On The Brink with Castle Island - DeFi Education Fund and Beba sue the SEC (EP.514)

Episode Date: April 2, 2024

Miller Whitehouse-Levine and Amanda Tuminelli of the DeFi Education Fund join the show. In this episode we discuss: Beba, an American apparel company based in Waco, TX and the DeFi Education fund have filed a complaint against the SEC, challenging the agency's pattern of regulation via enforcement. The specific's of Beba's airdrop campaign. The Debt Box case and the pattern of behavior that the case highlights. The status of Congressional action on market structure, stablecoins and SAB 121. How the DeFi Education Fund prioritizes key initiatives. How to get involved in this case and support the broader mission of the organization.   To learn more about the Beba case: https://www.defieducationfund.org/post/it-s-our-time-def-goes-on-offense-against-the-sec   To learn more about the DeFi Education Fund: https://www.defieducationfund.org/  

Today on the podcast, I sat down with Amanda Tuminelli in Miller White House Levine of the Defi Education Fund. This week, the Defy Education Fund in Beba, an American Apparel Company, filed a complaint against the SEC challenging the agency's lack of formal rulemaking on digital assets and their pattern of regulating via enforcement. In this episode, we go deeper on the Beba case, we talk about the recent debt box case, and also talk about the status of key legislation that is currently in front of Congress. I think you'll enjoy this one. So without further ado, here's my conversation with Amanda and Miller. Matt Walsh and Nick Carter are partners at Castle Island Ventures.

All of these expressed by them where the guests on this podcast are solely their opinions and do not reflect the opinions of Castle Island Ventures. Guest and host may maintain positions in the assets discussed in this podcast. You should not treat any opinion expressed by anyone on this podcast as a specific inducement to make a particular investment or follow a particular strategy, but only is an expression of their personal opinion. This podcast is for informational purposes only. Brought down by bad mortgage investments, Lehman, which has 25,000 employees will be

liquidated. government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more into Britain's ailing economy with a new round of quantitative easing. You print a couple trillion dollars, and all of a sudden, people start to worry.

So out of this worry, we have something called the Bitcoin. Bitcoin. All right, so Amanda Miller, thanks so much for joining us today on the podcast. Amanda, welcome back to the podcast. Thank you so much. Thank you for having me. Thanks for having us. So there's obviously a lot going on at the Defi Education Fund, Miller.

This is your first time on the podcast. Why don't we just start with some quick introductions on who you guys are and what you're focused on over at Defy Education Fund? Sure. Thanks again for having us. At the Defy Education Fund, we do policy, advocacy, and education on behalf of decentralized finance users, developers, the ecosystem more broadly. So we advocate for DFI in Congress. We do DFI demos, try to make sure the legislation that is under consideration will be good for D5. We do comment letters on regulatory proposals generally fighting them right now because they tend to be pretty bad ideas at the moment. And then, of course, are very active in the judiciary, which is the main topic of conversation. We're here to talk about today. So we do the whole spectrum of advertising.

advocacy work from a policy perspective on behalf of DFI, primarily focused on the U.S., but where there are developments internationally, DFI-specific, draw our hat in the ring there, too. And how are you guys thinking about just prioritizing what to work on? It's obviously there's a lot going on in DFI. There's regulatory actions from all different categories. And probably more importantly, there's just new things being built that require time and attention. So how are you prioritizing where to actually spend your time at the DFI Education Fund? Yeah, I think about policy as being a few years behind the markets, to say the least. Right now, I think that Defi conversations in D.C. are sort of in the period that DFI was in summer of 2020.

It's just getting going and things are heating up with respect to D5. And most policy conversations at the moment at core are focused on the regulation of C5 businesses. There are some notable examples at the IRS and the SEC, which clearly do target DFI, but those are the first substantive real proposals that are DFI specific. So notwithstanding, you know, I think DIPI has gone through two or three cycles of its life so far in the markets. The policy conversation is a few years behind. As far as where we prioritize our work between the legislature, the executive branch, the judiciary. I think that's shifted over time, just given the realities we face. You play the cards, you're dealt. And that's what we're doing here. Congress is moving as fast as molasses when it

comes to passing crypto legislation, be it on stable coins or market regulation. I don't think it's happening this Congress. And who knows what the next couple of years are going to look like from that perspective. We have regulatory agencies, particularly here in the U.S., that I think are committed to killing crypto and D5, particularly Chair Ginsburg's SEC. And so that leaves us with the judiciary, which is where we're focusing our efforts at the moment. That makes a ton of sense. Well, why don't we hop into that? You guys were in the news this week. The Defy Education Fund, along with Beba, has filed a complaint against the SEC. What's here what this is about. Tell us a little bit about the story. How did you come into contact?

