8 Crypto Insights from an Ex-SEC Lawyer ⚖️
All the Juiciest Nuggets from Carly’s Interview with Securities Attorney Karen Ubell
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We haven’t gone a week without a major headline starring the capricious Gary Gensler and the agency he oversees, the Securities Exchange Commission.
Last week alone, the SEC: Sued Binance. Sued Coinbase. And attempted to freeze Binance.US customer assets.
And now, there’s a major push underway by crypto-friendly congressmen to oust Gensler and restructure the agency.
Given all that, we thought it’s the perfect time to bring you eight of the biggest takeaways from Carly’s recent interview with former SEC attorney Karen Ubell.
Karen’s a partner at Goodwin Law, where she serves as Co-Chair of the firm’s Digital Currency & Blockchain practice. She also spent six years working in the Corporate Finance Division of the SEC and has a unique perspective on the rules, lawsuits, and political posturing surrounding U.S. crypto regulation.
This conversation has been edited for brevity and clarity. We highly recommend you check out Carly’s full interview with Karen on our YouTube channel or in any of our podcast feeds.
*Disclaimer: Karen’s comments do not constitute legal advice and she isn’t speaking on behalf of her firm, Goodwin, or any of her clients or partners.
On the SEC’s Hypocrisy in Suing Coinbase after Allowing it to Go Public:
Coinbase has been around for a long time. Coinbase has always focused on being a very compliant platform from day one. That was how they differentiated themselves. And in a disclosure-based regime, the SEC will allow for IPOs - and exchanges can go public - so long as they’ve disclosed all of the risks that a buyer would need to know when they purchase your securities.
But at the end of the day, there are other industries out there - cannabis, for example - where the SEC has preemptively said ‘this kind of market is illegal under federal law, so you cannot come and go through the SEC IPO process, we're not going to declare that effective.’
So while the disclosure-based regime concept is correct, I still think that Coinbase has a real point here, if the SEC thought what they’re doing is illegal, then certainly, there are places in history where they’ve stepped in and said, ‘We are not going to take things like this public, and let you use the public capital markets to raise money and sell common stock to retail investors.’ I think that's an example of where I appreciate and I understand their frustration, because the SEC has stepped in before if they thought this was a business operating in an illegal category. Instead they let Coinbase move forward by saying, ‘Yeah, there's some risks here [but you can still go public].’
On Navigating the ‘Everything is a Security’ Landscape:
Since Gary Gensler has been adamant that all of these things are securities, you could say that Coinbase has been pushing the line - just like anybody else in this industry has been pushing the boundaries - because we're getting all these speeches that say ‘everything's a security.’
But at the end of the day, everything is not a security, period, end of story. You don't have to be bullish on crypto to be in that camp. These things are not designed to be investments. The majority of them are designed to be used in a decentralized network to bring people together on a peer-to-peer basis. If we regulate these things as securities, this technology just simply cannot operate and it fails.
So when you take a position like the SEC has taken, that everything is a security, you're really kind of putting us all in a place where we just inherently disagree, because they're not intended to be securities. That's not how they operate and function. And it leaves the rest of us kind of reading the tea leaves as to what is and isn’t a security, notwithstanding this marketing and publicity push that we're getting from the SEC.
On the Misapplication of the Howey Test to Cryptocurrencies:
The SEC, in its 2019 staff guidance, kind of put out this idea that something may be sold as a security at one point in time, and later be declared not a security if the facts and circumstances have changed. So I think it's interesting that in the Binance complaint, they name a couple of projects that have been around for a really long time. Those projects, if asked, would even say that they at one point sold securities - that they filed a form D, and the SEC noted that they filed a form D. But the product itself - the token - is never a security.
The Expectation of Profits
You can get to a point where you have a fully functioning network and your tokens can be used in several different ways. If you’re buying tokens to use in a network, then you're not buying it with the primary expectation of profits. And it doesn't matter that somebody might buy it. Because there are a lot of collector's items out there - like purses, my personal favorite - that will never be securities, even though there's a whole resale market of people willing to buy it.
