Last Wednesday, the current and previous chairmen of the Securities and Exchange Commission (SEC) shared what was billed as a “fireside chat” to open the Digital Asset Compliance & Marketing Summit. Gary Gensler and Jay Clayton spoke, took no questions, and agreed that the multi-trillion dollar crypto innovation space is a dark, menacing threat that legitimate crypto entrepreneurs must follow opaque rules or face crippling SEC lawsuits. Gensler made it clear that there is no difference between “fraudsters” and “good-faith actors” in crypto – both are lawbreakers endangering the public.
Many in the audience of crypto industry leaders, just maligned as crooks, were stunned. Gensler repeatedly said that “platforms need to come in and get registered,” as if everyone knew what he was talking about. Perianne Boring, the head of the Digital Chamber of Commerce tweeted, “People in the room are looking around and asking, “register as what?””
It’s a fair question given that the exchange Coinbase – the only crypto company to have gone public on the stock market – tried “going in”. Upon sharing to share its lending platform information, the SEC slapped Coinbase with a subpoena and the threat of what Gensler affectionately calls “the enforcement tool.”
John Deaton was also in the room. The Rhode Island attorney represents a growing putative class of over 62,000 holders of the digital currency XRP claiming they are innocent victims of the SEC’s policy of regulation by enforcement. They have been collateral damage in the SEC’s blockbuster enforcement action against the cross-border payments company Ripple, filed in the last hours of Clayton’s chairmanship nearly a year ago to the day of the Summit. The case is poised to be the most important yet in deciding the fate of blockchain innovation in the United States and the SEC’s power to regulate it.
The SEC alleges that every sale of XRP has been an unregistered securities trade since it was first sold in 2013, including the billions of tokens sold on secondary markets by retail holders who had no connection to or even knowledge of Ripple. The agency insists XRP – the token itself – is a security, and has never had any utility other than as an investment contract in Ripple and that everyone on the market should have known it eight years ago despite the SEC not knowing it until the day it sued. No fraud is alleged, just the failure to “come in and get registered” back in 2013. The allegations are more surreal after Wednesday’s event, as no one has ever known what “registering” means for a digital asset, a decentralized finance product or a crypto trading platform.
Deaton’s legal pleadings ask: how the token XRP itself could be a security under the same legal authority that the agency cites for its broad power to regulated crypto, the so-called Howey decision by the Supreme Court in 1946? Howey was a case about orange groves in which the court determined that a security is defined as an "investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others." As Deaton points out, the oranges themselves were not securities in Howey, so the XRP token itself isn’t a security now. If the SEC succeeds in this case, then every digital asset in existence is in danger, suggests Deaton.
Currency exchanges immediately suspended trading on XRP when the SEC filed the suit against Ripple. This locked up billions of XRP tokens held by retail holders in digital wallets, making it impossible to access them as the value of XRP collapsed. After various legal tactics attempting to force the SEC to limit the scope of its allegations to Ripple’s sales of XRP and leave the token itself alone, Deaton’s clients were granted amici status by Judge Analisa Torres to advise her on dispositive matters.
Deaton emphasizes that a letter from former chairman Joseph Grundfest warned the SEC before it sued Ripple that “simply initiating the action will impose substantial harm on innocent holders of XRP, regardless of the ultimate resolution.”
“I am aware of no instance in which the simple announcement of a Commission enforcement proceeding has, absent allegations of fraud, misrepresentation, or omission, caused multi-billion-dollar losses to innocent third parties,” Grundfest wrote to all five commissioners. "Upon learning of the proceeding, intermediaries will cease transacting in XRP because of the associated legal risk. The resulting reduction in liquidity will cause XRP’s value to decline."
Clayton ignored Grundfest’s warning, filed the lawsuit and jumped ship, leaving the SEC in growing legal and ethical jeopardy. Gensler, meanwhile, is increasingly hinting that the Ripple case is just the opening shot in a war he intends to wage on the whole space.
It wasn’t lost on anyone covering the “fireside chat” – from the New York Times to Fox Business Channel – that the Ripple case loomed over the discussion even though both chairmen avoided it. But the disconnect between Gensler’s SEC and reality goes well beyond the issues implicated by Ripple. Crypto investors now realize that the SEC is making it up as it goes. It invents rules and uses enforcement—or the threat of it—to cement its arbitrary policy. A settlement with Ripple is arguably likely, and it probably won’t restrain the agency from going after Ethereum next, or filing a mega-enforcement action against multiple exchanges that could make the plight of Deaton’s XRP holders look small in comparison.
The House Financial Services Committee holds a hearing this Wednesday on crypto regulation. Of the crypto executives called to testify, Committee Chair Maxine Waters (D-CA) boasts she will “hold them accountable”, not Gensler. It’s interesting that investors and consumers—the stakeholders that the law is supposed to protect—have been left out of the “fireside chat” and the hearing. Deaton urges the aggrieved to contact their Members of Congress and demand accountability at the SEC. It’s Congress job, not Gensler’s, to make crypto law. Everyone who cares about the future of crypto should demand legislation which makes the rules clear—for the people and the SEC.
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