with Beba? How did you meet the company? And what is this complaint? Sure, yeah. So we first met one of the founders of Beba at Consensus, actually. So when we were down in Texas, and he was wearing a very cool backpack. And I asked him where he got the backpack and he said he made it. And I was like, what do you mean? So then I was able to see how great their products were on their website. And we formed a friendship. And we realized we are both greatly affected by the SEC's campaign against this industry. And the case, that's like how the case was born, we decided to bring two different claims. The first claim is by Beba that once they had done thisirdrop, which they just did, they need a court order clarifying that this freeirdrop of tokens is not a securities transaction

and that the tokens themselves are not investment contracts so that they can not live in fear that the SEC will enforce against them one day. So it's called a pre-enforcement challenge. You're essentially suing before the SEC enforces against you. You're getting that court order, that clarity in advance. It's a proactive action instead of a defensive action. So that's the idea behind count one, getting that clarity in advance. For count two, which we both bring together, we're bringing.

an Administrative Procedures Act, APA challenge. And the idea behind that challenge is that the SEC has adopted a policy or a final rule without submitting it for notice and comment, which violates the APA. And the APA says that if an agency engages in final rulemaking, they have to put that out for notice and comments so that we can all have an opportunity to know what it is and challenge it if appropriate in a court. And they haven't done that. And of course, the SEC will say we have no final rule or policy. And look, we haven't done a rulemaking. But the point is that they do have a policy. And the way that we know that is through the multitude of enforcement actions that we have seen them bring in the past few years. There is so much evidence that since Chair Gensler took office,

they have ramped up their enforcement efforts. They added something like 50% new staff members. to enforcement. And we all have lived through this increase in cease and desist orders, complaints. There's like something new every week, it feels like, that it makes clear, if you look at that great body of SEC statements, that they do have a policy. And that policy is that when a digital asset is involved, there is a presumption that they are implying that it's a security, the error is a securities transaction. And I think they best. back into their securities analysis after applying that presumption. They take different litigation positions, advocacy positions in front of whatever court they're in front of that day. But that

presumption applies. And their rule, in our opinion, is that they are saying every token or nearly all tokens are investment contracts and nearly all token transactions or securities transactions. So that's count two. And we bring those claims in the Western District of Texas. Awesome. Well, there's a lot to dig into there. I had never actually heard of Beba, but it seems like a really interesting use case for a blockchain. Could you talk a little bit more about what the company is actually trying to do here with this technology? Yeah, absolutely. So, they released Beba tokens as a marketing and promotion effort. So their token, if you hold 200 Beba tokens, you can redeem them for a discount on an exclusive duffel bag that is only available

to token holders. So they have historically made backpacks and duffel bags and other And they're very cool. They're all handmade and using resources in Kenya because the founders were raised in Kenya and saw the local communities there and how the economy there was going and realize that digital assets there could change the world and wanted to do something to lift up local Kenya and crafts people and their resources. So all their products are made using Kenya materials. But what is very cool is how they're using their digital assets now for marketing. They want to reach a wider audience. They hope to find more customers, of course.

And by releasing this token and hoping that people trade it and talk about it and use it to redeem for bags, they'll reach more people. It's really interesting. There's this category of emerging companies that are almost building the next generation of loyalty points or coupons or something like that. It doesn't seem like a security to me as much as it just seems like the logical evolution of things that have existed in the analog world for hundreds of years, really. I agree. And there's so many companies that are not at all what we would think of as a crypto business that are using NFTs and tokens to do the same thing. Like I think Sephora just released a metaverse with NFTs and you can have representations of their makeup products in the metaverse. And I think that we see that with other companies too. Tokens are a great way to reach a lot of people. From my standpoint, we certainly see a lot of companies that have ideas around doing this. And I would assume that you, you guys share the view that the reason why we're probably not seeing more of these in production is just this regulatory ambiguity around am I going to do this product launch, which cost me that much in the grand scheme of things, but am I going to be facing a situation where I have

to spend millions of dollars defending myself against the SEC if I actually take this step with my product? Absolutely. I mean, even responding to a subpoena can cost tens or hundreds of thousands of dollars in legal fees, just collecting documents and producing them in response to a subpoena can be existential for businesses. So I think the idea of just waiting around to find out if you're going to be next on the subpoena list or get a well's notice or just be handed a complaint is really terrifying for a lot of companies that would rather just not live in that fear. That's like what the lawyers would say are the credible fear of enforcement here that underlies count one of our complaint. And I think with this marketing angle,

