The Breakdown - The SEC's Horrible, No Good, Very Bad Week

Episode Date: July 2, 2024

The SEC (and really the administrative state more broadly) had an extremely tough week last week. NLW explains why, and what it means for crypto. 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 Monday, July 1st, and today we are talking about some insanely big stories in crypto-legal and administrative law more generally from the end of last 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. Happy July. At the end of last week on my live show with Scott Melker, we were talking about how Thursday had been an incredibly terrible day for Gary Gensler.

Between the Solana ETF, the Coinbase Freedom of Information Act lawsuits, and the Supreme Court striking down the SEC Internal Tribunals, it was not a good one to be Gary. However, there is an argument that Friday was even worse. We're going to get into stories around consensus, finance, But first, we have to dig a little bit into this Chevron story. It's a hugely important update in how the administrative state will operate moving forward, and is an event that has the potential to structurally change how the U.S. government operates. The main point here is that it is hugely impactful for the SEC-CFTC jurisdiction creep within crypto,

but will also likely be a more fundamental change for U.S. society and its relationship with the government. So let's get into that, and to be clear, this is nowhere near as comprehensive as it could be, but I didn't want to leave it unaddressed at all. The Supreme Court has overturned a 40-year precedent, bringing an end to Chevron deference, and significantly weakening the administrative state. The original 1984 case related to emissions control and allowed the EPA broad scope in how they implemented the Clean Air Act. The Supreme Court had ensured that federal agencies could fill in the gaps when legislation was ambiguous. Under Chevron deference, lower courts were bound to defer to

the agency's own definition of their powers, as long as it was a reasonable interpretation of the legislation. Many legal scholars, particularly on the left believed this was a good thing. It provided agencies with the ability to act as they felt necessary without the need to run back to Congress for additional powers. It also meant that in many cases, White House policy could be run through the administrative agencies without the need to consult with Congress. The issues with Chevron are also fairly clear after four decades. Congress has become accustomed to leaving large gaps in legislation, giving agencies broad power and deciding how to execute on general policy goals. This led to agencies becoming increasingly political,

and the heads of agencies becoming some of the most powerful members of the government despite having no accountability to voters. The decision to overrule Chevron has been framed as reinstating the separation of powers under the Constitution. Essentially, the Supreme Court said that Congress should be making new laws and the court should be interpreting legislation, and neither should be allowed to give these powers over entirely to the administrative state. In his majority opinion, Chief Justice Roberts said that the precedent was misguided as,

quote, agencies have no special competence in resolving statutory ambiguities. courts do. With this decision, the Supreme Court is saying that if the government wants to expand the power of a federal agency, they should get Congress to pass a clear law rather than send an email to an agency head. We've seen this happen over recent years in a huge range of areas. From AI regulation to health care, agencies have been increasingly of the opinion that they don't need Congress to pass a law before expanding into new territory. Since 1984, Chevron has been the most heavily cited case in administrative law to give a sense of how much it was relied upon to justify the expansion of agency powers. The topic is incredibly complex and the takes are flying freely at the moment. And while it deserves

way more analysis than we're giving it here, suffice it to say that the decision could have a major impact on the crypto industry. We are of course currently embroiled in a protracted legal battle with financial regulators over how their power should be interpreted. The Supreme Court has now called into question the way that these regulators have been operating for decades. However, some are suggesting that financial regulators have been ahead of the game on Chevron. The SEC and CFTC have been heavily criticized for pursuing a strategy of regulation by enforcement rather than rulemaking when it comes to crypto. While overturning Chevron calls expansive agency rulemaking into question, it's completely silent on enforcement actions. We'll have to wait and see how this plays out in courts, but this

is likely to be a fundamental change in how the government operates. What's more, it's clear confirmation that power is shifting back from bureaucrats and towards Congress. Said Melker after our show on Friday, Chevron being overturned may be the biggest news for the crypto industry ever. To my understanding, this effectively means that the SEC's interpretation of the Howey test as to whether crypto assets are securities or not is irrelevant in court. Courts will now make their own determinations based on the law potentially leading to different outcomes than those the SEC might expect under Chevron deference. Cryptot tax guy pointed out that this wasn't exactly what was meant, retweeting Scott and saying, no, killing Chevron deference doesn't kill the SEC's crypto witch hunt.

