The Breakdown - Judge Agrees with Coinbase in Public Hearing

Episode Date: September 25, 2024

The SEC's woes continue as a panel of judges largely agree with accusations levied against them by crypot exchange Coinbase. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to 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 Tuesday, September 24th, and this is SEC Week. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Hello, friends. Well, as I said, for those in crypto policy, this is SEC Week. It's the final week of the regulator's fiscal year, and the SEC is expected to jam in a few final enforcement actions to boost their already record numbers.

We also have Gary Gensler facing a pair of oversight hearings on Capitol Hill. Wednesday's Senate Banking Committee hearing should be a fairly sedate affair, but all eyes are on the House hearing. All five commissioners are present to give testimony, giving them an opportunity to speak out against the SEC's crypto strategy. SEC week got off to a really bad start for the regulator on Monday, as they received. received another dressing down in federal court. The case involves Coinbase's petition for rulemaking, where they demanded some clear rules of the road. These petitions are routinely ignored by the regulator, which is the approach they took way back in 2022 when the petition was originally filed. The court later forced the SEC to provide a response with the regulator denying the petition. They claim that existing securities law is perfectly workable when it comes to digital assets.

Further, they argued that it's important that the SEC retains discretion around when and how to conduct rulemaking. Coinbase appealed the SEC's denial, bringing the case to a head in oral arguments on Monday in front of a panel of three judges. The hearing was live-streamed, giving us an opportunity to listen in as the lawyers on each side made their case. The thrust of Coinbase's argument was that the SEC had acted in an arbitrary and capricious manner. They said the current regulations are unworkable and that it was fundamentally unfair that the regulator had not provided details on how to come in and register. Coinbase has been attempting to register and comply with U.S. law since at least 2021, attending over 30 meetings with SEC staff that year.

The SEC fired back that they have no obligation to conduct rulemaking on this topic. The SEC lawyer said, if Coinbase wants to arrange its business in a way that does not comply with the existing regulatory framework, that does not establish a right to have the framework adapted to meet their business. The judges seemed to agree that the SEC had discretion around rulemaking, but were baffled by the way they exercised their discretion when it comes to crypto policy. They were extremely hesitant to sign off on the SEC's approach, which one judge characterized as, we won't tell you the answer until we prosecute you. The SEC's logic folded up into a pretzel as the scrutiny continued. The judges asked how a crypto exchange is supposed to operate if

they are not allowed to custody assets as a clearing agent, but must do so as a broker dealer. Keep in mind, these are judges with decades of legal experience between them, and they seemed unable to figure out how Coinbase could comply with the SEC's view of the law. One of the judges even quipped that it looks like the SEC is attempting to kill off the industry. SEC lawyers suggested that there is no requirement that securities law can actually be complied with. Larry Floreo, the General Counsel of 1KX, said that this was, quote, one of the craziest things I've ever heard. The validity of a federal law isn't based on the ability to comply with the law. By all accounts, the hearing was an

utter train wreck for the SEC, who are trying to argue that their crypto rules are clear and workable. Jake Trevinsky, the chief legal officer of Variant Fund, tweeted, listening to this and SEC counsel keeps saying digital asset securities to the court. Two weeks after different SEC counsel apologized to a different court for the confusion they caused by saying crypto asset securities. But we're supposed to know what the rules are? Bill Hughes, a lawyer at Consensus commented, if you want to get the emotional fulfillment of a federal appellate judge flaying alive

an SEC appellate attorney for the SEC's contradictory and vague positions on crypto, then listen to this hearing. Bravo Coinbase for continuing to shake their fist on this rulemaking issue regardless of how it comes out. And that's really the rub of the hearing. While the judges didn't seem to understand or tolerate the approach, the question isn't whether they like it, it's whether it's legal. Bill Hughes picked up a hint of uncertainty from the judge when they asked Coinbase's counsel, what do we tell them they have to do? Hughes commented, making an agency engage in rulemaking sounds like a tall order in this oral argument. Court might agree with you, but still not say that you win. On the other hand, this was a

public dismantling of the SEC strategy. This was a panel of appellate judges, questioning whether a federal regulator is upholding rule of law and coming to a fairly stark conclusion. Even if they decide against Coinbase, it makes the SEC's approach even more untenable. Based on this hearing, it's difficult to see how it could survive the inevitable Supreme Court challenge. Trevinsky commented, it's dangerous to predict the outcome of a case based on oral argument, but wow, the SEC just got roasted. It's past time to put an end to the SEC's unlawful campaign of regulation by enforcement.

