The crypto industry talks a lot about "regulation by enforcement" in the context of the SEC? How different is that from enforcement of regulations?
The phrase "regulation by enforcement" is a critique often used in the crypto industry (and other sectors) to describe a regulatory approach where the SEC (or another agency) enforces laws and rules through lawsuits and penalties rather than through clear, proactive rulemaking. This differs from "enforcement of regulations" in significant ways:
1. Regulation by Enforcement
No Clear Rules in Advance: Critics argue that the SEC does not provide explicit guidelines on how crypto firms should comply with securities laws.
Legal Actions Instead of Rulemaking: Rather than issuing tailored regulations or engaging in formal rulemaking processes (such as public comment periods), the SEC takes action by suing companies or imposing fines.
Uncertainty for Businesses: Companies may not know they are violating the law until they face enforcement actions, creating uncertainty and chilling innovation.
Retroactive Punishment: This approach may penalize companies for actions they took before clear guidance existed.
2. Enforcement of Regulations
Based on Established Rules: In a traditional regulatory framework, enforcement follows well-defined rules that were developed through legislation or a formal rulemaking process.
Predictability & Compliance Pathways: Businesses know the compliance requirements in advance, allowing them to operate within a clear legal framework.
Preventative Rather Than Punitive: Regulation aims to guide compliance before violations occur rather than relying on enforcement as the primary mechanism.
Why Is This a Big Deal in Crypto?
The crypto industry argues that securities laws were not designed for digital assets, yet the SEC applies decades-old rules without providing specific new regulations tailored to crypto.
Major cases, such as those against Ripple, Coinbase, and Binance, highlight how the SEC is shaping crypto regulation through litigation rather than clear rulemaking.
The SEC contends that it is simply enforcing existing securities laws, but critics say this approach forces compliance through the courts instead of creating transparent, predictable rules.
Bottom Line
Regulation by enforcement means creating de facto policy through lawsuits and penalties rather than formal rules, whereas enforcement of regulations implies applying already established and clearly defined legal standards. The debate is whether the SEC should issue clearer guidance or continue its current strategy of enforcement actions.
Anonymous replied:
The regulated investment crowdfunding (Reg CF, Reg A, Reg D 506(c)) industry faces some challenges related to "regulation by enforcement," but not to the same extent as the crypto industry. Here’s how the issue manifests in regulated investment crowdfunding:
1. More Established Regulatory Framework
Unlike crypto, regulated investment crowdfunding operates under specific rules—mainly the JOBS Act of 2012, which created Reg CF and Reg A+. These frameworks were developed through a formal rulemaking process, providing more clarity than crypto companies have.
Reg CF (Regulation Crowdfunding): Capped at $5M per year, requires SEC-registered platforms, and has clear disclosure requirements.
Reg A (Regulation A+): Allows companies to raise up to $75M, with a detailed SEC review process.
Reg D 506(c): Requires accredited investor verification but allows general solicitation.
Since these rules were set through legislative action and refined by the SEC, most participants know the compliance requirements upfront—unlike in crypto, where the SEC argues that existing securities laws apply but has not issued new tailored rules.
2. Areas Where ‘Regulation by Enforcement’ Still Occurs
Despite the clear framework, the SEC and FINRA still use enforcement actions to clarify certain ambiguities, which can create some uncertainty:
Advertising & Solicitation Restrictions: Some platforms and issuers have faced enforcement actions for how they market offerings, with the SEC/FINRA providing more guidance through enforcement rather than proactive rulemaking.
Custody & Secondary Markets: The secondary trading of Reg CF and Reg A+ securities is still evolving, and the SEC has not issued comprehensive rules, leading to uncertainty about what is permissible.
Platform Compliance Risks: FINRA has taken enforcement actions against some funding portals over compliance issues, including fee structures, marketing, and investor communications.
Accredited Investor Verification (Reg D 506(c)): Some enforcement actions have set precedents on how issuers must verify investors, but there is still some ambiguity.
3. Key Difference: Crowdfunding Has More Rulemaking
While crypto operates under an uncertain legal framework (with courts frequently ruling on whether tokens are securities), regulated crowdfunding follows clear laws created by Congress.
However, areas of interpretation (such as secondary markets and marketing practices) are still shaped by enforcement rather than proactive guidance.
4. Industry Impact
Most Reg CF & Reg A participants follow clear rules, but enforcement actions still set precedents in gray areas.
Unlike crypto, there is less debate over whether securities laws apply—the question is often more about specific compliance nuances.
More guidance from the SEC on marketing, secondary trading, and emerging structures could reduce uncertainty.