Chevron deference is about agency rulemaking. Does an agency get deference when it issues rules to fill or clarify a statutory gap or ambiguity? Enforcement actions aren't rules. Howie isn't a statute. So basically the nuance here is that the unambiguous part of this is that it will curtail the power of the administrative state to act absent congressional authorization when it comes to rulemaking. However, when it comes to enforcement, which has, of course, been the biggest issue with crypto, it's less clear exactly what happens now.

Anyways, really interesting stuff. I'm sure something that we will continue to focus on. But for now, let's move over to consensus, where the SEC has filed their long-anticipated lawsuit against the company. The regulator claims that through their metamask product, consensus has operated as an unregistered broker and offered the sale of unregistered securities since 2020. The lawsuit also targets staking services provided by Lido and Rocket Pool as unregistered securities offerings which can be accessed through Metamask. The SEC made two major claims. One, that

Metamask's built-in swap function is operating as an unregistered securities broker, and two, that the pass-through staking service offered on the platform is the sale of unregistered securities. Regarding swaps, the SEC honed in on the fact that Metamask provides integration, which allows users to more easily access defy protocols. They claim that quoting pricing information, routing customer orders, and receiving fees makes the feature a brokerage service rather than a simple defy front end. The argument draws the distinction that Metamask is optimizing trades not just providing access to defy. Of course, a platform cannot be a securities brokerage without offering securities, so the SEC makes that claim for a range of tokens. Explicitly listed are Polygons

Matic, DeCentralands Manna, Chile's, Sandbox, and Luna. This is much the same list from the Coinbase and Binance cases, but notably excludes Solana. A separate court has already rejected the SEC's claims that Coinbase's wallet is a brokerage service. That ruling found that Coinbase wallet merely presents price information and conveys orders into a defy system. Even though they received a fee, the court found this was not enough to make Coinbase wallet a brokerage. In responding to that loss, the SEC has tightened up their pleadings. This time around, the regulator claimed that Metamask not only arranges trades, but also takes temporary control of assets via their own smart contracts.

The SEC seems to be making the case that by adding an additional layer of smart contract logic to the process, Metamask is acting more like a broker than Coinbase wallet. The claims around staking are far more novel. In the Coinbase lawsuit, the SEC had argued that Coinbase exercises managerial decisions about how to handle customers' funds to maximize yield. The regulator claimed that this makes the service closer to an investment scheme than a simple technical service. In this case, the SEC goes one step further, claiming that Lido and Rocket Pool are exercising the same managerial decision-making. The complaint also suggests that the liquid staking tokens offered by these protocols are unregistered securities. The SEC claims

the largest liquid staking protocols in the industry qualify as investment contracts and are therefore subject to SEC registration. The case doesn't name Lido or Rocket Pool as defendants, but claims that MetaMask acted as an underwriter for their services by offering them for sale. The lawsuit came as no surprise to consensus, who said, The SEC has been pursuing an anti-crypto agenda led by ad hoc enforcement action. This is just the latest example of its regulatory overreach, a transparent attempt to redefine well-established legal standards and expand the SEC's jurisdiction via lawsuit. The company claimed they would defend the lawsuit vigorously alongside their Texas case,

which seeks a ruling that the SEC has not been granted authority over crypto software. Crypto lawyer Mike Selig was unimpressed with the quality of the SEC's arguments, writing, In CoinBase and Consensus lawsuits, SEC spins staking services as programs where stakers allocate funds to a pool, managed by an operator with discretionary authority, who deploys the fund to earn returns for stakers. This is a warped characterization of technical services.

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breakdown 10 when you check out. If you go to the Blockworks website, blockworks.com, there will be lots of information about how to register, and again, use code Breakdown 10 to get 10% off. As you can tell, these lawsuits are starting to get to the very deep end of exact specifications on how these protocols function. The SEC is now hunting out moments of custody and intermediation within smart contract systems. Even if they win, it does again beg the question of why ill-fitting 90-year-old securities laws are being applied to defy. The lawsuit also obliterates any thought that the SEC is letting up on the crypto industry. Lomdart wrote,

