The Breakdown - The SEC’s Escalating Battle Against Crypto

Starting point is 00:00:00 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. The breakdown is sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, July 25th, and today we are talking about a major escalation from the SEC. 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 dig 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. Lastly, a disclosure as always. In addition to them being a sponsor of the show,

Starting point is 00:00:48 I also work with FTX. All right, guys, I am back here as usual. I hope you have enjoyed the midsummer macro series. The responses seemed really positive. It seems like these are topics and guests that you guys really like. Let me know if that's the case. Maybe there are topics that you want to hear more about or things that I didn't have a chance to cover that you'd like to hear more of. And I will see what we can do about getting those things covered. Now, you will also probably notice that I do not sound my normal self. I came back from traveling with COVID, as is want to happen, but we are powering through. There was a ton of stuff happening in this industry last week. Frankly, it was kind of a brutal one to be away from the microphone for, but I'm going to go back

Starting point is 00:01:32 to the stories that I think have the longest legs here, and today we are going to focus on the insider trading accusations brought by the Department of Justice and the Securities Exchange Commission last week. So let's start with the basics. Last Thursday, the Department of Justice brought criminal charges against former Coinbase product manager Isan Wahee and two associates in relation to insider trading. The trio are accused of trading at least 14 small-cap tokens using their of imminent listings on Coinbase. This will remind you, of course, of the OpenC case where Nate Chastine, who was in charge of determining which projects were going to be featured on the homepage of OpenC, was buying them before he featured them. The Gambit was pretty similar here.

Starting point is 00:02:14 Buy some small cap tokens before you know that Coinbase is going to list them, anticipating a bump thanks to the new liquidity and buying audience from Coinbase. The allegations are that these three won something like $1.5 million in ill-gotten gains. Wahi was arrested on Thursday and had been prevented from boarding a plane to India on a one-way ticket in mid-May, according to the Department of Justice. U.S. Attorney Damian Williams of the Southern District of New York said in a press release, quote, Today I announced the first ever insider trading case involving cryptocurrency markets. Our message with these charges is clear. Fraud is fraud is fraud, whether it occurs on the blockchain or on Wall Street. And the Southern District of New York will continue to be relentless

Starting point is 00:02:53 and bringing fraudsters to justice, wherever we may find them. Now, this part is really key. Coinbase has not been charged. They also claim that they were undergoing their own investigation of insider trading by employees of the exchange even before these charges came to light. So let's take a quick pause here. I have ranted about my feelings about insider trading in crypto before, particularly with regard to that open sea case. If this industry is trying to be better than the Tradfai space, then we should be utterly, and I mean utterly intolerant, of this sort of behavior. It is poison for everyone out here trying to actually build something. Chow Wang, guest on Saturday on the show, shared something which I wholeheartedly agree with,

Starting point is 00:03:33 saying, there are ways to make generational wealth in this industry in completely honest ways, yet people risk their career, reputation, and jail time to make a tiny fraction of that. Anyway, the point here is that I actually agree with the sentiment that fraud is fraud is fraud, and if this was just an insider trading case, that would be one thing. but it's not just an insider trading case. As part of the same case, the SEC has also brought charges. The SEC has charged the trio under the anti-fraud provisions of securities laws, alleging that of the 25 tokens traded, nine are securities.

Starting point is 00:04:07 Gerbier-Grewall, director of the SEC's Division of Enforcement, said, quote, we are not concerned with labels, but rather the economic realities of an offering. In this case, those realities affirm that a number of the crypto assets at issue were securities, and, as alleged, the defendants engaged in typical insider trading ahead of their listing on Coinbase. Rest assured, we'll continue to ensure a level playing field for investors, regardless of the label placed on the securities involved. So this is a much bigger deal, right? The issue at hand isn't that these three guys are being charged with insider trading,

Starting point is 00:04:38 but that the SEC has decided to bring a case about whether these tokens are securities without those projects having the ability to defend themselves, such as in the ripple case. Now, that will be the subject of most of the show, but before we get into that, let's talk about one of the most uniquely crypto industry aspects of this case. It appears that all of this actually comes back to Crypto Cobain, aka Kobe, aka one of the most stalwart and long-running members of crypto Twitter. On April 11th, he wrote, found an eth address that bought hundreds of thousands of dollars of tokens exclusively featured in the Coinbase Asset Listing Post about 24 hours before it was published, R-O-FL. The charges actually referenced this specific tweet and others. When the allegations came to light, Brian Armstrong from Coinbase wrote, At Coinbase, we actively monitor for illegal activity and investigate any alleged misconduct.

