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Suing the SEC

The narrative

It’s become clear that the SEC’s probes and litigation against cryptocurrency businesses have intensified significantly, leading companies to retaliate with lawsuits of their own and comprehensive public relations strategies in response.

Why it matters

The chances of Congress passing crypto-related legislation in the short term are becoming less favorable. Consequently, the crypto industry’s shift towards seeking judicial victories could prove effective. If lower courts and appellate courts, as well as potentially the U.S. Supreme Court, establish case law that benefits companies and regulators, it would provide a level of regulatory certainty the crypto industry seeks.

Breaking it down

A diverse group of entities, including the DeFi Education Fund, Beba (previously involved in an SEC lawsuit), the Blockchain Association and Crypto Freedom Alliance of Texas (both parties in earlier lawsuits against the SEC), and Lejilex (planning to launch “Legit.Exchange”), have united in their criticism of the Securities and Exchange Commission (SEC). Each entity has faced legal action for distinct reasons, yet they all hold a common perspective: either challenging the SEC’s regulatory reach within the crypto sphere or advocating for a clearer definition of how cryptocurrencies fit into securities laws.

Crypto companies have been adopting this expanding strategy by filing regulatory applications in federal courts that are generally more skeptical towards government regulations.

Recently, the Blockchain Association and lawyer John Deaton, who is additionally running as a Republican Senate candidate in Massachusetts, submitted amici curiae briefs to back up Coinbase’s request for an interlocutory appeal in one of its ongoing securities regulatory cases with the Securities and Exchange Commission (SEC).

Coinbase is urging an appeals court to provide clarity on how the Howey Test should be applied to digital assets, as there is ongoing disagreement among federal judges regarding this issue. Amicus briefs from both sides have emphasized the need for a definitive ruling from a higher authority to ensure consistency in the courts’ interpretations.

As a researcher examining the success of crypto-related lawsuits and arguments, I must acknowledge that predicting outcomes with certainty is a challenging task. The federal courts have shown a diverse range of decisions in cryptocurrency matters. The SEC has secured some significant victories against entities like Terraform Labs, Coinbase, Telegram, and Kik. However, it’s essential to note that not all cases have reached the trial stage or been decided upon yet. The industry also boasts some triumphs, such as the split ruling in the SEC’s Ripple case and the putative class action against Uniswap. Both of these cases are being overseen by the same judge presiding over SEC v. Coinbase and USA v. Roman Storm.

The diversity in what each suit requests doesn’t automatically provide clear answers to these complex issues.

During this period, the SEC is persistently carrying out its probes. Notably, Robinhood and Uniswap have disclosed receiving Wells Notices from the SEC regarding their crypto initiatives. These notices signify that the SEC holds sufficient evidence to potentially launch legal actions, and typically, addressees are granted an opportunity to present counterarguments against such actions.

From my perspective as a crypto investor, the broad outlook indicates that the Securities and Exchange Commission (SEC) is making progress in wrapping up some of its ongoing investigations. I believe we’re approaching a stage where the SEC will be prepared to hand these cases over to the courts for further proceedings.

As an analyst, I’d like to emphasize that SEC Chair Gary Gensler has consistently expressed his perspective on cryptocurrencies: the majority of tokens fall under the category of securities. He reiterated this stance during his recent interview on CNBC, differentiating token issuers from publicly traded companies.

As a researcher, I would explain it this way: “I want to clarify that I’m not making any assumptions about which of these cryptocurrency tokens are securities. However, based on U.S. Supreme Court interpretations, many of them do fall under the category of securities. Consequently, we abide by this law. Unfortunately, as investors, you’re not receiving the necessary disclosures regarding those assets. I’m curious, where can we find disclosure statements similar to quarterly earnings reports for these crypto tokens?”

One background factor contributing to the ongoing legal disputes is the current uncertain outlook regarding the passage of a stablecoin bill by Congress, not to mention broader market structure legislation.

Approaching the six-month mark before the US general election and less than a year until the inauguration, the Securities and Exchange Commission (SEC) finds itself in an election season that appears to be closely contested. While I’m not implying any time pressure on the SEC due to this tight race, it certainly adds an element of uncertainty.

Stories you may have missed

CZ gets sentenced

Last week, I embarked on a journey to Seattle together with Danny Nelson and a group of fellow journalists. Our objective was to report on the sentencing hearing of Changpeng Zhao, the ex-CEO of Binance.

