Coinbase on Trial

 

In 2018, Gary Gensler was but a humble professor at MIT, lecturing about a fringe topic: cryptocurrencies.  With conviction, he declared, “In terms of market value, probably three-quarters of this space has already been determined by the Securities and Exchange Commission not to be a security… So about three-quarters of the market value right now is what one might call cash, or a commodity, but not a security in this world.”  Oh, how the times have changed. Since ascending to the throne of the SEC, Gensler's tune has taken a peculiar twist. A twist so pronounced that one might not even be able to call it a twist. Maybe a twirl. Or perhaps even a convolution. In an about-face, Gensler quickly insisted that most cryptocurrencies are securities. Yet even then, Gensler remained steadfast in a singular message: the SEC is resolutely technology-neutral. Our sacred duty is to safeguard the innocent lambs of the investing world. What he told Bloomberg in 2021 would be repeated over and over in the mainstream media… He said: “While I’m neutral on the technology, even intrigued—I spent three years teaching it, leaning into it—I’m not neutral about investor protection. If somebody wants to speculate, that’s their choice, but we have a role as a nation to protect those investors against fraud.” The SEC, he said, acknowledges the importance of being open to innovation but emphasizes the need for a regulatory framework to ensure the protection of investors. That was Dr. Jekyll. Amenable. Gracious. Here to help. But slowly, over time, we began to see a different side of our affable academic: Mr. Hyde. “Come in and Register” As you probably know… The U.S. Securities and Exchange Commission (SEC) has filed a lawsuit against Coinbase, alleging the popular cryptocurrency exchange failed to register as a securities exchange. Are we shocked? No. The SEC's lawsuit follows a Wells notice issued to Coinbase six weeks prior, indicating the SEC's intent to recommend enforcement action against the company. As a result, Coinbase's stock (COIN) has dropped 14% on the week. Strangely, Paul Grewal, Chief Legal Officer of Coinbase, expressed a sense of relief upon receiving the lawsuit from the SEC. Coinbase has been seeking clarity from the SEC for years, he said, making the legal action somewhat of a welcome development. "Finally,” he said, “I now at least know what it is that we are accused of.” Grewal argues that Coinbase had been operating in the dark, with the SEC refusing to reveal which products and services were under scrutiny. He says that the SEC’s constant call for crypto companies to “come in and register” has been disingenuous at best. “As things currently stand today,” he said, “no operating exchange or other intermediary can register with the SEC. There’s no way for issuers to practically register under the current regime.” Worse, when crypto companies try to do so in good faith, they are made targets by enforcement actions. Of course, the struggle for clarity and regulatory guidance in the crypto industry is not exclusive to Coinbase. Robinhood’s chief legal officer, Dan Gallagher (yes, the former Obama-era SEC commissioner), claims he couldn’t get the agency to guide Robinhood into crypto compliance. “When Chair Gensler at the SEC in 2021 said, ‘Come in and register,’ we did,” Gallagher said in his testimony. “We went through a 16-month process with the SEC staff trying to register a special purpose broker dealer. And then we were pretty summarily told in March that that process was over and we would not see any fruits of that effort.” Ripple (XRP) CEO Brad Garlinghouse has been saying the same thing since at least 2020, when the SEC filed a similar lawsuit against Ripple. (Perhaps giving a glimpse of what’s to come for Coinbase, Ripple has since spent at least $200 million defending itself against the SEC.)

A Sign of Weakness? Some, like Garlinghouse, believe that Gensler’s actions are a sign of weakness. On Twitter, Garlinghouse wrote: “If it wasn’t already clear, it should be now - Chair Gensler’s laughable ‘pro-innovation’ stance (as he said today), is exactly the opposite. What this also tells me is that the SEC is throwing lawsuits at the wall and hoping they distract from the agency’s FTX debacle.” He followed up with this: “It’s embarrassing to watch an unelected bureaucrat flail like this to mask the fact that he and his agency don’t have the power that he so desperately craves. No one is fooled.” Lawyer and crypto enthusiast Bill Morgan wrote the following in response to Garlinghouse’s strong words: To Garlinghouse’s point…  Last April, Gensler told Congress that he didn’t feel he had the authority to regulate this industry, urging Congress to provide that authority. Republicans pushed back. Some, like Tom Emmer, believe Gensler’s method of “regulation by enforcement” has proved to be the worst, least efficient, least effective method of regulating an industry. Case in point: While the SEC was busy wagging their finger Kim Kardashian for promoting a crypto, Sam Bankman-Fried was defrauding its customers to the tune of billions of dollars. Moreover, while Gensler asserts that he has been "awfully clear about a bunch of this stuff," the specific “stuff” to which he is referring remains unclear to many startups. Gensler doesn’t even have unanimous support within the SEC. Hester Peirce, chair of the SEC, criticized Gary Gensler's anti-crypto agenda, summing up the problem: “Today’s Commission aggressively expands its regulatory reach to solve problems that do not exist. Today’s Commission treats its basic approach to exchange regulation as something that must not—indeed cannot—be altered to allow room for new technologies or for new ways of doing business. Today’s Commission tells entrepreneurs trying to do new things in our markets to come in and register. When entrepreneurs find they cannot, the Commission dismisses the possibility of making practical adjustments to our registration framework to help entrepreneurs register, and instead rewards their good faith with an enforcement action. Today’s Commission treats the notice-and-comment rulemaking process not as a conversation, but as a threat.” Peirce goes on, stating that: “Stagnation, centralization, expatriation, and extinction are the watchwords of this release. Rather than embracing the promise of new technology as we have done in the past, here we propose to embrace stagnation, force centralization, urge expatriation, and welcome extinction of new technology. Accordingly, I dissent.” Grewal offers a silver lining. Though he understands why crypto enthusiasts might be discouraged:  “If you just take a half a step back, you’ll see that you’ve now got clarity emerging all over the world… [They] recognize that crypto is an important asset class and critically that crypto is here to stay.” Chris Campbell