people have to worry that if they release tokens and then a secondary market arises because they are tokens that are freely tradable, the SEC is going to use that to say there's an ecosystem. If so facto, there's a common enterprise and use that to make there be an investment contract where these companies never intended for there to be an investment contract. Yeah, it's a real shame that we're not seeing some of these products actually see the light of day because of these concerns. So what happens now? So you've filed this complaint. Maybe just talk a little bit about procedurally, how do we get to a decision here? Sure. So assuming that the SEC accepts service when they are served, it hasn't happened yet. It should happen soon. Then they have

60 days from that point to respond. I would expect that they're going to move to dismiss the complaint and that will be the next big event or motion practice that you will see. It's possible they could ask for more time, but they automatically get 60 days to respond. Okay. So they do a motion to dismiss and a judge decides whether or not it's dismissed. And if it's not dismissed, it moves forward to a trial. Is that more or less how this usually works? Yeah. So if a motion to dismiss is denied, which we hope and expect that it would be, it would go to discovery. And we would have a chance to ask the SEC for their documents. And we expect to be asking for documents that show that policy that we were just talking.

about. There must be documents there that commissioners are relying on or the people within the SEC are relying on in analyzing all these different fact patterns that they are analyzing. So we would get to seek discovery from the SEC and they'll seek discovery from us. And then after that, there's usually one side or the other or both make summary judgment motions. And then there would be a trial. It's such an interesting space to operate right now as a crypto industry participant because the SEC has been actually on record with conflicting statements around a number of things. So the Coinbase case in particular, they've called out the SEC's posture towards Ethereum, the underlying asset and whether or not it's a security or a commodity.

And there have been contradictory statements even over like a six-day period from the SEC on whether or not ETH is a security. So I wonder if there actually is this document out there where they actually have the plan. It just seems like very scattershot to me. It's all scattershot in one direction, though, Matt, and to the detriment of U.S. businesses, to your point. It's scattershot, but all leading to one end, which is that digital assets are within the jurisdiction of the SEC. I think that one thing that folks on crypto Twitter, for example, like to point out a lot, is that the SEC's theories, legal theories, as applied to anything outside of digital assets, would capture collectibles, be they Nike sneakers, or Chia Pets, I think is the example used in the Coinbase case. But they're not bringing those cases,

because it is a digital asset-specific policy they've adopted here. And they wield the law in sometimes totally contradictory ways to your point, all in to reach the same end, which is that everything is in the scope of the SEC's authority. And the consequences are exactly why we think it's in this case is important to your point. Who knows how many innovative product ideas have not even seen the light of day because people fear ad hoc enforcement. It's just not possible for businesses to plan and invest in doing new things when they have no idea what rules they're supposed to be following.

And we think the SEC has a rulebook they're keeping secret that says everything belongs to us. And that's inappropriate. And we think the court should reject that approach to policymaking. If you just think about it from the perspective of how much money, how many resources are being wasted on some of these enforcement actions, it's pretty breathtaking when you just think about it from a taxpayer perspective. This was really driven home, I think, a couple weeks ago with this debt box case, which I wasn't closely following debt box as a company. But there was a decision by a judge that the SEC had essentially, I'd be curious, you guys, take on it. But the way I read that is that the SEC essentially misrepresented facts when they were seeking this temporary restraining order. So curious what you guys think about either that case

specifically or just generally speaking, the impact that that decision will have on the rest of the market. Yeah, I think that not only did they misrepresent facts, they totally made up facts and completely made up stories essentially in order to get a court restraining order, which was this really dramatic relief. What the SEC did is they went to a court and said, we need you to essentially seize all the assets of this company and its key employees. And they weren't even aware that the SEC was trying to do that. The way they convinced the court to do this was based on literally just made up facts. For example, they said in the 48 hours before the hearing where they got this temporary restraining order, the defendants had closed 33 bank accounts. This was last.

summer. Ends up, we find out that the defendant's debt box not only didn't close any bank accounts because the banks actually were closing their accounts, but no accounts had been closed in 2023 at all, let alone in the 48 hours before the hearing. So the judge found all of this out and the SEC had doubled down on the misrepresentations and false and misleading statements after they have been pointed out to the SEC. I think the most shocking part of the order is the absolute disbelief you can feel that the judge has with respect to the SEC's actions here.

