The Breakdown - Shockingly, Gary Gensler Doesn't Like Stoner Cats

Episode Date: September 15, 2023

The latest SEC action is a settlement with NFT project Stoner Cats. NLW discusses the community's response, which ranges from not-that-surprised to appalled at yet another example of unelected bureaucrats trying to expand their authority through enforcement. 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 Thursday, September 14th, and today we are talking about stoner cats. 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.L.I. slash breakdown pod. All right, friends, well, I have to tell you, at this point, we really have about four archetypes of breakdown shows. There's number one, oh God, more cleanup from 2022. There's number

two. Hey, look, a new TradFi player is getting in the game. There's number three. Hey, look, a judge or elected official is smacking a regulator down. And then there's number four. Hey, look, an unelected bureaucrat is trying to expand their power again. And today's show is indeed an example of the fourth, and the reason it matters is not just because it's another SEC enforcement action, but because I do really think that this represents and is a great example of that impulse to authority expansion. So what am I referring to? Well, of course, I am referring to the SEC bringing its second enforcement action ever against an NFT project. This time, the regulator targeted Stoner Cats, a profile picture NFT collection that was sold to finance a web series.

The SEC alleged that the sale of collectible NFTs constituted the sale of unregistered securities. The production company behind the project settled the allegations without admitting to the SEC's findings. So the details. Stonerats sold out their collection in around 35 minutes at the height of the NFT bull market in July 2021. The project raised $8 million from the sale. Marketing materials highlighted Hollywood producers and big-name celebrities attached to the web series and suggested that the success of the show would increase the value of the NFTs in secondary markets. The company received 2.5% of royalties from secondary market sales, which produced $20 million in volume. In the settlement, Stoner Cats agreed to a cease-and-assist order and a $1 million

penalty. In addition, a fund will be established to refund investors and all NFTs held by the company will be destroyed. Gribir Grawal, the director of the SEC's Division of Enforcement, said in a statement, regardless of whether your offering involves beavers, chinchillas, or animal-based NFTs. Under the federal securities laws, it's the economic reality of the offering, not the label you put on it or the underlying objects that guides the determination of what's an investment contract and therefore a security. aside, I wonder some time if they find their own writing as clever as they seem to. Beaver's chinchillas are animal-based NFTs. Moving on the statement reads, here the SEC's order

finds that Stoner Cats marketed its knowledge of crypto projects, touted that the price of their NFTs could increase, and took other steps that led investors to believe they would profit from selling the NFTs in the secondary market. It's therefore hardly surprising as the order finds that Stoner Katz sold its entire supply of NFTs in just 35 minutes, generating proceeds of over $8 million, dollars, most of which were then resold, not held as collectibles in the secondary market within months. Carolyn Walshans, the associate director of the SEC's home office, added, Stoner Cats wanted all the benefits of offering and selling a security to the public, but ignored the legal responsibilities that come with doing so. Now, Commissioner's Hester Purson, Mark Ueda,

offered what has become their customary dissent against the SEC's actions. They claim the enforcement represented a perverse extension of the SEC's jurisdiction and the borders of the Howie test into the realm of art and collectibles. In a statement they wrote, The application of the Howey Investment Contract Analysis in this matter lacks any meaningful limiting principle. It carries implications for creators of all kinds. Were we to apply the securities laws to physical collectibles in the same way we apply them to NFTs, artist's creativity would wither in the shadow of legal ambiguity. Rather than arbitrarily bringing enforcement actions against NFT projects, we ought to lay out some clear guidelines for artists and other creators

who want to experiment with NFTs as a way to support their creative efforts and build their fan communities. The commissioners claim the NFT project was more proper characterized as a fan crowdfunding. More broadly, they expressed concern that, through this enforcement, the SEC, were attempting to exert jurisdiction over collectibles in a way they had never previously done with physical objects. The commissioners likened stoner cats to a scheme surrounding the launch of Star Wars toys in Christmas of 1977. The toy maker sold early bird certificate packages in lieu of actual toys due to problems with production. These certificates were redeemable for toys in due course, but could also be resold for a profit in secondary markets at the time.

