Bipartisan bill would bring managed stablecoins within definition of ‘security’

By Mark S. Nelson, J.D.

The bipartisan Managed Stablecoins Are Securities Act of 2019, sponsored by Reps. Sylvia Garcia (D-Tex) and Lance Gooden (R-Tex), would address worries these lawmakers have about the entry of Facebook’s proposed Libra virtual currency into the cryptocurrency markets. The bill was first floated as a discussion draft at an October 2019 hearing of the House Financial Services Committee at which Facebook CEO Mark Zuckerberg had appeared as the sole witness. A press release formally announcing the bill said it would help protect consumers by subjecting stablecoins to regulatory oversight.

House FSC hearing. At the House FSC’s October hearing, Reps. Gooden and Garcia asked about how Libra would be managed and why it is not currently expected to be based in the U.S. Zuckerberg told Rep. Gooden that Facebook’s Calibra digital wallet subsidiary and other relevant Facebook platforms (e.g., What’s App and Facebook Messenger) are U.S. products and that reserves held by the Libra Association (Libra’s governing body) would be "primarily" U.S. dollars. Representative Gooden observed that he was less against Libra than he was previously, but that it remained difficult to back "something so big" if it is based outside the U.S.

Representative S. Garcia, following up on a question by Rep. Jesus "Chuy" Garcia (D-Ill), asked Zuckerberg directly whether Libra was a stablecoin. Zuckerberg agreed that it was a stablecoin. In later questioning, Rep. S. Garcia asked how the Libra Association would be able to maintain a one-to-one ratio that ensures stability when the association likely would have to use a basket of global currencies, such as euros, yen, and U.S. dollars, but without being backed by the full faith and credit of the U.S. Zuckerberg said he believed that the association would be able to do this and that was the "default" plan.

Stablecoin defined. The Managed Stablecoins Are Securities Act (H.R. 5197) would amend the definition of "security" contained in the Securities Act, the Exchange Act, the Investment Company Act, and the Investment Advisers Act to explicitly include the term "managed stablecoin" and to clarify that an item is a security regardless of its form. The bill would then add new definitions to the Securities Act for the terms "digital asset" and "managed stablecoin." A sense of Congress in the bill posits that managed stabelcoins are investment contracts and, thus, are securities.

The term "digital asset" would have several key characteristics: (1) it would be an asset, contract, agreement, or transaction (including a representation of an economic, proprietary, or access right); (2) a digital asset must be stored in a computer-readable format; and (3) a digital asset’s transaction history must be recorded in a distributed ledger or other type of digital ledger or structure. A digital asset, the bill states, may be a managed stablecoin and a security.

As a preliminary matter, a "managed stablecoin" must not be a digital asset that is a registered security under Section 8(a) of the Investment Company Act. To be a managed stablecoin, a digital asset must otherwise satisfy at least one of two criteria:

• The digital asset’s value is determined by the value of a reference pool or basket of assets (including digital assets) that is managed by one or more persons; and/or
• One or more holders of a digital asset are entitled to consideration or assets in exchange for the digital asset in an amount fixed in significant part by the value of a reference pool or basket of assets (including digital assets) that are managed by one or more persons.

The portion of the Exchange Act’s definition of "security" that states what is not considered a security would be revised to clarify that the term "currency" means "sovereign currency," presumably to distinguish legal tender from virtual currencies, a distinction that could require still further clarification if central banks around the world were to adopt their own digital currencies. The bill also would authorize the SEC to further refine the meaning of "digital asset" and "managed stablecoin" via regulation.

Executive compensation. A related discussion draft published by Michael F. Q. San Nicolas, the delegate from Guam, would limit companies’ ability to issue securities if their leaders are, among other things, paid in managed stablecoins. Specifically, the proposal would direct the SEC to require stock exchanges to bar the listing of an issuer’s security if, following registration of the security, the issuer or its executives or directors: (1) received managed stablecoins as compensation; (2) bought or sold a managed stablecoin; or (3) were affiliated with a person who bought or sold a managed stablecoin after the security was registered. Delegate San Nicolas’s discussion draft borrows the definitions of "digital asset" and "managed stablecoin" from the proposed Managed Stablecoins Are Securities Act.

Delegate San Nicolas also queried Zuckerberg at the October House FSC hearing on Libra. Specifically, the delegate had asked about whether Libra, an asset-backed currency, could manage a basket of fluctuating currencies. The delegate also asked more pointedly, who is responsible if Libra fails? Zuckerberg replied that the delegate’s concerns had been considered in developing Libra but that some economists would argue the basket of currencies approach is more stable than focusing on a single currency. Zuckerberg also said the Libra Association would have reserves and that the Financial Stability Oversight Council would be involved in discussions about Libra.