The SEC Came to Destroy Crypto, Not to Regulate It

By Roslyn Layton. (DC Journal). April 3, 2024.

Following the Securities and Exchange Commission’s effort to stretch, bend and twist the law to grant itself authority to regulate cryptocurrencies has been like watching an exhausting video game. By the last level, the monster has grown so grotesque and ridiculous that you’re just waiting for the relief of seeing it explode so the comforting words “game over” can finally appear.

Unfortunately, it’s not a game for many innovative U.S. Financial Tech companies. The SEC has mobilized all its resources to carry out a policy against crypto companies that is not designed to protect investors from fraud or even to clarify what legal compliance means. It is practicing what professor J.W. Verret of George Mason University has called “enforcement by destruction,” trying to turn courts into execution chambers for an industry it never intended to regulate but to destroy.

It comes down to a bait-and-switch strategy by two successive SEC chairmen to claim that every digital asset, no matter how it is designed, is itself a “crypto asset security,” and that gives the agency full authority to require they be registered like stocks. Nothing in nearly a century of securities law provides the SEC such all-encompassing authority over an entire asset class. But the SEC’s strategy was never to prove this theory in court so much as to have a pretext to launch enforcement actions never meant to bring anyone into compliance.

Read the full piece here: DC Journal

The SEC Is Engaging In Regulation By Destruction

By J.W. Verret. (Law360). April 1, 2024.

The term “regulation by enforcement” was coined in 1990 by Harvey Pitt in his days as a Yale law professor, about a decade after he served as general counsel of the U.S. Securities and Exchange Commission and before he became chair of the SEC. The warning was eerily similar to President Dwight D. Eisenhower’s farewell address cautioning about the growth of the military-industrial complex.

Regulation by enforcement has become manifest in the SEC’s approach to the emerging technology of cryptocurrencies, using lawsuits instead of rulemaking to claim that all digital assets are unregistered securities and fully under the commission’s authority.

Pitt’s term doesn’t fully capture what the SEC’s strategy on crypto has evolved into: “Enforcement by destruction” is more apt.

There is a lengthening docket of SEC lawsuits over unregistered crypto-asset securities, where no fraud was alleged and there has been no evidence of harm to investors.[1] Some of the SEC’s chosen defendants don’t have the resources to properly fight the allegations, and must choose between surrender or bankruptcy — and may end up with both. And those that do, like Ripple Labsface nearly $2 billion in fines from the SEC.

Private litigators understand spurious claims can be an effective means of drowning a defendant in legal costs even for meritless litigation. The SEC’s apparent adoption of this tactic has come to dominate its enforcement actions alleging failure to register crypto-asset securities.

It knows it may lose on the merits of its claims, as it did for most of the claims in the Ripple case, but is seemingly betting that the financial harm of prolonged litigation will far outweigh an eventual fine and the defendants will fold. The SEC gets a victorious press release, but the markets get no clarity on what compliance actually means.

The SEC could have easily provided that clarity by granting Coinbase‘s 2023 petition for a crypto rulemaking from the commission after the company received a Wells notice a year ago, but the SEC has stubbornly refused to take up the request, which is now before the U.S. Court of Appeals for the Third Circuit.[2]

The SEC’s apparent shift to destruction as a tactic was evident in its 2022 lawsuit in the U.S. District Court for the District of New Hampshire against LBRY, which built a blockchain-based content platform seeking to be a decentralized and uncensored version of YouTube. The SEC said LBRY’s distribution of the LBC token, a form of user credit on its platform, was an unregistered securities offering. The company decided to fight in court without the financial heft to mount a strong defense.

By the time LBRY later went bankrupt and shut down during the remedies phase, the SEC had reduced the fine it was seeking from $22 million to a mere $111,614. This provoked a public dissent by SEC Commissioner Hester Peirce, who questioned the proportionality and fairness of causing “the demise of a company” in a dispute over registering a token.[3]

“This case illustrates the arbitrariness and real-life consequences of the Commission’s misguided enforcement-driven approach to crypto,” Peirce said.

In my own review of settlements obtained between 2019 and today where the SEC simply alleged unregistered offerings of crypto-asset securities, the civil penalties it ultimately collected averaged 11.6% of the alleged unregistered sales. If no investors were defrauded or harmed in any of these cases, what was the point of threatening these companies with destruction if they opted to defend themselves?

