing is true in private industry and I think the world needs more people like you. So I'd just love to hear you talk about how you think about those things.

Thanks for sharing that. And Taylor, I'd love to hear for you. You've joined. It's been, I think, four months now since you've been with the SEC and the crypto task force. What drew you to the SEC?

Sure. And as Hester was saying, these are my own views. They don't necessarily represent the staff of the commission. So I would say like my journey was a little different than most because it started through working in crypto more than 10 years ago and I was being exposed to these securities laws issues in various different ways. This was 33 act stuff with investment contracts. It was brokers asking questions and each of these topics were different little puzzles that I was trying to fit together myself while I was in private practice and then more when I was in house and just trying to figure out what would I do if I had the ability to try to get a sensible rule in place or try to solve this problem definitively for folks in the market, what would that look like? And I spent a ton of time doing that in my personal life outside of work just trying to figure out how to solve these puzzles because it's like a game. Regulation is like a puzzle that has to fit together like a mechanism that has to fit together really well in order for it to work for society. And that was what drew me, that idea being able to go and do that kind of thing at a level that can help society and help this industry as well because this industry has a lot of these pernicious questions that need to have thoughtful governance brought to them and regulation brought to them.

Yeah, it's such an exciting time to be working in the capital markets and I'm so excited with what we're seeing and with clarity obviously is a big thing that we're seeing move forward and something that I flagged in the podcast that I did with the rulemaking process and the rules that will come next and I know this is something that is being worked on and so not completed as we're recording now but what does the rulemaking process look like when we hear things like rulemaking and we see dates 180 days a year? There's a lot of questions that I could ask there. But I'd love to turn to you Hester and just talk about what does that look like when we talk about rulemaking and how does an agency like the SEC tackle that.

And so when you say we take that all in, what does that look like at a more granular level in terms of is it different divisions? Is it the crypto task force? Like who is it that's taking all this information in?

Yeah. Just on that point, we're heading to Virginia Beach after recording this. I have my future home.

Yep. And probably some other classes as well.

There you go.

So those are two good examples. Could you talk a little bit about what you learned from those processes and then how what you've learned from those experiences has been applied to this rulemaking process?

Yeah. Just to speak to it a little bit generally. So I actually sit down with the staff every day and I've been there since I started just because that was an important part of trying to be really directly involved in some of the rulemaking and some of the day-to-day processes with the staff. And what I've seen with the rulemaking process even before Clarity is kicked off is that the rulemaking process is a lot different than how an agreement comes together in a law firm environment. There's a lot of artisans. There's people who are like craftsmen. They've been owning a specific area of the law and they've been thinking about that area of the law with a lot of ownership for a tremendous amount of time. And so their mastery of it really is key to getting things done right. And they each kind of have a role to play in assembling what can ultimately be one of these major rules. And so I've been able to see that just in the last four months. And also because what the task force enables us to do is we can see across the divisions. We can see how this rule is being received and thought about within a different division and then ensure that those issues whatever those issues are can be addressed or come up with novel solutions to help cut things off at the pass before they impede progress.

I'm so glad you said that because I was blanking on my question and I was trying to stall for time. So thank you Hester for jumping in there. That actually worked out really well. What I wanted to ask was about prioritizing the different areas because like I said this is such a hard thing to do. There's so many different things. There's 180-day deadlines. Like how do you individually think about what to prioritize in terms of how you're going to tackle this rulemaking?