The Third Circuit might do it. Hello, friends. before we get back to the rest of the show, I want to implore you to join me at Permissionless. Permissionless is the conference for crypto-natives by Crypto-Natives, and the reason it's so important this year is that despite regulators' best attempts to push industry founders, devs, and executives out of the U.S., the United States remains the beating heart of crypto. Today, the tide is turning. Policymakers have pivoted from fighting crypto to embracing it. Literally now we are in a major political party's platform, which will lead ultimately to the creation of new financial products,

new applications, and ultimately new adoption. Permissionless is the conference for those using and building on-chain products. It's home to the power users, the devs, and the builders. And perhaps more importantly, I will be there. The location is Salt Lake City, the dates are October 9th to the 11th, and tickets are just $499. If you want to get 10% off, use code breakdown 10. Go to the Blockworks website, blockworks.com. There will be links to register for the conference, and again, you can use code breakdown 10 to get 10% off. Moving on, ahead of this week's oversight hearings, Patrick McHenry and Cynthia Lummis laid further groundwork for questioning in a letter to the SEC. They urged the regulator to rescind SB 121,

an accounting rule which functionally prevented banks from offering crypto custody. Aside from a bipartisan vote to repeal the rule, the lawmakers noted that the SEC is now apparently picking favorites. We recently discussed how SEC staff are apparently issuing exemptions to a handful of large custodian banks and leaving smaller state banks out of the process. The lawmakers contended that, quote, instead of recognizing this failure in rescinding the guidance, the SEC has only caused further confusion. Working with certain institutions to avoid the balance sheet reporting requirements,

these consultations completed on a case-by-case and confidential basis do not provide the transparency or certainty needed to ensure SB 121's requirements are consistently applied across different institutions. They said the use of staff guidance instead of notice and comment rulemaking was, quote, not appropriate and violates both the spirit and the letter of the Administrative Procedure Act. The letter gathered 29 signatures from Republican House members and a further 13 from the Senate, just to give an idea of how many lawmakers will be lining up to take their shot at Gensler's SEC this week. Also getting out ahead of the hearing, Republican Commissioner Mark Yuwita sat down with Eleanor Territ of Fox Business

to give his views on SEC overreach. Making his position extremely clear, he said, we have not provided the rules of the road for crypto other than to declare they are nearly all securities, nor have we provided a practical pathway to comply with our rules. Instead, we have wasted time and money on crypto enforcement actions that provide limited guidance at best. At the same time, we are using enforcement resources on crypto. The commission is falling short in protecting seniors from relationship and affinity scams, which can be devastating when their retirement investments are stolen, presuming that everyone in the market is a potential scammer and

fraudster until proven innocent is the wrong course of action and not the American way. We also have some new data from paradigm dissecting the patterns in SEC enforcement actions. They called their report, regulation by enforcement isn't just a meme and set out to demonstrate the reality of the situation. Lawyers at the firm looked at all 171 crypto enforcement actions conducted since 2015, with a focus on seeing how the tactics have shifted since Gensler took office. They found that cases are now far more likely to go to court. The report said, litigation has always been one of the SEC's primary tools for enforcement. What is novel here is that the SEC is using litigation to decide policy instead of going through the process of finalizing

rules after they have gone out for public comment. Another key finding was that under Gensler, the SEC has gone after individuals more often. The report suggested, there's nothing inherently wrong with the SEC going after individuals. What's problematic is that the SEC under Chair Gensler is pursuing a barbell strategy of pairing its actions against the largest and most successful companies in the industry on issues related to institutional registration, with an increased focus on going after individuals who lack the resources and incentives to defend themselves on matters pertaining to the issuance of alleged securities. They suggested the goal is to maximize deterrence rather than to minimize harm. A key example of this would be the focus on going after celebrity defendants like

Kim Kardashian for promoting crypto products rather than the perpetrators of actual fraud. Finally, paradigm found that the SEC has preferred to go after large intermediaries rather than individual token issuers. The report stated, in doing so, the SEC is attempting to maximize its leverage to bring the entire ecosystem to heal and litigating the legal status of specific tokens in the absence of the token issuers, which are the party's best position to defend the claims. None of these findings are particularly novel for anyone that has been watching the SEC's rampage over the past two years, but it's useful to have solid data to back up industry opinion. Paradigm concluded, despite Chair Gensler and his advocates saying nothing has changed about

the SEC's approach to crypto, the empirical evidence is suggestive of the opposite. So if it feels like this is all prelude to the big hearing happening on Tuesday, you're not wrong. I'm currently traveling, so we're going to cut this one a little bit short this week, but we will have plenty to talk about in the days to come as we get more from that hearing. For now, it feels like we're reaching something of a crescendo when it comes to this SEC, and boy, am I excited to move past to the other side. For now, though, that's going to do it for today's breakdown. Until next time, peace.