Regulation by enforcement continues, but SEC enforcement actions are now being brought against exchanges without evidence of fraud or wrongdoing. Is the SEC overstepping its regulatory oversight of digital assets?
By Fizza Khan, CEO, and Tyler Schoenberg, Compliance Manager, at Silver Regulatory Associates *
With the criminal trial of Sam Bankman-Fried beginning this week, it’s easy to look at the collapse of FTX, other similarly high-profile implosions, as well as the general landscape of our current crypto winter, and understand why there is an increased public appetite for the Securities and Exchange Commission (“SEC”) to step in and regulate the crypto space right now.
The SEC’s current cases against Bankman-Fried, other FTX executives and Terraform Labs, to name a few, mark a trend going back to the earliest cryptocurrency-related enforcement cases brought by the SEC, which generally revolved around allegations of fraud, Ponzi schemes, misappropriation and malfeasance, and were, only occasionally, paired with a firm’s failure to register with the SEC.
However, there have also been a recent string of matters brought by the SEC against exchanges where there have been no allegations of malfeasance or fraud, simply a failure to register. In a stark contrast to the early cases involving crypto, that were typically just scams that happened to involve crypto, we are now seeing more cases being filed where the SEC has taken for granted that certain tokens are securities and are now going after exchanges when there is no evidence anyone has been harmed.
This shift in focus by the SEC can present many challenges for crypto companies, and their legal counsel, which could result in costly litigation if firms are not appropriately prepared and don’t have a robust compliance program in place that ensures they are operating above board and within the regulatory confines outlined by the actions of the SEC. Below is an overview of the “regulation through enforcement” crusade that the SEC is currently undertaking, and some key matters that illustrate the impact of, and industry reactions to, this trend, in an effort to help crypto companies appropriately navigate these uncharted regulatory and legal waters.
Historical Significance
It’s easy to see parallels between the crypto collapse we’ve experienced over the last year and a half and the Great Depression, where over-exuberance, coupled with limited oversight and rampant fraudulent activities, resulted in the evaporation of billions, or even trillions, of dollars.
Interestingly, there has been a running throughline of speeches made by SEC Chairman Gary Gensler about how the Great Depression led directly to the founding of the SEC, the enactment of the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company and Investment Advisers Acts of 1940 and subsequent rule-making that championed transparency, oversight and above all, the protection of investors. These regulatory agencies and standards continue to position the U.S. as the most trusted and attractive investment markets globally.
This narrative serves to highlight a clear difference between the aftermath of the Great Depression and the current regulatory environment, where there is a notable absence of a clear and workable set of rules and guidelines issued by the SEC and other regulators. Instead, we have seen a slew of haphazard, de facto legislation through enforcement actions, resulting in a significant rise in cases filed by the SEC than in years past. In fact, according to industry reports, the number of crypto enforcement actions is advancing at a record pace in 2023. By the beginning of June, the SEC had brought 24 enforcement actions against crypto firms this year. This compares to 30 cryptocurrency-related enforcement actions for the whole previous year, which was a 50% increase from 2021.
Key Cases
It bears repeating that when it comes to recent SEC enforcement actions, especially those involving staking-as-a-service, we have seen a shift from pursuing cases where there has generally been some element of fraud or wrongdoing to cases where there is no evidence of harm to any party, merely a failure to register with the SEC. Cases such as those against Bittrex, Coinbase, and Kraken (at one point, three of the largest exchanges) underscore this trend:
- Securities and Exchange Commission v.Bittrex Inc, 2:23-cv-00580, (W.D. ) – In April of this year, the SEC filed a complaint against Bittrex, a crypto trading asset platform, and its co-founder and former CEO, William Shihara, for operating an unregistered national securities exchange, broker, and clearing agency. The SEC also charged Bittrex, Inc.’s foreign affiliate, Bittrex Global GmbH, for failing to register as a national securities exchange in connection with its operation of a single shared order book along with Bittrex. Although the complaint alleged that Shihara coordinated with issuers who sought to list their assets on Bittrex’s platform to first remove certain “problematic statements” that might suggest the crypto asset was a security, there was no alleged wrongdoing beyond failure to register.