The White House shoulder-tap thesis for the SEC to go softer on crypto seems pretty blown out of the water now thanks to the Lido and Consensus case. Kind of sad. Others think that Gensler is simply taking advantage of the dwindling opportunity to go scorched earth on the industry. DC Investor tweeted, Gary now knows he can't be blamed as the reason for Biden losing the election, so he's literally going for broke with sham SEC lawsuits. Next up, there is the issue of finance where a new ruling in the SEC's lawsuit against finance found that most of the lawsuit can continue, save for a very few important components. Finance had been seeking a motion to dismiss the entire case. Claims that the exchange operated as an unregistered brokerage will continue,

as will claims that staking services are sold as unregistered securities. The losses for the SEC came from the claims that BNB token and BUSD are unregistered securities themselves. The court found that BUSD is absolutely not a security in any circumstance and decided that secondary sales of BNB are not subject to securities laws. Regarding BUSD, the SEC had alleged that the Stablecoin was a security due to its use in various yield generation and return opportunities across the platform. Judge Amy Berman-Jackson found this argument entirely unconvincing and lacking in detail. Primarily, she found that it was difficult to frame a stable coin as an investment opportunity

when, quote, the alleged defining feature of the stable coin was that its value would remain constant. For B&B token, Jackson ruled that claims related to the ICO and direct sales from Binance could continue. The order dismissed claims that secondary sales by third parties satisfied the Howie test. In making this ruling, Jackson explicitly confirmed the approach taken in the Ripple lawsuit, specifically that an investor buying from the open market is not making an investment of money in whatever scheme is behind a particular token. More troubling for the SEC was a complete rejection of their newly constructed ecosystem theory. This theory suggests that tokens which were

originally sold as securities during an ICO will carry that designation into secondary markets. The SEC claim this was because tokens were the embodiment of the original investment contract. Jackson wrote that, quote, insisting that an asset that was the subject of an alleged investment contract is itself a security as it moves forward in commerce and is bought and sold by private individuals on any number of exchanges and is used in any number of ways over an indefinite period of time marks a departure from the Howie framework that leaves the court, the industry, and future buyers and sellers with no clear differentiating principle between tokens in the marketplace that are securities and tokens that aren't.

It is not a principle the court feels comfortable endorsing or applying based on the allegations in the complaint. So, this ruling likely means that the SEC will need to be much more specific in token cases moving forward. They will need to go into each class of token transactions individually to demonstrate that they meet the Howie test. What's more, we now have a second ruling that says the tokens themselves are not securities. Beyond the narrowly targeted orders, Jackson made extensive comments on how inappropriate

the SEC's litigation strategy had become. She wrote, the agency's decision to oversee this billion-dollar industry through litigation, case-by-case, coin-by-coin, court after court, is probably not an efficient way to proceed, and it risks inconsistent results that may leave the relevant parties and their potential customers without clear guidance. Elsewhere in the judgment, Jackson commented that during one hearing on the topic of the ecosystem theory, quote, the SEC seemed to be speaking out of both sides of its mouth. For those unfamiliar with legal rulings, this is about as rough as the language ever gets. Crypto lawyer Orlando Cosme framed this as the court taking the SEC to task.

commenting, may not seem like it, but this is judge-speak for sharp rebukes. Uniswap chief legal officer Catherine Minerick also pointed out how frustrated Berman Jackson seemed, writing, Jackson expresses concern with the SEC's approach, not giving issuers a chance to defend themselves, not identifying the full set of assets about which the SEC takes issue. No court wants a dozen cases baked into one case, especially without the right parties or all the facts. This is why the SEC's approach to crypto is rightly called regulation by enforcement, not just enforcement. Rulemaking can be built on examples. Court judgments cannot. Not. Judicial opinions and jury verdicts are necessarily fact-specific. It's basic due process. No wonder, Judge Jackson's opinion essentially asks why we are here, because they're sure is a better way. More than anything, this decision is notable because it adds to the precedent surrounding crypto tokens. Until now, Ripple was the only case that found a circumstance where tokens are not securities. Finance lawyer Scott Johnson noted the judge from Ripple, quote, is no longer alone on an island and that's big. As these decisions are happening in district court, they aren't binding precedent in other cases. Still, we're starting to

see a consensus grow that the ripple decision was decidedly correct and can be relied upon. In particular, that secondary sales of tokens are not governed by securities laws, and the tokens themselves do not embody an investment contract. This growing collection of ruling should help out in other cases that deal with secondary sales of tokens. Fox News reporter Eleanor Territ wrote, You can fully expect Coinbase Cracken and consensus lawyers to use this opinion to bolster their positions in their own litigations. And the SEC lawyers can no longer argue that the ripple ruling was merely an outlier that no other judges agree with. As for Binance, they are still facing a ton of problems in this case. The remaining issues will now move forward

to discovery and a trial unless a settlement is reached. So lots of interesting things happening in the crypto legal world today. We'll see how the rest of the week plays out, given that it is a holiday week here in the U.S., but for now, that is the story. Appreciate you guys listening as always. And until next time, be safe and take care of each other. Peace.