Yeah. Well, I think if I would add anything, I would echo that I think it's more like trying to play, like there's a lot of different instruments in front of you and there's an orchestra and you can have all the instruments playing at once so that you can get a lot done that way. There can be just a whole wall of sound, so to speak. And that's going to be, I think, a big part of how things move quickly is ensuring that when one group is finished with one area, they've got the next thing. There's a logical building progression there, and that each of these builds upon the next. There's going to be foundational rules. I think those are going to be the things that are like the big chunks that are within the draft. And then there's going to be some stuff that's going to be kind of added on later. Now that you've got the foundation built, you're putting up the rest around the scaffolding. And then I'd also say that in addition to being able to hit it from many different divisions at once, there's also just the translation function that needs to be performed. So much of the existing securities markets and securities rules were designed with a very specific view towards a specific type of market structure and regulation around kind of this new market activity requires a lot of translation. And it requires that engagement with industry, which we've done a ton of in the last year, as well as just a lot of grappling with some of the nuances there about what the technology does and doesn't do, and ensuring that we're still matching things up appropriately towards our mandate and towards the relevant risks that still exist.

Yeah. No, it's an interesting paradigm shift in terms of how we think about these markets because I mean the 33 act, the 34 act, the creation of the SEC came after the roaring 20s, right? Trading on margin speculation, there was counterparty credit risk that sort of wasn't realized at the time. And now we live in this world where it's possible to build tools where you're not exposed to those same risks, those intermediary risks. And sometimes you are, right? It's sometimes it's like it seems like it's a decentralized project. I'm not going to name any but it's not right. And then so how do you guys think about navigating the not even just the rulemaking process but like the taxonomy and all the other work that you're doing given how I don't even want to say quickly the technology is changing though. Better way to say it is like how different it all is in terms of how we've traditionally thought about securities rules and capital markets.

I've got a slightly different approach towards this question because I've been thinking a lot just in the broader context of rulemaking and how good regulation happens and around technology. Prescriptive regulation can get really outdated very quick and it can become really problematic when you use the prescriptive tool but they come with predictability. And then on the other end of the spectrum you've got principles based regulation which is highly flexible and amenable to a lot of different circumstances but you end up in a world where interpretation can get harder and harder without touching grass so to speak on the reality of the situation. Principles approach I think has a lot of merit in it because it allows for the flexibility afforded to the different ways in which people build tech. But there's also a place for prescriptive rulemaking and that's I think an example that I could think of that's not necessarily just crypto related but offering exemptions. You've got a facts and circumstances approach with the investment contract test which I know you've spoken about at length and then you've got safe harbors. You've got things like the proposed reg crypto. The idea there is to try to provide a bright line test something that is a little bit more prescriptive that you can follow and have predictability around. Having both I think is the best way to address emerging technologies also find ways for predictability in the market.

Yeah. No, that was great. You guys really are coming for my job with this podcast stuff. That was going to be one of my questions, Taylor, about how you view your role to provide the market with practical guidance versus overly prescriptive guidance. So, great job. I'm getting a little nervous now with the Law of Code. I better hit the gas on that.

No, you guys are great. Thank you. Can we just talk quickly and Hester, you did a great job sort of outlining the agency divisions and how it works. Could we just get a sense of like how they would come into play when it comes to rulemaking for Clarity and just like what aspects they would maybe tackle?

Well, I would just say like you could almost run through the titles and say kind of where these are going to fall. Like title one's probably going to fall a lot with Corp Fin and title three is probably going to fall a lot with trading and markets. And then some of these are going to be across the board.

Yep. And the last time I think the last time we did a podcast it was you and Mike too which is pretty cool. One thing I want to say is just like commend the work that the crypto task force has done and the policy divisions as well too. I mean over the past well since inception really I mean the work has been incredible and I think it's done a great job not only in United States but also showing the rest of the world like how policymaking could be done which is talk to experts in the industry figure out how the rule how the things work figure out rules to make those things work and you use the analogy earlier Taylor of the puzzle and like I think of it like when you're playing a board game if you're playing the game of Monopoly and someone can manipulate the rules or if the rules don't make sense and you're disincentivized from building or something, it's going to lead to some very perverse outcomes. So when you think about rulemaking, when you think about just the taxonomy and all those things, what are some of the steps that go into tackling these hard problems in crypto internally? If you can speak on that because I know like we've seen the public roundtables and stuff, but like what does it look like internally?

