Policy newsletter

Carta Policy: Debt ceiling hit. Extraordinary measures underway.

January 20, 2023
The Carta Policy Team

The Topline

  • Debt ceiling reached: default months away
  • IRS continues to provide nonbinding guidance on digital assets
  • SEC Commissioner pushes for more retail access to private markets
  • Cyber breach pushes SEC to sue for sensitive data
  • FTC order penalizes Drizly for security failures
  • Climate goals: Fed establishes climate scenarios and Republicans push back

Debt ceiling reached: default months away

The United States hit its debt ceiling on Thursday, forcing the Treasury Department to begin taking extraordinary measures to prevent a default. 

What’s the deal with the debt ceiling?

The debt ceiling is the US’s borrowing cap, which currently sits at $31.4 trillion. Hitting the debt ceiling means the Treasury is unable to borrow additional funds to pay bills the country already accrued. Once we spend the remaining capital we will run out of money to pay creditors, and since we cannot issue more debt to raise capital, we will default.

Now, what does that mean for us? A U.S. default could lead to the downgrade of our credit rating, roil financial markets, create economic turmoil, and other things that are, well, unpleasant and unnecessary. The Treasury Department’s “extraordinary measures” are just a band-aid on a bullet wound—they merely delay the deadline. A 2011 Federal Reserve Board discussion provides the best assessment as to how the government responds: we prioritize paying Treasury securities and delay other payments, including to agencies and for government benefits. Treasury has signaled we have until June before their extraordinary measures run out and we formally default on various debts. 

Political dynamics complicate matters

House Republicans insist that to raise the debt ceiling they need concessions on items such as reductions in federal spending, while President Biden and Democrats insist they will not negotiate over raising the debt limit. Posturing and politicking will stretch through spring, and likely take us up to the limit—hopefully not beyond. 

Why it matters: Aside from potential negative macroeconomic outcomes, the debt ceiling debate will hamstring Congress’ ability to legislate: it will take up attention and increase partisanship. The showdown also sets up Speaker McCarthy’s first big challenge in navigating a narrow majority.

Carta Innovator Forum: Atlanta

On Feb. 7, Carta is convening founders, investors, and policymakers in Atlanta for a half-day summit to showcase opportunities, highlight challenges, and discuss how to bolster the innovation ecosystem. SEC Commissioner Hester Peirce will join us to share insight into the regulatory landscape for venture capital and how policy can support small business capital formation. We will host the event at Atlanta Tech Village and hope you can join us. 

If you’re interested in attending, please register here.

IRS continues to provide nonbinding guidance on digital assets

In the absence of tax guidance for digital assets, taxpayers continue to rely on online FAQs and IRS legal memorandums (ILMs), which outline the IRS’ current thinking, but are subject to change without notice. In their most recently issued pair of crypto memos, the IRS provided:

  • No loss deduction for substantial decline in crypto value: Taxpayers who still own cryptocurrency that has declined in value, but is not worthless, do not qualify for the section 165 loss deductions. The IRS also noted that even if a taxpayer had sustained a qualifying loss, that loss would be a disallowed miscellaneous itemized deductions for tax years 2018 through 2025. Crypto losses may still be used to offset capital gains. (ILM 202302011
  • Appraisal required to deduct cryptocurrency charitable donations: Taxpayers must obtain a qualified appraisal to substantiate the value of cryptocurrency donations over $5,000 for purposes of the charitable contribution deduction under section 170(a). The IRS has not defined what counts as a “qualified appraisal,” but insists that digital assets do not fit the guidelines for exceptions that are granted to cash and securities. (ILM 202302012)

Why it matters: These recent ILMs further highlight the need for the regulation of digital assets. In the case of section 165 loss deductions, the IRS should clarify whether cryptocurrency is always treated as property for tax purposes or whether it may be treated as securities in certain circumstances. On charitable donations, the IRS memo might provide further impetus for Congressional response as Sens. Cynthia Lummis and Kirsten Gillibrand have proposed legislation requiring the IRS to issue guidance to remove the appraisal requirement for charitable contributions of digital assets. 

SEC Commissioner pushes for more retail access to private markets

SEC Commissioner Mark Uyeda is pushing for retail investors to have additional opportunities to participate in private market investments. Uyeda suggested allowing everyday investors to allocate some investment exposure (8% or 10%, for example) to private market securities as part of a diversified portfolio, especially if the investor works with a financial professional who has a duty to make investment recommendations that are in the investor’s best interest. 

Generally speaking, only accredited investors have access to private market investment opportunities. A major focus for House Financial Services Chairman Patrick McHenry will be expanding investor access, which includes modernizing the accredited investor definition.However, the Commission is expected to move in the opposite direction. In the coming months, the SEC is expected to consider changes that would raise the financial thresholds to qualify as an accredited investor, meaning fewer investors would have access to the private markets. This action could also limit access to capital for founders and emerging managers, especially in lower cost of living regions. Carta is working with our coalition partners to maintain the current parameters.

