The Breakdown - Operation Choke Point 2.0 Comes for Crypto Auditing

Episode Date: July 29, 2023

The latest target of SEC animosity is *checks notes* auditors?! On this edition of the Weekly Recap, NLW covers the SEC's auditing warning; an AML bill passage; Binance asking for CFTC suit to be dismissed; Sequoia reducing their crypto fund size. Today's Episode Sponsored By: In Wolf's Clothing -- The first startup accelerator exclusively for Bitcoin and Lightning startups -- Applications for Cohort 3 open NOW -- https://wolfnyc.com/apply ** 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 Saturday, July 29th, and that means it's time for the weekly recap. A quick note before we dive in. I mentioned this yesterday, but I am looking for a research assistant specifically for the AI show. This is a role that would help craft newsletter content as well as video and podcast content. And so if you are someone who is obsessed with AI and keeping track of the latest tech developments, and particularly if you're someone who either lives in the APAC region or Australia or who just

really likes working all night, send a note to jobs at breakdown.network. The second quick thing is today's show is, of course, again, brought to you by In Wolf's Clothing. Wolf is the startup accelerator for Bitcoin and Lightning companies, and its goal is to give companies that are changing the world with Bitcoin the absolute best tools they can, including mentorship, advice, and of course, funding. Right now they are accepting applications for their third cohort this fall, so if you're interested, go to wolfnysc.com. Thanks again to those guys for supporting the breakdown,

and with that, let's get to what was a very busy week. Today is going to be a bit of a grab bag catching up on stories that were important, but we haven't had a chance to cover yet, and we kick off with a fiery tweet from venture capitalist Nick Carter. He writes, This is such an evil little text, basically threatening audit firms with enforcement actions if they do business with crypto companies. They want to strip crypto of all institutional infrastructure and trust provision.

Regulatory demolition job. So what was Nick talking about? On Thursday, the SEC's chief accountant Paul Munter published a statement on the hazards-facing accounting firms who take on crypto clients. Now, while the communication was framed as a warning, a simple warning, to accounting professionals, the ramifications of these statements are a lot larger than just a casual off-the-cuff-cuff. statement. Munter reiterated a point that he has made often over the past year, that proof of reserve attestations are not audits, and firms should be careful when taking on that kind of work. He warned that attestations, quote, are neither as rigorous nor as comprehensive as a financial

statement audit and may not provide any reasonable assurance to investors. Now, this line of communications is nothing particularly new for the SEC, but the remainder of the statement included a long list of ways in which audit firms could be exposing themselves to liability when engaging crypto clients. Munter explained that accounting firms can be held responsible for the misleading statements of their clients. He suggested that if an auditor becomes aware that a crypto firm has made misleading public statements about the nature of a reserve attestation, quote, the accounting firm should consider making a noisy withdrawal, disassociating itself from the client, including by way of its own public statements, or if that is not sufficient,

informing the SEC. He closed the statement by emphasizing that accounting firms play a vital gatekeeper role and reiterated that they have a responsibility to ensure that their reputation is not being, quote, used to convey a false sense of legitimacy or to mislead investors. So, on the one hand, like, duh, right? There's nothing in here that's not obvious. Accounting firms shouldn't be cool if their clients lie. Big whoop, right? But of course, what makes this insidious is that this isn't just a casual reminder. It's an active warning. This is a great example of Operation Choke Point, where Munter didn't say outright that accounting firms are not allowed to provide proof of reserve attestations for crypto firms, what he communicated, however, was that the SEC views those

attestations as a high-risk activity, which will likely bring an accounting firm under regulatory scrutiny. You don't got to ban something if you make it so politically costly that no one wants to touch it with a 10-foot pole. Rob Hamilton, the CEO at Anchor Watch, tweeted, I had just heard about a major auditing firm stepping away from business in the industry. They must have had advanced knowledge of this. SEC Commissioner Hester Purse wrote, crypto platforms and their accountants should be clear about what proof of reserves is and isn't, and customers should understand the limitations, but why would we want to discourage good faith

efforts to provide more transparency? I think my favorite tweet, however, came from Zero X Kingfish, who wrote, thank you American government for protecting me from, Czech's notes, accounting firms. Next on our weekly recap grab bag today, strict anti-money laundering provisions for crypto have been passed in the Senate as part of the sprawling 886 billion national defense. Defense Authorization Act. This annual must-pass bill, which authorizes the military budget, is considered one of the few vehicles to actually get legislation passed in Washington. For that reason, the bill attracts hundreds of amendments each year on unrelated topics. This amendment came about as an odd mix of anti-money laundering provisions from the Cynthia

