The Breakdown - Hinman Emails Show SEC Just Making It Up As It Goes Along

Episode Date: June 14, 2023

Yesterday three consequential legal events happened. Former SEC officer Bill Hinman's emails were released; the SEC was forced to respond to Coinbase; and Binance had their hearing on the SEC's emergency asset freeze request. NLW covers all of the important details.  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Wednesday, June 14th, and today we are doing part two of one of the most consequential days in crypto-legal history. Before we get into that, however, if you are enjoying the breakdown, please subscribe to it, give it a rating, give it a review. Or if you want to dive deeper into the conversation, come join us in the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, so today we are going to start with the same tweet we started with yesterday from Coinbase's Paul Grewell.

He wrote one, hearing on motion to seize Binance assets in DDC. Two, release of Hinman docks in SDNY. Three, SEC response to order on Coinbase petition in Third Circuit. Not every federal court day is eventful in crypto, but tomorrow, i.e. Tuesday, is. Patrick Hillman, the chief communications officer at Binance, quote, tweeted that and said tomorrow will likely prove to be one of the most consequential days in the history of the U.S. blockchain community. Buckle up and pray the judicial system helps provide relief for U.S. users. So today, we are following up yesterday's analysis going into those with what

actually happened. And we're going to start with Coinbase. Now, you'll remember that this was a Coinbase rulemaking lawsuit, basically that Coinbase said that the SEC had not responded in a timely manner to Coinbase's petition for rulemaking. And effectively, what Coinbase is trying to ascertain is whether the SEC plans on offering any guidance in the crypto space. Coinbase alleges in the case that the SEC has already made up their mind not to pursue crypto rulemaking, but refuses to make this statement publicly in order to avoid the decision being appealed in court. Last week, the court ordered the SEC to explain the apparent contradiction between remaining undecided on rulemaking while pursuing wide-ranging enforcement action.

Chairman Gary Gensler's multitude of public comments stating that the rules are clear was also noted by the court. So yesterday we got the SEC's response letter. David Hoffman, the co-host at Bankless, summed it up thusly saying, SEC just told us to go F ourselves. So in their response letter, the SEC wrote that they have, quote, not decided what action to take on that petition in whole or in part, which is entirely reasonable given the breadth of the rulemaking petition. Now, while the SEC maintained that Coinbase's lawsuit was without merit, they begrudgingly offered the timeline of four months for when, quote, commission staff anticipate being able to make a recommendation to the commission regarding Coinbase's rulemaking petition.

The SEC also offered to provide the court with a status report after the four months had expired. The SEC reconciled their position with the recent slew of lawsuits by claiming that, quote, regardless of whether the commission determines to undertake the rulemaking sought by Coinbase, a decision the commission has yet to make, Coinbase, like everyone else, is bound by existing law. And Coinbase is free to vigorously assert its position that it has not violated that law in the current enforcement action. The SEC argued that, quote,

to find that consideration of new regulatory action is inherently inconsistent with the enforcement of existing law would be to require agencies to effectively suspend enforcement of the law every time they assess whether to adjust regulatory requirements in light of evolving conditions. Now, Coinbase Chief Legal Officer Paul Grewell criticized the SEC's response, noting that the regulator had failed to directly address the court's request for a firm timeline to deal with the petition.

He tweeted what he called his initial thoughts, One, he wrote, they repeat the fallacy that they haven't made any decision on new crypto rules. Two, they refuse to commit to any deadline despite the court's explicit order. Three, they instead, quote, anticipate making a quote recommendation in 120 days. And most notably, four, they ignore the clear statements of the chair that confirm they have no intent to issue new rules and instead conflate the evidence of a decision those statements provide with an argument that the statements are themselves a decision. Ex-lawyer NFT writes,

the SEC's response can be summed up simply. The SEC tells the court that the court should trust it, but that the court should give no weight to the commissioner's statements in Congress and on national TV, and that the court should give no weight to its actual actions. Essentially, the SEC tells the court, trust what we say, but not what the chair says and ignore what we do. The response is simply the SEC, again, acting in bad faith. I don't think this response will work too well for the SEC. Dysopia Breaker writes, if it's as simple as come in and register, then why do they need four extra months to respond to basic clarification requests. It's almost as if clarity is something they do not want. Instead, they want to foster an environment with maximum uncertainty and legal risk,

so as to disincentivize participation in an industry they don't like, while giving excuses to selectively prosecute things they don't like. Seems like an illegal end run around the Administrative Procedures Act in Congress, an immoral approach which contradicts their mandate and robs the American public of the rule of law while allowing bad actors to thrive. Now then again, Thormythiasin of Coinbase had a more generous take. Given those four months were waiting, he said, I'm sure the extra time is to make it extra awesome. Next up, we turn to the Binance case. This is the one that had seemed potentially the most consequential in the short term, but yesterday's afternoon hearing kind of failed to live up to the high drama potential.

