Gensler says crypto treated just like the market; 200 SEK lawsuit says otherwise.

By law, regulatory bodies must only regulate what they have the authority to regulate. Respect is allowed to a certain extent, if the agency’s justification is reasonable and ideally documented. Specifically, Congress promulgated the Administrative Procedure Act (APA) in 1946 to guide the agency process for publishing notice of rulemakings in the Federal Register and allowing for public comment. This default process appears to have never occurred for cryptoassets at the Security and Exchange Commission (SEC). The SEC website does not include a listing for crypto regulation, either completed or proposed.

In May 2022, the SEC strengthened its cyber unit into the Crypto Assets and Cyber ​​Unit, budgeted for 50 dedicated officers and more than doubling the department’s headcount. The unit counts around 200 lawsuits since it was founded in 2017, with fraud as a topic in at least 80 investigations. The agency also reports the recovery of $2 billion in bailouts.

No one denies that cryptoassets, like any asset or technology, can be used fraudulently. The very features that make cryptoassets desirable can also be exploited, including but not limited to ease of startup and use, anonymization, and lack of intermediaries. In addition, some users can undoubtedly be greedy and gullible. It doesn’t help that some have disguised crypto scams as legitimate services.

It’s also true that at least $1 billion had been lost to crypto fraud in 2021. However, this pales in comparison to the more than $15 billion lost overnight by investors when the SEC filed a $1.3 billion non-fraud lawsuit against enterprise blockchain company Ripple Labs. When the news dropped, exchanges stopped trading XRP currency.

The SEC’s broad brush approach which a priori singles out all crypto offerings, exchanges, lending, decentralized funded, non-fungible tokens, and stablecoins appear guilty until proven innocent. So many lawsuits suggest that the SEC prefers “regulation by enforcement” (a lawsuit against a financial actor intended to extract a settlement) over “regulation by rules” (expressing guidelines for trading currencies, securities and other assets) . If the SEC can devote 50 of its 4,000 employees to detecting crypto fraud, a handful can work on regulations to help legitimate crypto actors.

The SEC has not responded to my request for comment.

The chairman’s view

In a recent article titled “SEC Treats Crypto Like Rest of Capital Markets. Securities Laws Protecting Investors Continue to Apply Even as New Technologies Come,” SEC Chairman Gary Gensler made a seemingly reasonable proposal for investor protection against fraud, arguing that SEC rules protects against this. In fact, he claimed that crypto-lending is already subject to SEC regulation and that “the rules have been around for decades.” However, a cursory search on SEC.gov for the term “crypto-lending” only returns results related to the SEC’s BlockFi enforcement , no “rules” as such. Instead, the chairman advises: “I encourage platforms that offer crypto lending to come in and talk to SEC staff.” What is www.SEC.gov for if not to read the rules?

On various occasions, Gensler observed that any digital asset is likely to be a security, and that every firm should know that. However, this is not what the SEC said previously (see the 2018 William Hinman speech). There is principled, ongoing debate in legal and academic circles that cryptoassets can be either currency (medium of exchange) or security (investment in an asset with an expectation of return) or both. This important distinction is not made explicit on SEC.gov, and the SEC acknowledges that both categories exist.

This question of currency or security is at the heart of it SEC v. Ripple Labs and the status of the digital currency XRP. Apparently, SEC executives themselves discussed the issue internally for some time, but never conducted an investigation or rulemaking. Magistrate Judge Sarah Netburn has repeatedly ordered the internal documents on the 2018 speech to Ripple in discovery, but the SEC refuses to comply. Her July Opinion & Order blasted the agency for “hypocrisy” and conduct that “suggests that the SEC enacts its litigation in furtherance of its desired goal, and not out of a faithful allegiance to the law.” The SEC further alleges that Ripple should have known that XRP was a security from the ledger’s debut in 2013, even though the SEC itself did not know until it filed the lawsuit in 2020.

A similar argument supports SEC v. LBRY, although it involves a different technology and goal. Speaking at the 2021 Aspen Security Forum, Gensler observed, “Make no mistake: It doesn’t matter if it’s an equity token, a security-backed stablecoin, or any other virtual product that provides synthetic exposure to underlying securities. These products are subject to the securities laws and must operate within our securities regime.”

Complying with the SEC’s securities regime is a tall order for any business, whether it’s a big bank or a lone developer. That Second SEC Commissioner Hester Peirce released a proposal for a token safe harbor to “facilitate participation in and the development of a functional or decentralized network, exempt from the registration provisions of the federal securities laws for three years” suggests that the SEC’s rules are less. than clear.

At the Aspen event, Gensler also argued that the Supreme Court’s Howey benchmark is a “three-part” test, when in fact it is four. The critical fourth prong is the “investment contract” defined as an investment of money in a joint venture with the expectation of profit from the efforts of others. It appears that Gensler eliminated this because it contradicts the reasoning in the Ripple and LBRY cases, which suggest that tokens per se are securities regardless of how they are packaged and sold.

What the SEC should do

The SEC was founded in 1934 in response to the stock market crash of 1929 and with the purpose of protecting markets from manipulation. However, the SEC’s own actions to “regulate by enforcement” are a form of manipulation through arbitrary and capricious decisions and a lack of processes and rules.

In fact, about 90 percent of SEC cases are settled, rather than concluded in court. Such a high rate of enforcement and settlement suggests that the SEC rules are not clear and possibly non-existent.

There are hundreds of SEC attorneys tasked with prosecuting companies for failing to comply with rules that Gensler says exist but are not found on SEC.gov. Gensler can protect investors through transparency. Crypto players have been begging Congress and the SEC for clear rules for years, but it hasn’t happened. Gensler has been in the job for half a year. It’s time to get this done.

Note: The title and content of this article were updated from an earlier story that could have been misinterpreted as news, when it was intended as analysis. Neither the author nor her family members own or trade in digital assets, XRP, bitcoin or the like. The author accepts no external compensation, financial or otherwise, for covering this important regulatory policy topic. The author has no relationship with any of the parties in this story.