US House of Representatives Passes FIT21 Major Crypto Legislation | Practical Law

US House of Representatives Passes FIT21 Major Crypto Legislation | Practical Law

The US House of Representatives passed H.R. 4763, the Financial Innovation and Technology for the 21st Century Act (FIT21), which would create a US regulatory framework granting the CFTC new jurisdiction over digital commodities and clarify the SEC jurisdiction over digital assets offered as part of an investment contract. This marks the furthest congressional advancement of any major US crypto legislation to date.

US House of Representatives Passes FIT21 Major Crypto Legislation

Practical Law Legal Update w-043-4047 (Approx. 6 pages)

US House of Representatives Passes FIT21 Major Crypto Legislation

by Practical Law Finance
Published on 23 May 2024USA (National/Federal)
The US House of Representatives passed H.R. 4763, the Financial Innovation and Technology for the 21st Century Act (FIT21), which would create a US regulatory framework granting the CFTC new jurisdiction over digital commodities and clarify the SEC jurisdiction over digital assets offered as part of an investment contract. This marks the furthest congressional advancement of any major US crypto legislation to date.
On May 22, 2204, the US House of Representatives passed H.R. 4763, the Financial Innovation and Technology for the 21st Century Act (FIT21), marking the furthest congressional advancement of any major US crypto legislation to date. FIT21 would:
  • Create a US regulatory framework with the Commodity Futures Trading Commission (CFTC) granted newly created jurisdiction over "digital commodities."
  • Clarify the Securities and Exchange Commission’s (SEC) jurisdiction over digital assets offered as part of an investment contract.
The bill would establish a process to permit the secondary market trading of digital commodities that were initially offered as part of an investment contract. H.R. 4763 would also impose comprehensive customer disclosure, asset safeguarding, and operational requirements on all entities required to be registered with the CFTC and/or the SEC. The legislation is designed to provide a clear process to determine which digital asset transactions are subject to the SEC’s jurisdiction and the CFTC’s jurisdiction.
Under FIT21, crypto platforms would be required to register, as applicable:
  • With the CFTC as a:
    • Digital commodity exchange;
    • Digital commodity broker; or
    • Digital asset dealer.
  • With the SEC as a:
    • Digital asset broker;
    • Digital asset dealer; or
    • Digital asset trading system.
FIT21 sets out requirements for these registrants, as well as for registered qualified digital commodity custodians.
Digital asset developers would have a pathway to raise funds and would be required to provide disclosures, including information relating to the digital asset project’s operation, ownership, and structure. Digital asset customer-serving institutions, like exchanges, brokers, and dealers would be required to:
  • Provide appropriate disclosures to customers.
  • Segregate customer funds from their own.
  • Reduce conflicts of interest through registration, disclosure, and operational requirements.
FIT21 explicitly states that a digital asset offered or sold or intended to be offered or sold pursuant to an investment contract is not and does not become a security as a result of being sold or otherwise transferred pursuant to that investment contract. This language would appear to explicitly undercut application of the Howey test to the determination of whether a crypto or digital asset is a crypto asset-security. Rather, under FIT21, a crypto asset would be a digital commodity subject to CFTC oversight (and not a security subject to SEC oversight) if the blockchain on which the crypto asset is issued is sufficiently "decentralized." If the blockchain is not sufficiently decentralized, the crypto-asset could be a security.
FIT21 defines "decentralized" to mean that:
  • Within the prior 12-month period, no individual controls or has controlled the blockchain associated with that digital asset.
  • Within the prior 12-month period, no issuer or affiliated person:
    • holds or has held 20% or more of the digital assets issued or used on that blockchain; or
    • unilaterally controls or has controlled 20% or more of the voting power controlling the blockchain on which the digital asset was issued.
  • With in the prior three months no issuer or affiliated or related person has contributed intellectual property to the source code of the blockchain that has materially altered the blockchain functionality or operation, unless:
    • to address vulnerabilities, errors, cybersecurity risks, or regular maintenance; or
    • implemented through a decentralized blockchain consensus mechanism.
FIT21 would provide for an exclusion from application of the rules, with the exception of their antifraud and antimanipulation provisions, for certain decentralized finance (DeFi) activities, including:
  • Compiling network transactions, operating or participating in a liquidity pool, relaying, searching, sequencing, validating, or acting in a similar capacity with respect to a digital asset.
  • Providing computational work, operating a node, or procuring, offering, or utilizing network bandwidth or other similar incidental services with respect to a digital asset.
  • Providing a user-interface that enables a user to read and access data about a blockchain system.
  • Developing, publishing, constituting, administering, maintaining, or otherwise distributing a blockchain system or software that creates or deploys a wallet or other system facilitating an individual user’s ability to safeguard or custody such user’s digital assets or related private keys.
The legislation was introduced on July 20, 2023 by Chairman Glenn Thompson (R-PA), Rep. French Hill (R-AR), Rep. Dusty Johnson (R-SD), Whip Tom Emmer (R-MN), and Rep. Warren Davidson (R-OH), with Chairman Patrick McHenry (R-NC) a cosponsor of the legislation (see Legal Update, Legal Update, US House Financial Services Committee Advances Crypto Bills: Financial Innovation and Technology of the 21st Century Act (FIT21)).
It is not yet clear if or when FIT21 may be taken up for consideration by the US Senate, but the prevailing sentiment among commenters has been pessimistic regarding advancement of the legislation. In addition, the White House issued a Statement of Administration Policy (SAP) opposing the bill because it "would affect the regulatory structure for digital assets in the United States." The SAP may be viewed as a warning that the legislation would be vetoed if approved by congress, which could further dampen efforts in the Senate.
SEC Chair Gary Gensler issued a statement expressing disapproval of the legislation, which in his view would weaken the role of the SEC in crypto regulation and enforcement. Gensler notes his view that FIT21 would weaken investor protections because the legislation would, among other things:
  • Remove investment contracts that are recorded on a blockchain from the statutory definition of securities and the time-tested protections of much of the federal securities laws.
  • Allow issuers of crypto investment contracts to self-certify that their products are decentralized "digital commodities" not subject to SEC oversight but through self-certification by any person that files a certification. The SEC would then have 60 days to review and challenge the certification that a product is a digital commodity. Those that the SEC successfully challenges would be re-classified as restricted digital assets and subject to the bill’s "lighter-touch" SEC oversight regime. Gensler suggests it is implausible that the SEC could review and challenge more than a fraction of crypto assets.
  • Abandon the Howey test developed by the US Supreme Court in 1946 (SEC v. W. J. Howey Co., 328 U.S. 293) for determining whether an investment contract has been created in favor of determination based on "labels" and the accounting ledger used to record transactions.
  • Specifically exclude crypto-asset trading systems from the definition of an exchange, reducing custody protections for their customers.
  • Permit non-accredited investors to purchase crypto assets worth up to 10 percent of their net worth or annual income before the issuer would be required to provide any disclosure.