The judge ultimately decided to send the parties away for more negotiation. Now, the SEC had come into the hearing asking for a freeze on assets held by Binance U.S., with concerns that customer funds were being misappropriated by Binance's international entities. In their defense, Binance U.S. claimed that this asset freeze would be tantamount to shutting down the business, and made a counterproposal with specific carveouts for business transactions to allow the company to continue to operate. Binance U.S. claimed that the SEC had rejected this compromise, saying that business transactions could be used to mask a transfer of funds to offshore entities. On Tuesday, the judge refused to issue the restraining order on the terms requested by the SEC.

See, instead, parties were told to continue negotiating on a reasonable set of restrictions that addressed the SEC's concern about the protection of customer assets without needing to shut down the exchange. If the two sides can agree, the judge said, quote, there's absolutely no need to issue the restraining order. The judge also noted that the sides were, quote, not that far apart. In the interim, the judge has ordered Binance U.S. to present a list of business expenses to the court to be included in a future order. Parties were also asked to provide a status update on negotiations by the close of business on Thursday. The SEC's key argument was that they were suspicious that customer funds had been misappropriated by Binance International and perhaps even CZ himself.

However, the regulator did not present any direct evidence that this had occurred and instead framed their asset freeze request as a precaution until they could prove that the keys to customer assets were inaccessible to offshore staff. The judge appeared frustrated with evasive responses from the SEC when asked whether funds had actually been removed from the U.S. platform. Well, the hearing was not specifically about the core issues of the case, the judge delved into the SEC's position on the classification of crypto assets. She asked the SEC attorneys to distinguish between a crypto asset and a crypto asset security. In response, a lawyer for the SEC said that the regulator had provided many example of

crypto asset securities in its filings, but was reserving the right to assess other tokens later. Digging in further, the judge asked both parties which crypto tokens were commodities. She said, the ones you're not calling securities, what are they? The judge was unable to obtain any meaningful clarity on this question, which of course goes to the heart of the case. When Binance U.S. lawyers were asked whether the B&B token is a commodity, they simply replied, it's a crypto asset. Echoing the sentiment of basically the entire industry over the past few years, the judge exclaimed,

What is that? No one wants to tell me. Now, a lot of the chatter on Twitter was about how this judge seemed not particularly enthused by the SEC. James Murphy at Meta Lawman writes, Judge does not enter SEC's requested asset freeze order. Judge encourages parties to try to come back to an agreed compromise order and report back on Thursday. The judge apparently caught on that there was no actual emergency.

I'm told the judge pressed the SEC lawyers on whether they had any actual evidence of Binance U.S. customer assets being moved overseas. They had none. Round one to Binance NCZ. The New York Times is reporting that at the hearing, Judge Berman expressed skepticism about the SEC's use of its enforcement powers to regulate the crypto world, calling it inefficient and cumbersome. In a later thread, he went on, it sounds like the hearing in SEC versus Binance went even worse for the SEC than I had heard. According to CoinDesk, the judge, quote,

hammered the SEC attorneys about their intransigence on the freeze order. The judge was also, quote, frustrated by the SEC's inability to answer the simple questions of whether U.S. customer assets had been transferred overseas. Now let's get to the third of these issues that has led to the most chatter on Twitter, and that is the Hinman emails. Yesterday got off to an early start when the Hinman documents began pouring into the Ripple court record. The much-type documents disclose a series of internal comments at the SEC regarding a speech made by former director of corporate finance, Bill Hinman. The speech made in 2018 spoke about how cryptocurrencies can become decentralized and therefore no longer appropriate to regulate as securities. The speech used the early years of Ethereum

as its example of the decentralization process. Much of the documentation showed a collaborative feedback approach to drafting the speech, with many staffers marking up notes on a shared document. Now, it is hard to overstate how legendary these emails are among the Ripple faithful. Ripple's defense in their lawsuit against the SEC has relied on the HINMAN documents extensively, trying to paint a picture of the regulator's view of tokens at the time. Some in the community even assume the documents contain some sort of smoking gun, showing SEC bias in favor of giving Ethereum a free pass on securities enforcement. Throughout the Ripple case, meanwhile, the SEC has maintained that Hymond's speech

represented his personal views only, with Ripple lawyers counter-arguing that extensive comments from staff clearly showed an attempt at forming a consensus approach within the agency. Now, rather than a clear articulation of some secret criteria to decide which tokens are securities, the documents reveal a rather confused state at the SEC back in 2018. Some staff pushed for the speech to provide clarity to the market one way or the other. SEC Director of Trading and Markets Brett Redfern wrote, As written, the language remains vague as to whether Eth is a security. If you want to make an affirmative statement that it is not a security,

the language could be stronger, i.e. just say it. If you don't want to take an affirmative stance, we suggest using language similar to what you use for Bitcoin, regarding the disclosure regime to make it more consistent. In a separate comment on the speech, he said, parts, quote, appear likely to create more confusion about the status of Eith. An unnamed SEC staffer out of the comment, quote, this speech is what the general public and market participants have been asking for, so we are very supportive of the speech and what it is communicating. Others at the agency wanted to maintain strategic ambiguity on the topic of whether cryptocurrencies can decentralize to become commodities. Valerie Sapanek, the current head of the SEC's FinHub group, wrote, the less detail, the better. She did, however, comment that the legal theory being advanced by Hinman, quote,

