The Breakdown - SEC Finally Responds to Coinbase Lawsuit

Episode Date: May 16, 2023

After ignoring a Coinbase request for rulemaking for 10 months, Coinbase sued the SEC, compelling a judge to compell the SEC to respond. In 36 pages of legalese, the SEC effectively said "we don't have to move any faster than we want and regulation by enforcement is fine."  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 Tuesday, May 16th, and today we are talking about the SEC finally replying to Coinbase's lawsuit. 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 are go to bit.ly slash breakdown pod. All right, friends, well, today we have some updates in the legal battle to get regulatory clarity for the crypto industry. And if you've followed the show for a while,

you'll know that it seemed more and more over the last year or so, but even more the last six months, that to get any actual answers, the crypto industry was going to have to avail itself of a legal path, particularly in the wake of FTX. It's been clear, and we'll get into this today, that the various regulatory bodies are quite comfortable with regulation by enforcement rather than providing proactive guidance, and that's put many in the industry in a position where they have to actually follow through with legal threats in order to get anything done. Well, yesterday on Monday, we got some updates in at least one of those cases. On Monday, the SEC filed its response to a recent Coinbase lawsuit. Coinbase had sued in late April accusing the SEC of unreasonable

delay in responding to the exchange's petition for rulemaking. While the petition was wide-ranging and complex, Coinbase's lawsuit had a simple contention. That contention was that rather than engaging with the substantial regulatory suggestions put forward, the SEC had decided secretly that no rulemaking would be done. Rather than publish this decision, the SEC had kept silent on the matter to avoid any potential for a legal challenge on rejecting the petition for rulemaking. With 10 months elapsed since the petition for rulemaking was filed, Coinbase sued, asking the court to require the SEC to make their decision on the petition public. In other words, to give a simple yes or no answer as to whether the regulator is considering rulemaking for the crypto industry. So what did we get back?

Well, the SEC's response, as Coinbase Chief Legal Officer Paul Grewell put it, was a, quote, resounding maybe. The SEC argued that it's inaction regarding the Coinbase petition did not imply that it has decided not to engage in rulemaking. To the contrary, the SEC claimed to be, quote, actively considering its regulatory approaches in this area, including the path suggested in Coinbase's petition. The SEC brushed off Coinbase's argument that taking enforcement action in the absence of clear rulemaking could undermine the right to do process and fair notice. Instead, the regulator claimed that these actions are, quote, not inherently inconsistent, explaining that, quote, judicial determinations made on a case-by-case basis in the crypto asset space

may inform the commission's consideration of other regulatory action. Addressing the point that the SEC may be avoiding answering Coinbase's petition to avoid the scrutiny of the court, the SEC pointed to the numerous crypto cases currently being litigated. Now, the second limb of the SEC response was that Coinbase is not entitled to rush regulatory decisions along. The SEC pointed out that in other cases involving various regulators, delays of 10, years in rulemaking and 20 years in implementation have not been viewed as a problem requiring the court's intervention. They noted that Coinbase's petition has been outstanding for only 10 months at this stage, has been revised twice in that time, and that the rulemaking suggested

in this petition outlines a, quote, necessarily complicated endeavor. Driving home the point, the regulator reminded the court that, quote, no statute or regulation requires the commission to take such action on a specific timeline. Rather, the only limitation is that a response must be offered within a subjectively reasonable time in the eyes of the court. In addressing recent public comments from Chairman Gary Gensler, which seemed to indicate that no further rulemaking is being considered, due to what he sees as sufficient clarity and thoroughness of the current rules, the SEC wrote that, quote, those comments did not and could not constitute agency action denying Coinbase's rulemaking

petition. They note that Gensler only ever speaks his own opinion and not to the broader opinion of the regulator. The SEC also argued that there is no material harm to Coinbase that can be demonstrated as a result of the delay in response. Summing up, the SEC asserted that, quote, the commission continues to consider Coinbase's petition in the ordinary course, adding that the fact, quote, that Coinbase would like its policy preferences addressed immediately does not entitle it to extraordinary relief, ordering the commission to act on a rulemaking petition that has been pending for well under a year. Ultimately, the SEC argued that Coinbase's lawsuit was baseless. Remarking on the filing, Coinbase Chief Legal Officer Paul

Graywell tweeted that, quote, today the SEC responded to Coinbase's petition for a writ of Amanda's, asking the court to require the SEC to respond just yes or no to whether it will undertake rulemaking for our industry. The SEC's answer, a resounding maybe. Today's filing may be the first time when the SEC has formally explained in court its views on whether and how the SEC should create rules for the crypto industry. The SEC told the court that rulemaking may take years, and they're in no rush. The SEC acknowledged that it will continue to use enforcement actions as a substitute for rulemaking for the foreseeable future, but not to worry, those enforcement actions may eventually inform not yet planned rulemaking.