Lummis and Kirsten Gillibrand-sponsored Responsible Financial Innovation Act, as well as the Elizabeth Warren and Roger Marshall-sponsored Digital Asset Anti-Money Laundering Act. the amendment is primarily about instructing the government to study various ways to crack down on the illicit use of crypto. The Treasury would be instructed to establish risk assessment and compliance standards, as well as researching ways to combat anonymous crypto transactions. This would include taking a good look at crypto mixers and other anonymity tools. Importantly, nothing in the bill has immediate effect, rather it appears intended to get the ball rolling on setting AML standards for crypto. Now, from a process standpoint, the House passed their version of the NDAA earlier this month,

replete with its own gigantic list of amendments, and so the two chambers will now negotiate on a joint bill that can pass in both. Moving on, Binance have filed a motion to dismiss the lawsuit brought against them by the CFTC. The filing claims that the CFTC has moved beyond their jurisdiction by suing an offshore company that does not operate in the U.S., as well as personally suing Binance CEO-C-Z, who does not reside in the U.S. Binance argues that the first six claims from the CFTC, quote, do not apply to the foreign conduct alleged, while several of the charges do you not meet legal standards set out in legislation, including the seventh claim which involves abating compliance requirements. Binance was sued in March in relation to offering unregistered derivative

products to U.S. residents. The lawsuit also contained a massive set of allegations around poor compliance and conduct at the exchange. Binance wrote in their filing, there is no dispute that the CFTC has no regulatory authority over spot trading even in the United States, let alone abroad. The issue posed by the CFTC's complaint is whether, when Binance.com began offering additional products in or after 2019, by which point it had already begun to restrict an off-board potential U.S. users, it became subject to certain registration and regulatory compliance provisions of the Commodity Exchange Act and CFTC regulations. Most of the crypto folks seem to think this is pretty procedural and don't expect it to go much of anywhere at all.

Next up, one that's been getting a lot of chatter on crypto Twitter, Sequoia Capital, have cut down the size of their crypto fund by more than 65%, shrinking it from 585,000, shrinking it from $585 million to $200 million. Now, the firm is in the middle of a broader reshuffling effort. It announced in June that it would spin off its India and China divisions. Staffing turnover has also affected the firm, most notably two senior partners who recommended the fund's investment into FTX have departed. You will undoubtedly remember that Sequoia placed a large bet on FTX during Series B fundraising and eventually marked their entire $150 million investment down to zero. Sequoia said they will continue to invest in the crypto industry, but will shift their

focus to backing younger startups rather than these later stage rounds for giants. And of course, by reducing fund sizes, Sequoia will require less capital from investors. Now, as I mentioned, there is a lot of chatter around this, but a few selected pieces. First, Nick Carter again, writes, this is why crypto founders shouldn't raise from generalists. They're in, they're out, they're back in. You need a GP that has genuine conviction in the space and has the support of their colleagues in LPs. Investor Adam Cochran writes, Sequoia was barely in crypto and Yolod the hell into FTX and praised SBF for playing lull during their pitch call. They were tourists. Industries improve when tourist dry powder moves on to the next flashy thing and takes the snake oil sellers with them. Now, speaking of FTX and

disgraced former CEO Sam Bagman-Freed, SBF was hauled before the judge on Wednesday following a New York Times article which published excerpts from the journal of Carolyn Ellison. Carolyn, of course, acted as the CEO of Alameda Research and is a material witness in the criminal case against SBF. Prosecutors claimed that he had provided some of the excerpts to journalists in an attempt to embarrass and intimidate her. Now this was another hot hearing. The DOJ opened it up by calling for Sam's bail to be revoked, urging the judge to send him to prison to await his trial in October. The U.S. attorney said, quote, it is the government's view that no set of release conditions can secure the safety of the community. It appears to be undisputed that the defendant provided the documents quoted in the New York Times