Conclusion: Some, but Not as Much
The regulated investment crowdfunding industry faces some regulatory uncertainty, but it is not as severe as in crypto. Crowdfunding laws are much clearer, though the SEC still uses enforcement to define certain boundaries rather than always issuing proactive guidance.
If the SEC were to engage in more rulemaking (especially around secondary markets and advertising), it could help reduce the risk of "regulation by enforcement" in this space.
Anonymous replied:
Yes, Congress and the SEC could apply a framework similar to Regulated Investment Crowdfunding (Reg CF and Reg A+) to crypto businesses, but they haven’t done so yet. The main barriers are legal, political, and philosophical differences in how regulators view crypto versus traditional securities. Here’s why:
1. How a Crowdfunding-Like Framework Could Work for Crypto
If regulators treated crypto token offerings more like Reg CF or Reg A+, they could:
> Set clear fundraising limits (e.g., Reg CF’s $5M cap or Reg A’s $75M cap).
> Require investor protections (e.g., limits on non-accredited investors).
> Define disclosure requirements (e.g., financial audits, risk disclosures).
> Allow secondary trading on regulated exchanges after a set lock-up period.
> Register compliant platforms for facilitating offerings, similar to funding portals.
This approach would create legal certainty for compliant token offerings and avoid the current "regulation by enforcement" problem.
2. Why the SEC Hasn’t Done This Yet
The SEC has not applied a crowdfunding-like framework to crypto for several reasons:
A. Different View of Tokens vs. Securities
The SEC generally sees most crypto tokens as securities that must comply with the full Securities Act of 1933, rather than as a new fundraising method needing special rules. Reg CF and Reg A+ are exemptions from full securities registration—but the SEC hasn’t extended these exemptions to most crypto projects.
B. Chair Gensler’s Approach: No New Rules Needed
SEC Chair Gary Gensler has stated that existing securities laws already apply to most crypto projects. Instead of creating new rules (as was done for crowdfunding under the JOBS Act), he believes crypto firms should comply with existing regulations for securities offerings.
C. Lack of Congressional Action
The JOBS Act (2012) created Reg CF and Reg A+, providing the legal authority for those exemptions. Congress has not passed a similar law for crypto fundraising. The SEC could theoretically create an exemption through rulemaking, but they have shown no interest in doing so.
D. Anti-Fraud & Consumer Protection Concerns
The SEC and regulators argue that many crypto projects are highly speculative or fraudulent. They may be reluctant to create an easy pathway for fundraising without additional investor protections. Unlike crowdfunding platforms, crypto projects often don’t have real businesses or revenue, making risk assessment harder.
3. Would a Reg CF Model Be Good for Crypto?
Yes, a structured, compliant pathway like Reg CF could reduce uncertainty for crypto entrepreneurs and provide investor protections.
Potential Benefits:
✅ Legal clarity—crypto companies would know how to raise funds legally.
✅ Investor protections—limits on non-accredited investors would reduce risk.
✅ Secondary market rules—tokens could trade under defined rules after issuance.
✅ Prevention of "regulation by enforcement"—reducing SEC lawsuits.
Challenges to Implementing It:
🚧 SEC’s resistance—they want crypto firms to comply with existing securities laws.
🚧 Need for Congressional action—similar to how the JOBS Act authorized Reg CF.
🚧 Lack of enforcement mechanisms—ensuring compliance with a crowdfunding-style model would require robust oversight.
4. What Needs to Happen for This to Become Reality?
For a crypto crowdfunding framework to exist, one of the following would need to happen:
1. Congress Passes a New Law
A new "Crypto JOBS Act" could create a Reg CF-style exemption for crypto startups.
This would provide a clear legal pathway for token offerings with investor protections.
However, Congress is divided on crypto regulation, making this unlikely in the near term.
2. The SEC Issues a New Exemption
The SEC could create a Reg CF-style exemption for crypto through rulemaking.
However, under Gensler, this is unlikely, since he believes existing securities laws already apply.
3. Another Regulator Steps In
The CFTC or a new digital asset regulator could create a crowdfunding-style rule for crypto.
Some bills in Congress (like the FIT 21 Act) propose a new framework, but they are not yet law.
Conclusion: It’s Possible, But Unlikely Without Congressional Action
Applying a Reg CF-style framework to crypto makes sense and could resolve uncertainty, but political and regulatory resistance make it unlikely in the near future. The SEC has taken a strict enforcement approach instead of crafting new rules, and Congress has not yet acted to create a clear pathway.
For crypto fundraising to benefit from crowdfunding-style rules, Congress would need to pass a law, just like it did with the JOBS Act. Without that, the SEC is unlikely to create such an exemption on its own.