House committee set to move forward on stablecoins

Topline 

• July congressional agenda to include funding bills and oversight of SEC

• HFSC poised to move forward on stablecoins

• SCOTUS to hear arguments in case with major tax code implications on “realized” income

• AI continues to pose problems for lawmakers, who struggle to define —and regulate—it

Programming note: Carta Policy Weekly (and Policy Weekly Live) will be off next week for the July 4th break. As always, let us know if you have any questions. See you back here July 14th.

Looking ahead: The dog days of summer session

July is a reliably busy month in Washington. Lawmakers, fresh off a two-week July 4 recess and approaching the August break, will try to advance initial versions of bills to fund the government and make progress on must-pass legislation like the annual National Defense Authorization Act. Committee chairs will double down on their policy agendas, including the House Financial Services Committee (HFSC), where lawmakers are expected to focus on ESG, crypto (see more below), and some additional priorities:

• SEC oversight:Republicans have increasingly focused on SEC oversight, including through hearings with SEC division leadership. As part of HFSC’s oversight, we expect Corporation Finance Director Erik Gerding to testify in July. While the focus of the conversation will largely center on proxy voting reform and ESG climate disclosures, a hearing would provide an opportunity to press Director Gerding on the Commission’s plans to reign in the private markets—most of the anticipated rulemakings around Regulation D, Section 12(g), and changes to the accredited investor standard would originate under his division.

• Corporate Transparency Act: On Jan. 1, FinCEN will require a large swath of small companies to provide information on their beneficial owners to help law enforcement combat illicit financing. Although initially bipartisan, the implementation has been rocky and the Committee will hold a hearing in July in which Republicans may focus on the rulemakings burdens on small businesses and push for delay. Carta is working with partners to scope a compliance regime to help covered entities on our platform.

Why it matters:Spending bills and the NDAA can become vehicles for a host of members’ other legislative priorities—including key financial services policy riders such as increasing accredited investor onramps. Dynamics can change rapidly when the clock is ticking, so stay tuned for movement in the coming weeks (and note that while Congress takes a month-long break in August, regulators do not).

HFSC poised to move forward on stablecoins

The House Financial Services Committee is getting close to agreement on a bipartisan stablecoin bill. With the recent progress (perhaps motivated by recent strides in Europe), HFSC Chair Patrick McHenry is planning to hold votes on crypto legislation in late July. The positive movement on stablecoin legislation follows comments made by Federal Reserve Chair Jerome Powell last week, when he noted that the Fed does see payment stablecoins as a form of money and emphasized that there needs to be a “robust federal role” in regulating stablecoins moving forward.

Why it matters:Although last month, stablecoin legislation was stalled, progress has been made with the expectation that the committee of jurisdiction would vote on it July 19th.  This bodes well for the longer-term effort to define a stablecoin regime. There is not, however, a clear path forward on the Republican draft proposal for a comprehensive framework to regulate digital assets.This week, HFSC Ranking Member Maxine Waters sent letters to Treasury Secretary Janet Yellen and SEC Chair Gary Gensler, asking them to share their analysis on the draft digital asset framework proposed by Republican committee leaders. Gensler is likely to take issue with the framework, which reallocates power from the SEC and gives it to the CFTC. This likely complicates the politics for Democrats in supporting the framework without changes that would bolster the SEC.

SCOTUS to hear arguments in case with major tax code implications

This week the Supreme Court announced it would consider a tax case to determine whether the mandatory repatriation tax (which levies tax on foreign earnings even if they have not been distributed) is constitutional under the Sixteenth Amendment. The issue at stake in the case is whether an individual or business can be taxed on unrealized gains. The Court is set to consider arguments in its upcoming October term, with a decision expected next year.

Why it matters: While the case at hand involves a repatriation tax and a mere $15K in dispute, its ramifications could upend swaths of the tax code, including aspects around investment income and equity. 

• Refunding past tax liabilities:  A decision in favor of the taxpayers (ruling the repatriation tax unconstitutional) could invite further litigation from businesses who have been paying the tax, which could potentially result in billions in refunds. 

• Definition of realization of income: If the Court finds income must be realized for a tax to be constitutional, there could be far-reaching impacts. For example, a realization requirement could call into question how pass-through entities like LLCs and partnerships are currently taxed, where partners or shareholders are assessed taxes on profits they may not have personally received. 

• Wealth tax: A decision scoping whether non-distributed income is subject to tax could also impact mark-to-market tax treatment for certain financial products and impede progressive proposals that would impose taxes on net worth or unrealized capital gains.

More to come, but it will be a case to watch.