- Securities and Exchange Commission v. Payward Ventures, Inc. (D/B/A Kraken) and Payward Trading Ltd. (D/B/A Kraken), Case 3:23-cv-00588 , (San Francisco, CA) – In February, the SEC charged Payward Ventures, Inc. and Payward Trading Ltd., both commonly known as Kraken, for failing to register the offer and sale of their crypto asset staking-as-a-service program, whereby investors transfer crypto assets to Kraken for staking in exchange for advertised annual investment returns of as much as 21 percent.
- Securities and Exchange Commission v. Coinbase, Inc. and Coinbase Global, Inc., 1:23-cv-04738, (N.Y., New York) – In June, the SEC charged Coinbase with operating its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency. The SEC also charged Coinbase for failing to register the offer and sale of its crypto asset staking-as-a-service program.
Industry Reactions to the SEC’s ‘Regulation through Enforcement’ Approach
Make no mistake, the SEC’s current course of action has not gone without criticism. Commissioner Pierce, among others, has voiced her disagreement with the Commission’s actions regarding Kraken, opining that whether Kraken’s staking-as-a-service program amounts to an unregistered securities offering is neither here nor there, and at the end of the day, no one was being harmed – Kraken was making money providing a service to individuals, who were in turn, also making money. Furthermore, she stated that guidance on staking should have been issued long before now and using enforcement actions to tell people what the law is in an emerging industry is neither efficient nor fair. Finally, she opined that shutting down the program instead of developing a workable registration process is paternalistic and lazy.
There have also been numerous calls from political figures and industry participants for more clarity and rule-making, as evidenced during Gensler’s recent testimony before the House Financial Services Committee, wherein Congressman John Rose (R-TN) asked Gensler: “Regarding cryptocurrencies … I’m interested in why you have pursued a litigation-heavy strategy despite the fact that neither you nor any of your senior staff are litigators — neither your Chief of Staff nor your Policy Director or even your General Counsel. Why have you settled on such a litigation-heavy strategy to address the cryptocurrency market?” Additional evidence of questions being raised about the noticeable lack of regulatory guidance in the crypto space can be seen in a lawsuit brought by Coinbase earlier this year, in which a federal judge was asked to force the SEC to share its answer on Coinbase’s July 2022 petition, which asked for regulatory guidance for the crypto industry.
But still, no formal guidance has been handed down from the SEC to help crypto firms, and their legal counsel, understand how to navigate through these unchartered waters compliantly, safely and with the best interest of investors in mind.
Impact on Crypto and the Investing Community Overall
Ultimately, this enforcement-based approach has unintended side effects, as several crypto exchanges have shut down, or announced they are considering, or even taking steps towards, moving outside the U.S. and beyond the reach of SEC oversight. This could be disastrous for investors now and into the future because it stymies progress and hinders innovation within the marketplace.
It’s important to remember that these crypto exchanges provide valuable services to investors and players in this space want to exist in a manner that is consistent and compliant with U.S. laws. However, given the onslaught of enforcement actions handed down by the SEC this year, many exchanges are finding themselves unable to do so under this current enforcement-based regime, pushing U.S. investors towards lesser-regulated or entirely unregulated foreign platforms.
While some critics argue that the SEC’s “regulation by enforcement” approach is an attempt to snuff out crypto all together, it seems to us that this approach represents, at the very least, a stark abdication of the Commission’s duty to guard investors.
* Fizza Khan is founder and CEO of Silver Regulatory Associates, a firm specializing in compliance and ESG for the investment industry. Tyler Schoenberg is a compliance manager at the firm.
Reprinted with permission from the October 5, 2023, edition of the New York Law Journal © 2023 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or asset-and-logo-licensing@