Starting point is 00:05:30 In April, we received information about possible front-running of assets shortly before being listed on Coinbase. We immediately launched an investigation into this. As a result of our investigation, we identified three suspects and provided this information to law enforcement. One person was a Coinbase employee who was terminated. Today, the DOJ has criminally charged as former employee and two other individuals for this abusive conduct. Anyway, Kobe was sort of shocked about all this, saying, Confusing that people actually read tweets from this Twitter account in the real world and then do stuff about them.

Starting point is 00:06:00 I thought this was like a mobile app game for mentally ill people. He also wrote, I was asked by several powerful crypto industry people to stop tweeting about Coinbase's listing and front-running issues, that it was, quote, bad for the industry to draw attention to it because regulators may want to get involved. involved. The problem is not my tweets. The problem is Coinbase. Anyways, a very interesting little note about how this stuff comes to light in an on-chain world. Moving back to the main complaint, it is not just the crypto industry who is upset about the SEC's approach in this

Starting point is 00:06:31 situation. The CFTC seems to be fuming that the SEC just decided a bunch of stuff as securities without legislation deciding the framework and it seems without any interagency cooperation. Caroline D. Fam, a commissioner at the CFTC, released a statement calling the actions of the SEC, quote, a striking example of regulation by enforcement. She goes on, the SEC's allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together. Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input through notice and comment rulemaking pursuant to the Administrative Procedure Act. Regulatory clarity comes from being out in the

Starting point is 00:07:15 open, not in the dark. Tweng V. Li, a partner and head of regulatory and policy at Bain Capital, writes, can't underscore enough how remarkable it is for a CFTC commissioner to call out a fellow regulator like this. End quote. It does seem to me to be a huge escalation of the interagency turf war around crypto, and from a legal perspective, it's just very weird. On CoinDesk, Ian McGinley, a former prosecutor in the Southern District of New York, explained that the SEC would need to prove that the tokens were securities to successfully prosecute the case. He says,

Starting point is 00:07:49 this is the SEC saying we don't need any new regulation here. A security token acts like a security. It walks like one, and we're going to treat it like one for this insider trading case. Now, for the DOJ, they're prosecuting a wire fraud case. They don't need to prove that these tokens were securities to be successful. Not so for the SEC. The other weird piece of this is that based on these charges,

Starting point is 00:08:10 Coinbase is a victim of this crime as it was their confidential information that was allegedly stolen, but they also may wish to be heard in the case to refute claims that these tokens are securities. Jason Gottlieb, a lawyer with Morrison Cohen, pointed out the problems with the SEC asserting that certain tokens are securities without Coinbase and other parties having the ability to speak to the matter in court. He writes, The SEC insider trading action alleges that nine tokens are securities and charges Coinbase employees with insider trading before they're listing on Coinbase. But the projects aren't parties here, they can't defend themselves here, and there may be immediate knock-on effects.

Starting point is 00:08:44 Should Coinbase keep listing them? If not, or even if that's a likelihood to happen in the near future, what happens to the token values? Will they take a hit? Doesn't that primarily hurt retail users who held them on Coinbase? Seems to me that the SEC is helping itself to a whole bunch of injunctive relief against nine projects without actually bringing any actions against those projects or giving them the ability to defend themselves against collateral consequences. It's just going to cause more businesses to move outside the U.S., which makes it less safe for U.S. retail, not more. I'd say these are the unanticipated consequences of regulation by enforcement.

