The SEC’s Shadow Crypto Rule takes shape as enforcement cases mount
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US Securities and Exchange Commission (SEC) Chairman Gary Gensler believes the cryptocurrency industry is playing a game with his agency. He has said that companies are well aware of what they must do to operate legally in the US, but they have decided not to do it – some of them in open contempt for the regulator.
Is the crypto industry pretending it doesn’t know what the SEC wants—as the agency continues to illustrate in cases like the recent crackdown on the Terra/Luna ecosystem and its founder—and how long can that continue?
“The law is pretty straightforward,” Gensler said in response to questions from CoinDesk last week. The ongoing insistence by the industry that the SEC is abandoning crypto without clear rules is a “false narrative,” he said.
Late last year, a what-is-the-SEC-is-waiting-for feeling began to build among industry insiders, as the encryption cases had apparently subsided. Many wondered if the commission was waiting for the outcome of its pivotal lawsuit with Ripple before moving forward into legal battles with crypto firms. But the SEC burst out of the gates in 2023 with a series of actions and policy decisions with huge potential implications for digital assets.
“It’s been quite deliberate in trying to reach more types of players in the market, and have an ability to conduct enforcement actions across a broader range of targets,” said Amy Jane Longo, a former SEC litigation attorney in Los Angeles who now working at Ropes & Grey. Aside from campaigning against token issuers and platforms, her previous agency has tackled everything from staking services to stablecoins to celebrity campaigns.
Industry rejected
The industry’s main complaint hasn’t wavered: The SEC is rejecting the sector’s requests for the regulator to issue actual rules, so crypto labor has no choice but to continue as government walls close. But the US securities regulator has built up a fairly detailed set of implied standards with every enforcement action, application decision or policy decision it makes.
Crypto lawyers are, in most cases, well aware of what the SEC believes defines a token as a security, and rely on legal standards like the so-called Howey test to lay it out over and over in enforcement filings. And the lawyers also know which companies the SEC thinks should register as national exchanges.
“The SEC has consistently applied long-standing, well-known and clear securities laws to crypto activities,” said Dennis Kelleher, CEO of Better Markets, a Washington, DC group pushing for tougher financial protections. “The fundamental problem is that the crypto industry has deliberately chosen not to comply with these securities laws.”
Read more: Are the remaining crypto giants staring down the barrel of the US government’s gun?
Now a long list of issues have formed this shadow standard of what is not OK in digital assets. And the trillion-dollar question is how the SEC supports Gensler’s claim that nearly all tokens in circulation are securities. Insisting to a group of reporters last week that there are virtually always business interests attached to every token effort, the chairman checked one of the boxes for what his agency weighs in the securities tests.
“Besides bitcoin, where isn’t there a group of entrepreneurs in the middle?” he asked.
In late 2020, the SEC targeted Ripple in a lawsuit accusing it of selling the XRP token as an unregistered security. That case remains in federal court, and the final decision is bound to send shockwaves through the industry, whichever way it goes.
But the SEC already found some success in the meantime with similar charges against startup LBRY. A federal judge in New Hampshire ruled in November that its original LBC tokens were unregistered securities.
A $50 million settlement with failed crypto lender BlockFi targeted its high-yield lending product. And the agency’s enforcement division even built indirect cases against other tokens and issuers by naming several of them in an insider trading case against a former executive at Coinbase ( COIN ).
On the exchange front, the agency went after Poloniex in 2021 as an unregistered exchange, and the company’s $10 million settlement began to signal the SEC’s view on when digital trading platforms should register as national exchanges.
Gensler suggests that he is frustrated by crypto platforms’ unwillingness to come through his doors.
Kraken’s CEO “publicly said they were never going to register with the SEC — boldly said so,” Gensler said. “These platforms don’t even come in and ask for the meetings,” he said, adding that “I really respect” the few that have come in.
For their part, industry insiders say the SEC rarely has a real path to offer crypto firms. Longo said few companies have made progress on the registration issue.
“It feels a little hollow for people in the markets who are trying to figure out how to comply with what the agency wants,” she said.
Enforcement wave
While Gensler continues to warn that the compliance runway is getting shorter, recent weeks have seen an increase in SEC cases that could tip the scales further.
