A new rating program developed with help from the financial technology practice at O'Melveny & Myers may help companies trying to stay on the right side of U.S. securities laws in the rapidly developing cryptocurrency industry.

The Crypto Rating Council, a group of cryptocurrency financial services firms that came together to create the compliance resource, announced its creation last month. It is composed of digital asset companies and trading platforms Coinbase, based in San Francisco, which spearheaded development of the system, and Anchorage, Bittrex, Circle, Cumberland, Genesis, Grayscale and Kraken. The rating system was developed with the input of these companies and their technical experts and in-house and outside legal teams, including O'Melveny.  

"When you don't have a clear sense of how something is classified, it is difficult to figure out from a client perspective what you need to do," said Eric Sibbitt, an O'Melveny partner and chair of its financial technology practice group who was among the advisers to the CRC in devising and applying the new rating system. "Clients are trying to build the next big thing and it increases the cost and risk associated with compliance." Sibbitt is not a spokesman for the CRC, however, and his comments are his own, he said.

The Crypto Rating Council scoring system on a scale from one to five is meant to provide the nascent industry with a standard for determining whether a digital asset is more likely or less likely to be viewed as an investment contract under U.S. federal securities laws. Under the scheme, a "one" score means "an asset has few or no characteristics consistent with treatment as a security" and a "five" means that the asset "has many characteristics strongly consistent with treatment as a security."

More organizations are developing rating systems for digital assets in an effort to introduce some self-regulation into the industry. The CRC's debut comes as the U.S. Congress has been scrutinizing Facebook's Libra cryptocurrency and efforts are stepping up to create a comprehensive regulatory scheme in the U.S. and elsewhere. Companies and individuals have complained that the U.S. is lagging behind some other countries, hampering the development of the industry here and causing some U.S. companies to relocate to Europe and Asia to localities with more regulatory certainty.

On Thursday, the Commodity Futures Trading Commission, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Securities and Exchange Commission issued a joint news release announcing they are joining the Global Financial Innovation Network launched in January 2019 by an international group of financial regulators and related groups with the intent of creating a global framework for cooperation between financial services regulators on innovation-related topics.

The U.S. Securities and Exchange Commission also has been trying to clarify the application of existing securities laws to cryptocurrencies in recent months, including issuing guidance in April 2019 describing a framework for deciding whether federal securities laws apply to the issuance and sale of digital tokens and cryptocurrencies. The guidance provides a means of analyzing whether a cryptocurrency or digital token should be regulated as a security, citing the so-called Howey test, based on a 1946 U.S. Supreme Court decision SEC v. W.J. Howey Co. 

The CRC members select assets for review, and their outside counsel performs a review based on the SEC's Howey test. The CRC review includes a study of the asset's history and developer team materials, its related blockchain and other factors. Counsel creates a summary memo and uses the framework to produce a score. Members' own legal teams then vote to adopt or revise the score, and then it is published to the council's website. Scores are subject to change without notice, according to the CRC website.

"The Crypto Rating Council is an effort to apply some of the guidance the SEC has provided through speeches and rulings to help participants to decide if there is some activities have more or less risk associated with them," Sibbitt said.

Coinbase CLO Brian Brooks has stated on Twitter that the CRC is "not providing legal advice" and that the council says so on its website.

The CRC, however, is not without critics. Some cryptocurrency executives have said in published remarks that they believe the attempt at self-regulating could lead to even more confusion in the cryptocurrency markets.

But Sibbitt said the CRC could be helpful for companies trying to stay lawful as they innovate. "Regulators have become increasingly more sophisticated and increased their understanding of the nature of these assets. But it is still a world where a lot of the guidance is from looking at an enforcement action, or what people have said in a speech. It is almost like old-school Kremlinology where people are trying to interpret the words as to what it means in terms of what regulators are thinking. Additional clarity would be welcome."

Read More: