“Regulatory clarity––yeah––that’s the ticket.”
From the moment the FTX bankruptcy debacle began, the Big Crypto cartel has predictably pivoted to their flawed and anemic go-to talking points when any investor suffers crypto-related losses:
- The SEC is to blame for all crypto-problems, because the SEC has failed to provide the crypto ecosystem with “regulatory clarity.”
- The SEC consistently violates the due process rights of legitimate crypto-financiers, by failing to provide “fair notice” of its anti-crypto posture.
- The SEC repeatedly and recklessly exceeds its authority and is a rogue and dangerous regulatory outlaw, practicing “regulation by enforcement” and stifling innovation, technological progress and investor empowerment.
What a crock.
Big Crypto’s pivot to the tired and toothless refrain of berating the SEC after a dumpster fire like FTX is not just a dubious deflection, it’s farcical and a flat-out ruse. It’s like Holmes or Balwani blaming the U.S. Food and Drug Administration for bogus blood test results from Theranos’ counterfeit blood test machines; like Hannibal Lecter blaming the U.S. Federal Bureau of Investigation for his killing spree; or like Oswald blaming the U.S. Secret Service for JFK’s assassination.
Despite its pervasiveness and bluster, the laughable Big Crypto tagline calling for regulatory clarity is nothing more than a desperate deflection and noxious red herring. Intended to sidetrack and dissemble the plain truth — that the crypto-emperor has no clothes — the regulatory clarity and SEC hit-pieces are pure subterfuge, and an impulsive and frantic attempt to appeal and co-opt fundamental notions of fairness, liberty and freedom (which most people cherish and hold dear). Here’s why:
First off, securities regulation is not meant to be precise but is instead intentionally drafted to be broad and all-encompassing; clarity is not just uncommon, it is deliberately avoided.
Second, though securities regulation is primarily a principles-based legal framework, there already exists extraordinary regulatory transparency and lucidity regarding crypto.
Finally, although the crypto industry constantly grouses for regulatory clarity, whenever any specific regulatory crypto-related rules are promulgated or proposed, the crypto industry cries foul and almost instantly files a flashy legal challenge to its enactment.
The litany of aggrieved and angry crypto-enthusiasts, breaking the Internet with their pleas for regulatory clarity, run the gamut from the endless parade of shameless shills and online busking carnival barkers, to the sad procession of victims who have now tragically evolved into victimizers. Some examples:
Famed Shark Tank investor Kevin O’Leary, who has suffered FTX-related losses (and is a paid FTX spokesperson) blamed the lack of “regulatory clarity” for his FTX injuries and has vowed to “fly to Washington, DC” to lambaste Congress and the SEC for their negligence. Renowned billionaire Mark Cuban similarly chimed in regarding FTX, even though he faces a lawsuit for his ties to Voyager Digital Holdings, an equally horrendous crypto-shell game.
SEC Commissioner Hester Peirce, who has become a toxic voice of crypto-related financial regulation, told CNBC just moments after FTX claimed bankruptcy, that “this is a learning time for regulators and evidences the need for regulatory clarity.”
Peirce spoke similarly in an alarming interview just a week before with Decrypt. Despite massive investor carnage from crypto, Peirce continued her relentless quest for a kinder and gentler crypto-SEC. In fact, Peirce has dissented from, or criticized, just about every SEC effort to stop crypto-chicanery and fraud, but even worse, Peirce has also become a top crypto-gospeler, preaching time and again for “regulatory clarity” in the crypto-marketplace.
Along the same lines, CFTC Commissioner Caroline Pham, who previously posted to Twitter a photo of herself with Sam Bankman-Fried, argued recently that the SEC and CFTC “should have joint roundtables to look into the crypto crash and the events surrounding it and come up with a thoughtful approach towards crypto regulation and providing regulatory clarity that engages the public through these roundtables.” On Twitter, Pham went on to proclaim: “We must protect customers and ensure strong risk management in the crypto sector. Regulatory clarity will enable growth that is compliant, fair and responsible.”
The “regulatory clarity” chorus in particular is non-stop. Like stomach-turning elevator music blaring in a stalled elevator, the ceaseless noise continues ad infinitum. For instance, Coinbase CEO Brian Armstrong, who since FTX’s collapse has tweeted and editorialized the need for regulatory clarity around-the-clock, asserted that, “Our goal is to establish relationships and help answer questions about crypto. And to see what we can do to help the U.S. get more regulatory clarity in this space. . . . There is not a ton of regulatory clarity today in the U.S. because crypto is not just one thing. Some cryptos might be securities (SEC), some are commodities (CFTC), some are currencies/property (Treasury/IRS), and some are none of the above.”
Per Coinbase Legal Chief Paul Grewal, “Instead of rulemaking, the SEC appears to be following an enforcement-first approach to addressing crypto-related regulatory challenges. . . . Leading with enforcement actions before ensuring regulatory clarity results in arbitrary outcomes with limited value as guiding precedent.”
Per Binance Founder and CEO Changpeng Zhao, “Having regulatory clarity will actually ease adoption . . . I think for the mainstream users, 95% of users that are not in crypto yet, having regulation will ease them into crypto.”
Per Grayscale CEO Michael Sonnenshein, “At Grayscale, we have long supported increased regulatory clarity that supports the positive use cases of innovation. We know that hundreds of thousands of investors want the U.S. to embrace crypto and Web3 — both to protect their financial interests, and to allow the U.S. to remain competitive with the rest of the world on both a technological and financial front.”
Per former FTX CEO Sam Bankman-Fried (in the most ironic “regulatory clarity” demand of them all), “I think just getting to a position as a space where there is regulatory clarity for those who are looking for it or whether there are clear ways to register products, will help a lot because right now, if it’s not even clear how to register, then you’re going to get a lot of unregulated products with no oversight.”
Last week, Crypto-focused law firm Hodl Law PLLC (yes, that’s the law firm’s actual name) went so far as to file a lawsuit against the SEC, alleging that the SEC has failed to provide regulatory clarity regarding its jurisdiction over digital assets and that the SEC has failed to define whether it views digital assets as securities.
This lawsuit is perhaps one of the most ludicrous legal documents ever written regarding crypto (and that is saying a lot), which will undoubtedly transform an esteemed California federal courtroom into a derisory Theatre of the Absurd. The Hodl lawsuit, which demands declaratory relief form the SEC, states, inter alia:
“Plaintiff, a law firm that focuses on legal and regulatory issues regarding digital assets (also known as digital currency units (“DCUs”) and/or cryptocurrencies), requests declaratory relief in the face of years-long, purposeful delay and obfuscation by the Defendant regarding its jurisdictional authority with respect to this technology. For over fourteen years, the Defendant has vaguely and ambiguously asserted its “right” to police digital assets as securities yet has refused to identify more than one digital asset that it believes is a security prior to initiating enforcement actions. This intentional, weaponized ambiguity as to why the Defendant provides no guidance or rules regarding its view of DCUs is perhaps best summarized by its then- Senior Adviser for Digital Assets and Innovation, Valerie Szczepanik. When asked at a public event whether she believed the Defendant’s lack of earnest guidance on DCUs was sufficient, Ms. Szczepanik responded: ‘I think if you were to start down road of being very prescriptive and putting out specific releases about hypothetical situations, not only would you probably waste a lot of time but you would probably create a road map to get around it.’ This deliberate approach by the Defendant has unsurprisingly bestowed upon itself maximum prosecutorial discretion over an asset class for which it has no jurisdiction from Congress.”
Regulatory clarity is anathema to securities regulation. Securities regulation is rarely prescriptive but is a principles-based regulatory framework, much like other U.S. laws. For example, U.S. laws do not specify that one cannot steal a neighbor’s lawnmower from their garage, but rather prohibits the theft of someone else’s property, which covers all things, including lawnmowers. The same goes for securities regulation.
This is why the definitions of “security” in Section 2(a)(1) of the Securities Act of 1933 (Securities Act), 15 U.S.C. 77b(a)(1), and Section 3(a)(10) of the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C. 78c(a)(10), include not only conventional securities, such as “stock[s]” and “bond[s],” but also the more general term “investment contract.”
Along these lines, in Reves v. Ernst & Young, the Supreme Court stated that:
“The fundamental purpose undergirding the Securities Acts is ‘to eliminate serious abuses in a largely unregulated securities market.’ United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 421 U.S. 849 (1975). In defining the scope of the market that it wished to regulate, Congress painted with a broad brush. It recognized the virtually limitless scope of human ingenuity, especially in the creation of ‘countless and variable schemes devised by those who seek the use of the money of others on the promise of profits, SEC v. W.J. Howey Co., 328 U.S. 293, 328 U.S. 299 (1946), and determined that the best way to achieve its goal of protecting investors was ‘to define the term “security” in sufficiently broad and general terms so as to include within that definition the many types of instruments that in our commercial world fall within the ordinary concept of a security.’ . . . Congress therefore did not attempt precisely to cabin the scope of the Securities Acts . . . Rather, it enacted a definition of ‘security’ sufficiently broad to encompass virtually any instrument that might be sold as an investment.” (emphasis added)
Crafted to contemplate not only known securities arrangements at the time, but also any prospective instruments created by those who seek the use of others’ money on the promise of profits, the definition of “security” is broad, sweeping, and designed to be flexible to capture new instruments that share the common characteristics of stocks and bonds.
Consider, for example, so-called prime bank notes, which have been promoted for decades as sound and safe investments — but are actually bogus financial instruments purporting to derive their value from secondary European markets for standby letters of credit, a wholly fictional concoction.
In the seminal prime bank case, SEC v. Lauer (52 F.3d 667 (7th Cir. 1995), the purveyors of prime bank notes argued that prime bank notes were not securities because they were fictional. The 7th Circuit disagreed, noting that the so-called Howey test did not require that the securities existed but rather whether the investment, if true, had the characteristics of securities –– underscoring just how broad the definition of security is.
While it is an interesting academic exercise to debate the Howey test, the reality is that be it an Article III judge or an SEC administrative law judge, the SEC will be granted tremendous latitude with respect to its jurisdiction, and betting against the SEC with a “not a security” defense remains a highly risky gamble. This is probably why former SEC Chairman Jay Clayton once testified before Congress: “I believe every ICO [initial coin offering] I have ever seen is a security . . . ICOs should be regulated like securities offerings. End of Story.”
Crypto-enthusiasts offer no reason why the SEC interpretation of crypto-related investment offerings would not be afforded the high level of deference historically and routinely extended to the regulatory agency charged with oversight and enforcement responsibilities.
Indeed, federal courts have already confirmed the SEC’s jurisdiction in numerous SEC crypto-related emergency asset freeze hearings where the issue is always considered and affirmed, same as it has been by hundreds of federal courts across the country since the Howey Decision, which the Supreme Court adopted over 75 years ago.
The Flexibility of Securities Regulation (Fraud is Fraud)
When SEC Commissioner Hester Peirce recently complained to CNBC of the need for “regulatory clarity” in the crypto space, one Twitter user quipped, “[Hey Hester], Is someone suggesting that the ‘don’t steal your customer’s money’ rule isn’t clear?” This is a salient point indeed.
In other words, fraud is fraud, whether committed on the bustling trading floor of the New York Stock Exchange in 1929, amid the basement confines of a Long Island New York boiler room in 1980, or within the borderless virtual landscape of a high-tech crypto-trading platform in 2022.
As Supreme Court Justice (and former SEC Commissioner (1935) and Chair (1936-37)) William O. Douglas opined in Superintendent of Insurance v. Bankers Life and Casualty Co.:
“We believe that section 10(b) and Rule 10b-5 prohibit all fraudulent schemes in connection with the purchase or sale of securities, whether the artifices employed involve a garden type variety fraud, or present a unique form of deception. Novel or atypical methods should not provide immunity from the securities laws.”
From policing foreign bribery payments (before the Foreign Corrupt Practices Act) to municipal securities fraud, to derivatives and insider trading, to prime bank frauds, the SEC has addressed emerging regulatory issues without the benefit, or the hindrance, of precise proscriptions. Instead, the SEC has relied on the general proscriptions of the federal securities laws and applied them with practicality, soberness, and prudence.
Hence, since its inception, the SEC has typically adopted a reasonable and necessary application of the basic requirements of the federal securities laws to new and evolving market conditions and technologies. Merely because no blackletter rule exists does not somehow violate due process or render the SEC’s efforts into ex post facto punishment. Like financial markets, prudential regulation must remain flexible, adaptive, and evolving.
Regulatory Clarity Regarding Crypto Already Exists
Although SEC regulations are primarily principles-based and not proscriptive, that does not mean that the crypto marketplace lacks clarity of existing statutes, rules, and regulations. In fact, the reality is precisely the opposite.
With respect to digital tokens and digital assets, never in its history has the SEC taken such drastic measures to make its views known. Along these lines, the SEC has used multiple distribution channels to share its message and concerns regarding crypto, digital trading platforms, initial coin offerings, and other digital asset products and services.
For instance, with respect to crypto generally, the SEC has publicized its position through countless enforcement actions, multiple speeches, a series of Investor Alerts, a rare Section 21(a) Report of Investigation, staff guidance, Congressional testimony, and several official SEC statements and proclamations.
In fact, former SEC Chair Jay Clayton engaged in an unprecedented multi-year crypto-tour, always speaking bluntly and thoughtfully about the need for digital token offerings to be registered and addressing the many misconceptions in the digital asset marketplace. Speaking at a legal gathering in January of 2018, Clayton even went so far as to admonish the lawyers counseling clients engaged in digital coin and token offerings and current SEC Chair Gary Gensler gave a very similar speech in late 2022 at the annual SEC Speaks securities regulation conference.
Additionally, Gensler has often spoken about the perils of crypto lending platforms and decentralized finance in his speeches, warning that their failure to register with the SEC may violate U.S. securities laws. In fact, in an extraordinarily frank interview with Yahoo! Financial News, Gensler warned crypto exchanges that they are not just on his radar, but they have fallen squarely within his sights, stating:
“The law is clear, it’s not about waving a wand. Congress spoke about this in 1934 . . . When a [digital] platform has securities on it, it is an exchange, and it’s a question of whether they’re registered or they’re operating outside of the law and I’ll leave it at that.”
To claim a lack of clarity and meaning amid such a concerted SEC effort for crypto-related transparency, notice, and candor seem not only disingenuous and ill-advised — but just plain foolish.
SEC Crypto-Related Enforcement Actions and Regulatory Clarity
In addition to all of the SEC’s crypto-related statements, regulatory pronouncements, etc., there are also tens of thousands of pages of comprehensive pleadings and fillings associated with the 100+ SEC crypto-related enforcement actions and the SEC’s undefeated crypto-track record, which include five of the most notorious SEC crypto victories — Telegram, Kik, BlockFi, LBRY and the SEC’s Wells notice of Coinbase (regarding its crypto-lending program).
SEC v. KIK
In Kik, the SEC’s complaint, filed in the U.S. District Court for the Southern District of New York on June 4, 2019, alleged that Kik sold digital asset securities to U.S. investors without registering their offer and sale as required by the U.S. securities laws.
Kik argued that the SEC’s lawsuit against it should be considered “void for vagueness.” Kik lost.
The court granted the SEC’s motion for summary judgment on September 30, 2020, finding that undisputed facts established that Kik’s sales of “Kin” tokens were sales of investment contracts (and therefore of securities) and that Kik violated the federal securities laws when it conducted an unregistered offering of securities that did not qualify for any exemption from registration requirements. The court further found that Kik’s private and public token sales were a single integrated offering.
The final judgment permanently enjoined Kik from violating the registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933. For the next three years, Kik is further required to provide notice to the Commission before engaging in enumerated future issuances, offers, sales, and transfers of digital assets. Kik was also ordered to pay a $5 million penalty.
SEC v. Telegram
In Telegram, the SEC filed a complaint on October 11, 2019, alleging that the company had raised capital to finance its business by selling approximately 2.9 billion “Grams” to 171 initial purchasers worldwide. The SEC sought to preliminarily enjoin Telegram from delivering the Grams it sold, which the SEC alleged were securities that had been offered and sold in violation of the registration requirements of the federal securities laws.
Telegram argued that the SEC has “engaged in improper ‘regulation by enforcement’ in this nascent area of the law, failed to provide clear guidance and fair notice of its views as to what conduct constitutes a violation of the federal securities laws, and has now adopted an ad hoc legal position that is contrary to judicial precedent and the publicly expressed views of its own high-ranking officials.” But Telegram lost.
On March 24, 2020, the U.S. District Court for the Southern District of New York issued a preliminary injunction barring the delivery of Grams and finding that the SEC had shown a substantial likelihood of proving that Telegram’s sales were part of a larger scheme to distribute the Grams to the secondary public market unlawfully.
Without admitting or denying the allegations in the SEC’s complaint, the defendants consented to the entry of a final judgment enjoining them from violating the registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933. The judgment ordered the defendants to disgorge, on a joint and several basis, $1,224,000,000 in ill-gotten gains from the sale of Grams, with credit for the amounts Telegram pays back to initial purchasers of Grams. It also ordered Telegram Group Inc. to pay a civil penalty of $18,500,000. For the next three years, Telegram is further required to give notice to the SEC staff before participating in the issuance of any digital assets.
SEC v. BlockFi
In BlockFi Lending LLC, the first SEC case ever involving a crypto-lending program, on February 22, 2022, the SEC charged BlockFi with failing to register the offers and sales of its retail crypto-lending product and also charged BlockFi with violating the registration provisions of the Investment Company Act of 1940.
BlockFi argued for “increased regulatory clarity.” But BlockFi lost.
To settle the SEC’s charges, BlockFi agreed to pay a $50 million penalty, cease its unregistered offers and sales of the lending product, BlockFi Interest Accounts (BIAs), and bring its business within the provisions of the Investment Company Act within 60 days. BlockFi’s parent company also announced that it intends to register under the Securities Act of 1933 the offer and sale of a new lending product. In parallel actions, BlockFi agreed to pay an additional $50 million in fines to 32 states to settle similar charges.
SEC Wells Notice to Coinbase
When high-flying media darling Coinbase — a popular and publicly traded crypto trading platform — began marketing a crypto product called Lend, the SEC began investigating. The Lend program purportedly planned to allow some Coinbase customers to earn interest on certain assets on Coinbase, starting with 4% annually on USD Coin, or USDC. The SEC and several states had already raised concerns about these kinds of programs, including that the products are securities that require state and federal registration.
According to Coinbase, its lawyers reached out to the SEC to discuss Lend. But rather than helping, the SEC staff opted to serve Coinbase with a Wells Notice, informing Coinbase of its intention to seek approval from the SEC commissioners to file a civil enforcement action against Coinbase for violating federal securities laws.
After Coinbase received the Wells notice, Coinbase orchestrated an online firestorm of SEC-criticism, beginning with a posting on its blog by its chief legal officer decrying the SEC’s actions, seeking “regulatory clarity” and asserting that “mystery and ambiguity only serve to unnecessarily stifle new products that customers want and that Coinbase and others can safely deliver.”
Coinbase’s GC’s post was followed by a Twitter thread from its CEO dubbing the SEC’s behavior “sketchy,” and asserting that “we’re being threatened with legal action before a single bit of actual guidance has been given to the industry on these products. If we end up in court we may finally get the regulatory clarity the SEC refuses to provide. But regulation by litigation should be the last resort for the SEC, not the first.” But Coinbase recognized theirs was a lost cause and pulled the plug on Lend. With Coinbase, the SEC single-handedly averted a massive product rollout of Coinbase’s crypto-lending program, likely saving investors hundreds of millions in losses.
SEC v. LBRY
In LBRY, Inc., filed on March 29, 2022 (continuing the SEC’s undefeated streak of 100+ crypto-wins), the crypto-defense (and now war-cry) of “lack of regulatory clarity” was specifically and unambiguously addressed – and summarily rejected.
Specifically, Judge Peter Barbadoro of New Hampshire federal court granted the SEC’s summary judgment motion against LBRY, Inc., a software firm that issued crypto asset securities called “LBRY Credits” or “LBC.” LBRY argued that the SEC’s attempt to treat LBC as a security violated its right to due process because the agency did not give LBRY fair notice that its offerings of LBC are subject to the securities laws. But LBRY lost.
In the first part of the ruling, the court held that LBRY offered/sold LBC as a security (LBRY had argued that LBC functioned as a digital currency that is an essential component of the LBRY Blockchain). This part of the decision was unprecedented because it was the first time a judge had determined that a coin that was not distributed through an ICO, was a security. Also, in its final point on its Howey analysis, the court rejected LBRY’s argument that LBC could not be a security because it was a utility token with demonstrated purchases for consumptive, not investment, use.
The court noted that “[n]othing in the case law suggests that a token with both consumptive and speculative uses cannot be sold as an investment contract.” The court summarized its holding: “[w]hile some unknown number of purchasers may have acquired LBC in part for consumptive purposes, this does not change the fact that the objective economic realities of LBRY’s offerings of LBC establish that it was offering it as a security.”
The first part was not surprising. Judge Barbadoro merely reaffirmed what Chair Gensler explained at SEC Speaks when Gensler said, “These are not laundromat tokens: Promoters are marketing, and the investing public is buying, most of these tokens, touting or anticipating profits based on the efforts of others.”
In the second part of the ruling, the Court held that LBRY did not have a defense that it lacked fair notice of the application of securities laws to the LBC offer/sale, resoundingly rejecting the so-called Fair Notice defense, which has become a critical page of the crypto-defense “regulatory clarity” playbook. Judge Barbadoro stated:
“LBRY relies on the 2nd Circuit’s decision in Upton v. SEC for the proposition that the SEC may not impose a sanction for violating the securities laws ‘pursuant to a substantial change in its enforcement policy that was not reasonably communicated to the public.’ But the facts of Upton bear no resemblance to the present case.
Upton involved an attempt by the SEC to sanction the CFO of a brokerage firm for violating an SEC rule that established a formula for setting the amount of money that the brokerage was required to maintain in a customer reserve account. Although it was undisputed that the brokerage had at all times complied with the “literal terms” of the rule, an ALJ relied on a novel interpretation of the rule by the SEC to conclude that the CFO could be sanctioned. Because the SEC did not give public notice of its new interpretation until after the brokerage had ended its offensive practice, the Second Circuit vacated the sanction imposed by the Commission. The present case is obviously quite different from the problem the court confronted in Upton.
The SEC has not based its enforcement action here on a novel interpretation of a rule that by its terms does not expressly prohibit the relevant conduct. Instead, the SEC has based its claim on a straightforward application of a venerable Supreme Court precedent that has been applied by hundreds of federal courts across the country over more than 70 years . . . ”
As some experts have now explained, in rejecting LBRY’s contention that the SEC’s suit constituted a “substantial change in its enforcement policy that was not reasonably communicated to the public” because LBRY did not conduct an ICO, “the court held that the SEC’s theory fit comfortably within the bounds of prior caselaw.” The Court noted specifically that LBRY had no basis for asserting it was unaware of Howey’s guidelines, even if it sold LBC tokens in a non-ICO context.
Big Crypto Lawsuits
Whenever any government law, rule, or regulation gets specific about crypto, crypto lobbying groups protest and file interminable lawsuits challenging the action. Consider the following five examples during the past few years involving Big Crypto’s challenges to:
- The Infrastructure Investment and Jobs Act (“Infrastructure Act”);
- SEC Rule 3b-16;
- OFAC Sanctions Against Tornado Cash;
- A Proposed Bitcoin Spot-ETF; and
- FinCEN Anti Money Laundering (AML) Crypto-Rules.
The Infrastructure Act
On November 15, 2021, The Infrastructure Act added a series of crypto-reporting requirements for retailers and exchanges to shed sunlight on the crypto industry and protect consumers from fraud and chicanery of crypto grifters.
For example, the Infrastructure Act heightens IRS reporting requirements relating to cryptocurrency by expanding two traditional reporting forms – Form 8300 and Form 1099-B. Specifically, the Infrastructure Act includes an information reporting requirement for certain persons who accept large payments in cryptocurrency in such person’s trade or business on an IRS Form 8300, and an information reporting requirement for cryptocurrency asset exchanges and custodians on an IRS Form 1099.
Coin Center, a crypto-focused non-profit research and advocacy group based in Washington, filed a lawsuit against the United States Treasury Department and the Internal Revenue Service – claiming that the crypto tax reporting requirements included in the Infrastructure Investment are “unconstitutional.” In a filing submitted to a branch of the Kentucky District Court, as well as an accompanying post on its website, Coin Center explained:
“If the government wants us to report directly about ourselves and the people with whom we transact, it should prove before a judge that it has reasonable suspicion warranting a search of our private papers.”
Coin Center’s lawyers called the mandate a “mass surveillance regime on ordinary Americans.”
SEC Rule 3b-16
On January 26, 2022, the SEC proposed changes to several regulations — namely, Rule 3b-16 of the Securities Exchange Act, Regulation ATS, and Regulation SCI — that would put more so-called “alternative trading systems” under its purview as exchanges, including crypto trading platforms and exchanges.
The SEC adopted Regulation Systems Compliance and Integrity and Form SCI in November 2014 to strengthen the technology infrastructure of the U.S. securities markets. Specifically, the rules are designed to:
- Reduce the occurrence of systems issues;
- Improve resiliency when systems problems do occur;
- Enhance the Commission’s oversight and enforcement of securities market technology infrastructure.
In response, the Blockchain Association wrote a scathing comment letter, claiming that the SEC lacks the authority to define an exchange so broadly, stating:
“First, the expansions to Rule 3b-16 under the Proposal exceed the scope of the SEC’s statutory authority under the Exchange Act by subjecting actors and activities not covered by the definition of “exchange” under Section 3(a)(1) of the Exchange Act to substantial regulation. Second, the SEC’s promulgation of the Proposal violates statutory rulemaking requirements by eliminating the opportunity for meaningful stakeholder engagement in the rulemaking process, both by providing an insufficient comment period and by offering insufficient analysis relating to the detrimental, and potentially fatal, impact of the Proposal on an entire industry. Third, we are concerned by the vagueness of the Proposal with respect to decentralized finance in light of the SEC’s recent efforts to regulate the industry.”
ADAM, the Association for Digital Asset Markets, wrote a similar comment letter, stating:
“In particular, the revisions to Exchange Act Rule 3b-16 that would capture a vast array of new technologies, and the persons who develop and advance those technologies, has the real potential of chilling further development in the United States of digital asset technologies at a time when U.S. investors and the U.S. economy cannot afford to take a back to seat to these innovations. While ADAM and its members generally agree that regulation in the digital asset space can advance investor protections, the public interest, and help maintain the United States’ position as a global leader in financial technology, the wrong approach can leave the United States at a long-term competitive disadvantage as it has in the past. To this end, we encourage the SEC to specifically exclude digital assets as coming the Proposal’s scope and instead work with its fellow regulators to develop a comprehensive approach to the regulation of digital assets.”
OFAC Sanctions Against Tornado Cash
On August 8, 2022, the U.S. Treasury Office of Foreign Assets Control (OFAC) imposed sanctions on crypto mixing service Tornado Cash, which has been used to launder over $7 billion worth of crypto since 2019. Per OFAC:
“Tornado cash is a virtual currency mixer that operates on the Ethereum Blockchain and indiscriminately facilitates anonymous transactions by obfuscating their origin, destination, encounter parties, with no attempt to determine their origin. Tornado receives a variety of transactions and mix them together before transmitting them to their individual recipients. While the purported purpose is to increase privacy, mixers, like tornado are commonly used by illicit actors to launder funds, especially those stolen during significant heights. Virtual currency mixers that assist criminals are a threat to US national security. Criminals have increased their use of anonymity – enhancing technologies, including mixers, to help hide the movement or origin of funds.”
Coin Center once again filed a lawsuit, this time against OFAC, alleging that OFAC does not have the authority to impose sanctions on Tornado Cash. It has been joined by crypto investor David Hoffman, software developer Patrick O’Sullivan, and “John Doe,” who was described in the filing as a human-rights activist who has been donating crypto to Ukraine, claiming OFAC’s actions were unconstitutional and violated the First Amendment right to free speech.
Along the same lines, in September of 2022, Coinbase announced that it was financing a civil suit to ask a Texas judge to force the Treasury Department to reverse sanctions against the Tornado Cash platform. The suit includes arguments similar to Coin Center’s.
Grayscale ETF Application
On June 29, 2022, the SEC denied Grayscale’s application for a spot bitcoin exchange-traded fund (ETF) in a meticulously documented and thoroughly explained series of SEC orders, citing, inter alia, the extraordinary lack of critical protections of any invented bitcoin ETF. The denial is the most recent of a dozen or so similar bitcoin ETF denials from the SEC.
The crux of the SEC’s position is that bitcoin’s price is subject to manipulation on unregulated platforms, and approval of a bitcoin spot ETF would only invite further manipulation. The SEC offered numerous examples of crypto-related conduct that triggered their concerns, including:
- Wash trading, matched trades, spoofing, and other manipulative trading schemes on unregulated crypto exchanges, which could fraudulently inflate or deflate the price and volume of bitcoin;
- Persons with a dominant position in bitcoin who could manipulate bitcoin pricing and move markets in their favor without detection or culpability;
- Malevolent actors, who, given the lack of enforced or mandated cybersecurity standards for crypto-trading platforms, could hack into customer accounts or gain malicious control of bitcoin-related networks;
- Crypto platform insiders, who could trade based on material, nonpublic information or could disseminate false and misleading information to orchestrate schemes to create bogus new sources of demand for bitcoin;
- Bitcoin-based investment vehicles, which, when responding to a “fork” in the bitcoin blockchain, could wreak havoc by creating two different, non-interchangeable types of bitcoin;
- Stablecoins like Tether or platforms like Binance, both of which are wholly unregulated and operate in secret, who could facilitate bitcoin-related destructive and nefarious manipulative and fraudulent activity.
Grayscale obviously anticipated the result and, on the very same day of the SEC denial, filed a lawsuit opposing the SEC’s decision. Grayscale excoriated the SEC’s ETF opinion as “arbitrary, capricious, and discriminatory,” and asked the U.S. Court of Appeals for the District of Columbia Circuit to review and overturn the SEC’s decision.
Led by CEO Michael Sonnenshein, Grayscale had engaged in an unprecedented high-stakes campaign to pressure the SEC to approve its ETF application, including renting all of the billboards in Washington D.C.’s Union Station, encouraging people to write “comment letters” to the SEC and demand that the SEC approve the bitcoin ETF. In addition, Grayscale went so far as to publish an FAQ about their lawsuit, continuing their effort to rally public support in their favor.
Since the filing of the Greyscale lawsuit and despite the mammoth FTX contagion and continuing fallout, The Blockchain Association, The Chamber of Digital Commerce and Coin Center have all piled on, filing amicus briefs in the Grayscale lawsuit, claiming that the SEC had approved a similar yet riskier type of product: ETFs that hold bitcoin futures contracts rather than bitcoin itself (as Grayscale wants to do). The ETF approach is “ideally suited for investors that desire exposure to bitcoin,” according to their filing. The SEC’s” ‘thumb on the scale’ approach,” the groups asserted, “does not withstand scrutiny.”
FinCEN AML Crypto-Rules
In October 2019 and November 2020, FinCEN proposed applying the Travel Rule and the Recordkeeping Rule (both part of the Bank Secrecy Act) to virtual currencies. These steps were part of a larger initiative by FinCEN to establish an anti-money laundering (AML) regulatory framework for digital currencies comparable to fiat currencies.
The Travel Rule and Recordkeeping Rule apply when two money service businesses (MSBs), or other financial institutions covered by the FinCEN rules, transfer $3,000 or more in funds, including digital currencies, on behalf of a client. The rules specify records to be kept by the originating business and relevant information to be provided to the receiving business.
These rules could be circumvented by transferring digital currency funds from one institution to a personal wallet (i.e., an unhosted wallet) and then from the unhosted wallet to the second institution, which has created tremendous law enforcement challenges and enabled a global crypto-crime wave. For instance, according to the U.S. Treasury Department, unhosted wallets “enable terrorists, state-sponsored and transnational organized criminals and cyber hackers and extorters to quickly and covertly shift large sums of money across the globe to support their illegal activities.”
Along the same lines, U.S. federal law requires financial institutions to report cash transactions over $10,000 conducted by, or on behalf of, one person and multiple currency transactions that aggregate to be over $10,000 in a single day. These transactions are reported on Currency Transaction Reports (CTRs) to FinCEN. The federal law requiring these reports was passed to safeguard the financial industry from threats posed by money laundering and other financial crimes. To comply with this law, financial institutions must obtain personal identification information about the individual conducting the transaction, such as a Social Security number, driver’s license, or other government-issued documents. This requirement applies whether the individual conducting the transaction has an account relationship with the institution or not.
Similarly, on FinCEN Forms 114, so-called Reports of Foreign Financial Accounts (FBAR), U.S. taxpayers who own offshore accounts with an aggregate value of $10,000 or more in any tax year must disclose their offshore accounts. Failing to do so can lead to steep penalties. For instance, “knowingly and willfully” filing a false FBAR can carry criminal penalties of up to five years of incarceration.
Currently, FBAR regulations do not define a foreign account holding virtual currency as a type of reportable account. For that reason, at this time, a foreign account holding virtual currency is not reportable on the FBAR (unless it holds reportable assets besides virtual currency).
Though not yet promulgated, on December 31, 2020, FinCEN stated in its 2020-2 Regulatory Pronouncement entitled, “ Report of Foreign Bank and Financial Accounts (FBAR) Filing Requirement for Virtual Currency,” that it now intends to propose to amend the regulations implementing the BSA regarding FBAR reports to include virtual currency as a type of reportable account.
Mandating the reporting of cryptocurrency transactions could dramatically impact cryptocurrencies worldwide, shining additional sunlight upon the secretive and unregulated digital wallets of tech-savvy criminals. U.S. persons would have to consider their cryptocurrency assets when filing FBARs for accounts containing cryptocurrency and non-cryptocurrency assets. In addition, U.S. persons would have to determine whether their cryptocurrency digital wallets independently trigger FBAR filing requirements as well.
In response to the litany of new FinCEN rules targeting crypto, crypto-lobbying groups came out swinging. Per an analysis from King and Spalding, the first round of comments responding to FinCEN’s December proposed rulemaking “criticized FinCEN for needlessly increasing financial surveillance . . . and suggested that the government would receive limited benefits under the rule due to user circumvention, and that those benefits would not outweigh the inordinate costs imposed upon virtual currency platforms to overcome significant technical barriers to achieve compliance with the proposed rule . . . and decried inequitable regulatory treatment between virtual currencies and traditional financial systems.”
For instance, The Blockchain Association wrote in a January 4, 2021 letter that the FinCEN proposed rule: was 1) procedurally defective; 2) would constitute an unprecedented and untested expansion of the Bank Secrecy Act to include collection of counterparty information; 3) would stymie innovation; 4) would fail to achieve its law enforcement goals; and 5) Implicates important privacy rights and does not account for risks to Americans’ data security.
Similarly, ADAM, in their own comprehensive objection to the FinCEN proposed rules, stated inter alia that:
“Unhosted wallets are foundational to innovation involving blockchain-based systems, including those that involve both financial and non-financial products and services. Restrictions on unhosted wallets would have significant impact on innovation and US leadership in this space – and would most likely force a lot of innovative and productive activity overseas.
Gensler’s Virtual Scylla and Charybdis
SEC Chair Gary Gensler enjoyed a memorable and unexpected moment during his speech at the 2022 SEC Speaks conference, which immediately went viral.
Gensler was talking about crypto-related issues and explaining how the SEC has spoken with a clear voice regarding crypto through regulatory pronouncements such as the July 2017 DAO 21A SEC Report of Investigation; administrative directives like the December, 2017 SEC Munchee Administrative Order; and dozens of SEC crypto-related Enforcement actions, all approved by the SEC Commissioners, disseminated worldwide and discussed by SEC staff at countless conferences, events, meetings, etc.
Gensler also noted how his Republican-appointed predecessor, former SEC Chair Jay Clayton, often spoke to the applicability of the securities laws in the crypto space testifying before Congress, speaking to lawyers, and addressing Wall Street financiers – even appearing on CNBC to share his crypto-views.
Yet the crypto industry, Gensler exclaimed, still begs for regulatory clarity. Finally, with an exasperated and resounding tone, Gensler admonished the crowd: “Not liking the message isn’t the same thing as not receiving it.”
This vividly illustrates the deception and duplicity of the Big Crypto cartel. Big Crypto demands regulatory clarity, but they do not like it when they get it – so they file lawsuits, comment letters, and mount billboards worldwide in a feeble attempt to manipulate the public, and bully the SEC, into accepting their point of view.
A cursory analysis of these frivolous and baseless Big Crypto lawsuits manifests not just hubris but absurdity, and is arguably as bad of an affliction as the plague of bitcoin itself. The stark reality is that the only thing these lawsuits will accomplish will be to generate offensively high fees for the legal teams who filed them.
Gensler went on in his now infamous 2022 SEC Speaks crypto-homily to explain in clear and certain terms –– and ad nauseum –– how the law works with respect to crypto. And Gensler could not have said it any plainer:
“Investors are following crypto projects on social media and scouring online posts about them. These tokens have promotional websites, featuring profiles of the entrepreneurs working on the projects. It’s not about whether you set up a legal entity as a nonprofit and funded it with tokens. It’s not whether you rely on open-source software or can use a token within some smart contract. These are not laundromat tokens: Promoters are marketing and the investing public is buying most of these tokens, touting or anticipating profits based on the efforts of others.”
Of course, Gensler was thereafter quickly thumped with a barrage of OK Boomerisms, condemning him for hindering technological progress and clinging to an antiquated, flawed, and undemocratic financial ecosystem.
Along these lines, Gensler and the entire SEC have fought against crypto-corruptions despite intense political pressure not to do so — and therein lies the rub. For instance, the SEC was apparently investigating FTX in March, 2022, when eight members of the U.S. Congress, now notoriously labeled, “The Blockchain Eight,” wrote a letter to Gensler, expressing their concerns that the SEC’s actions against crypto firms were “overburdensome, unnecessary, and stifling of innovation.” The Blockchain Eight published their letter online, even though the applicable precedent of SEC v. Wheeling-Pittsburgh specifically prohibits improper political influence upon SEC investigations.
Five of the eight members signing the “Blockchain Eight Letter” received campaign donations from FTX employees, ranging from $2,900 to $11,600. Rep. Ted Budd (R-NC), one of the signatories, received $500,000 in support from a Super PAC created by FTX Digital Markets co-CEO Ryan Salame.
In a particularly disturbing irony, notoriously crypto-friendly U.S. Representative Tom Emmer from Minnesota directed a virulent criticism at the SEC’s investigation of crypto firms, all in plain view, both as the first signatory of the Blockchain Eight Letter, and also tweeting on March 16, 2022:
“My office has received numerous tips from crypto and blockchain firms that SEC Chair Gary Gensler’s information reporting “requests” to the crypto community are overburdensome, don’t feel particularly… voluntary… and are stifling innovation.”
But after the FTX collapse, Representative Emmer suddenly, once again in plain view, directed a virulent criticism at the SEC for failing to prevent the FTX bankruptcy, tweeting on November 25, 2022:
“We are even more concerned now as we’ve seen Gensler’s strategy miss Celsius, Voyager, Terra/Luna– and now FTX.”
So just to review: First, in March, 2022, Emmer leads the war on Gensler, scolding him for the SEC’s aggressive investigations of crypto firms. Now, in November, 2022, after the FTX disaster, Emmer leads a second war on Gensler, this time scolding him for the SEC’s failure to investigate crypto firms. Yes, Emmer’s hypocrisy knows no bounds, but it also bleakly underscores Gensler’s conundrum – no matter what Gensler does regarding crypto, the Big Crypto cartel will condemn him.
Wherever the source, crypto-criticisms of Gensler, crypto-denunciations of the SEC, and crypto-pleas for regulatory clarity, are all nothing more than distorted sophistical rhetoric and cacophonous cognitive dissonance.
It’s like arguing that banning asbestos means banning building construction, when in reality, just as asbestos asphyxiates and contaminates the lawful construction of buildings, crypto pollutes and suppresses benevolent technological transformation.
Like clearing out organized crime in a big city, crypto regulation and transparency clears the way for legitimate technological innovation, progress, and development, rendering it free from abuse and criminal exploitation.
Crypto shills have for over a decade promised how crypto will benefit U.S. citizens by transforming the way U.S. businesses conduct financial transactions; rendering U.S. use of energy, water, and any other raw material more efficient, more transparent, more reliable, and less costly; verifying transactions instantaneously, eliminating significant costs, uncertainty and fraud; and dramatically improving the way all U.S. citizens carry out our daily lives. But these ambitious prospects are nothing more than hi-tech delusions overflowing with hype, distortion, flimflam, drivel, and bluster.
In fact, Big Crypto consistently fails to reference any practical or tangible use of crypto that is not aspirational or cannot be accomplished more easily, more efficiently, more powerfully, and more safely by about a bazillion other digital means. With the exception of criminals, people do not use crypto for anything at all. Indeed, if anyone asked what problem in life crypto solves, no one can (honestly) name a single one. The Web3 industry is not just replete with bad apples, it’s rotten to the core.
To those crypto-shills screaming for regulatory clarity, trying to distinguish FTX from their wares and catalog, defending the cryptoverse, and deflecting the blame upon the SEC, please read the room. Rome is burning. Now is not the time to point fingers at the SEC and denounce a mythical lack of regulatory clarity. Now is not the time to advocate to exonerate and excuse crypto-related greed, grift, irresponsibility and folly. Now is the time to preach the truth:
- That crypto solves no societal problem and provides no tangible use (other than speculation);
- That crypto fails as a currency because the price is too volatile; fees too high; taxes too burdensome; and risks too infinite;
- That crypto fails as an investment because there is no regulatory oversight, transparency, consumer protections, insurance, and the entire crypto rug-pull bazaar is so rife with market manipulation and insider trading and other fraud that investors stand no chance from the get-go;
- That crypto has no intrinsic value and is better described as a 2008 relic of computer code of mind-numbing arithmetical blather whose sole characteristic seems to be that another fool may be induced to pay more for it. In fact, calling the crypto-ecosystem a Ponzi scheme is not hyperbole — it’s axiomatic;
- That a mere record on a glorified append-only, limited writer spreadsheet linked to the solution of a very complex yet entirely meaningless and irrelevant mathematical problem is not, and will never become, a fiscal heal-all or financial inclusion panacea;
- That the sole benefit of crypto flows to criminals who use it to transact from anywhere and secretly commit perilous crimes like ransomware/murder-for-hire/terrorism/drug dealing/sanctions evasion/money laundering/human sex trafficking/child pornography/etc.;
- That the use of crypto presents extraordinary challenges for law enforcement to trace and to recover, and requires immense resources, years of doggedness and lots of luck – and prosecutorial success rarely happens; and
- That it is easy to imagine a world without crypto and if crypto disappeared tomorrow, nothing would change for anyone except criminals, who would lose their most effective felonious device and instantly suffer immeasurably.
In every one of their lawsuits, the Big Crypto cartel demands regulatory clarity, but whenever regulators actually deploy meaningful crypto-regulatory initiatives, the Big Crypto cartel does everything possible to strike down and cancel those initiatives.
The origin of the saying “Be careful what you wish for, because you just might get it” is not from The Pussycat Dolls, but rather Aesop’s Fables, the notable collection of morality tales. But whatever the saying’s origin, it rings especially true for Big Crypto and its eternal quest for regulatory clarity. In his next speech, Gensler should add a second and even more important message: Be careful what you wish for Big Crypto, because you just might get it.
John Reed Stark is president of John Reed Stark Consulting LLC, a data breach response and digital compliance firm. Formerly, Mr. Stark served for almost 20 years in the Enforcement Division of the U.S. Securities and Exchange Commission, the last 11 of which as Chief of its Office of Internet Enforcement. He currently teaches a cyber-law course as a Senior Lecturing Fellow at Duke University Law School. Mr. Stark also worked for 15 years as an Adjunct Professor of Law at the Georgetown University Law Center, where he taught several courses on the juxtaposition of law, technology, and crime, and for five years as managing director of global data breach response firm, Stroz Friedberg, including three years heading its Washington, D.C. office. Mr. Stark is the author of “The Cybersecurity Due Diligence Handbook.”