Unlike LBRY, Ripple had the resources to fight the SEC’s allegation that all sales of its XRP digital token, even on public exchanges, are unregistered investment contracts in Ripple. After more than three years in court, U.S. District Judge Analisa Torres of the U.S. District Court for the Southern District of New York in July 2023 found only a narrow set of actual investment contracts with institutional investors were unregistered securities, and dismissed the rest of the SEC’s claims.

Ripple is now eight months into the remedies stage. The SEC also promises to appeal Judge Torres’ ruling despite it being narrowly tailored to facts and circumstances and not setting any precedent. Brad Garlinghouse, Ripple’s CEO, said in December 2022 that the case has cost the company over $100 million so far, having long offered to settle in exchange for the legal clarity that Judge Torres ultimately provided.[4]

But the SEC on March 27 revised its demand to now nearly $2 billion in fines for those institutional sales where all the investors made money.[5] Actual regulation or useful legal clarity won’t be a result, since even if courts determine that some sales were of securities, the courts can’t fashion a workable registration regime for crypto. Only the SEC can do that. What results instead is just more legal costs.

Regulation by enforcement has always been an opaque process that fails to clearly define the rules or what compliance entails. The SEC’s use of it against digital assets indicates it’s more interested in causing harm to crypto companies than providing guidance to the markets or protecting investors.

The consequences of this shift are far-reaching. By pursuing this strategy, the SEC risks permanent damage to its authority and credibility for little reward. It also opens the door for financially secure defendants like Ripple to make arguments to appellate courts on wider questions of law, which could ultimately boomerang on the commission.

The more the SEC engages in enforcement by destruction, the higher the likelihood that its legacy will be one of undermining the very principles it is meant to uphold.


J.W. Verret is an associate professor at the George Mason University Antonin Scalia Law School. He is a former member of the SEC’s Investor Advisory Committee.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Good list here: https://www.morrisoncohen.com/insights/the-morrison-cohen-cryptocurrency-litigation-tracker. You will see a list of them starting on page 4, most do not allege fraud but only failure to register with the SEC.

[2] https://www.sec.gov/files/rules/petitions/2022/petn4-789.pdf.

[3] https://www.sec.gov/news/statement/peirce-statement-lbry-102723.

[4] https://news.bloomberglaw.com/business-and-practice/wall-street-veteran-is-the-face-of-crypto-in-ripple-sec-fight.

[5] See last week’s news at https://finance.yahoo.com/news/sec-ripple-well-positioned-pay-044615741.html.

Judge slams SEC for ‘gross abuse of power’ in crypto case, imposes sanctions

By Leo Schwartz. (Fortune Crypto). 3/18/24.

On Monday, a federal judge took the unprecedented step of imposing sanctions on the Securities and Exchange Commission related to a lawsuit the agency brought against the Utah-based crypto company DEBT Box in July.

The case drew widespread attention after the defendants accused the SEC of misrepresenting key facts when the agency obtained a temporary restraining order to freeze assets on the crypto platform. After U.S. District Judge Robert Shelby ordered the SEC to explain its actions, lawyers for the agency admitted the SEC had committed errors, but asked Shelby not to issue a formal punishment.

In Monday’s decision, Shelby denied the SEC’s request, citing multiple instances of “bad faith” conduct and finding the agency responsible for a “gross abuse of power.” In the 80-page filing, Shelby imposed a sanction in the form of a requirement for the agency to pay for DEBT Box’s attorneys’ fees and costs related to the restraining order. The judge also denied the SEC’s motion to dismiss the lawsuit without prejudice, which would have meant the agency could bring the lawsuit again at a later date.

“[The SEC’s conduct] substantially undermined the integrity of these proceedings and the judicial process,” Shelby wrote.

Read more here: Fortune Crypto.

Government’s Attack Vectors

By Kristi Warner

The government’s approach to remedies and bitcoin mining are similar examples of agencies utilizing tools at their disposal to attack the crypto industry. 

Remedies

In July 2023, the SEC lost in the Ripple case on the main legal theories – Judge Torres ruled that secondary market sales were not sales of unregistered securities and XRP itself is not a security. 

Individual XRP holders got their resolution.