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Starting point is 00:11:13 But instead of having a dialogue with us about the seven assets on our platform, the SEC jumped directly to litigation. The SEC's charges put a spotlight on an important problem. The U.S. doesn't have a clear or workable regulatory framework for digital asset securities. And instead of crafting tailored rules in an inclusive and transparent way, the SEC is relying on these types of one-off enforcement actions to try to bring all digital assets into its jurisdiction, even those assets that are not securities. In an even simpler Twitter thread, Paul Grewell, the chief legal officer at Coinbase writes, Coinbase doesn't list securities, period. We 100% disagree with the SEC's assertion that any of the

Starting point is 00:11:48 crypto assets we list are securities. Coinbase has a rigorous process to analyze and review each digital asset before making it available on our exchange, a process that the SEC itself has reviewed. We have cooperated with both the DOJ and SEC on this investigation. The DOJ reviewed the same facts and chose not to file securities fraud charges against those involved. This is a another example of regulation by enforcement on behalf of the SEC, which is not an effective or transparent approach to regulation. Back to Gottlieb again, he goes even farther, saying it's not even regulation by enforcement. It's regulation by enforcement against other people. So the crazy thing here is that because of the nature of the case, neither Coinbase nor the tokens that the

Starting point is 00:12:28 SEC is accusing of being securities get to actually defend themselves in court, which is just hugely problematic. Jake Chivinsky wrote a long thread about this, but I think it's worth reviewing in full, as it helps give the overall context. He writes, The SEC filed a complaint yesterday accusing 10 companies of violating securities laws, nine digital asset issuers in one exchange. None of them are defendants in the court. None of them will get their day in court. If this isn't regulation by enforcement, nothing is. Some background. The defendants are three individuals, a former Coinbase employee, his brother and his friend, who allegedly engaged in insider trading. In addition to the

Starting point is 00:13:03 SEC suit, the DOJ indicted them for criminal wire fraud. To be clear, I'm not trying to excuse insider trading or fraud in any way. If the allegations are true, these defendants should be held accountable. But we can and should condemn both the defendant's alleged conduct and the SEC's unjust tactics too. The SEC alleges that the defendants committed securities fraud by using material non-public information to trade ahead of Coinbase listing announcements. To establish jurisdiction, the SEC claims that the assets in question, nine digital assets, are unregistered securities. As far as I know, the SEC has never addressed these assets before. We learn the SEC's views on the fact patterns that it believes qualify them as securities for the first time in a federal complaint rather than in guidance or rulemaking.

Starting point is 00:13:45 This is regulation by enforcement. It's not uncommon to learn for the first time that an enforcement agency has identified a violation when a complaint is filed, but typically that happens when the agency files an action against the person who they think broke the law. This is different, very different. Here, the SEC isn't just accusing the defendants of breaking the law. The SEC is also accusing 10 unrelated, uncharged companies. of breaking the law. Nine for failure to register digital asset securities and one for operating an unregistered national securities exchange. Despite leveling accusations against uncharged companies in

Starting point is 00:14:17 public, the complaint is devoid of legal analysis. The SEC just makes a few allegations of fact and then summarily concludes that they satisfy Howie. But surely these are securities, you say. This misses the point. Federal agencies aren't supposed to go around accusing people of breaking the law without explaining their rationale or providing due process. The mere accusation can cause real damage on its own. The burden is on the SEC and they didn't even try to carry it. To win, the SEC must prove that one or more of these assets is a security. In a real sense, these companies are on trial too. But because the SEC didn't name them as defendants, they aren't allowed to defend themselves in court. On principle, this is deeply unfair and unjust.

