Nigeria’s Securities and Exchange Commission (NSEC) recently announced its intention to study the adoption of fintech and crypto. That is a welcome development. Nigerians are, after all, the highest users of cryptocurrency on a per capita basis. Foreign investors are pouring money into Nigerian fintech companies. The benefits of the industry to the Nigerian economy are widespread and substantial. All the more reason for regulatory clarity.
In other ways, however, the announcement was troubling. For one, it was bereft of specifics. For another, the announcement felt like déjà vu all over again – after all, NSEC adopted a roadmap for fintech regulation two years ago and, with the exception of a few announcements here and there, there has been little mention of the roadmap since it was announced in 2019.
The main concern, however, is the substantial risk that Nigeria will not see cryptocurrency for the opportunity it presents, and will instead seek to restrict and overregulate it. There are several troubling portents, all of which lead to the conclusion that Nigeria’s regulators are determined to thwart any potential challenge cryptocurrency might pose to its fiat currency, the naira. For example, the Central Bank of Nigeria has directed banks not to facilitate transactions in cryptocurrency. NSEC has followed in the footsteps of the CBN, decreeing that all crypto assets are presumed to be securities, and charging crypto companies with the burden of demonstrating otherwise. In neither case has there been any real analysis as to why, or more importantly whether, all crypto assets should be deemed to be securities. This all feels a little bit like the Queen’s proclamation from Alice’s Adventures in Wonderland: “Sentence first – verdict afterwards!”
It does not have to be this way. As Jude has argued elsewhere, Nigeria has the opportunity to conduct a comprehensive review and overhaul of its securities law, one that “leapfrogs” creaky and outdated regulatory systems to one that is nimble and future oriented. And when we say creaky and outdated, we are looking at you, America.
America’s securities laws began with the best of intentions. Passed in the wake of the 1929 stock market crash, these laws – the 1933 Securities Act, the 1934 Securities Exchange Act, and the 1940 Investment Company Act – cracked down on abuses retail investors suffered at the hands of unscrupulous promoters. These abuses were amply documented in hearings by the Pecora Commission, named for Ferdinand Pecora, the Chief Counsel of the U.S. Senate’s Senate Committee on Banking and Currency. (Pecora subsequently became one of the first commissioners of the Securities and Exchange Commission, and his book Wall Street Under Oath detailing the Commission’s findings is required reading for anyone interested in securities regulation.)
The ‘33 Act defines a “security” very broadly. Its breadth is deliberate, intended to guard against the sophistry of well-heeled financial firms and their counsel. Accordingly, it includes not just commonly understood terms such as stocks and bonds, but also more amorphous terms such as “investment contracts.” In the seminal case of SEC vs Howey, the Supreme Court defined an investment contract as consisting of four elements: (1) an investment of money; (2) in a common enterprise; (3) with the expectation of profit; and (4) to be derived from the efforts of others. If, as in the Howey case itself (which involved the sale of citrus groves to passive investors by the company and the cultivation and sale of the fruit by the company), the financial activity meets all four requirements, it is considered an investment contract. And, therefore, a security subject to the registration, disclosure, and anti-fraud strictures of the securities laws.
Howey remains good law, and its analysis has been extended to a myriad of other business ventures. From our perspective, that is precisely the problem. The extension of Howey to new, innovative products purports to provide clarity, but instead introduces uncertainty and regulatory bias, two things inimical to the development of nascent industries. This is particularly true as it pertains to cryptocurrencies. Consider these recent examples:
- SEC sued Ripple last year for conducting what it deemed to be unregistered securities offerings of its XRP token. In contrast, the SEC has indicated that it considers Bitcoin and Ether, major competitors of Ripple, not to be securities. The SEC’s position appears to be that Bitcoin – and potentially Ether as well – was a security at one point, but is not now. But so far it has refused to identify that precise moment in time at which Bitcoin transmuted from a security to something else.
- Coinbase recently announced that the SEC is considering suing it for its proposed “Coinbase Lend” program. However, as Coinbase points out, other cryptocurrencies with similar programs have not been targeted by the SEC.
- The U.S. Senate’s recently passed infrastructure bill was nearly derailed by a provision its opponents contended would have subjected retail investors to unfeasible know your customer (KYC) provisions.
The SEC claims that the rules are “awfully clear” on crypto. But as the above examples indicate, the opposite is the case. As one commentator has remarked, “[y]ears of SEC speeches, public statements, meeting records, correspondence and first-hand accounts from market participants provide anything but clarity for the rules on digital assets or distributed ledger technology (DLT) projects.”
This regulatory uncertainty is exacerbated by jurisdictional skirmishes between regulators, a phenomenon occurring with increasing frequency as the distinctions between securities, commodities and other financial products become increasingly blurry. The infighting last occurred in the 90s when the Commodity Futures Trading Commission (CFTC) and the SEC could not agree on which of them had authority over securities futures. The CFTC argued that the investments were futures within the exclusive jurisdiction of the CFTC; the SEC argued that the contracts were securities within its exclusive jurisdiction. The agencies went to court to resolve the question. As the dispute raged, financial institutions argued that America was in danger of losing the competitiveness battle to foreign financial centers. The situation was resolved only when the two regulatory agencies entered into an agreement – jurisdiction over securities-based options was granted to the SEC, jurisdiction over future (and options thereon) on government securities to the CFTC, and trading in futures (and options on futures) on single corporate and municipal securities was prohibited.
