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.

SEC Crypto Litigation Ventures Into Dangerous Legal Territory

By John E. Deaton.

The US Supreme Court issued the landmark SEC V. Howey decision in 1946, laying out a specific definition of what constitutes a security. Those justices couldn’t have guessed how complex digital commerce over encrypted lines of computer code would fit in almost a century later.

The Securities and Exchange Commission under Chairman Gary Gensler has its own idea of how cryptocurrencies should be regulated today, but bears little resemblance to that decision—and it’s straying into dangerous legal territory in court.

The Howey case involved orange groves sold by a Florida resort to tourists in a scheme where the investors earned passive income from the resort’s management and commercialization of the oranges. The so-called Howey test says a transaction is a security if it is an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others. All three prongs of the test must be met.

Hundreds of federal cases that followed found unregistered securities in the packaging and sales of whiskeycondos, chinchillas, oil and gas, and beavers. A scheme to sell any asset, including cryptocurrencies, could easily fit into this test. All modern securities law is built on it.

Ripple and XRP

But this isn’t what the SEC has been arguing for two years in the biggest unregistered securities enforcement action to date against a crypto company. The suit was filed against US software company Ripple Labs, which sells a digital payment solution for banks, and includes cryptocurrency XRP as a bridge asset to settle cross-border payments in seconds for almost no cost.

Since 2013, the company has also sold billions of XRP tokens it holds to various crypto exchanges who resold them on the secondary markets to millions of retail holders.

Over the last decade, the XRP ledger grew as a decentralized permissionless distributed ledger with a variety of uses by other companies and individuals. The XRP token eventually rose to having the third-highest market cap for any cryptocurrency in the world.

I am an XRP holder and trial lawyer, so I read the SEC’s complaint as soon as I heard about it. I expected to see the SEC pointing to a scheme of specific early sales by Ripple of XRP, which met the Howey test. That would’ve made sense. But I was shocked to read that the SEC was arguing that all sales of XRP have always been and would always be securities, because “the very nature” of the digital asset is to be a security and nothing else. The token itself is “the embodiment” of an investment contract in Ripple, they argue, even on the secondary markets with no involvement of the company, including mine.

This goes beyond anything the 1933 Securities Act and over 250 federal appellate and Supreme Court decisions about securities law ever imagined. The SEC’s argument is the equivalent of the oranges in Howey being “the embodiment” of the scheme to sell the groves. If that’s the case, how does a corner grocer register an orange with the SEC?

All US exchanges immediately suspended XRP trading in fear of SEC reprisal, locking up the tokens of innocent retail holders as the value plummeted by $15 billion. The collateral damage done to these holders that the SEC claimed to be defending was staggering.

I organized a class of over 75,000 retail XRP holders and gained amicus curiae status in the case. Our reasons are pretty logical. The vast majority attest they’d never heard of Ripple Labs when they acquired the token for their own purposes.

These lines of computer code they obtained can’t be an investment contract or a common enterprise with a company they’d never heard of, and nothing in the law—before or after Howey—supports that idea.

Judge Analisa Torres in the Southern District of New York is taking her time with a ruling in the Ripple case because she must understand the stakes, particularly on appeal. The questions to be decided go to the foundations of modern securities law, and what assets can and can’t be included in it. Torres also knows the current US Supreme Court has been knocking down regulators that overreach the powers Congress specifically granted them.

Similar Suits Follow

Other crypto companies from Coinbase to LBRY started facing similar SEC lawsuits. Gensler’s public statements on crypto grew sharper. The larger objectives became clear. He inherited the Ripple case from his predecessor, but he’s made its legal theory the centerpiece of an expansion of regulatory power in court, not through rulemaking or legislation. That has drawn Congress’ ire.

I’m all for clear rules and regulations to protect people. But the SEC is exploiting legal uncertainty about crypto to radically redefine what constitutes an investment contract and a common enterprise in the US. The legal and economic consequences could be enormous and that will only harm people.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

John Deaton is an American attorney acting as amicus counsel for retail digital asset holders in a number of high-profile federal SEC enforcement cases on crypto, most notably SEC v. Ripple (SDNY) and SEC v. LBRY (DNH).

Reproduced with permission. Published May 2, 2023. Copyright 2023 Bloomberg Industry Group 800-372-1033. For further use please visit https://www.bloombergindustry.com/copyright-and-usage-guidelines-copyright/  

The Crypto Uprising The SEC Didn’t See Coming

by Roslyn Layton. August 31, 2021. (Forbes).

When the U.S. Securities and Exchange Commission (SEC) filed its bombshell lawsuit against cryptocurrency innovator Ripple Labs in December 2020, it didn’t expect blowback. But during the pre-trial phase, Ripple’s legal team has put the SEC itself on trial after years of conflicting and confusing guidance on the rules for cryptocurrencies. No one expected the tsunami of legal, political and social media action from retail cryptocurrency investors, outraged by the betrayal from an agency claiming to protect their interests. The meltdown of the SEC’s credibility with this $2 trillion global investor community exposes a costly SEC miscalculation.

Indeed, official Washington has been back-footed by the size, scale and diversity of the crypto investor class and the industry they support. Lampooned by mainstream media and the U.S. government for years, the crypto community has built a media ecosystem that connects millions of investors, consumers, developers and entrepreneurs across the globe. It’s fitting that the pioneers of the blockchain economy would apply consensus protocols to their communication. This decentralized social media apparatus has proven powerful — just ask Congress after the backlash of the infrastructure bill over a badly written crypto tax provision. When the Ripple lawsuit was filed, that ecosystem galvanized an independent battlefront unexpected by the SEC.

Read the Full Article Here.