Starting point is 00:14:58 The individual defendants are now on the hook for litigating the security status of all nine assets and for paying the cost of defending nine separate sub-trials. The amount of money this would take as astronomical. If I were cynical, I'd say that's why the SEC did it this way. It's even worse than that, though. Some of these assets are currently listed on other trading platforms in the USA. These platforms now have to wonder if they should delist the assets identified by the SEC to protect themselves from enforcement. We saw that happen to XRP. Just by making unproven accusations in an enforcement action, the SEC can impose obligations on platforms and restrictions on companies of a type that usually requires regulation. Literally, regulatory. Regulation. Literally,

Starting point is 00:15:37 by enforcement. But unlike actual regulation, no opportunity to be heard. The SEC isn't supposed to act like this, accusing people of breaking the law without bringing in action. From its website, quote, it is the general policy of the SEC to conduct its investigations on a confidential basis to preserve the integrity of the investigative process, as well as to protect persons against whom unfounded charges may be made, or where the SEC determines that enforcement action is not necessary or appropriate. The SEC should keep its accusations confidential until and unless, it sues the wrongdoer. You might say the SEC is just doing its job, going after bad actors in crypto and we should forgive defects like these for the greater good. Maybe that's what the SEC

Starting point is 00:16:16 hopes you'll say. Don't. DoJ charged wire, not securities fraud. There's no purpose to the SEC piling on, at least not if the goal is to see bad actors punished and justice done. Instead, this appears to be another effort by the SEC to expand its own regulatory authority over crypto market by enforcement without doing the hard work of proving that security's laws apply. It's sad but not surprising to see the SEC continue its unfair attacks on crypto. As I said, we knew the SEC planned to ramp up enforcement this year, so I assume this is only at the beginning. I hope their next move won't be so unjust and unfair. So this gets through the real nut of this thing. What is the SEC's goal? It might be worth getting

Starting point is 00:16:56 a take from slightly outside crypto, given that obviously our opinions are going to run hot here. Bloomberg columnist Matt Levine writes, this is a weird way for the SEC to say that Coinbase is running an illegal securities exchange. Like, the insider trading stuff is interesting, and the DOJ sensibly goes after it as wire fraud without caring if they're securities. But the SEC view is that, you know, almost everything Coinbase lists is a security, and therefore insider trading in it is subject to SEC jurisdiction.

Starting point is 00:17:21 By the way, my point here is that it is weird, not that, like, the SEC is coming for Coinbase or whatever. I think that the SEC, one, believes that like 90% of crypto is securities, two is probably correct, and three is not willing to follow that view to its logical conclusion. Like going after Coinbase for listing arguably security tokens or going after BigBC firms for blowing out arguably security tokens to retail is harder for the SEC as a matter of litigation, but most of politics than going after some dumb insider trader. Stephen Paley from Anderson Kill agrees.

Starting point is 00:17:50 It is an interesting choice to charge three people with insider trading of unregistered securities under the 34 Act, but not to also charge the exchange where they are listed. Tactical brilliance of some kind by going after people without resources? I mean, I guess, but any findings in those cases wouldn't be binding on Coinbase as it's not a party. As regular readers of this feed know I am no fan of Coinbase, but I'm not suggesting they should be charged, nor do I think insider trading is good or fair. Just if you're going to do it, SEC, take them on straight. This seems like some weasly weak-ass tea to me.

Starting point is 00:18:22 How can you charge people with insider trading without charging the massive publicly traded exchange for listing on registered securities? So the TLDR of this, as I said, right up front is escalation. The SEC is clearly escalating its complaints against the industry. The CFTC clearly has no chill around their willingness to let the SEC just do that. And in fact, others in government are getting more upset about this as well. On July 19th, Tom Emmer wrote, the SEC Director of Enforcement admits that the SEC is cracking down on companies outside

Starting point is 00:18:52 its jurisdiction, absolutely unacceptable. Under Chair Gensler, the SEC has become a person. power-hungry regulator, politicizing enforcement, baiting companies to come in and talk to the commission, then hitting them with enforcement actions discouraging good faith cooperation. Unfortunately, as Jake Trevinsky said, this feels like the beginning, not the end of what we're going to see as this regulatory battle heats up in the U.S. If there is any good news, at least these issues are finally coming to a legal head. For now, I want to say thanks again to my sponsors, nexus.io, chainalysis and FTX.

Starting point is 00:19:26 and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - The SEC’s Escalating Battle Against Crypto

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