Like the judge literally cannot believe that the SEC engaged in the behavior they did and describes it not just as a failings of a few staff attorneys, but a systemic problem that implicates the entire commission. So it's really an indictment, I think, of their entire ad hoc enforcement campaign against crypto, where they're making it up as they go, be it the law or the facts. Is a private citizen here, I feel like if I had done something like this, I would be held accountable and I would face jail time or something.

And in this case, it just makes you feel like you're living in a banana republic to see an agency of the government do something like this. and what happens here is just the fine and the taxpayers are on the hook? Is there a logical punishment here? How should we think about this? Yeah, so I would just say as a lawyer when you go to court and you stand in front of a judge, you are appearing as an officer of the court. The judge has to be able to take you at your word.

If you are a lawyer who the judge cannot trust, then imagine every oral argument just being like you'd have to hand up a document every single time you set a fact. the judge is taking it on good faith that you are accurately conveying to the judge of things that you are saying the rule of law goes away if we can't have lawyers, rely on what lawyers are saying to judges on the record. You're not sworn in, but there is that level of trust there. And I think breaking that trust is why such a drastic consequence was imposed here. Rule 11 sanctions are rarely used. they are even more rarely used against government attorneys. That is a huge step.

They're going to be ordered to pay all the attorney fees of debt box in dealing with the TRO and the receiver that was appointed by the court and their sanctions. So I think that it's a drastic remedy, but the language of the order makes it clear that it was needed. There's this great quote in there that where the court says the pervasive misconduct exhibited demonstrates a pattern of organizational bad faith and broadly implicates the commission itself, not just isolated individuals. That, I've never seen the words bad faith in an order

so many times as in this order. And I think that shows why the court thinks it was necessary to impose this level of a sanction. But Matt, I think the court agrees with you that more needs to be done here, but there's only so much the court can do. At one point, the order says that the conduct constitutes a gross abuse of power, Congress entrusted to the agency,

but that gross abuse of power is not a matter for this court to consider. I think the implication being that it's Congress's job to figure out how to deal with an agency that's grossly abusing the trust the American public has given it. Well, that's ultimately the right answer here, right, is that we need Congress to act on a certain number of fronts here, whether that be a market structure bill, a stable coin bill, repealing staff accounting bulletin 121 would be another kind of no-brainer. But as a non-lawyer, it just strikes me that the SEC is not going to go out of its way to engage in proactive rulemaking on this. I'd be curious how you guys think this actually gets resolved. I think that you're right. Ultimately, the long-term solution here and the only

enduring solution is going to be new legislation that is enacted and signed by the president. I think that is several years away for every issue we're currently dealing with and maybe stable, quite a market structure move more quickly, but fingers crossed for next Congress. But I think you're absolutely right. No matter what all of this needs to be solved legislatively, and I think it's very encouraging the extent to which crypto has stepped up its engagement in the political process in a way that it hasn't before. I mean, thinking back to like 2020, 2018, I don't think there was any crypto engagement

in any organized fashion in the political process. Obviously, that has changed. And I think the real fruit of that is going to be borne out next Congress. So I'm quite hopeful because you're absolutely right that the long-term solution here is going to be legislative action on most of these issues. In the meantime, the SEC's anti-crypto crusade, I do think is working. To your point, there are products out there that aren't being launched.

There are new ideas that aren't being tried because of their campaign of regulation by enforcement. So in the meantime, I think we are hoping to pursue other ways to push back against that, which is why we're taking this a new look at proactive litigation and try, to take the fight to them as quickly as possible while Congress figures itself out. I would also just add that Coinbase's petition for rulemaking could get decided in the short term, and that would potentially force the SEC to do rulemaking. It's possible there that the Third Circuit will order them to do rulemaking, so we might see something from that. And hopefully our case will move relatively quickly. There's also another proactive action that.

that was filed last month by Legilex and the Crypto Freedom Alliance of Texas, which is another proactive action seeking a court order declaring that Legilex is not an unregistered securities exchange. It's a digital asset trading platform. So I think these proactive measures have a good chance of moving more quickly than Congress, as Miller was saying. So we could actually see something from those in the next year. That would be great. It's been interesting because you guys reference Congress and obviously the industry is mobilizing and is reaching out to representatives and trying to influence that discussion, trying to talk about here are the companies I'm trying to build in this local district and we need clarity.

But now we actually have the bank lobby getting involved in this, particularly on Sab 121. So you never would have thought that there would be an alliance there between the crypto industry and the banks. But you look at these Bitcoin ETFs and how much capital has flown into these things. And how many U.S. banks are serving as custodians for these products, which is precisely zero because of staff accounting Bolton 121. So is there reason to be optimistic that maybe there's a bigger pool of capital here that might be pushing some of the same issues? I think so, 100%. I think it's less that Trad Vives crypto with any favorability at all.