The agency added to the litany of civil and criminal charges against the fallen crypto platform FTX by saying that its exchange token, FTT, is an investment contract that should be in the hands of SEC oversight. The regulator then pursued cases against Gemini Trust and Genesis Capital for yield products it also rates securities (such as BlockFis), and against Kraken, arguing that the firm’s betting service fit the same bill. (Genesis is a subsidiary of Digital Currency Group, CoinDesk’s parent company.)
Last week, the regulator accused Terraform Labs and co-founder Do Kwon of knowingly misleading investors about the strength of the doomed TerraUSD stablecoin and — in a now-familiar SEC allegation — selling unregistered securities. Next in line for SEC securities scrutiny could be Paxos, which received a notice from the agency that it could be in trouble for issuing the Binance USD token as an unregistered security – a charge Paxos denies.
“For all these settlements and district court cases that are out there, there are still a lot of aspects that are unanswered, and I think that’s part of what makes it particularly difficult to try to navigate enforcement risk in this area,” Longo said.
Difficult or not, Kelleher is rooting for the federal authorities.
“The way forward to rein in a deliberately lawless industry like crypto is for regulators like the SEC and prosecutors like the Department of Justice to apply the full force of the law,” he said.
Last year, the SEC bulked up its newly named Crypto Assets and Cyber Unit by 20 positions, signaling the enforcement we see now. Putting aside most of the agency’s crypto cases, which chased old-fashioned crooks who stole people’s money or pursued an attack on so-called initial coin offerings, the list of follow-on cases remains substantial.
Gensler has been trying to send a message to the group of celebrities who have acquired digital tokens for money, including Kim Kardashian. The agency’s latest action was against National Basketball Association Hall of Famer Paul Pierce, a former Boston Celtics star, who agreed to pay $1.4 million last week to settle allegations that he promoted ethereumMax (EMAX) tokens without to reveal that he was paid $244,000. .
With its enforcement measures, the commission has defined which tokens, return products and betting services are considered investment contracts in the eyes of the regulator. And it has also been defining which firms should register as exchanges and how to avoid getting into trouble with marketing symbols while getting paid to do so.
Political moves
But the SEC has also shaped the industry with other moves, including its series of high-profile rejections of applications to create a spot bitcoin exchange-traded fund (ETF). Most recently, the regulator has finally entered into policy work with explicit mention of the crypto sector.
Last week, the commission proposed a rule that would insist that SEC-registered investment advisers — including massive hedge funds and advisers representing big institutional money — ensure that their clients’ assets are placed only with “qualified custodians.” That’s a narrow selection of banks, broker-dealers and similar regulated firms, which Gensler said would exclude unregistered crypto platforms.
While a number of digital asset companies — such as Coinbase, Anchorage Digital Bank, BitGo, Bakkt and Gemini — quickly insisted they could qualify as custodians under the rule, industry lawyers are still analyzing the 434-page proposal. At the very least, the language makes cryptocurrency players suspicious.
SEC Commissioner Mark Uyeda argued that the proposed rule appeared to “mask a policy decision to block access to crypto,” and he suggested “it is unlikely that crypto assets can be maintained with qualified custodians or traded on crypto trading platforms in accordance with the proposed rule.” “
Uyeda, who had previously worked with congressional Republicans and as an adviser to conservative members of the commission, had previously criticized “regulation by enforcement” more generally in a speech in September, then — alongside the commission’s outspoken opponent of government overreach, Hester Peirce — There may be some internal resistance to the SEC’s campaign to shape crypto without writing direct regulations.
“A significant shortcoming of regulation in enforcement is that it fails to provide a mechanism for the commission to consider the views of market participants, which can result in a myopic approach,” Uyeda said at a well-attended conference on SEC policy. “Market participants should be able to look to the Commission’s rules rather than compare how their particular facts and circumstances may differ from those of a specific enforcement case.”
Many in the industry argue that relying piecemeal on laws based on the 1930s is not a way to establish clear rules of the road for the innovations that separate crypto from the financial instruments of the past.
“The U.S. needs to make the call to get in the game,” said Brett Quick, head of government affairs for the Crypto Council for Innovation. “It’s like we just dip our toe in the water when we need to dive in.”