“History does not repeat itself. But it rhymes.” The emergence of the crypto industry has reignited these inter-agency disputes. The current SEC Chair, Gary Gensler, stated last month that stock tokens and stablecoins are securities. The very next day, a CFTC Commission countered by tweeting “Just so we’re all clear here, the SEC has no authority over pure commodities or their trading venues, whether those commodities are wheat, gold, oil….or crypto assets.” The U.S. House Committee of Agriculture – which has oversight over the CFTC – retweeted the CFTC Commissioner’s post, adding that “#crypto is bigger than the SEC” and urging Congress to “write the rules… to protect investors AND innovation in the digital economy.”
How did we arrive at such a sorry pass? We believe the problem lies with the 1933 Act’s overbroad definition of “security,” which, combined with associated disclosure and registration requirements, subjects financial innovation to excessively strict standards. This regulatory overreach has merely swapped one set of risks for another – in its zeal to protect retail investors from unscrupulous promoters (and from themselves), the SEC has tilted the playing field in favor of sophisticated investors and to the detriment of ordinary investors. Equity crowdfunding, for instance, is a recent innovation that offers retail investors and resource-challenged entrepreneurs alike a means to participate in the capital markets. The SEC, however, has been very stingy in permitting crowdfunding, imposing limitations on how much retail investors can spend and requiring entrepreneurs to raise funds through a portal that is registered and has other complicated compliance requirements that undercut the raison d’etre of crowdfunding. The same is true with respect to private, exempt securities offerings – as a practical matter, only wealthy investors can participate. And you see this dynamic at play again with rumblings about the SEC banning payment for “order flow,” which threatens to adversely affect the zero-fee trading feature popularized by Robinhood and that is responsible for so many retail investors coming into the market.
The net effect of the above is that retail investors believe the system is rigged against them and in favor of the wealthy. And that is precisely the appeal of cryptocurrencies. Anyone can trade. The markets are on 24/7. And for all the real concerns about the volatility of cryptocurrencies, in Nigeria and other African countries the risk runs exactly the other way. Nigerians are investing in crypto as a hedge against volatility. One popular meme on Nigerian social media shows that in the 1980s, $1,000 dollars cost 546 naira. Today, that same amount of naira will purchase only $1. To underscore the point, this CoinDesk article from March notes that low-income Nigerians are turning to dollar-backed stablecoins as an inflation hedge.
Small wonder, then, that Nigerians have jumped into crypto with both feet. And, despite all the roadblocks erected by the government, Nigerians are resolute in their commitment to crypto. It is time, then, for the Nigerian government to echo the apocryphal words of a French politician and say “There go my people. I must find out where they are going, so that I can lead them.” The whack-a-mole strategy will not work. The government bans the use of bank accounts and Nigerians revert to peer-to-peer transactions; it bans the use of Twitter, and Nigerians resort to VPNs. And the cat and mouse game continues, ad infinitum. And in this game, Nigeria’s citizens have the distinct advantage – their median age is 18, and they are all digital natives.
We readily acknowledge that Nigeria is taking some tentative steps in the direction of financial innovation. We applaud, for instance, the recently-announced initiative to establish a central bank digital currency (CBDC), the e-naira. This is a great step, as it addresses one of the main challenges of private decentralized digital currencies – interoperability.
But we think Nigeria (and, by extension, other countries in sub-Saharan Africa) can do even more. Consider the African Continental Free Trade Agreement (AfCFTA), to which Nigeria and 53 other African countries are signatory. The World Bank estimates that AfCFTA will boost regional income by $450 billion, boost wages for women, and lift 30 million people out of extreme poverty by 2035. A key component to accomplishing this objective will be the development of payment rails that facilitate trade within the continent. This, in turn, is exactly the kind of use case for which crypto, and more generally blockchain, is tailor made. Another is lowering the cost of Diaspora remittances to Africa (in the interest of disclosure, Jude is working on a blockchain-based project that combines remittances with a pooled investment vehicle for investment in Africa-based projects).
So how might Nigeria follow its citizens, and also thereby lead them? By rejecting America’s overbroad, confusing, and balkanized regulatory structure in favor of one that is simpler, nimbler and more encouraging of innovation. In plain language, this means less of a focus on protecting investors from themselves, and more of a focus on protecting investors from fraud. It means sidestepping the obsession with whether a particular financial innovation is an “investment contract” (or a commodity) and focusing instead on whether the promoters of said innovation – whatever it may be – have been open and forthright with prospective investors about the risks and rewards associated therewith. We note that the definition of “securities” in Nigeria’s 2007 Investment and Securities Act (ISA) does not include “investment contracts,” only the more typical references to stocks, bonds, commodities, futures and options. Under current law, therefore, it is hard to understand NSEC’s categorical position that cryptocurrencies are securities. There is a 2019 bill (not yet passed) to amend the ISA’s definition by adding “virtual assets issued or proposed to be issued to the public” and “Investment Contracts.” The bill does not define the term “Investment Contract,” but it seems safe to assume its authors intend it to apply as broadly as in the U.S. context.
