Tom Williams/CQ Roll Call
SEC Chairman Gary Gensler testifies before the Senate Banking, Housing, and Urban Affairs Committee on September 15, 2022.
Earlier this month, two top Republicans on the House Financial Services Committee wrote to Securities and Exchange Commission (SEC) chair Gary Gensler, accusing him of orchestrating the arrest of Sam Bankman-Fried, former CEO of collapsed crypto exchange FTX, right before the committee was going to hold a hearing about the company. If there is a pettier Congressional letter than this one, asking Gensler to explain why he arrested a criminal before Congress got to grandstand in front of him, you’d have to find it for me.
The letter from Reps. Patrick McHenry (R-NC), now chair of the committee, and Bill Huizenga (R-MI), oversight subcommittee chair, reflects a change of posture for many House Republicans. In the immediate aftermath of FTX’s collapse, GOP members with an affinity for crypto (and a couple of Democrats) were fulminating that Gensler allowed the implosion to happen. Now, apparently, they’re mad that Gensler is doing too hasty a job of enforcing the law.
But this behind-covering move from crypto’s allies in Congress appears to have been a huge tactical error. The Blockchain Eight, who wrote to the SEC last year to get the agency to back off an inquiry that included an investigation of FTX, turned on a dime once FTX fell, arguing that Gensler and his team “failed to foresee this meltdown,” in the words of Rep. Jake Auchincloss (D-MA). That, and the real-world implications of the volatile FTX bankruptcy for investors, gave motivation for Gensler to move to the next phase of enforcement against the crypto industry, which he has done with renewed vigor in the past few months. If the Blockchain Eight actually just wants to protect the public from crypto disasters, Gensler is obliging by rooting out the fraud from every nook and cranny of the industry.
Key to this crackdown is Gensler’s repeated contention that most crypto firms are offering unregistered securities to the public, in violation of federal law. Without registration, investors are not given disclosures about the risks of owning the assets. Unregistered securities are also supposed to be off-limits to so-called “unqualified” investors who don’t have a certain net worth or annual income. Unregistered offerings are frequently seen as scams, and the SEC has long warned crypto firms that they will go after digital assets that aren’t registered.
A pending lawsuit with Ripple Labs over its crypto token XRP, which the SEC has deemed an unregistered security, will go a long way to deciding whether the industry will have to comply with this registration requirement. (A judge last November seemed to side with the SEC on this point, in a case involving the blockchain platform LBRY.) But pressure in the wake of the FTX disaster that the SEC stop crypto scams before they fester invited Gensler to make his move on this front.
“We were starting to get frustrated that [Gensler’s] words weren’t being matched with action,” said Lee Reiners, Policy Director at the Duke Financial Economics Center, who recently testified about crypto in the Senate Banking Committee. “But he was giving the industry a chance to come in and get into compliance. The industry willfully chose to not do that. This is the action part.”
In January, the SEC charged the crypto lending arm Genesis and crypto exchange Gemini Trust with selling unregistered securities, and it fined Nexo $45 million for its unregistered crypto lending product. Gensler called the lack of compliance with registration “part of the business model.”
Gensler has outmaneuvered the phalanx of crypto industry mouthpieces and supporters in Congress, using the generalized whining about an alleged lack of action prior to the FTX collapse to take swift action across the crypto space.
This month, the agency forced Kraken to close its crypto staking operation—whereby individuals can lock up their crypto assets on a network and earn passive income—on the grounds that staking is an unregistered security. It also informed Paxos that it would soon face charges for minting Binance USD, for the same unregistered security reason. (Stablecoins are crypto assets supposedly pegged to the value of the dollar, and Binance USD is one of the largest.) Paxos was later ordered to stop minting by New York regulators. The SEC’s action against Paxos is in turn applicable to the entire stablecoin market.
Beyond the unregistered securities push, the SEC last week sued Terraform and its CEO Do Kwon for defrauding the public with its “algorithmic” stablecoin, which was supposed to be automatically pegged to the dollar through a complex set of interconnected assets. While the agency also highlighted that the Terra offerings were unregistered, this was more of a garden-variety fraud case. In another enforcement action, former NBA star Paul Pierce was fined $1.4 million for failing to disclose he was paid to endorse Ethereum, a crypto asset. The settlement was seen as a warning for other celebrities making paid crypto endorsements.
The SEC also proposed a new rule this month that would force institutional investors like pension or hedge funds to use qualified custodians to hold crypto assets, which would make it more costly for them to do so.
This aggressiveness has spread to the rest of the government. In January, a group of banking regulators essentially warned financial institutions against holding crypto assets, citing the risk of fraud. Banks have already begun to pull away from the industry. In addition, the Federal Reserve denied access to the payment system to a crypto bank called Custodia.
It should be said that this crackdown is happening without any new legislation from Congress. The SEC is using existing securities laws to contain the industry and section it off from the rest of the financial system. Discretionary enforcement and regulatory guidance depend on the regulators, and does not have the permanence or force of law. But a law from this set of legislators is unlikely to produce much of value for the public. Provisions like the one proposed by Sen. Elizabeth Warren (D-MA) to force crypto firms to comply more stringently with anti-money laundering laws would be welcome. But the more likely legislative outcome from a Congress littered with recipients of crypto cash would be some definitive de-fanging of the SEC’s efforts to enforce existing law.
While Reiners believes it is difficult to get an entire unwilling industry into compliance with securities laws through litigation alone, and that there are regulatory gaps in other offerings like bitcoin that are more like commodities, he acknowledged that the actions taken by the SEC and other regulators are both protecting investors and keeping the financial system stable. “Some consumers invested in this stuff will get hurt and that’s bad,” he said. “But gambling is risky and this is gambling.”
Gensler has outmaneuvered the phalanx of crypto industry mouthpieces and supporters in Congress, using the generalized whining about an alleged lack of action prior to the FTX collapse to take swift action across the crypto space. In fact it was easier to do so after FTX, because industry insiders became more willing to give up information about fraud in their business.
The Blockchain Eight was not all that serious about the SEC’s enforcement record, of course; they were looking for a way to pin FTX’s troubles on an agency they wanted out of the picture for crypto. But this has now backfired spectacularly. “It certainly didn’t help their cause,” Reiners said.
People are still going to speculate on crypto: Bitcoin prices briefly spiked last week before falling. But there’s a big difference between a speculative instrument or a vehicle for gambling not unlike a racetrack, and a financial asset that’s connected and tied to the broader banking system. Gensler figured out how to push crypto into the first category, with some unlikely help from the industry’s biggest defenders.