I think it's more that particularly the SEC has taken the approach that has adopted to crypto and it is now over the last couple of years applied that to the traditional financial markets and they are all rightly freaking out as we have been for the last eight years because it's impossible to do business in this environment where they're making it up as they go and write rules that are completely ambiguous and you have no idea what your obligations are or are not. One example of that being the recently best SEC dealer rulemaking. So that rulemaking we care about because it potentially, depending on who you ask, it's ambiguous, captures participants in liquidity pools, AMM liquidity pools as dealers under the securities laws. Setting aside the predicate

issue of what digital assets are and are not securities, we're setting that aside, but don't want to forget to mention it. Tradfai has already sued over that rule because I don't know the details as to why it affects them negatively, but this rule that could be bad for AMM liquidity pools is similarly terrible for trad-fi businesses and they're suing over that rule-making. But I will say, like, the last few years of financial regulatory policy has really upended the relationship between the private sector and public sector in a fundamental way. As we have been commenting on all of these, we've been looking at how TradFi has pushed back on these rules in the past, and we're surprised to discover that a lot of the TradFi trade

associations and businesses had never even thought about suing a federal agency, and they've run around for decades because the SEC in particular, their approach to regulation is completely upending the markets as their approach to crypto has been for the last eight years. So I think yes, although I think the Trad V thinks of crypto as perhaps being the loyal opposition while the SEC's the enemy. But I think they used to think that the SEC was the loyal opposition and we were the enemy. Yeah, that makes perfect sense. Well, I guess it's hard to kind of lose yourself in these specific cases and just the overall posture of the SEC. But then comes the obvious question of with respect to defy, how should this actually work from a market structure and regulatory

perspective? And I know you guys have been particularly active here. And that's almost like the bigger picture issue. So maybe talk a little bit about how you guys are thinking about proposing how things ought to work in a functioning government. Well, I think our view is that we need to start with the big consumer-vasing issues. I think D-Fi should come after, long after, C-Fi regulation, stable coin regulation, figuring out custody, et cetera, just because that is where the vast vast at the moment majority of consumers engaged with crypto assets. So we support regulators and Congress's focus on that at the moment and hope that those get resolved before we get to the more tricky and questions around how it should work for defy. That certainly makes sense to me. I mean,

the obvious ones are stable coins, custody, market structure, just figuring out how to get actually on the centralized side, some of the most trusted institutions in the United States actually able to enter this market without having to spend hundreds of millions of dollars on regulatory strategy. what is kind of the ideal outcome here, I guess, with respect to maybe Beba, but also just broadly what you guys are advocating for? Sure. So the ideal outcome here is that we get a court order that says the Beba tokens themselves are not investment contracts and free airdrops are not securities transactions and that the SEC

has violated the APA by finalizing this rule that they are enforcing against the industry and they got to stop. That would be the absolute pie in the sky. We open a bottle of champagne. That's what we get. So we are in it for the long haul. If we don't get that on the district court level, we will take it up to higher levels if we need to, but that's what we're committed to getting. We get a lot of listeners of the podcast reaching out after hearing us talk about the SEC and asking, what should I be doing? What can I do to help as just an everyday person who's either building something in the crypto space or maybe just a fan of the technology and wants to see it exist in the United States, where would you send people? What should normal people do here in order to help the cause?

So if you'd like to help us with our litigation, you absolutely can support the Defi Education Fund. We have a few links on our Support Us page about how you could donate to our efforts. You can support Beba by buying their products, and they're also really great. So I am out here shilling for them. I think that they're great. but you should absolutely support them as well because they are doing a brave thing that reflects a lot of the convictions that we all feel in this industry about how the SEC has harmed us. So we welcome your support. And I think politically, know who your reps are, talk to them, tell them that you care about these issues.

I think this is going to matter, going into the next selection. So make your voices heard. That's a great place to leave it. Well, Miller, Amanda, thanks so much for coming on the podcast. I'm sure we'll check in here. It seems like there's a new case every couple months here, whether it's you guys or someone else in the crypto industry. So we'll stay on top of it.

But keep up the great work. Thank you so much. Thanks for having us, thanks for listening to another episode of On the Brink with Castle Island. To find out more about Castle Island, visit castle island. To listen to all of our podcast episodes, please go to On the Brink-Podcast.com or just click on the tab in our website.

Thanks for listening.