Policy Newsletter

Policy weekly: FTX investors drawn into the fray

February 17, 2023
The Carta Policy Team

The Topline

  • Class action case filed against FTX investors

  • SEC custody proposal takes aim at crypto and expands scope to include private assets

  • Senate Banking Chair outlines principles to guide crypto legislation

  • Republican FTC Commission to resign, leaving only Dems during key rulemakings

  • Carta-led coalition seeking permanent changes to facilitate 83(b) elections

Class action case filed against FTX investors

A class action suit has been filed against FTX investors Sequoia, Paradigm, and Thoma Bravo, alleging that the venture funds’ substantial investments incentivized them to use their professional reputations and capabilities to bolster FTX’s legitimacy. Questions swirl around the diligence that went into FTX investments, but this suit hits at what firms can do to support their portfolio companies.

Why this matters: This FTX fallout will extend beyond crypto into the private market ecosystem:

  • Investor access:FTX is a private company and raised capital under the existing securities framework. As Carta and other private market actors attempt to expand investor access to private markets, skeptics will argue that if the most sophisticated players in the market—those named in this lawsuit—can’t do effective diligence, the average retail investor will be in an even worse position.

  • PortCo support: Venture firms increasingly use their reputation and                                                                                                                                     operational support as a hook to attract dealflow. Part of that may include marketing and promoting the company. This suit—if successful—could chill firms’ willingness to engage in such practices. 

  • Private fund adviser proposal: The SEC’s recent private fund adviser proposal would limit an adviser’s ability to shield itself from liability, which could leave the adviser even more vulnerable for investments that go bad or actions they take on behalf of the firm that may not pan out. If the proposal goes through, expect even more of a foundation for lawsuits (and potential enforcement actions).

SEC issues custodial proposal to clean up the crypto industry 

The SEC issued a proposal that would significantly expand its custody rules to SEC-registered investment advisers, including those to private funds. The rules would: 

  • Expand the scope of covered assets by including more private securities, physical assets, and crypto (see below);

  • Mandate custodial relationships by requiring advisers and qualified custodians to agree in writing that the custodian will undergo annual independent audits, provide client account statements, and provide records to the SEC upon request; and 

  • Increase recordkeeping obligations by requiring advisers to maintain more records of transaction activity and improve the accuracy of custody-related data available to the Commission.

Opposition to the proposal has largely focused on implications for crypto (see below), but it will be important to assess the proposal’s expanded scope into private securities, the SEC’s ability to influence private contracts between advisers and custodians, and the additional data the SEC may now request. 

Implications for crypto

Chair Gary Gensler took particular aim at the crypto industry, warning that investment advisers could not rely on crypto platforms as qualified custodians. He reiterated his views that most crypto assets are securities and would be covered by the current custody rules, adding that even cryptoassets that are not securities (i.e. bitcoin) would be covered by the new proposal—an overt attempt to regulate the industry through investment adviser regulation. 

Commissioner Uyeda argued the proposal is an attempt by the Commission to block crypto as an asset class, alleging that the SEC was trying to force advisers to go to banks for crypto custody, even as banking regulators caution banks against crypto activity—a tension that could make investing in crypto through an adviser challenging. 

Why it matters:This proposal represents a significant expansion in the SEC’s exercise of authority and a sea change in the relationships that currently exist between advisers, their clients, and their custodians. If adopted, compliance would likely be challenging and costly, particularly for smaller advisers. 

Senate renews crypto focus as Binance enforcement action looms

Senate Banking Chair Sherrod Brown outlined seven principles to guide the development of crypto legislation during a Senate Banking hearing:

  • Clear disclosures and transparency

  • Prohibitions on conflicts of interest and self-dealing 

  • Separating customer funds from company assets

  • Internal governance and risk management

  • Strong consumer and investor rights and protections

  • Anti-money laundering and fraud prevention

  • Oversight and supervision

Why it matters:There is bipartisan support to build a regulatory framework for digital assets, but the sides diverge on its composition. The House is further along in its work, especially on policy related to stablecoin oversight, but successful legislation will require Brown’s buy-in. We do not expect legislative consensus in the near-term. As previewed before, the SEC and other regulators will take action where possible under their current authorities as lawmakers sort out their plans. 

Speaking of SEC enforcement actions:

  • The SEC and CFTC are reportedly discussing a settlement with Binance, the world’s largest crypto exchange, to resolve compliance failures. 

  • The SEC brought charges against Terraform Labs and its founder for orchestrating a multibillion-dollar crypto asset securities fraud involving an algorithmic stablecoin. 

  • The Commission also announced charges against NBA hall-of-famer Paul Pierce for unlawfully touting crypto securities.

Republican FTC Commission to resign, leaving Democratic-only Commission at key period

Christine Wilson, the Federal Trade Commission’s (FTC) sole sitting Republican, announced her resignation in an op-ed that detailed a litany of grievances against the agency’s Democratic chair, Lina Khan. Wilson directly credited her departure to Khan’s “disregard for the rule of law and due process,” citing rulemakings to ban the use of noncompete clauses, misuse of the merger review process, and antitrust policy broadly as contributing factors. This resignation leaves both Republican slots vacant, and an exclusively Democratic FTC will further provoke House Republicans, who are already preparing to ramp up oversight of the agency. 

Why it matters: The FTC is pursuing rulemakings on noncompete clauses and commercial surveillance, as well as aggressively pursuing enforcement actions. The FTC will have a governing quorum, so it will likely proceed on all fronts with only Democratic input, but expect aggressive oversight from the Republican House and an industry that questions—potentially through the courts—the reach of the FTC’s rulemakings and actions. 

Carta & partners push to extend electronic signature relief for 83(b) filings

Carta led a coalition of companies, law firms, venture capitalists, and accelerators to urge the IRS to allow for the electronic signature and filing of 83(b) elections, a tax filing that moves up the tax liability to the grant date of equity issuance. An 83(b) election can save shareholders thousands of dollars in tax obligations. Modernizing this highly manual process would help founders and employee-owners manage their tax liability and maximize the value of their ownership. 

Why it matters: Carta and its coalition partners secured the current relief that allows electronic signature, but that sunsets October 31, 2023. Industry voices and policymakers need to push the IRS to extend—and expand—that relief before the deadline. This is a step in that campaign.

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