Now the case is really at a point where institutional sales and remedies are the focus. The SEC utilizes remedies and reliefs in many cases, and the type of remedies asked for typically varies based on the type of litigation. 

In the Ripple case, the SEC after losing on the legal theories, and vindicating the two executives still wants the company to pay a lot of money in remedies so they can hold the company “accountable”, and right any wrongdoing. 

The irony is that the people the SEC are supposed to be protecting (you and me) were not harmed by any of Ripple’s actions. Instead, it was the SEC’s action that resulted in restricted access, delistings and actual harm to us. 

That is because the SEC has weaponized its authority in an attempt to destroy innovation. Thankfully what we have been seeing in a lot of the cases are ourts keeping the SEC in check. 

The American Government was designed to be a system with checks and balances between the three branches. 

So while I agree we can look beyond the SEC v. Ripple case, I still think lawsuits in general are important to pay attention to as they are key to keeping the government agencies accountable and allow the industry to fight back. 

Bitcoin Mining

Another recent example of this is the RIOT Platforms and Texas Blockchain Council suit against the Biden Administration in a Texas court

The backstory is the U.S. Dept. of Energy had decided to conduct an “emergency” survey of the energy use by crypto miners based on its own unwarranted assertion that mining is a threat to the power grid. Allegedly the agency threatened companies with criminal fines and civil penalties if they did not answer the survey. The survey was requested without proper procedure established by law including public notice and comment requirements.

Once again we’re faced with a government agency trying to sidestep the law and bully crypto companies into submission by misusing tools at their disposal.

Solution

How can we combat that? 

In today’s world one solution to maintain the system of checks and balances is heading to Court. That’s what RIOT and Texas Blockchain did and while it was not the exact relief they were seeking, the lawsuit forced the government to halt their survey and destroy the sensitive and confidential information they had already acquired through the survey. 

Same with Ripple – they exposed government overreach by fighting back against the SEC in court. 

These are both huge blows to the government’s war on crypto because when these agencies are committing government overreach, the courts are putting that power in check and forcing them to follow the law. 

Watch the full livecast here: https://www.youtube.com/watch?v=eQxoBShe2CI&t=2s

Gary Gensler’s Blundering SEC Mirrors Biden’s Incompetence

By Gerard Scimeca. (RealClear Markets). March 6, 2024.

Touting historically low approval ratings rivaling that of paper cuts and hay fever, one might think Joe Biden and his handlers cared enough about voter sentiment to address the more problematic areas of his administration serving to inflame his unpopularity. 

An obvious place to start would be to cut bait with the capricious, reckless, and rogue Chairman at the Securities and Exchange Commission (SEC), Gary Gensler. That Biden has yet to remove the haughty Gensler is an affirmation of all that is wrong with his presidency and the SEC itself, whose continued bungling has drawn the ire of millions of American investors. 

After 10 years of denials, last month the SEC approved a number of spot Bitcoin exchange-traded funds (ETFs), even as Gensler himself continued to denounce them. While the occasion represents a watershed moment for digital assets in the U.S., the approval was given grudgingly by a Commission boxed into a legal corner.

Read more here: RealClear Markets

To Restore the SEC’s Credibility, Appoint a New Chair

By Rep. Todd Tiahrt. (RealClear Policy). February 21, 2024.

Economic uncertainty is one of the top issues facing the country today. Many Americans have been forced to rethink their spending habits while concerns about job stability and fluctuating market conditions are leading families to focus more on savings and debt reduction as they prepare for potential financial challenges ahead.  

To guide the United States through this tumultuous period, it is crucial to have trustworthy and reliable regulators who can stabilize markets during a crisis and who will collaborate with American businesses throughout such instability. That is why it is difficult to comprehend why Gary Gensler remains President Joe Biden’s chair of the Securities and Exchange Commission (SEC). It is even a puzzle why President Biden selected him in the first place.

After a scandal-tinged tenure as President Barack Obama’s chairman of the Commodity Futures Trading Commission (CFTC), Gensler has led a series of gaffe-prone crusades against American companies as SEC Chairman with embarrassing results. A recent study found that most of the flurry of proposed and finalized rules under Gensler was not tied to any authority granted to the SEC by Congress. He has mostly freelanced, letting politics and press releases guide his actions rather than the letter of the law.