The commissioners asserted that, quote, using the analysis of today's enforcement action, the SEC should have parachuted in to save those kids from Star Wars mania. The main point of the dissent was that the SEC should not use its enforcement to stifle innovation and creative industries through the use of NFTs. The commissioners said that, quote, artists of all kinds have long struggled to support themselves, and NFTs offer a potentially viable way for them to monetize their talents. The fact that money is involved does not transform NFTs into securities. They argued that the SEC's, quote, application of the securities laws here makes little sense and discourages content creators from exploring ways to harness social networks

to create and distribute content. More generally, it contributes to the legal ambiguity-facing artists, writers, musicians, filmmakers, and others seeking to build a loyal, engaged following. Now, there are a few different categories of reactions from people in the crypto community. Some honestly said that the stoner cats were not necessarily the best example to be a standard bearer for the industry. Gabriel Shapiro, General Counsel at Delphi Lab, said, the way most bull market NFT sales were done with roadmaps, etc., pretty clearly makes them securities offerings under the Howie test. So unlike in the typical case, I don't even really have a gripe here with the SEC, but there will likely be some weird details that will trigger me once I read more carefully.

NFT trader, ex-lawyer NFT said, I don't really have a problem with the SEC going after Stoner Cats. That initial offering could have been a securities offering. The problem comes in paragraph 4, which says in part, in addition, at least 20% of the Stoner Kat's NFTs purchased in the offering were resold in the secondary market before the first episode of the Stoner Cat series aired. Two days after the offering, and the majority of the NFTs purchase in the offering were resold in the secondary market before the release of the second episode on November 15th, 2021. That is completely irrelevant to a securities analysis and the natural extension of that

is any collectible that has a robust resale market, Jordans, baseball cards, comics, rare whiskey and wine, etc., is potentially sold as a security. That is not the law, but it seems that the SEC is using essentially dicta in an order to creep its jurisdiction. Crypto-criminal lawyer Carlos says injecting language like this into settlement seems to be a recurring pattern. To which ex-lawyer again responded, 100% intentional. Now the SEC can point to this order and try to use it as evidence that secondary markets are evidence of a securities offering. Obviously, to us, that's not true, but the SEC doesn't play fair and we'll take advantage of it.

And indeed, this take that the SEC was overreaching here was buy in a way, the most common take. Marissa Tashman Cople, the Senior Council at Blockchain Association said, So now the SEC is in the business of regulating creatives and artists? Creating opportunities for ownership in the creative process is one way crypto and Web3 transforms how we interact online. The SEC shouldn't interrupt this process. Crypto lawyer Ugin writes, artists sell their art on the premise that it will go up in value. Early artists appeal to collectors by emphasizing that they have a long and fruitful career ahead of them, enough time and skill to build notoriety and that collectors should buy. The early overpriced art with the expectation of profit later. Expectation of profit is what many

artist careers are based on and depend on. It should be okay to advertising speculative value of real products, but not of mere investment contracts. Hester Purse emphasized in her dissent that the SEC's position limits legitimate ways for artists to make a living and she is right. Speculative sales of art are the basis for many sales of art, and that doesn't make those sales a security offering. Now, still one more take was that we are seeing something of a positive pattern of dissent. Framework Ventures Van Spencer said, Interesting to see that it's both commissioners purse and UADA, two out of five, now offering dissents for most crypto enforcement actions and policy. Purst was on her own for a long time.

Important to remember for something like an ETF approval, which requires three of five. Now, staying on the theme of Gensler for a moment, it's like after the Senate hearing where he had to take some punches earlier this week, he had to go out and find a venue to get his own shots in. Appearing at a conference hosted by lobbyist group, Better Markets on Wednesday, Gensler said, millions of investors have been hurt in this field. It's an area that can hurt investors, but it can also hurt the broader economy because it can hurt investor confidence and finances ultimately built on trust. The conference was, of course, being held to mark the 15th anniversary of the collapse of Lehman Brothers, giving Gensler plenty of opportunity for histrionics about financial risk.

Gensler trotted out his usual talking points, although adjusted to consider recent criticisms raised in court. Still, there was one kind of awkward and sweet moment where the host suggested that the crypto industry, quote, do seem to be finding some sympathetic judges recently, to which Gensler was uncharacteristically silent in response. Now, Jason Franek from Alliance Dow really sums it up. He wrote what Gary Gensler calls arbitrage, I call trying to launch a viable startup under a non-existent regulatory framework

with a hostile regulator who has, A, prejudged every asset in offering, B, thinks every good faith founder is a criminal, and C, thinks the entire industry has no merit. Projects are spending hundreds of thousands of dollars, sometimes millions working with counsel in good faith, to find viable ways to run their businesses. It is a complete waste of capital and of time, but they do it to try to comply. And then the regulator disparages them.

