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Technologies May Change, but Fraud is Fraud

The global financial industry needs to speed up its fraud detection through analytics

By: Thomas Lee, Senior Writer at SharesPost

We have a tendency to think we live in unique times, that the introduction of new technology forever changes things.

But strip away the bells and whistles and we find that human behavior remains the same, especially when it comes to financial markets. Investors want to make money, sometimes illegally.

So calls for the Securities and Exchange Commission to craft new rules specifically for cryptocurrencies largely misses the point. The laws that have successfully governed our markets and protected investors for more than 80 years don’t change just because the technology does.

“Whatever you call the underlying instrument or interest, fraud is fraud,” Troy Paredes, a former SEC Commissioner under Presidents George W. Bush and Barack Obama, recently told me. “If it’s a security and there’s fraud, the SEC has an obligation to act.” Paredes now runs Paredes Consulting firm in New York.

The cryptocurrency industry has been calling for the SEC to issue guidance that offers broad clarity on what constitutes an utility token, which allows the user to exchange for a service or perk, and security token, in which the holder expects a financial return, and thus subject to SEC regulation.

Without such guidance, the industry warns, the cryptomarkets will continue to be volatile. But be careful what you wish for.

Crypto investors may crave certainty but for the SEC to quickly push out new rules will only hurt the industry, not help it. If the SEC decided this is a utility token and this is a security token, then the agency would just box itself into a corner.

For example, a token might start as utility, in that it grants the user access to certain services on the Blockchain, but then becomes a security once it gets traded on the secondary market. In other words, a holder might initially buy a token to exchange for a service but then decide to sell it to another investor for profit.

What’s more desirable, the SEC issues rules now only to entirely scrap them a year later because they were wrong? Or a thoughtful, gradual approach that allows the agency to adjust accordingly should circumstances demand it?

There’s something much larger at stake here. Since Congress passed the Securities Exchange Act of 1934, which created the SEC, the capital markets in the United States have been the best in the world. Why?

It helps to have the world’s largest economy. But China is the world’s second largest economy yet even its own companies like Alibaba choose to go public in America.

Investors prefer U.S. financial markets because we operate under the rule of law, a system that’s both transparent and consistent. Investors park their cash in America because they trust our markets. We don’t swap our foundational principles for short term convenience and fleeting investment opportunities.

Messing with a system that has served so well is unwise. There will always be new technologies like cryptocurrencies and Blockchain. And then there will be something else. Should the SEC keep creating new rules to suit these technologies?

Some critics warn that the United States risks falling behind the rest of the world in cryptocurrencies and Blockchain. They point out Japan, which has been more permissive of coins and tokens. But Japan has also experienced some big growing pains.

In 2014, crypto exchange Mt. Gox filed for bankruptcy after disclosing that 850,000 Bitcoins suddenly disappeared, probably stolen. And last January Coincheck said hackers stole more than $500 million worth of NEM coins.

People often forget the point of financial regulation is to not only promote stable markets but also fight fraud. Focusing on investor protection helps the SEC stay focused on its core mission and not get distracted by flashy new terms and technologies.

In early April, SEC chairman Jay Clayton attended a conference at the University of Chicago when a person asked him about things that surprised him so far about the job.

The amount of fraud with initial coin offerings and penny stocks, Clayton said.

Clayton probably sounded like he was equating ICOs with penny stocks. Combined with a recent SEC penalties against shady Blockchain and digital coin outfits, some people predicted the SEC would adopt a hard stance against the industry.

However, Clayton was not making a wholesale judgement on ICOs so much as a general observation about human behavior. Whenever someone has introduced a new financial innovation, bad actors have tried to cheat investors.

Take penny stocks. You could argue that penny stocks and the online exchanges that trade them were an innovation in the sense that it added liquidity in the market and allowed a greater portion of the public to invest in companies. But over time, people ultimately committed a great deal of fraud with penny stocks, forcing the SEC to act.

Technologies may change. But fraud is fraud.

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