Read more here: RealClear Policy

Hinman Investigation: The Chance for the SEC to Get Something Right

By John E. Deaton.

It didn’t just take a village. It took an army of activists, lawyers and everyday citizens to demand, insist and even sue the Securities and Exchange Commission to be transparent. From the moment William Hinman got on that stage in San Francisco on June 14, 2018, to declare that Ethereum’s native token, Ether, is not a security, something just didn’t seem right.

Indeed, that speech didn’t appear on Hinman’s official SEC calendar. The SEC has also forcefully refused under several chairman – including current Chairman Gary Gensler – to ever prejudge the status of a digital token with one very glaring exception: Hinman’s speech on Ether.

After six years, many lawsuits and tens of thousands of messages flooding into Washington, we learned today that the SEC Office of the Inspector General (OIG) is “in the final stages” of an investigation into the clear appearance of impropriety and conflicts of interest around Hinman’s speech and his many actions as SEC Director of Corporation Finance. My further understanding is that the investigation will delve into how the SEC ethics staff handled Hinman’s documented actions, or failed to.

It started with hundreds of internet sleuths working together in what I call decentralized justice. We discovered quickly that Hinman’s annual financial disclosures at the SEC showed he was receiving millions of dollars in payments from his old law firm, Simpson Thacher. We also learned that Simpson Thacher was a member of the Enterprise Ethereum Alliance, a group with the sole purpose of promoting Ethereum. Dozens of videos were located that had Hinman and other SEC officials, as well as key investors and stakeholders in Ethereum, saying in their own words what was happening in front of the cameras and behind the scenes around what Hinman called “the Ether speech”. I put them all together in a Video Library on the CryptoLaw website, and the evidence of possible conflicts of interest took shape.

At the same time, the excellent legal team defending Ripple, Brad Garlinghouse and Chris Larsen against the SEC’s lawsuit on the XRP digital token were locked in a long discovery fight over getting the internal emails and drafts of Hinman’s speech. That took years because the SEC fought so hard to hide the Hinman documents, defying so many court orders to produce them, that Magistrate Judge Sarah Netburn called them out for their lack of “faithful allegiance to the law.” As amicus counsel for 75,000 XRP holders in that case, I couldn’t agree more with Judge Netburn’s conclusion.

In August 2021, the government watchdog organization Empower Oversight jumped into the fight, with Freedom of Information Act requests and lawsuits when the SEC refused to comply. It took them years to force the SEC to produce the emails that proved how Hinman fought to receive million in payments from Simpson Thacher. They showed he was warned repeatedly he had a “criminal financial conflict” if he ever had any contact with that law firm, and he ignored them.

The Hinman emails obtained by Empower Oversight show he met over and over with Simpson Thacher, including with the head of their China office – Chris Lin – when his client had a pending IPO application before his division. The emails also showed direct contact between Joseph Lubin, one of the highest profile third party promoters of Ether, and Hinman before the 2018 speech.

In May 2022, Empower Oversight sent a referral of evidence about these conflicts to the SEC OIG. For almost two years, the group has been requesting internal communications about that referral and has been locked in litigation with the SEC to get compliance with those requests. That’s why today’s news confirming the OIG investigation is so important, and such a vindication for the thousands of people who have worked so hard to make this government agency transparent and compliant with the law.

I will not prejudge the SEC OIG’s investigation, nor should anyone else. They have pledged to give a redacted version of their final report to Empower Oversight, which means it will be made public for us to review ourselves.

But one thing is very clear. We must have our ethics rules followed by public officials like Hinman. When they are not followed, the law must be enforced. America is greatest when we have a level playing field and we allow the best technologies and innovations to compete fairly. And we must always stand up against gross government overreach.

This is the chance for the SEC to get something right for once. I hope the OIG issues a complete, fair and well-reasoned report which shows the kind of faithful allegiance to the law that the SEC Enforcement Division and Division of Corporation Finance have clearly failed to show to date.

Stop Ignoring the SEC’s Malfeasance on Crypto

By Roslyn Layton. (RealClear Policy). December 14, 2023.