Now, somewhat related, while presenting a speech at a conference hosted by the Practicing Law Institute, CFTC enforcement director Ian McGinley pressed home his agency's antipathy towards defy. McGinley said, The existence of unregulated defy exchanges is an obvious threat to the markets regulated and customers protected by the CFTC, and it is one we have taken very seriously. McGinley presented the complete list of CFTC victories in Defi cases, including a settlement with prediction market, polymarket, and derivatives exchange operator Uki Dow. He said, quote, all of this is to say, the CFTC has brought groundbreaking actions in the DFI space,

standing for the proposition that when offering core derivatives products based on digital assets to the public, whether in a centralized or decentralized manner, you must comply with the law. The comments came just a week after the CFTC announced settlements with Defi trading platforms open, Zerox, and Derridax for offering, quote, illegal digital asset derivatives trading. The enforcement actions were widely viewed as the regulator taking on easy targets in an attempt to send a message. Indeed, the attack on defyce was so brazen that one dissenting commissioner even openly suggested that the CFTC was, quote, creating an impossible environment for those who want to comply with the law. Bankless co-host Ryan Schott Adams tweeted, the IRS is attacking crypto,

FinCen is attacking crypto, the SEC is attacking crypto, the CFTC is attacking crypto, OFAC is attacking crypto. This is what the now they fight you phase looks like. Now speaking of the fight and not going down without one, Coinbase CEO Brian Armstrong has called for Defy Protocols to take the fight to the CFTC and defend enforcement actions in court. He said in a tweet on Wednesday, the CFTC should not be creating enforcement actions against defy protocols. These are not financial services business, and it's highly unlikely the Commodity Exchange Act even applies to them. My hope is these defy protocols take these cases to court to establish precedent. The courts have proven to be very willing to uphold rule of law. The only thing this is

accomplishing is to push an important industry offshore. Now, following last week's enforcement action against that trio of defy platforms, many commented that the order was a stretch of existing law. And while their cases may have been defensible, the diminutive defy platforms were unlikely to have had the resources to take on the U.S. regulator, which is, of course, why many believe they were targeted in the first place. Now, while Brian Armstrong stopped short of offering funding, many others in the space urged collective defense. Crypto law, U.S. founder John Deaton said, the industry needs to create a legal fund of some sort to help defend these winnable cases. Elio trades amplified that, saying, Brian, if you really want to affect policy

change, you and Coinbase should help create a fund for projects facing enforcement. Let's be real. Everyone is worried about the financial burden of litigation. This would honestly be a better use of resources than vague political campaigns. Now, a different take was summed up by Jameson Lopp, who wrote, My hope is that DFI protocols be so decentralized that the notion of them going to court is absurd. Lawyer Jason Gottlieb wrote a threat about this as well, saying, I agree with Brian Armstrong that DFI protocols should challenge the CFTC and SEC in court on overreaching settlement demands. The sad reality is that the agency's first attack smaller outfits, for whom it makes vastly more economic sense to settle,

rather than litigate. We see what happens when well-funded projects go to court to fight shaky theories of defy liability. Cases or causes of action are dismissed. Partial liability can be dropped. The dynamics are greatly changed. But the regulators start with huge advantages. They have typically worn down projects with an expensive investigation first. Even just satisfying the overbearing demands for document production in these investigations can cost six figures easily. I've said it before, I'll say it again. Every single subpoena a regulator sends to a blockchain project is one less engineering job in America and more money for lawyers. Even the lawyers who benefit from that, hi there, think that is a terrible tradeoff for America. One problem is funding. The regulators can

wear projects down and then offer deals that, while expensive and onerous, are better than more years of continued litigation, where even if the project wins, it is massively lost time, funding runway, and momentum. Another problem is that these are people's lives. An investigation is obtrusive enough. Litigation is personally highly disruptive. For us litigators, it's just what we do, it doesn't feel bad. But for founders, devs, people just trying to build, it can feel terrible. So I would love for more DFI projects to take the CFTC and SEC to court. And is this attorney advertising? I'd love to be the lawyer who represents them. But it costs a lot of money and it's emotionally hard. Companies that have taken on the fight have done great work protecting the space,

sometimes behind the scenes in ways people won't widely know about. We need more. But not everyone is well-financed and in a fighting mood. So we need to support the smaller projects financially and otherwise, everyone who believes in the efficiency, privacy, and self-control advantages of digital assets is in this fight together. The battle over the future of crypto is the battle over the future of all digital. And since more and more of our lives are digital, that's more and more of our lives. This fight is far more important than when moon antics. It is literally the battle for the future of your digital life. The legal battles over digital assets are the battles over the direction of our collective future. Here, here. I think I will let Jason have the last word on that one,

I can't do any better. I appreciate all you guys listening. And until next time, be safe and take care of each other. Peace.