Yeah. No I was going to give a couple more tactical things. So I benefited from there being 200 plus task force meetings, all of these roundtables, hundreds of written submissions. I have this trove of data for purposes of getting signal regarding where are the kind of most important areas of focus and a tremendous amount of those have already a path for those have been charted which was so helpful. But I was also interested in understanding especially as we're starting to move more towards these intermediary questions, questions around brokers and transfer agents and others, what were the questions that were being asked the most frequently. And so one of the tools that we had at our disposal there was just to crunch some of this with AI tools. So pull chunks from all of the submissions, bring those in to take a look at how these issues were being addressed and stack rank, think about them from a holistic standpoint based on maybe a dozen submissions that were all of a similar style and similar type to really try to get to the heart of some of those specific issues. That was a tactic that I think has been pretty successful to date. The other thing that I would think about is just as you just mentioned it too, which is there's a translation function that goes the other way, which is the staff often knows how things work and how it could work, but they may not have told anybody. They be like, "Oh, why are they doing it this way? They're just running up against the wall. They don't need to. They can just go around the wall this way." And sometimes that's the most useful thing that we can do is not change anything, just enable the market by providing transparency around a solution that may not just be obvious to a market like this that hasn't grown up around the securities laws as long as folks in this building and as long as traditional firms and participants have.

Are there any examples you can give of that?

I was thinking exactly the same lane as I was which was there are existing ways for you to bring securities into the market. These people who are thinking about tokenizing should be thinking about those because there are other very sophisticated organizations who've been using these same tools for a lot of years and those tools are well-developed and functional regardless of the technology. So running in those lanes, just finding the lane and going and running down it is a really I think a powerful thing.

Yeah, that's something I want to touch on quickly because it's a phrase the industry's heard for years, the come and register. What do you mean when you say that? And let's just talk in the context, let's say, of an issuer or a token related project, not an ATS. Like what does that mean when it's come in and registered?

The only other thing I would add is that there's just a really broad range of securities that exist. And I think when a lot of people say come in and register, they're thinking this is an S1 and this is going to be an equity. You know, I'm about to IPO. It's not the only way to register a security. And there are a lot of different types of securities that are out there that come with a lot of different features. And so, as this technology encounters those different types of securities that are out there, the different paths that are available to them are the same as the conventional path. It's just with a technology wrapper a lot of the time.

Yeah. And as they should. I mean, I got into golf last year for the first time and I play with some friends of mine who I won't name, but they know who they are who like to move their ball sometimes if it's not in an optimal spot or they want to maybe move it back a little bit. And I tell them, "Guys," and I'm maybe I'm a pain in the ass, but I say, "Guys, if we don't follow the rules, we're not playing golf anymore." Like, and the same is true in the capital markets where these rules are made and you, I don't need to say to you guys, but you have to follow these rules and they exist for a reason. It's not that some regulator just arbitrarily made up these rules. A lot of them came after something bad happened.

Yeah. I don't know if there's anything.

That is the right spot. I agree. So let's just talk. So you mentioned the CFTC and I know there's this coordination and collaboration between the SEC and the CFTC right now. What does that look like in reality? Is that like a weekly meeting? Is that inter-agency sort of cooperation at a more granular level? Like can you...

And I guess that would look like almost like a counterparty in a private deal where it's like, hey, we're negotiating on something. We're trying to figure this out together. We're going to exchange information, get on calls, emails. I would just add that it is as frequent as you could probably imagine. There's so many areas of our laws that are butting up against each other. And so those are the points of coordination. That's where the conversation happens. Hey, we're thinking about doing it this way. Let's make sure that we're both doing it this way because, yeah, this is a special moment to be able to try to find regulatory equivalencies, find ways for harmonization to occur.

