The Breakdown - Why One Crypto Company Is Suing the SEC

Starting point is 00:00:00 Look, if the SEC is going to regulate by enforcement, first, they have to play by the enforcement rules, that's just table stakes, and two, they can't really expect that this extremely well-funded industry is just going to roll over. 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 Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Monday, October 25th, and today we are discussing why one crypto company is suing the SEC. If you remember about a month ago, there was quite the stir

Starting point is 00:00:45 at Masari's main net conference in New York. At around noon on the first day of the event, one of the attendees tweeted that they had seen the SEC serve someone who was about to go be a panelist just before their panel. Now, that's a panel. Now, that's a one of the attendees. tweet didn't reveal who had been served, and there was immediately a ton of question and speculation about whether it was actually true. Now, my instinct was to believe it, given that I knew the person who had tweeted at least, if not the person that they were discussing, and a couple hours later, Ryan Selkis, the founder and CEO of Masari, seemed to confirm, again, without giving any details that the SEC had, in fact, served someone at his conference. He jokingly, or maybe not jokingly,

Starting point is 00:01:30 said that when we look back and ask when he exactly decided to run for the Senate, that was it. Either way, like I said, it's been about a month now and we haven't got any confirmation. That was until Friday. Terraform Labs, the makers behind Terra and Luna, and its CEO, Doe Kwan, filed a lawsuit against the SEC. So, what is this all about? Well, first, let's talk about the specific product in question. The relevant product here is the Mirror Protocol, which is a a defy platform that mince synthetic stocks that mirror the price of U.S. stocks. Mirror is far from the only protocol doing something similar, but it's one that apparently has gotten the SEC's notice. Indeed, careful listeners will have heard Gary Gensler referenced this sort of synthetic stock

Starting point is 00:02:18 as exactly the type of thing that he questions in defy. To his point, if something is referenced against a security, it's probably a security. Now, this action by the SEC goes back to May. On May 24th, the SEC's enforcement division emailed Kwan and sought voluntary cooperation with their formal investigation around the Mirror Protocol. The lawsuit, which was revealed Friday, would later claim that this request for voluntary cooperation was framed as such because the SEC knew they didn't have jurisdiction to go after Kwan, who is a Korean citizen, and Terraform Labs, which is a Korean company. On May 27th, just a few days later, Kwan and Terraform Labs retained Dentons to represent them around this action.

Starting point is 00:03:01 Dentons negotiated an interview with the SEC under the condition that it couldn't be used against Kwan or Terraform Labs. Kwan met with the SEC via video conference on July 8th for an interview that ended up lasting five hours. Following that, the SEC requested more documentation. The lawsuit would later claim that they requested documents that either don't exist or are so broad as to be nonsensical,

Starting point is 00:03:25 and at heart here is something that's coming up more and more with these regulatory enforcement actions, which is the question of whether the SEC really understands what they're trying to regulate. Fast forward a couple months, and this is again from that later lawsuit. Quote, in a conversation on September 15, 2021, the SEC attorneys advised that they believed that some sort of enforcement action was warranted against terraform labs and any cooperation, and implementation of remedial actions as to the mirror protocol, would result in a reduced financial sanction as part of any consent agreement. On September 17th, Denton, tried to get info about the specific actions the SEC was seeking to correct perceived issues with

Starting point is 00:04:03 Mirror. Given that the Mirror Protocol has decentralized governance, they wanted to get a sense about whether they even could comply with those requests. By that time, however, the SEC had already decided on its course of actions. Its subpoenas had already been signed and were served at Mainnet seeking production of documents, as well as for Doquan to testify in person in D.C. Now, a month later, we have this lawsuit. There are two issues here. One is about the specifics of the platform, but that's clearly not what the lawsuit is about. The lawsuit is really about due process. This lawsuit from Terraform Labs and Doquan claims, first, that the two subpoenas were improperly issued and served by the SEC. They're arguing that they should have gone to the lawyers, not to Doe Kwan, since

