One part of the rule would prevent venture capital firms from seeking indemnification from the funds they manage for any losses related to a governmental investigation or a lawsuit.

We think this is a bad idea.

Why? For one, these arrangements are negotiated by sophisticated investors with superior information and market power.  They've determined that indemnification incentivizes the behavior they want from their venture capital funds: taking smart risks and helping portfolio companies to succeed.  (Who would serve on a board of directors without it?) These investors are nowhere near the top of the list of those in need of the SEC's protection.

So why is the SEC pursuing this change?  Hard to say, but I wanted to underscore one observation from our letter that's directly relevant to crypto—which wasn’t mentioned in the rulemaking, but could be affected nonetheless.  We wrote:

For venture capital funds that invest in digital assets, it is difficult to decouple these proposed prohibitions from the SEC’s review of the industry. . . .

[T]he combination of evolving regulatory guidance, increased SEC enforcement, and this proposed ban on adviser indemnification for government investigations, might have the foreseeable consequence of dampening venture capital investment in crypto (as well as in other areas where regulation is uncertain).

This would not be a positive development.

We believe that having experienced venture capital investors involved in the crypto industry and other nascent fields is a constructive force—tending to increase companies’ focus on consumer protection, risk mitigation, legal compliance, and other important public policy goals.

To spell this out a bit more: the rule, if enacted, would cause venture capitalists to think twice about investing in crypto projects—or any project in an area of regulatory uncertainty—because the VC would no longer have the indemnification safety net in case of a government investigation or a private lawsuit (at the same time the SEC has promised greater enforcement in crypto). Some investments might not happen at all.

This would hurt companies working in this area, not just because they'd miss out on U.S. investment dollars, but on the experience of VCs who have seen a lot of the issues they're facing over many years.

And it'll certainly hurt VC investors—the very people the SEC is purporting to protect—because they won't have exposure to a wide swath of potentially successful companies.

We urged the SEC to pull these provisions from the proposed rule. Let's hope they do.

While many folks I respect took this as a good sign, or even a win…

https://twitter.com/RepTomEmmer/status/1523703436478656514?s=20&t=bKyYkEY88-ES1lmYushqFQ

https://twitter.com/LeXpunK_Army/status/1523681958014128128?s=20&t=15rdqR4PVv1dv8TYjyQ6YA

…I’m not so sure.

While I hope the SEC extended the comment period to give the potentially affected class(es) a better opportunity to weigh in, it is just as likely that the Commission’s lawyers convinced leadership that a 30-day comment period would hurt them in the lawsuits that will inevitably come. In other words, this move diminishes an argument that the rules’ opponents could use in court.

This is OK. Good government sometimes comes from litigation pressure.

Importantly, the move didn’t eliminate the most potent good government argument against the exchange rule -- the fact that the proposal doesn’t mention crypto at all, depriving the industry of the opportunity to comment (and the SEC of the opportunity to grapple with important crypto-specific questions). As @xethalis and I say in our comment letter:

This comment focuses on what the proposal does not discuss: whether the SEC intends the phrase “communication protocol systems” to cover computer code deployed on a blockchain (or the people who deploy or maintain that code), which computer code may allow users to purchase, sell or otherwise transact in cryptographically-secured digital assets without an intermediary. Given its recent intensive focus on digital assets and their regulation, it would be surprising indeed if the SEC and its staff had not considered these questions in depth—and had not developed a view on their answers—before the Commission voted, but there is not a whisper of the SEC’s intentions on this topic in the proposal’s 650-plus pages.

Bottom line: the proposal fails to give clear and specific notice to a potentially regulated class, and, as a result, it fails to grapple with the legal and practical issues that would arise if the SEC intended to regulate that class. The SEC has been criticized for pursuing a strategy of “regulation by enforcement” over crypto. While that may be somewhat unfair, particularly given the difficulty of regulating a space as fast moving and varied as crypto, we should not add “regulation by surprise” to the complaints—especially when we are on the cusp of a national crypto strategy that should guide regulation in this area.

Takeaway is that the a comment period’s extension is not necessarily a win.