Yeah. No, I'd love to be in one of those with the microphone and get some of that content for this because that'd be great. I think one thing that to me I was such a big fan to see what you guys, what the SEC did, what the crypto task force did to re-engage the industry. Like there was a time where the industry was very, and when I say the industry I just mean Americans were afraid to come in and talk to their regulator because they were worried about what could happen and the consequences of that, and they didn't want to put their hand up and say, hey, I'm thinking about doing something you might need to be involved in some way, I want to figure out how with you, and then sort of paint a target on their back. How, like what did those initial conversations look like when you started to re-engage the industry and how did you find you were able to best do that?

That's so considerate of you though to take into account people's funding because I've seen...

So I don't know if you have anything to... you've been outside, so yeah.

Yeah, I would say that I experienced that full range for clients that I had. I represented a lot of clients in a transactional practice, but I sat on a floor when I was at Perkins Coie that also represented a ton of clients that were in enforcement posture with the SEC and on crypto matters, and so I got exposure directly to this building and how it was working at the time, and it was painful. It was a lot of clients that, you know, the funding was gone. We were representing them pro bono to keep that case moving forward. And a lot of those cases were, I mean the vast majority were registration violations for companies that were people who were a couple guys in New Hampshire. And that was a painful lesson for me, but also I think galvanized my interest in finding more productive ways to do policy. And so for me, that was a big turning point in my career in terms of where I wanted to focus and specialize. But it was also a realization that there's a very human cost to regulation.

Yeah. Yeah. And good regulation isn't zero sum. It's positive sum. It's like the industry can win, all the users can win, regulators can win, Americans can win. And that's sort of that principle I think is what made America such a great country where it was just win-win for everybody. And I think what we've seen now with the SEC re-engaging not just the crypto industry, but just like Americans and allowing them to build is so important.

And so, I'd love if you guys could just walk me through how the crypto task force will operate within the rulemaking process. What role does the crypto task force have? Because I think a lot of people who might not be too in the weeds might see it as like, oh, they're just there to get everything through for crypto, but it's like, are they explaining technical things? Walk me through what's...

Yeah, I'd say so. I think one thing in my engagements with the staff, especially because I've been doing this not for very long, a lot of it is I want to be able to be there to help provide context or provide answers if they have questions and things, but not to persuade because they're the ones that have been thinking about how these rules should work. And so it's not about persuasion. This is about surfacing questions, making sure that the issues being looked at from all sides. And the side that I can bring is usually that of the technologist or that of the person who's utilizing it. But then giving the space for that decision and that judgment to be made by staff whenever possible because they are the experts. I am not the expert. I am this guy who's coming in who knows a decent amount about the security laws but will never know what a person who's been studying and focusing on an issue for 20 years does, and respecting that.

Yeah. It's sort of, to use the analogy you used earlier of going through the door, right? I'm sure the crypto task force helps to say, "Hey, here's a door" in the same way the divisions and the policy experts and those artisans that you talked about. They can do the same thing, right? You can do that from the technology side, from the second order effect side. There's a lot of good when experts talk about things that they know better than others. Yeah, that's I think just to put a final point on that. I think when the task force is working its best, it's when it's bringing those experts that may be experts in the areas of the securities laws within our building in close enough contact with the ways that things are really working on the outside such that they can come up with good workable solutions, and that is probably our best value. That's the biggest value that we bring.

That was a good sound bite. That was a very good sound bite. Thank you, Taylor. That was a good one. One thing I want to ask, because you mentioned the Dodd-Frank rulemaking and sort of how there's, I don't know if there's still some outstanding things that happen.

Are there things we're doing differently now to avoid that happening with clarity?

Yeah, I don't think it'd be good for anyone for it to take as long for rulemaking with clarity as it does for Dodd-Frank.

Yeah. Yeah. What do you guys think in terms of the timing on rulemaking? I mean, I recall 180 days in some cases a year, like what...

Yeah. No, I agree. Very small minor point. And this is a personal point. My wife will definitely say this is true. I'm a very impatient person just in my life. So that's all I can add to this conversation other than saying I'm impatient.

