Investment and innovation are underpinned by predictable, transparent, and coherent regulation based … [+]
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Investors are looking for leadership from the President on financial innovation; instead they get a word salad of an executive order on consumers, financial stability, national security, and climate risks. The EO is a regulatory pile-on which asserts that ten federal agencies; a cadre of state insurance, banking, and securities regulators; and a smattering of other bureaucrats to protect consumers, investors, and business while ensuring “sufficient oversight and safeguard against any systemic financial risks posed by digital assets.” Consumers and financial innovators have long wanted a coherent, predictable regulatory regime which supports investment and experimentation while providing needed information to the public. Sadly Biden’s order merely punts the issue back to regulators to codify their capricious and abusive overreach.
The Ripple Case: A Settlement is Not Enough
Ironically, the EO increases the importance of the landmark federal court battle going on in the Southern District of New York between the Securities and Exchange Commission (SEC) and enterprise blockchain software company Ripple Labs. With all the sweeping arguments put forth by the SEC in its complaint, and the scrappy, brilliant defense put up by Ripple, the questions now go well beyond whether Ripple and its two senior executives violated of Section 5 of the Securities Act through with the unregistered sale of XRP. The SEC’s assertion of unlimited power in the absence of regulatory clarity is what’s really on trial. A settlement isn’t the right outcome in the case if it leaves the government unchastened, uncontained and free to attack again.
Moreover, class action against the SEC also needs to play out. Thousands of retail XRP holders with no connection to Ripple were needlessly harmed by the SEC’s inexplicable behavior. The enforcement action, filed on then-SEC Chairman Jay Clayton’s last day in office, dealt a one-two punch by crashing the value of the third largest cryptocurrency in the world (which had been trading on the secondary markets since 2013) and then locking up consumers’ holdings when exchanges suspended XRP trading for fear of SEC reprisal. Court evidence suggests that consumers lost as much as $15 billion as a result of the SEC’s enforcement. Others have had their assets padlocked for over a year. Represented by attorney John Deaton, over 65,000 of them were granted friend of the court status by the judge who confessed she found no judicial precedent of investors seeking to intervene in a case as defendants. Some have understandably been clamoring for Ripple to settle at any cost so they can get relief. But the SEC’s capriciousness in court and in public has needlessly dragged out the case and raised the stakes for all.
Chairman’s Conquest
The SEC’s 2020 complaint alleges that all distributions of the XRP token since 2013 have been unregistered securities transactions. The agency argued that the token itself is a security and that its open source decentralized ledger has no other utility but as an investment contract in one company, and that this was evident to all. This abruptly departs from Howey, the 1946 Supreme Court test for determining a security.
Ripple’s defense countered that the SEC gave no fair notice for seven years. In fact, Clayton and his hand-picked deputy, William Hinman, put out a blizzard of contradictory guidance to the markets. Ripple documented multiple attempts by many to get a clear answer from the SEC but to no avail.
Current SEC chairman Gary Gensler guidance is clearer: he wants to crack down on every digital asset. Stablecoins, utility tokens, centralized or decentralized ledgers –and he will use every weapon he’s got against the industry to expand the agency’s turf and lengthen his resume for promotion to Treasury Secretary.
Conflicts of Interest
Conflicts of interest certainly appear to be significant with the former SEC officials. Clayton’s first job after the Ripple case was filed was with One River Digital Asset Management, a crypto hedge fund that had made a $1 billion bet exclusively on Bitcoin and Ether shortly before the Ripple case was filed against the main market rival for those tokens at the time, XRP. Deaton and his army of XRP holders have asked Congress to investigate.
Hinman reported receiving over $15 million in retirement payments from Simpson Thacher, a law firm closely aligned with Ethereum, while he made SEC policy favorable to Ether. He then immediately returned to the firm after leaving the SEC, and was signed to a billion dollar fund managed by venture capital investors in Ethereum. A settlement could close the book on these egregious actions and encourage further conflicts.
Leadership starts at the top
If the President is not willing to back a coherent framework, there is no reason for his administrative minions to do so. With Biden punting and Congress unable to legislate, court is the last stop for justice against a runaway train of regulatory overreach. Let’s hope that the cryptocurrency trial of the century ends with the judge’s public decision rather than the parties settling in private.
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