Back in November 2022, Zhao admitted guilt for Bank Secrecy Act violations and resigned from the cryptocurrency exchange he established. Binance reached an agreement to pay a fine and penalty of approximately $4.3 billion, as well as obtain a court-appointed monitor (still to be named). Yesterday, Zhao was given a four-month prison sentence.

At the hearing, I provided real-time updates on Twitter, while Liz Lopatto of The Verge wrote a detailed account in the form of a live blog. For those interested in intricacies of the proceedings: Judge Richard Jones invited the legal teams representing defendant Zhao and the Department of Justice to share their perspectives on the DOJ’s proposal to increase the sentencing guidelines for Zhao beyond the suggested less than 18 months. The DOJ contended that the leniency of the initial recommendation did not adequately reflect the nature of Zhao’s actions.

The DOJ lawyers appeared somewhat unprepared when the judge initiated questioning about the enhancements, necessitating a quick consultation at their table prior to responding.

As a researcher, I’ve noticed that during the attorney’s argument, his points appeared somewhat thinly supported. At a particular moment, he proposed that the judge could infer knowledge of wrongdoing on Zhao’s part based on the judge’s statement about the lack of evidence for this claim. For context, I want to emphasize that this situation pales in comparison to the prosecution of Sam Bankman-Fried’s team, where DOJ attorneys in New York meticulously dismantled Bankman-Fried’s public image in a much more confrontational manner (metaphorically speaking).

The defense case was simply put: Zhao chose to come to the US without resisting extradition, admitted guilt, expressed remorse, and had initiated actions for making amends (resigning from Binance, agreeing to pay a $50 million penalty).

There were many unspoken words in the courtroom. The defense document from last month contained a substantial redacted section, hinting at a potential mitigating circumstance for Zhao’s sentencing. The judge chose to keep silent about this matter, leaving us all to ponder what exactly this extenuating factor could be. Given Zhao’s reported cooperation with one or more federal investigations, it’s plausible to assume that this could provide a clue.

From my perspective as an analyst, it’s been noted by many that Zhao’s light sentence could be attributed to the fact that he only admitted guilt for one charge of violating the Bank Secrety Act (BSA). One attorney I consulted with expressed his viewpoint that this single charge, in his opinion, was a significant concession.

The Department of Justice (DOJ) didn’t accuse Zhao and Binance of fraud during the legal proceedings. Although the DOJ’s sentencing memo indicated potential concerns over sanctions violations, no charges were filed on this matter. The opportunity for the DOJ to bring more severe accusations would have been during last year’s indictment against Zhao and Binance, instead of waiting until last month in the sentencing memorandum.

“The attorney remarked that his client’s decision not to admit guilt for violating sanctions was a significant advantage for him. This outcome wouldn’t have transpired if the client hadn’t demonstrated remorse.”

Instead of planning to win their argument for a tougher-than-prescribed sentence for Bank Secrecy Act violations, the DOJ seemed to anticipate losing this case. They have already initiated efforts to persuade Congress to establish more stringent sentencing rules in this area. The upcoming sentence will certainly strengthen their case for harsher penalties.

As a researcher, I’ve come across numerous statements from the Department of Justice (DOJ), but none quite like this one: “This marks a precedent-setting instance where a CEO will face jail time for violating the Business Software Alliance (BSA) regulations.”

It was truly captivating to witness the depth of admiration displayed by the judge toward Zhao, despite his acknowledging the criminal charges he had admitted to. Although Zhao’s well-known “ask for forgiveness” statement raised concerns for Judge Jones, in the end, she believed that Zhao had put significant effort into establishing Binance and showed sufficient remorse and commendable character. As a result, she handed down a sentence lenier than the five months suggested by the Probation and Pretrial Services Office.

At some future date – it’s not been set yet – Zhao will report to a federal prison for four months.

And then he’s done with this whole episode.

This week

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Tuesday

Friday

Elsewhere:

If you have ideas or queries regarding the topics I should cover in the upcoming week or any suggestions you’d like to make, please don’t hesitate to reach out to me via email at nik@coindesk.com or connect with me on Twitter @nikhileshde.

You can also join the group conversation on Telegram.

See ya’ll next week!