I'm glad to hear that. That is great. Yeah. And I think it's so important to have people like both of you in agencies like the Securities and Exchange Commission. And I'm not sure if it ever dawns on you how cool the jobs are that you both have.

Yeah. Could you, I mean could you just walk through at a very high level those other things that are going on just so people get a sense of how much you guys are doing here.

All right. I'm convinced. Yeah, it's not just crypto here. That's very fair. One thing I just want to quickly touch on before we wrap up is this change in approach that we've seen from the Securities and Exchange Commission with the new administration and sort of the regulation by enforcement sort of changing to, hey, we want to work with you. We want to figure things out, still enforce and still have rules, but figure out a way to make it a win-win. You know, that's sort of been the theme. How do we, like, is there anything we can do to avoid a future where things can change so quickly depending on who's in power? Because to me that doesn't seem like the right thing.

Yeah, that's generally my thought as well, which is it's true like having durable rules and durable legislation that is hard to revert is part of it, but I think even more important than that is just the everyday nature of a new technology being adopted by registered firms and unregistered firms and people in between, and the normalization of that will, I think, be pretty rapid here, and I think we've seen it with past technologies. When things digitized the first time, it was a lot of questions and there was a tremendous amount of tumultuous arguments and things. ATMs I think were a big issue once upon a time, and alternative trading systems and venues were a big issue once upon a time, and they normalize over time, and our markets, you know, are better for it. And I think the crypto market is kind of going through that exact same thing right now. And I mean part of the thing that has been interesting about this past year and a half or so is, you know, obviously when we came in, crypto task force was created. I wanted to send the message that we're doing things differently now, but it turns out a lot of the interest in the topic was coming from firms that before hadn't really been able to experiment in this area because they're SEC regulated entities who felt like they couldn't step into this area, at least not publicly, because it could result in regulatory backlash. We don't have that now. And so we've seen a lot of traditional financial firms want to come in. And so we're very enthusiastic about all kinds of participants coming in. We want a level playing field for folks. And so I think what I really urge is that people come and tell us what it is they're trying to do, what it is they think the right regulatory approach is. Don't get carried away by seeing specters of terrible things happening because of a story that you've read or because you think this is how things are going to come out. We really are doing things iteratively. We want to hear from people. We want people to tell us when we're doing things wrong, but we want them to base it on things we've actually done. So, as an example, there's been a lot of conversation around the innovation exemption that both Chairman Atkins and I have talked a lot about. And, you know, we're thinking very deliberatively about how to get to a good place there. And, you know, specifically kind of thinking about what are the limitations around that look like, what do the conditions look like? You know, we are thinking about what kind of it'll be tokenized NMS stocks, right? And that's stocks that are either natively issued on chain or digital representations of stock, which is just really formatting stocks in a different way. It's not as new and scary, I think, as some people think. It's really just onchain finance. I don't know if...

Yeah, they could be transformative, and yeah, it's fun to see that part too, and I think that is also part of what builds the bulk work of keeping this around. And I do see so many parallels with cloud and other adopting and emerging technologies that you disrupt things, force changes, force reconsideration, and then ultimately consolidate around something that is just better market structure as a result.

Yeah. And even more recently the on-prem server to the cloud. What a scary concept that must have been for so many firms. A lot of questions being asked there. Doesn't seem very safe, this cloud. Where is the cloud? And yeah, that question got resolved and now it's the market practice, and same things will happen with these onchain markets, I think. Over time it's just another venue, it's another medium, it's another mechanism for coordination.

Well, even the principles that you opened the podcast by speaking about, if the SEC was to be a merits-based regulator, all of a sudden that's out the window because now the SEC is in charge of what's built in America, which, no offense, it probably isn't the best idea. I know it's not the goal or the mission.