Why it matters: Increasing private market investment opportunities has become more partisan in recent years, especially as the size of the private markets has increased. There is bipartisan recognition, however, that financial metrics do not necessarily equate financial sophistication. More tailored measures to expand access to private markets, such as through an investment professional or retirement plan, could gain traction with moderate Democrats, who view ownership opportunities as a means to enhance wealth creation.

Cyber breach pushes SEC to sue for sensitive data

In November 2020, Covington & Burling reported a cyberattack to the FBI. In March 2022, it received a subpoena from the SEC seeking information related to the attack, including the names of impacted clients. Covington complied with other aspects of the subpoena but declined to name its clients based on its duty of confidentiality. The SEC is suing for those names.

The SEC claims it intends to use the information to understand what notifications Covington’s affected entities provided and to investigate whether traders inappropriately used information obtained in the hack. The SEC could potentially undertake enforcement action on both these fronts. The agency issued interpretive guidance on the cybersecurity disclosures in 2011 and 2018, and released a proposed rulemaking in 2022. The latter will likely be finalized later this year and would standardize disclosures in two areas: (1) incident reporting and (2) risk management, strategy and governance. If clients are named that did not make adequate disclosures about the cyber incident, they could be subject to an enforcement action.

The case juxtaposes investor protection with client confidentiality, raising concerns within the legal community about the precedent it could set. The SEC contends that its subpoena is tailored so as not to infringe on attorney-client privilege, narrowing the scope of its request to the roughly 300 clients subject to SEC oversight. Covington maintains it has a broader duty to protect client confidences, and that the SEC has no precedent to demand confidential information from a law firm without some suspicion of wrongdoing. In other words, this is a fishing expedition.

Why it matters: The SEC’s actions demonstrate its aggressive pursuit of potential enforcement actions. If the SEC wins, the precedent could deter entities from making good faith disclosures of future cyberattacks to other branches of the federal government for fear of broader repercussions. It also previews how it may use information companies would be required to provide under the proposed cyber disclosure framework. 

FTC order penalizes Drizly for security failures

The FTC found Drizly and its CEO knew of (but did not correct) security vulnerabilities that allowed hackers to access the personal data of over 2.5 million consumers in 2020. The company’s shortcomings included failing to monitor security threats and housing data in an unsecured platform.

Setting a model that may be echoed in future enforcement actions, the order requires Drizly destroy collected personal data that is not required for the provision of its services, implement a robust security protocol, and publish information on its data collection practices via its website, including via a retention schedule.

Why it matters: Companies’ increasingly robust data collection practices expose them to greater losses in cyberattacks. FTC Chair Lina Khan told Congress early in her tenure that “policing data privacy and security is now a mainstay of the FTC’s work”—a commitment evidenced by the scope of the Drizly order and the FTC’s growing focus on these matters.

Climate goals: Fed establishes climate scenarios and Republican pushback

Don’t call it a stress test: Fed previews climate scenario exercise

The Federal Reserve unveiled detailed instructions for participants in its inaugural climate scenario analysis (CSA) exercise; the exercise is meant to gauge banks’ abilities to remain sound during a climate-related stressors. The six largest U.S. banks will participate in the scenario analysis, which the Fed emphasized is distinct from the regular stress tests, which can result in the Fed taking regulatory action or directing the bank to raise more capital. Fed Chair Jay Powell has come under fire from Republican policymakers who are concerned that the Fed is overstepping its authority by expanding into climate related matters, but Powell and Fed officials continue to reassure that the educational and exploratory exercises will not have direct capital consequences for banks.

Republican AGs call foul on proxy firms’ ESG positions

Twenty-one Republican state attorneys general united in protest of proxy advisory firms Institutional Shareholder Services’ (ISS) and Glass Lewis’ considerations of climate commitments when making recommendations. In a letter, the group accused the firms of violating their fiduciary duties by weighing environmental goals over financial ones, including recommending votes against companies’ climate transition plans when they are not in alignment with the Paris Agreement. ISS said the letter “reveals a fundamental misunderstanding of market forces at work.” The AGs asked ISS and Glass Lewis to respond to 11 questions by Jan. 31.

Why it matters: While the Biden Administration continues its government wide push to incorporate climate-related policies into various regulatory frameworks, Republicans at the state and federal level have pushed back on the adoption of ESG-focused policies, scrutinizing involvement in international climate groups and the role of banks in directing capital flows, for example. With control of the House, Republicans will have more opportunities to amplify their concerns and highlight criticisms of ESG policies via hearings, letters, and legislation, among other avenues.  

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