to discredit Ellison. The DOJ are effectively arguing that the sharing of Ellison's diary amounts to witness tampering. This, of course, compounds earlier attempts by SBF to contact former FTX U.S. General Counsel, Ryan Miller, which the judge said they, quote, still do think, was intended to influence testimony. Wildly, the DOJ alleged that Sam had sent more than 100 emails to reporters and had more than 100 phone calls with the New York Times reporter who published the story. Prosecutors were also concerned that Sam had more than 500 phone calls with author Michael Lewis, who was set to publish a book on Sam shortly before the commencement of the criminal trial. They said they were concerned about what might be published so close to the beginning of the hearing. Now, Sam's lawyer said that he was not attempting to discredit Caroline and had not proactively

contacted reporters. That being the case, the lawyer did admit that Sam had a strategy to engage with reporters in an attempt to influence the media narrative. Sam's lawyer claimed that there had been over one million negative stories published about him and continued, What we have here is a defendant who believes, given the literally thousands of stories about his relationship with Miss Ellison, that he had the right to make fair comment. Sam's lawyer went on that locking him up would make it difficult to prepare for the trial, with many of the documents of the case available only through online tools. The DOJ scoffed at that excuse, stating that the use of digital documents should, quote, not be a get-out-of-jail-free card. Ultimately, the judge imposed

the requested gag order prohibiting Sam from communicating with the press or making public statements. They warned him to take matters seriously and set a tight timeline to consider revoking bail. The DOJ will submit a brief supporting their argument on Friday, with SBF's team's response due next Tuesday, and a hearing likely to be held late next week. Now, one more bit of news that has gotten tons of chatter online. Late on Thursday, the Justice Department informed the court that it does not intend to proceed with a campaign financing charge against SBF. They said that this decision was made after consulting with the Bahamas government about modifications to Sam's extradition agreement. When SBF was extradited in December of last year, he was indicted on seven charges and one campaign

finance violation. The DOJ later added five additional charges. Sam's defense team has argued that these additional charges had not been formally included in the extradition agreement with the Bahamas government as required by treaty. The DOJ acknowledged this defect and postponed additional charges until a second trial, currently penciled in for early next year pending an updated agreement from the Bahamas government. The DOJ now claims that the Bahamas did not include the campaign financing charges in the agreement either. They wrote to the judge in the case, quote, The government has been informed that the Bahamas notified the United States earlier today, that the Bahamas did not intend to extradite the defendant on the campaign contributions count.

Accordingly, in keeping with its treaty obligations to the Bahamas, the government does not intend to proceed to trial on the campaign contributions count. The DOJ's letter did not state whether they will seek to attach the campaign finance charge to next year's supplementary trial. Sam is still currently slated to face seven fraud and conspiracy charges during a trial set to begin on October 2nd. Now, as you might imagine, this has gotten a lot of people talking. Journalist Glenn Greenwald wrote,

Congrats to Sam Bankman Freed, the Dem Party's second largest donor, on having his campaign finance fraud charges dropped by the Biden DOJ. Their hilarious claims that they couldn't proceed because the big powerful Bahamas wouldn't let them. Sam Eichen wrote, all campaign finance charges dropped against the freed bankman by the DOJ. Totally would have happened to anyone, right? There's no two-tier justice system, you conspiracy theorist. Now on top of this, there was also some specific speculation. Investor Adam Cochran again tweeted, they claimed to have dropped it on the grounds of jurisdictional complexity with the Bahamas extradition since this charge came afterwards. However, it's also days after SPF was seen in New York, at the same time the SDNY filed new docs against Tether

Bitfinex-Polonex in their 2019 case, where they request to interview a new, quote, anonymous trader whose name is redacted, claiming that he will testify that Tether was unbacked and engaged in market manipulation with fake USDT. SBF via FTX and Alameda was the largest user of USDT, and yet it was the only large stable coin that they refused to treat one-to-one in their USD basket product on FTX. This totally reeks of him testifying against other entities to get some charges dropped. Now, we don't have any more on that accusation other than what Adam just tweeted, so take it with not just a grain, but a giant mountain of salt. However, it has been broadly speculated about whether Sam will try to use insider knowledge of other actors in the ecosystem

to try to make the justice system go easier on himself, so it's probably worth keeping an eye on. Still for us, that is going to do it for today's episode. Big thanks again to wolf-Nyc.com, Wolf the Accelerator for Bitcoin and Lightning Companies for sponsoring the show. If you're building something great, go apply, be a part of their third cohort. And thanks, of course, to you guys for listening. Until next time, be safe and take care of each other. Peace.