AI continues to pose problems for lawmakers, who struggle to define it

The Biden administration recently released a strategic plan on investment in AI research and an RFI. Senate Majority Leader Chuck Schumer proposed a framework for the development of artificial intelligence policy. Policymakers understand regulating AI is a priority—but the question of how to regulate continues to stump Washington. This remains the educational phase, and we do not expect legislation to pass this year. 

Crafting regulations for emerging technologies is always going to be a difficult task, especially when the potential of the new technology is still unknown. With creating any new set of regulations, the first step is defining what you are trying to regulate (see the securities vs. commodities debate going on in the crypto world). 

With AI, developing a clear definition has proven to be difficult. Debate about what exactly encompasses AI—which technically can range from simple mathematical formulas to extremely complex systems capable of reasoning, learning, and problem-solving—continues to unfold. Some groups prefer a nontechnical definition, which typically defines AI as machines that are able to perform tasks that normally require human intelligence. While this definition is likely broad enough to encompass future advances in AI technology, it lacks the legal precision necessary for creating laws  that are less vulnerable to loopholes. But more technical definitions are likely to become outdated as the technology advances, and would require lawmakers to make tough decisions about what should be included in the definition (e.g.,whether to focus on complex modern systems, or also include classical algorithms, which likely will require different sets of laws). 

Aside from the problem of how to define AI, additional factors make policy creation difficult:

• Innovation:What’s the right balance between protecting the public and allowing for innovation, and how would a licensing regime play a role?

• Timing:Is now the right time for comprehensive AI regulation?

• Geopolitical implications:Will overregulating AI push innovation overseas? Will a lack of AI regulations create opportunities for adversaries to inflict harm? 

Lawmakers are also feeling pressure from industry leaders, with prominent AI companies publicly calling for regulation. The CEO of OpenAI openly called for regulation last month in front of the Senate Judiciary Committee. Microsoft just published a 42-page report that lays out a regulatory blueprint for AI. Google has recently published their own set of policy recommendations regarding AI, and has been actively involved in policy formation in the EU as well.

Why it matters:Artificial intelligence—almost no matter how it is defined—is a transformative technology. And there is no clear roadmap on how to regulate it. While Congress and the Biden administration have started to explore what legislation could look like (Senator Schumer does not have a timeline for the release of legislative text that supports his framework), there is still a long road ahead. In the meantime, other countries continue to make progress. Expect a continued focus on AI in Washington in the coming months, but no legislating in the near future.

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News to know

• Fed announces early adopters for new real-time payments system. The Fed announced that 57 entities are certified to participate in its new real-time payments system, called FedNow, that launches next month.

• EU negotiators reach a deal on bank capital reforms. The EU finalized the implementation of the Basel III regulatory reforms, which will place limits on leading banks’ usage of their own internal models to measure capital requirements among other new requirements. The agreements still require the approval of the Council and Parliament before they can be formally adopted.

• Prometheum plans to use exemption to trade crypto. Prometheum aims to use Rule 144, which is an exemption that was put in place over 50 years ago and used to trade restricted stock. The CEO of Prometheum was on the Hill earlier this month, where he endorsed the SEC’s work in regard to crypto and spoke out against the Republican’s draft digital assets framework.

• New York legislation passes non-compete ban. The New York State legislature has passed a bill banning almost all non-compete agreements for all workers, regardless of their salary level or job function. The bill currently sits with Governor Kathy Hochul, who is expected to sign it.

• House Republicans send letter to SEC citing a failure to comply with federal record keeping laws. The chairmen of three influential House committees, Rep. Patrick McHenry, Rep. Jim Jordan, and Rep. James Comer, penned a letter to SEC Chair Gensler in which they question the SEC’s failure to reply to Congressional requests and cite potential recordkeeping infractions. 

• SEC Enforcement Director urges cooperation and self-reporting of violations. SEC Enforcement Director Gurbir Grewal addressed the agency’s approach to cyber risks and urged the broader securities industry to cooperate with investigations and self-report potential violations to receive “real benefits,” such as reduced penalties. It was an active week on the enforcement front, with a number of actions announced regarding SPACs, insider trading, and private market fraud.

Upcoming events

• CFTC Market Risk Advisory Committee public meeting – July 10 at 7:00 a.m. PT / 10:00 a.m. ET

• House Financial Services Committee Capital Markets Subcommittee Hearing on ESG – July 13 at 11:00 a.m. PT / 2:00 p.m. ET

• Commodity Futures Trading Commission’s Technology Advisory Committee meeting – July 18 at 9:00 a.m. PT / 12:00 p.m. ET

• House Financial Services Committee Subcommittee on National Security, Illicit Finance, and International Financial Institutions Hearing on Beneficial Ownership – July 18th at 11:00 a.m. PT / 2:00 p.m. ET

• House Financial Services Committee Markup on Digital Asset Bills – July 19th, time TBD

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