And it's a place that I wanted to come to do this interview, and so thank you so much both. Dang, I messed that up. The whole podcast I was doing great, and then I mess up the close. Gosh. Just on that point though, I'll maybe I'll redo it. Maybe I'll leave this in. I don't know. But America is a place like I wanted to come and I admire the rules that are here and the foundation that the country was built on and the freedoms that drew all the immigrants, that drew all the people who came across the world, the builders who built this world, and honestly the world benefits when America does well, and I think the work that both of you are doing is really important. So thank you so much for having me. Just a quick question because I'm curious, like how come you were willing to let me come here? Because I feel like I might wake up and I'll be like, still at my house in Ancaster and be like, "Oh yeah, of course that didn't happen."

Oh, well, hopefully we get a chance to do it again soon. Thank you both so much. Thanks. All righty. And now, before we go, I do have to say, as someone who's been a lifelong Knicks fan for the past two weeks, I couldn't be happier with the result of the NBA championship. Congratulations to Jaylen Brunson and the whole team on the Knicks. I mean, he's probably my new favorite player who said his favorite player growing up was Steve Nash. Like, what a great team. What a great run. Anyways, thank you so much for listening. If you enjoyed that podcast, you can subscribe to a newsletter that I'm going to be launching. It will be free for now, lawfode.fm. Thank you obviously to Commissioner Peirce and Taylor Linman who were so nice, you know, talking with my wife and I after we recorded the podcast. Taylor actually helped us carry our bags. We had these huge suitcases with all the recording equipment. Such great people and really just was an honor for me to be able to do that. So, thank you for listening. If you found this episode helpful, it'd really mean a lot for me if you could share it. Even if you're a Spurs fan, help me get this type of content out more. Now, if you're a longtime listener of this podcast, I've been doing this for about 6 years. This is going to be episode 203. You might notice the camera quality is a little bit better. You know, I'm now traveling for interviews and I'm so grateful that I get to do that thanks to some of the sponsors of this podcast. Day One Law has been a big sponsor for a long time and really helped me get this podcast back on its feet after some health issues that I had over the past couple years. Thank you to Nick Pullman and the whole team there for that support. Now, I have been able to get more sponsors on the podcast, which has been amazing. So, thank you all so much for listening and supporting and sharing the podcast. It really, really means a lot to me. This podcast, this episode, nobody's sponsored this one or paid for this, but I do want to give a special shout out to the team at Cahill, Cahill Next in particular, Sam Enzer and Lewis Cohen, who have been longtime supporters of the podcast. And when I told them what I went through with getting diagnosed with cancer and sort of going through basically a three-year process of dealing with that, you know, a lot of times people say, "How can I help?" But Sam and Lewis immediately began a conversation with me about supporting the podcast and making this type of work publicly accessible. So, I'm really excited that that'll be announced in the next episode, which is going to be on prediction markets. But really, I just wanted to say a quick thank you to Sam and Lewis because the support they've given me really means a lot. I work with them because I think they're both world-class people, world-class lawyers, and so I'm excited to see all the value that they bring to the Law of Code podcast as well. So, shout out Sam, shout out Lewis. Thank you guys so much for believing in me and the whole team at Cahill really for backing this podcast and making it possible. And there's so many other sponsors that I'm excited to share in the future because this is important to me. I really want to just make these conversations more public and help make the world a better place. So, thank you all for listening. And if you are listening and you're in Ontario, this podcast is eligible for 50 minutes of substantive continuing professional development hours. As I've mentioned multiple times, there's going to be an upcoming episode on prediction markets, which I'm really, really excited. That'll be June 28th. So, make sure you subscribe wherever you get your podcasts to get that one. I feel like such a YouTuber now saying things like subscribe. I wanted to be a lawyer and I guess I am. But thank you so much for listening. Go Knicks. Congratulations again to everyone in New York who I know is going to have a lot of fun over the next couple days. Yeah. So we'll see you next time. Thanks for...