Securities and Exchange Commission (SEC) Chairmen of both parties, Jay Clayton and Gary Gensler, have asserted regulatory power over digital assets and blockchain. They pursued a ruinous “regulation by enforcement” policy to punish innovators like Ripple, LBRY, Grayscale and Coinbase, while they coddled criminals like Sam Bankman-Fried.  Courts have pushed back, but only in those cases where litigants have the resources to fight the SEC, but there is no recourse for victim companies or individuals. The SEC is still immune to civil liability (what US House Rep. Todd Tiahrt calls “appalling bad faith”). Only Congress or the White House can stop the SEC’s illegal runaway regulatory train.

Publicly available evidence points to rampant conflicts of interest and ethical questions around senior SEC officials. Clayton and former Director of Corporation Finance William Hinman were revealed to have financial incentives to favor Ethereum over the rival network XRP, and the two officials moved to give the former a regulatory pass and file a blockbuster lawsuit against the latter on Clayton’s final day in office (Full disclosure: I filed a legal motion to compel the release of some of those documents which exposed Hinman’s conflicts.) 

Read more here: RealClear Policy.

Danger for U.S. Crypto Markets Rises As SEC’s Credibility Falls

By Hassan Tyler. (RealClear Markets). November 30, 2023.

The conviction of Sam Bankman-Fried for the fraud that destroyed the once mighty digital asset exchange FTX may have been a low point for public opinion on the cryptocurrency industry. But a potentially game-changing upside event for crypto could be coming soon which could bring trillions of dollars in reliable capital into the emerging industry. Bloomberg’s James Seyffart reports a high likelihood that the first spot exchange-traded fund (ETF) for cryptocurrencies in the United States could be approved by January.

This story of two extremes is reflexive of the federal agency tasked with regulating it and calls into question whether the Securities and Exchange Commission (SEC) can act appropriately and carry out its mission under current leadership.

SEC Chairman Gary Gensler, according to his public schedule, met with Bankman-Fried and his top brass several times to discuss regulation. Rep. Tom Emmer (R-MN), a senior Republican on the House Financial Services Committee, said his office has received reports that Gensler “was helping SBF and FTX work on legal loopholes to obtain a regulatory monopoly.” According to the court record, Bankman-Fried’s fraud and theft of customer funds was in full bloom at the time of those meetings. But Gensler was too busy at the time waging an all-out war on crypto companies like LBRY, Ripple, and Coinbase, none of whom are accused of fraud.

Gensler inherited an SEC that was covered in doubts on its crypto regulation in the previous administration. The agency under his predecessor, Jay Clayton, put out guidance on crypto trading that gave a free regulatory pass for the trading of Ethereum’s native token, ether. William Hinman, Clayton’s director of corporation finance, gave a high-profile speech in 2018 laying out the SEC’s reasoning why “we believe that current offers and sales of ether are not securities transactions”. But on his last day in office, Clayton filed the Ripple lawsuit despite Hinman’s guidance applying to XRP as well as ether. Instead of clarity, it caused confusion and fear.

Read the full piece by Hassan Tyler here: RealClear Markets.

Gary Gensler and the SEC Lose Again

By Editorial Board. (The Wall Street Journal). November 1, 2023.

Is Gary Gensler ever going to win a case? On Tuesday the Fifth Circuit Court of Appeals handed the Securities and Exchange Commission Chairman another legal defeat by scuttling the agency’s stock-buyback rule (U.S. Chamber of Commerce v. SEC.)

The SEC in May finalized a rule requiring public companies to disclose their daily share repurchases and the reason for buying back their stock. Mr. Gensler claimed companies might buy back their stock to boost executive compensation, which is sometimes tied to accounting metrics such as earnings per share.

A 2020 SEC staff study found scant evidence for Mr. Gensler’s suspicion, explaining that repurchases help issuers “maintain optimal levels of cash holdings and minimize their cost of capital” and “on average” have “a positive effect on firm value.” Nonetheless, Mr. Gensler claimed that investors would benefit from knowing why and when shares were being repurchased.

His real motivation appears to have been to shame companies and help his friends in the securities litigation bar sue companies over their buybacks. Companies faced potentially hefty legal bills defending against lawsuits challenging the motivation and timing of their share buybacks, especially if they resulted in higher executive compensation.

Read the full piece from the Wall Street Journal here: Gary Gensler and the SEC Lose Again.