The SEC also said that the public statements by Chair Gensler are not formal guidance or policy statements from the SEC, and that the public cannot rely on them as such. Overall, the SEC's response reinforces Coinbase's longstanding concern that our industry does not have clarity on what the SEC may consider to be within or outside its jurisdiction at any time, and it is likely to continue changing its mind along the way. We look forward to the opportunity to reply formally next week, and as always, we continue to appreciate the court's careful consideration. Now, given that the SEC has now grounded its argument in the idea that no decision has been made, you might think that Chair Gansler would shy away from making further public comments

on the subject? But, of course not. Just hours before the SEC's response was filed, Gensler appeared for a keynote speech at the Financial Markets Conference, where he was asked to address the Coinbase litigation. Gensler simply repeated his well-rehearsed talking points, saying, this is a field that has been largely non-compliant. Our agency has put out rules about what it is to be an agent, what it is to be a broker-dealer, and how to register a securities offering. Those rules are in existence, and there's nothing about a new technology that makes it non-consistent with the public policies that Congress has laid out. So what did the crypto industry think about this?

Well, pretty much exactly what you'd expect. Coin Bureau tweeted, So Coinbase has its answer from the SEC, and it's even less clear than before. Regulation by enforcement is likely to be the norm. It's a noble fight by Coinbase, but is it a fight worth having? There are other countries that are looking to welcome them with open arms.

Jorge Soto, the head of crypto at TC Investments, writes, SEC basically chickened, no surprises on that front. but it seems clear to me, not a lawyer, that they're basically willingly making markets less clear. Their whole job is the opposite. Ramanu Mai, a researcher at Men Your Research, said, saying either yes or no kind of traps SEC, so we get more waffling, naturally. Bankless co-host Ryan Sean Adams writes, Coinbase got a court-ordered request for the most trivial crypto clarity from the SEC,

and they responded with 36 pages of legalese amounting to, we don't have to if we don't want to. wouldn't it just be easier to provide some clarity? Gensler's SEC is proving unfit to regulate. And then there was investor Adam Cochran who wrote, Dear American lawmakers, let's be clear, the current pace of the SEC rulemaking is not only an embarrassment to the United States, but a real and present danger. Chair Gensler cites cases suggesting that 10 to 20 year rulemakings are acceptable. Meanwhile, innovation in America is under attack. Regulation is being used as a cudgel to stamp out neobanks, payment apps,

non-bank money lenders, and digital asset providers on the grounds of quote-unquote safety. All the while, OCC-regulated banks crumble with user deposits. One can appreciate that new technology can be challenging to understand the implications of and merits time to study, which is why despite crypto being created in 2010, it took other U.S. regulators' time to respond, but respond they did. In the U.S. and abroad, that guidance came almost a decade ago for everyone but the SEC. FinC, 2013-13, IRS 2014, FEC, 2014, EBA, 2014, GAO, 2014, CFTC-2015. While other departments figured out where they stand, Gensler refuses to provide guidance.

If the SEC wishes yet another decade for formal rulemaking on digital asset transactions, that's fine. But we can expect those transactions done in the yuan and not the dollar. So I think the big takeaway here is probably just that regulation by enforcement, which has been the default path so far, seems to be the actual truly default path for the SEC for the time being. This is the first time I've seen them be so explicit about regulation by enforcement as a regulatory tactic and actually put forward a legal defense for it being a valid way to operate. Now, the important thing here is that there's a big difference between regulation by enforcement

as a function of having insufficient authority to do rulemaking and explicitly stating that the intention is to do regulation by enforcement as a conscious choice to inform later rulemaking, but that's where we are. Unfortunately, for those of us who watch the industry closely, this is pretty much what we expected. Now, staying on the theme of the SEC, the complaints about that agencies proposed changes to crypto custody rules continue to pile up. The rules, which were proposed in February, required that investment advisors hold their customer assets with a qualified custodian in separate accounts.

The initial industry response indicated that these rules changes would likely lead to a de facto ban on investment advisors handling crypto. given the uncertainty around whether established crypto custodians would qualify. In particular, trading platforms like Coinbase were concerned that the new rules would eliminate industry best practice of holding customer assets and combined accounts to minimize the risk of handling a multitude of private keys. This situation would then obviously leave investment advisors unable to use the major exchanges. Republican lawmakers are one of the groups that made it clear that they are no fan of the proposed rule. Last Wednesday, House Financial Services Committee

Chairman Patrick McHenry penned a letter expressing these concerns on behalf of himself and the head of all six subcommittees. He wrote that the lack of comprehensive economic analysis surrounding the proposed rule is, quote, unacceptable and indicates a reckless approach to rulemaking. He urged that the SEC, quote, withdraw the proposed rule and reconsider its approaches to regulating entities outside its jurisdiction. This week, new criticism arose from the broader financial services industry. The American Bankers Association, the Securities Industry and Financial Markets Association, and the Independent Community Bankers of America, all registered their displeasure in a joint letter. Together, these trade associations represent hundreds of thousands of financial companies from the