Derived from the Efforts of Others
I think the SEC has been a little bit dismissive of this prong, but who are the others? Can you say who the others are? Is the success or failure of the project substantially dependent on an individual or entity or group of individuals? Is it still that core team that wrote the original code that’s responsible for success or failure? And for most projects that are really building something that utilizes the innovation of the decentralized network, once their token is out in the world, the answer to that is no, it's not. It’s all these different node operators, it’s 1,000 different developers. To me, those are the weak points and that’s why it’s so fact-specific. It depends on the type of protocol, what they’re building, how many people have integrated what they’ve built. And those facts and circumstances evolve over time.
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On the SEC’s Jurisdiction:
I don't think that the SEC has the rule-making jurisdiction that it thinks it has. And we see that where they’ve drafted new rules that are designed to reach DeFi platforms and DeFi protocols. You could make the argument that if they already had the jurisdiction and the authority that they needed to reach DeFi, they wouldn't have to add it to a new rule. So I think that most people would say that this is outside their jurisdiction and that they're overreaching.
On Rewriting Rules for a Decentralized World:
The challenge right now is that the rules aren’t set up to work for decentralized entities. In the early stages, there’s kind of a group of people or an entity that's responsible for shepherding the project forward. But eventually these things become decentralized.
Today’s securities laws are set up for a world in which there’s an issuer that provides disclosures, and provides “current event reports” on your form 8K. And with a decentralized protocol, it could be 100 other people that know what that ‘current event’ is that affects its price, not just the so-called ‘issuer.’ So I think there needs to be some more customized disclosure regimes for a crypto project.
And I think most importantly, there also needs to be an off-ramp. It makes sense for the issuer of that entity to provide the disclosures an investor needs, but at some point in time, recognize they're no longer the ones that should be held liable and responsible for those disclosures, because there's 100, or 300, or 1,000 developers that are contributing to a decentralized ecosystem. Right now there’s no off-ramp for them, they’re still having to be accountable and file reports with the SEC.
On Gensler’s Inability to Classify Ether:
I think with Ethereum in particular, they're just hedging their bets because I think they're worried that if they say out loud that Ethereum is not a security then there's a lot that flows from that, so they’re taking a very conservative position. But I think it’s just generally accepted within the industry and I think that we had guidance back in 2018 that Ethereum was not a security.
I suppose that going back to my earlier comment about things being able to go from being a security to a non-security with respect to the mechanism and the way that it's offered and sold, it could be argued that what Gensler was trying to allude to in connection with the switch to proof of stake was that the facts and circumstances have changed. But I think that’s a tough argument. I would argue [staking] makes it even less like a security.
On Who Should Regulate the Crypto Industry:
Definitely an amalgam of agencies. The challenge is that retail investors - everyday people - have lost money, so there's certainly a feeling that something should be done to protect those individuals. In my view, however, that doesn't need to be the Securities regulator.
In the Ishan Wahi case, the DOJ first brought their complaint and filed criminal charges because they can actually prove and charge insider trading without having to prove that it's a security. So there are mechanisms for investor protection and market monitoring that don’t involve the SEC calling everything a security to then achieve some form of everyday protection for people.
I think the market infrastructure bill does an interesting job. They actually grant jurisdiction authority to the SEC, but I think they're doing it in a way that contemplates a more customized disclosure and also contemplates an off-ramp for things to become regulated by the CFTC. And the CFTC would be a great regulator in some respects because they have anti-fraud and anti-manipulation authority over the spot markets, so they'd be able to watch out for those very things that are you know potentially putting everyday people's money at risk.
On Where we Go From Here:
I think time is on the side of innovation. As more and more token projects really can demonstrate to Congress, to the world, to the US, to these regulators, and then even to a judge that innovation continues to grow at an exponential pace in this world - I think it shows how silly this looks if these are all securities. And that that's why I remain pretty optimistic about it.
Because there are still great, amazing projects that are continuing to innovate. And when you have those examples, and when you can show that in a court of law, I think it's going to be really hard to say, for a judge to say ‘yeah, these are securities and shut this entire thing down.’
Maybe somebody has to pay a fine. But recognizing the fact there is an actual network of users and individuals out there that have built something. And why are we punishing them?
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