Starting point is 00:04:46 counsel had already been retained at that time, and they question whether there is any jurisdiction at all. There's a concept called tag jurisdiction, which is basically when an enforcement agency tries to gain jurisdiction over an out-of-jurisdiction entity by serving a person who represents that entity while that person is in the jurisdiction. Second, the lawsuit claims that the SEC failed to keep confidential their investigation about the mirror protocol. Specifically, the implication of the lawsuit is that the SEC wanted to embarrass and intimidate Kwan and perhaps the industry as a whole by choosing to serve him in such a public way at this extreme. extremely public event. Finally, the lawsuit claims that these actions are in breach of the due process clause and the SEC's rules. NIDIG, which is the sponsor of this podcast, is at Money 2020 this week. So if you're in the banking industry and you're thinking about offering Bitcoin to your customers, bring your questions over to the NIDIG booth. Let's turn now to the crypto industry's reactions,

Starting point is 00:05:52 and first we'll get one take from an actual lawyer, Stephen Paley, at Anderson Kill. He said that while a preemptive lawsuit might seem a little unusual, it actually makes sense in this context. Quote, it's a reminder to regulators that there are rules of engagement that they need to abide by as well. Dr. Nick A. says the way that Doe Kwan was served at a conference was done to not just scare him, but everyone working in Defi. This is an important case and will hopefully put an end to these kind of scare tactics. Many people were proud of Do Kwan and Tara for actually taking this battle on. Michael Arrington wrote, I'm more proud of Do Kwan today than I've ever been of any founder I've ever known. Ryan Selkis from Masari tweeted, just want to say that

Starting point is 00:06:33 Doe Kwan is such a legend. He got served a subpoena unlawfully at Mainnet minutes before he came on stage with me and others for a killer session, and I didn't know until hours later what had happened. Unflappable. Now a couple more point out that this might be important precedent. Simon Kim, the CEO at Hashed, wrote, Terraform Labs and Doe Kwan is suing the SEC for violations of the 14th Amendment, the SEC's rules, and the Administrative Procedure Act of 1954. At Hashed, we respect the rule of law and compliance when it is fair, predictable, and consistent. But despite our industry effort to engage with the regulators for so long, if they themselves do not follow their own rules, where should we place our faith? As one of the most loyal

Starting point is 00:07:13 supporters of the taram money ecosystem, I personally empathize with though, since this decision could not have been an easy one to take on the SEC face-to-face. But there are clear values to be gained if this could force all of us to reevaluate some of the legislations and regulations that are quickly becoming obsolete. To this end, instead of settling, it may be time to re-stratage our overall approach. To borrow the words of Cryptoam, aka Hester Purse, when a party settles an SEC enforcement action, it often is trying to get the case wrapped up so it can move on. It has no incentive to force the SEC as a condition of the settlement to lay out a clear legal analysis. If the SEC cannot easily articulate an unassailable legal theory for why particular

Starting point is 00:07:50 assets are securities. Is the line as clear as the SEC maintains it is? End quote. In addition to whether a particular token is a security or not, there are many more questions being raised by more and more decentralized projects, so I believe we are at an important crossroads to fear or to face. I therefore commend Doe for starting what could be a seminal precedent for the industry, and I hope to lend my support in his brave decision to face the SEC. Calvinius Victoria gave a bit more of a market context. He wrote, thoughts on Doquan versus SEC. One, Terraform Labs is not being sued. They've been asked to come in for questions. Two, it's about mirror, not Luna or UST. Three, this actually puts all eyes on Terra with moral high ground. Four, could force regulatory clarity that the SEC would also have to follow.

Starting point is 00:08:35 Five, biggest question will the SEC end up suing Terraform Labs slash Doe Quan? Six, for now, some traders will be hesitant. Others will be buying with their middle fingers in the air. 7. In 2 weeks unless Luna tanks, it'll be like nothing has happened, really. 8. Look at the XRP case. They move slow and don't seem that formidable. Government salary versus lawyers that Doe Kwan can fund? 9. If the SEC tries to sue by the time anything consequential happens, bull market is probably over by then. 10. Worst case, there's Protocol Armageddon. 11. At that point, the question is, will they fight UST?