largest banks and asset managers to the smallest community banks and hedge funds. Their concern was that in modifying the definition of a qualified custodian, the SEC could strip some banks and savings associations of that status, which, quote, could have a material impact on their business. The major issue is that it appears that only federally regulated institutions will qualify, leaving state chartered institutions out in the cold. The trade associations have thus requested an extension of the 30-day public comment period to 60 days in order to allow for more comprehensive analysis on the proposed rules intended and unintended consequences. These new concerns add to the existing stack of industry comments. Remember last Monday, stablecoin issuer circle weighed in,

suggesting that the SEC could minimize fallout if they so desired by explicitly including some types of firms in their new definition of a qualified custodian. They argued that currently existing crypto industry custodians should be included, as well as state chartered banks and trust companies. Despite their complaints, Circle was supportive of the spirit of the rule, which provides guidelines for custodian intended to limit the risks to consumers in the event of further crypto-bankruptcies. Stablecoin issuer Paxos, venture capital firms, A16C, and Paradigm, as well as Coinbase, have all logged complaints in a similar vein. The big thing here is that these large financial services trade associations are now putting their thumb on the scale. They're not so much focused on the

crypto custody side, but rather on the potential for unintended consequences throughout the broader financial industry. One of the major issues is the requirement that custodians be federally charted, which wipes out any state chartered custodians of anything. The VC firms and hedge funds might come under this umbrella being close enough to investment advisors to be captured by the new rules, and this could create just a whole lot of issues for investors in private companies. So the TLDR of all of this is that the industry bodies are talking about massive collateral damage and seemingly unintended consequences. One small additional note from SEC land, the SEC is looking to cut down on their library

or LBRY fine. After successfully prosecuting Crypto Publishing Protocol Library for breaches of securities laws late last year, the SEC has returned to court asking to slash the fine from $22 million to just $11,614. The regulator explained that library has a, quote, lack of funds in near-defunct status. Jeremy Kaufman, Library's founder, had previously warned that this enforcement action could have broader impact across the crypto industry and maintain that Library's token was not a security. The firm also argued that the original fine was excessive, pointing out that messaging app Kikk had only been fined $5 million in a settlement surrounding the app's 100 million sale of tokens.

Moving to a different department in the U.S. government, the Justice Department's head of Crypto enforcement has promised a crackdown on illicit behavior on trading platforms, according to reporting from the Financial Times. The head of the DOJ's newly established national cryptocurrency enforcement team, Yun Yong Choi, said that the scale of crypto crime has grown, quote-unquote, significantly in the past four years. She said the DOJ is targeting crypto exchanges alongside mixers and tumblers with an emphasis on money laundering.

The targeting will be broad, focusing on both the companies that commit crimes as well as those that allow them to occur. Choi explained that, quote, they're allowing for the other criminal actors to easily profit from their crimes and cash out in ways that are obviously problematic to us, and so we hope that by focusing on those types of platforms, we're going to have a multiplier effect. The hope is that by focusing on platforms, the crackdown would, quote, send a deterrent message to firms that have lacks anti-money laundering or client identification procedures. Now, while claiming that the scale of criminality has increased in recent years,

Choi acknowledged that she thinks this is, quote, concurrent with the increase of its adoption by the public writ large. Now, without referring to a specific entity, Choi dismissed concerns that a crackdown on large industry players could destroy the broader crypto industry. She said, if a company has amassed a significant market share in part because they're flouting U.S. criminal law, the DOJ cannot be in a position where we give someone a pass because they're saying, well, now we've grown too big to fail. Think of what message it would send. It can't be the way that we think when it comes to crypto, when it comes to any white collar crime. Now, beyond a crackdown on crypto platforms, the DOJ is also focused on more pedestrian fraud and investment scams.

According to FBI victims report, the losses related to such scams have ballooned from 900 million in 2021 to over 2.5 billion last year. Last up today, the U.S. Secret Service and the Bay Area Regional Enforcement Allied Computer Team took to Reddit for a lengthy crypto-focused Ask Me Anything or AMA on Monday. Officials from the agency confirm that crypto networks are a crime fighter's dream, stating that, quote, the blockchain provides us with an amazing opportunity to track the flow of money. Now, fun fact, as well as being tasked with guarding the president, the Secret Service has teams

charged with protecting the integrity of the national financial infrastructure. The agency now has a dedicated team with crypto expertise for whom the Bitcoin White Paper is, quote, required reading for any new agents. Much of the team's work is involved with scams and hacks, and during the AMA, they boasted, quote, we can and do recover funds and return them to victims. They said that in the past nine months, they've recovered stolen crypto for 17 victims. They also noted that although money laundering and crypto is on the rise, it still pales in comparison to the money laundering that goes on in fiat currency, according to the Treasury Department's report

from last year. Maybe the strangest thing that came up in the AMA was that the Secret Service launched a series of NFTs last year. Yes, the nine-item collection featured stylized Secret Service agents posing throughout San Francisco. The agency explained that they're not trying to make it big in the NFT scene, but rather the mint was just a research exercise. Quote, we try to learn as much as we can about the various digital. assets in the space. Strange times, my friends, strange times. That is it for today's breakdown.

I appreciate you listening, as always. Until next time, be safe and take care of each other. Peace.