For the reasons stated above, we urge NSEC not to go down this path. The irony is that U.S. lawmakers are headed in the opposite direction. The U.S. Congress is currently considering a bipartisan bill to exclude from the definition of a security “investment contract assets.” Such an approach would treat an Initial Coin Offering (ICO) as an offering of securities; but the underlying tokens themselves, like the orange groves in Howey, would not themselves be considered securities. This would then distinguish so-called “utility tokens,” governance tokens, and newer innovations like NFTs from tokens or other instruments used to raise capital. We commend this approach to NSEC in the event it considers a complete carveout of investment contracts a bridge too far.
We also urge Nigeria to adopt a “both/and” rather than “either/or” approach to innovation. CBDCs and private cryptocurrencies are not necessarily in conflict. In fact, we believe they are complementary: Private cryptocurrencies can piggyback on CDBCs such as the e-naira to build their own products. And as these products gain currency in the marketplace, and outside investment follows, the naira’s value will strengthen. Accordingly, regulators ought to be open-minded and avoid crowding out the private crypto-currencies or stifling them in the name of regulation.
Associated with the above is the concept of a regulatory sandbox. The earlier working group recommendations already mentioned this, but it bears repeating. We know that the Nigerian government is concerned, and with some justification, about the risk that widespread adoption of cryptocurrency will turbocharge fraud and illicit transactions. We think the risk is overstated; if anything, recent developments in crypto ransom attacks have demonstrated the utility of cryptocurrency in tracing and thwarting crime. There is literally no place to hide when you move money on a public, immutable ledger that records and verifies every single transaction.
But we do not want to understate the risk either. Crypto scams are, indeed, proliferating in Africa. But this is very reason to implement a regulatory structure, the first component of which should be the regulatory sandbox. In said sandbox, NSEC and the banking authorities can assure themselves of, among other things, whether the promoters of the enterprise are sufficiently capitalized; if they have sufficient fiat reserves (in the event they offer stablecoins); if they implement rigorous KYC measures; and if they adopt stringent measures to deter hacking.
Further to the above, and to avoid inter-agency disputes of the sort that have plagued America’s regulators, we recommend that NSEC combine its regulatory sandbox with one recently implemented by the CBN. The need for a harmonized regulatory system cannot be overemphasized. Accordingly, in addition to combining regulatory sandbox efforts, NSEC and CBN should coordinate with Nigeria’s National Information Technology Development Agency (NITDA), which recently proposed a draft National Adoption Blockchain Strategy. We recommend that NITDA’s proposed framework provide the overall blockchain governance framework guiding the crypto regulatory environment.
In closing, we note this statement from the Fintech Roadmap of the Nigerian Capital Market’s April 2019 Final Report:
The [SEC] must be FinTech proactive by facilitating responsible policy that balance financial innovation and investor protection, with a view to optimizing the value offerings of FinTech in the [Nigerian capital markets] and the Nigerian financial ecosystem whilst keeping abreast of FinTech developments globally.
We agree completely with this sentiment. The recommendations set forth above will, in our humble opinion, go a considerable way towards achieving that balance. We encourage Nigeria’s regulatory agencies to seize this unique opportunity and customize the regulatory environment with an eye to the future rather than a blind obeisance to the past. Doing so will catalyse Nigeria’s economy and ensure the country takes its rightful place in the vanguard of nations prepared to reap the rewards of 21st century innovation.
Jude Chidi Ogene is the Founder & CEO of Charles Winnsboro, a strategic advisory firm focused on infrastructure development in sub-Saharan Africa. Jude also serves as senior counsel at Sterlington, PLLC, a virtual law firm specializing in high-end transactional and litigation matters. Jude has a combined JD/MBA from Georgetown University, an LL.B. from the University of Nigeria, and a certificate in Blockchain Strategy from Oxford University. He qualified to practice law in Nigeria, New York, and Washington, D.C.
Rotimi Ogunyemi is an Information and Communications Technology (ICT) Attorney with years of critical experience in commercial legal practice and core expertise in handling legal issues relating to ICTs. He is an Adjunct Faculty Member of ICT Law, Policy & Regulation at the Nigerian Communications Commission’s Digital Bridge Institute and has facilitated International Telecommunications Union (ITU) Courses on ICT Law & Policy. He is Co-Chair of the Digital NBA (Nigeria Bar Association) and Chair of the ICT Committee, NBA Section on Business. Rotimi is the Managing Partner at Bayo Ogunyemi & Co (a member of Johnson & Wilner LLP, Technology Lawyers) based in Lagos & Abuja, Nigeria.