is introducing a concept that will probably generate much discussion, so leaving room for that discussion is good, I think. Now, the speech was most notable for advancing the legal theory of sufficient decentralization. That's the idea that a token can transcend the need to comply with securities regulation and disclosure requirements by becoming decentralized. One staffer wrote out that this novel legal theory, quote, seems to point out what might be considered the regulatory gap that exists in this space. The then head of trading and markets said that, quote,

because the list of factors is so extensive and appears to include things that go beyond the typical Howey analysis, we have concerns this might lead to greater confusion on what is a security. Now again, one of the key legal arguments during the Ripple case has been whether or not the hymn speech represented legal guidance from the regulator or merely the personal opinion of one SEC director. Judging from the extensive staff commentary, it seems hard to argue that the speech didn't at least represent the result of a consensus-building effort at the agency. So there are really two things going on here. One is to what extent this represents some silver bullet for Ripple to win its case, and the other is what it says about the SEC and its process

of rulemaking or lack thereof over the last five or six years. Gabriel Shapiro, the general council at Delphi Labs, writes, Hinman emails are a nothing burger, though great for ETH. No idea why Ripple think these emails help Ripple's case. Columbia Business School prof and stablecoin expert Austin Campbell wrote, I think they're more helpful in showing the SEC doesn't deserve the benefit of the doubt for their current actions against crypto. It's only a potential win in the court of public opinion.

Gabriel responded to that, sure, but I think we all, and even members of Congress, take that as a given at this point. Marginally bolstering existing knowledge and sentiment is pretty different from the huge hype that was given to these emails. Now, Preston Byrne, a partner at Brown Rudnick, wrote,

The Hymn speech has proven to be a new kind of regulatory statement I propose we call anti-guidance, guidance which creates work for the regulator by luring companies into non-compliance. Fox business journalist Eleanor Territ got to the root of what it might mean for the case. She writes, My biggest takeaway from these Hinman emails is that it seems SEC officials who weighed in on the speech believed the goal was to provide market guidance and tried to write it in a way that would convey that. Thus, in the Ripple case, the SEC lawyer's argument that the speech was solely Hinman's opinion

and not intended for market guidance could now be undermined. Orlando Cosme writes, one of the biggest takeaways from the hymn emails is that they directly undermine Gary Gensler's main talking point. The security's laws are clear as applied to crypto. If it's so clear, why were lawyers at his own agency waffling about their position on ETH? And from a public opinion perspective, Gabriel Shapiro again really summed up what I think the main conclusion is. He writes, whatever you think of Hidman's emails and Ripple's chances of winning or losing, I think we can all agree SEC policy, tactics, everything on crypto, has been an absolute mess, even before Gensler, inviting arbitrary application of the law through nebulous morphing,

guidance. We cannot have arcane priests going token by token through elaborate analysis of facts and circumstances deciding these issues every time. We need Congress to step up and create a clear, reasonable, easily navigated set of fit-for-purpose rules for crypto. Even within this set of documents, you have trading and markets cheering on that Hymann will clarify that ETH is not subject to the 1933 Act, but then seemingly implying that there could still be Exchange Act issues regarding ETH, makes no sense at all. Jake Chavinsky from the Blockchain Association responded to that and said, I fully agree with this thread. The SEC has no idea what it's doing on crypto and never has. Now, when it comes to implications, Mike, the general counsel at Alliance Dow wrote,

I'm hearing that the immediate fallout of the Hinman emails within the SEC is that staff will be more secretive, more cautious about what they put in comments and internal chats. If true, that's embarrassing. Our regulators should be willing to stand behind their words. My take, frustrating though it might be, is that across all three of these cases, cases, almost nothing changed yesterday. There were legal nudges. The Hinman emails do kind of undermine the SEC's case about it just being Bill Hinman's opinion. The judge does seem frustrated with the SEC when it comes to Binance and Coinbase. But those things have all kind of been clear and present throughout every recent court hearing. It certainly doesn't change the damage in the

short term that the SEC is doing just by taking the actions that they're taking. And when it comes to public opinion, I don't really think anything here is going to change what anyone thinks already. If you've already had it up to here with the SEC like everyone in crypto has, and some of our congressional allies have as well, this is just confirmation of what we already knew. If you haven't had it up to here with the SEC, at this point that basically means you hate crypto in other markets, and you see a sheer number of enforcement actions as evidence of a good job. That's clearly at this point the House Dem position. Therefore, nothing about this is likely to change either of those opinions. So to the extent that this was a big day

from a legal perspective, it was mostly just kicking the can down the field, and to the that we thought it might be a big day from a public relations perspective or a public opinion perspective, I just don't see it. We remain here a bunch of squawking chickens circling the drain waiting for something real to happen and change. But unfortunately, yesterday wasn't it. Until next time, guys, be safe and take care of each other. Peace.