Starting point is 00:09:07 Choke off and on ramps? Kill Alice? Cause exchanges to D-Luna and UST? Maybe. but that's way down the line if we get there. We'll see it from miles away. 12. For now, SEC is playing defense against Doe Kwan, struggling on offense with XRP. Bull run continues. None of any of the bullish fundamentals on Luna have changed. 13. We'll accept that nearly everyone is rooting for us because they are us. Best fucking marketing. 14. All of Defy, nay, all of crypto should be rallying together around this. I love so much that Doe and TFL's spirit has been about collaboration over

Starting point is 00:09:42 competition with other projects. I believe in hope others will reciprocate. Fifteen, we're all going to make it. So what is my take? Well, look, if the SEC is going to regulate by enforcement, first, they have to play by the enforcement rules, that's just table stakes, and two, they can't really expect that this extremely well-funded industry is just going to roll over. To me, it seems just from a completely practical standpoint, the SEC has two choices. First, an ever-broadening set of legal skirmishes on multiple fronts that drag their limited resources to many different areas, weakening them in each case and making it harder and harder to keep fighting. Or second, engagement with willing stakeholders to help design rules of the road that take

Starting point is 00:10:27 into consideration the specifics of this industry. Sure, the SEC can just keep suing, but what if every protocol decides to fight back? The SEC can't possibly fight that many battles. And frankly, as much as we want legal battles to go our way, if we're not, we're going to that's the choice that the SEC makes, I think that our industry would rather just have there be good policy to begin with to avoid the cost and distraction. It just seems so clear to me that if option A is regulate by enforcement through a series of increasingly litigious battles, or B, actually get the stakeholders that are willing to engage together to actually help engage

Starting point is 00:11:04 versus just screaming the names of old court precedents at them, it shouldn't even be a choice. 0x-B-E-W-Yunt Capital made sort of this point as well in a longer thread that I'll read the end of. Quote, If Doe's suit was frivolous, it would have been really easy for the SEC to provide evidence requested by Denton to prove they didn't break their own rules. That they didn't, and this got to the point where a suit was filed, doesn't seem to augur well for the SEC. At the very least, this likely puts a pause on any progress the SEC hoped to make on this case as it relates to Doe. In my opinion, this is a good strategy and one I'd like to see more in our space employ. Rather than bend over like Coinbase and Uniswap, push back.

Starting point is 00:11:42 SEC has already revealed their hand to some extent and seem fine to let this all play out in the courts. With the amount of money floating around in crypto, this is a game we can easily win, even by just papering the SEC to death, drown them in motions, injections, requests. The name of the game right now for crypto is to survive the next three to five years as adoption increases and the space matures. If the SEC wants to make this a court battle, then so be it. Now, this was obviously the main regulatory news of the last few days, but two more stories that actually makes something of a similar point. The first is that the CFTC is doing some investigations of its own. According to Bloomberg, sources say that the CFTC is investigating

Starting point is 00:12:21 decentralized prediction market, polymarket. It is, quote, investigating whether Polymarket is letting customers improperly trade swaps or binary options, and if it should be registered with the agency. Polymarket says that they are, quote, firmly committed to complying with applicable laws and regulations into providing information to regulators that will assist them with any inquiry. Now, the report also says that they haven't been accused of any wrongdoing, but Polymarket has hired a former CFTC enforcement leader who is now at Sullivan and Cromwell as part of their response. It's obviously different than Terra as there's no accusation of wrongdoing in that Polymarket is formally cooperating, but you got to see that hire as a flex.

Starting point is 00:12:59 Second, Coinbase spent $800,000 in Q3 of this year ramping back up their lobbying effort. This includes re-registering their internal lobbying program and also hiring outside lobbyists. The takeaway is that there is clearly an attitude shift happening in the crypto industry right now. Many in this space used to be in the camp of ignore, deal with things quietly, but now when it comes to regulation, crypto is asserting itself. That doesn't mean that it's not going to collaborate with regulators, but the industry is sending very clear signals that it will not be pushed around and intimidated. I think you can make an argument that the infrastructure Bill was extremely galvanizing for this, in that this sucker punch from out and left field

Starting point is 00:13:40 ended up creating context for the industry to really understand and flex its Washington muscle. There is perhaps also the example of the action of China against crypto as something that pushes the industry to a different place. China serves as an example of what an angry government might do, but its withdrawal from the market as a whole also makes winning the U.S. jurisdiction all the more important. Net net, I think this shift in approach from the crypto industry is a good thing. Not because screw the government agencies or anything like that, but simply because to have good, long-standing pro-innovation and pro-investor protection sort of policies, you have to have engagement that happens on something of an equal footing. Regulation by enforcement inherently undermines that,

Starting point is 00:14:22 and so I appreciate the pushback. At the same time, I still hope that government agencies start to choose a different type of engagement as their first and foremost approach rather than what we're seeing currently. Until tomorrow, guys, be safe and take care of each other. Peace.

The Breakdown - Why One Crypto Company Is Suing the SEC

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