United States: RFIA Seeks Crypto Clarity And Consumer Protection

With more investors participating in cryptocurrency markets, the need to clarify and modernize the rules governing digital asset trading, buying, selling, and taxation has become ever more pressing. Senators Cynthia Lummis (R-WY) and Kristen Gillibrand (D-NY) responded earlier this month by introducing the Responsible Financial Innovation Act (RFIA) as a measure to protect consumers, brokers, financial institutions, coin issuers, investors, and other market participants. RFIA would expand the Commodities Future Trading Commission's (CFTC) purview into the crypto asset sector and update Securities and Exchange Commission (SEC) parameters for regulating and taxing digital assets. The bill would distinguish between crypto "ancillary" assets to be overseen by CFTC, and crypto "securities" which, like stocks and bonds, would fall under the SEC's jurisdiction. Other provisions contained within RFIA would include consumer protection reforms, clearer definitions of "broker" and decentralized autonomous organizations (DAOs), and more.

Our previous article on this topic explored the bill's key legal definitions, the cryptocurrencies that would be regulated as commodities, taxation de minimis for certain sales of digital assets, and how the Act seeks to avoid the stablecoin conundrum. Here, we will discuss additional RFIA provisions such as brokers' roles, information disclosure, consumer protections, and DAOs.

Brokers and Selling Crypto Assets

Section 202 of RFIA narrows and clarifies the definition of a "broker" within the crypto asset space as "any person who (for consideration) stands ready in the ordinary course of a trade or business to effect sales of digital assets at the direction of their customers." It would amend the definition included in the Internal Revenue Code of 1986 and the Infrastructure Investment and Jobs Act that some have interpreted as including transaction administrators and facilitators.

The definition of "broker" excuses many employees from reporting and fiduciary responsibilities. Only people who perform the traditionally understood activities done by brokers (i.e., effecting trades for retail clients) and earn compensation by connecting crypto sellers with buyers would be subject to taxation of income accrued through these duties. Crypto miners, buyers, and other participants would not be taxed on their investments until they are converted to cash.

RFIA reforms how brokers can sell cryptocurrencies in the marketplace, requiring the reporting of certain information on digital assets. In mandating custody procedures, RFIA would require the SEC to adopt amendments to Rule 15c3-3 (the "Customer Protection Rule") under the Securities Exchange Act of 1934 to permit broker-dealers to take custody of digital assets for customers. If ultimately enacted, RFIA would provide a meaningful and long-awaited path for broker-dealers to maintain custody of digital asset securities.

Digital Assets Safe Harbor Trading Provision

Currently, non-US citizens who trade stocks, securities, and commodities—even when using a domestic agent—are not subject to domestic taxes because their activity is not considered as being conducted within the country. To extend this protection to cryptocurrency investors, RFIA carves out an exception for digital assets. The introduction of a "safe harbor" provision for non-Americans who sell digital assets allows non-US traders without US-based offices to use a domestic financial institution to conduct their trading activities.

Section 203 creates this trading "safe harbor" exception under section 864(b)(2) which covers commodities and securities trading. Non-US based traders would not be considered conducting business "within" the US for purposes of taxation as long as they are customarily dealt with in the digital asset exchange. However, if the non-US trader does maintain a US-based office or a fixed place of business, this provision would not apply because the exchange would occur on US soil and therefore be taxable.

Consumer Protection Provisions

If enacted, the bill will provide additional protection provisions for consumers. As cryptocurrency has become more popular and mainstream, many have bought often-volatile digital assets based on incomplete and incorrect information or understanding of the risks involved. When these digital assets collapse, as occurred with Terra/UST stablecoin, millions of dollars of collective consumer capital can be wiped out. Crypto markets carry inherent risks, so consumers must have sufficient information and disclosures to help them make educated and informed investment decisions. RFIA Section 505 would require suppliers of digital assets to clearly disclose information about their product in customer agreements, including a discussion of investment risk, applicable fees, redemption procedures, digital asset treatment in bankruptcy actions, and more.

RFIA's consumer protections extend beyond brokers and sellers. The bill also would require customer disclosure requirements from digital asset service providers, which would include digital asset intermediaries and financial institutions as defined by section 1a of the Commodity Exchange Act (7 U.S.C. § 1a). The legislation further requires that any person conducting digital asset activities pursuant to a federal or state charter, license, registration, or other similar authorization would need to be disclosed. Additionally, the Act requires the SEC to complete its Custody Rule (17 C.F.R. § 240.15c3-3) and Consumer Protection Rule (17 C.F.R. § 275.206(4)–2) within 18 months of enactment. The new rules would need to account for the regulatory changes in custody practices, digital assets, broker-dealer practices, changes in market structure, technology, and parity of state and national banks.

The legislation closely follows other emerging approaches to crypto market regulation, such as the European Union's proposal for governing markets in crypto-assets, and amending Directive (EU) 2019/1937 (MiCA). It imposes similar mandates on token issuers, brokers, and other market participants as RFIA.

Decentralized Autonomous Organizations

The legislation also includes provisions for decentralized autonomous organizations. These entities are relatively new phenomena but are becoming increasingly popular. There are some 4,000 DAOs with over $8 billion in assets in the US, with the majority organized in Wyoming and the Marshall Islands. These entities have become power players in the crypto and NFT spaces.

RFIA attempts to "mainstream" DAOs, at least for the purposes of categorizing them in the IRS tax code. The Act specifies that certain DAOs constitute business entities for taxation purposes. These entities must be properly organized or incorporated under a state's DAO statute. Under the law, DAOs can be structured as an LLC, corporation, partnership, foundation, cooperative, or similar organization.

Going Forward

RFIA has the potential to reform the digital asset marketplace within the US by bringing long-overdue government regulation and clarity to the space. If signed into law, its provisions would be rolled out within certain time frames—not overnight. Some of the tax revisions would go into effect from December 31, 2022, while others would not take effect until 2025. Until then, RFIA will have to overcome the hurdles of congressional committees in order to eventually become law. This gives industry participants time to plan their strategies for dealing with increased regulation and to consult an attorney experienced in the space to reduce their tax burden and ensure they comply with the new rules on disclosure.

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