Second Trump regime could put fox in SEC’s ‘crypto’ henhouse

‘Crypto’ operators could get a fox inside the financial regulatory henhouse if Donald Trump retakes the White House, putting a serious crimp in regulators’ willingness to hold operators to account.

On October 7, Politico reported that Dan Gallagher, currently chief legal officer at crypto-friendly online brokerage Robinhood (NASDAQ: HOOD) and a former Securities and Exchange Commission (SEC) commissioner, could be in line to replace Gary Gensler as head of the SEC should Trump prevail at the polls in November. The report cited “a dozen former top regulators, lobbyists and securities lawyers” as sources for this claim.

Other allegedly potential candidates include current SEC commissioner Hester ‘Crypto Mom’ Peirce, former Commodity Futures Trading Commission (CFTC) chairman Chris ‘CryptoDad’ Giancarlo, and former SEC general counsel Robert Stebbins.

While Politico’s sources claim Gallagher is a ‘natural’ for the position, his appointment would be extremely awkward given that the SEC sent Robinhood’s crypto division a Wells notice this spring, indicating that an enforcement action was being prepared regarding its “cryptocurrency listings, custody of cryptocurrencies, and platform operations.”

Gallagher issued a statement at the time saying the assets listed on Robinhood Crypto “are not securities” and the company looked forward to making clear “just how weak any case against Robinhood Crypto would be on both the facts and the law.”

America’s ‘revolving door’ between industry and government is already notorious, but Gallagher’s appointment would represent a new gear for the phenomenon of ‘regulatory capture,’ in which industry wields unnecessary influence over the agencies that oversee their operations. Politico noted that Gallagher’s nomination could face stiff opposition from Senate Democrats at his confirmation hearings.

A few weeks back, billionaire investor Mark Cuban claimed that he would be open to serving as Gensler’s replacement should Trump’s Democratic opponent Kamala Harris win in November. Cuban, who supports Harris over Trump, later claimed he was kidding regarding serving at the SEC and was only trying to “send a message to Gary Gensler that he’s doing it all wrong.”

Cuban also claimed that he’d had a face-to-face confrontation with Gensler in late September when the two were both in the CNBC green room ahead of separate interviews. Cuban said he told Gensler, “you’re screwing the whole thing up. You’re pushing industries overseas.” Cuban claimed Gensler has “some of that Elizabeth Warren in him,” referring to the Massachusetts senator who is among the most vocal crypto critics.

Enforcement exit

The SEC recently underwent some voluntary senior staff turnover as Gurbir Grewal, director of the SEC’s enforcement division, announced on October 2 that he was leaving the agency effective October 11. Current deputy enforcement director Sanjay Wadhwa will take over as acting director, while the division’s chief counsel Sam Waldon will serve as acting deputy director.

Grewal expressed pride with the SEC’s accomplishments during his tenure, “from recalibrating penalties and remedies to confronting emerging risks to holding issuers, insiders, and gatekeepers accountable.” Grewal also hailed Gensler’s “unwavering commitment to investor protection and support of a robust enforcement program.”

On October 4, Bloomberg reported that Grewal will join the law firm of Milbank LLP as a partner in the litigation and arbitration practice at the firm’s New York office. Milbank has a fintech unit that helps clients “optimize opportunities and manage risk on a full range of fintech transactions and initiatives.”

In 2020, some Milbank attorneys co-authored a paper on ‘blockchain and cryptocurrency regulation,’ with their contribution focused on “the potential applicability of distributed ledger technology (DLT) to the transfer of assets represented by ‘tokens’ or other digital assets.” Should be an interesting orientation.

Once more unto the breach

Grewal’s announcement came the same day the SEC filed notice of its intention to appeal a U.S. District Court for the Southern District of New York ruling on Ripple Labs, issuers of the XRP token. The SEC has yet to file the actual appeal, but a spokesperson said the district court ruling “conflicts with decades of Supreme Court precedent and securities law.”

The appeal to the U.S. Court of Appeals for the Second Circuit follows a July 2023 ruling by U.S. District Judge Analisa Torres. The ruling found that, while institutional sales of XRP represented unregistered securities under the Howey test, so-called ‘programmatic sales’ of XRP to retail customers on digital asset exchanges were in the clear.

(This opinion was rejected a few weeks later in a separate federal court dealing with Terraform Labs, in which the judge found the Howey test “makes no such distinction between purchasers” for identifying securities offerings.)

In August, Torres imposed a $125 million fine and an injunction prohibiting Ripple from future violations of U.S. securities law. Judge Torres scolded Ripple for “egregious” conduct in its “recurrent, highly lucrative violation” of the Securities Act and found reason to suspect a “reasonable probability of future violations.” But the $125 million penalty was a fraction of the $2 billion fine the SEC had sought, allowing Ripple execs to claim victory.

Ripple CEO Brad Garlinghouse was quick to express his displeasure with the SEC’s “misguided—and infuriating—appeal,” tweeting that “[i]f Gensler and the SEC were rational, they would have moved on from this case long ago.” Garlinghouse claimed that the SEC had “lost on everything that matters” and Ripple would “fight in court for as long as we need.”

A different view was voiced by John Reed Stark, another former SEC enforcement director, who found that the July 2023 ruling “resides on shaky ground, will very likely result in reversal, has already been solidly rebuked by a slew of other federal judges in subsequent decisions, and will rarely, if ever, count as precedent.”

Us too

On October 4, the Coinbase (NASDAQ: COIN) exchange filed a notice with Judge Katherine Polk Failla of the U.S. District Court for the Southern District of New York, who is overseeing the exchange’s fight with the SEC. The notice urges Failla to grant the motion to certify interlocutory appeal of a Failla ruling that Coinbase filed in April.

In March, Failla rejected Coinbase’s bid to dismiss the SEC’s suit, which accuses Coinbase of operating as an unregistered securities exchange, broker and clearing agency. Failla’s ruling was based on Coinbase’s failure to rebut the SEC’s “well-pleaded allegations,” which Failla said “plausibly support the SEC’s claim that Coinbase operated as an unregistered intermediary of securities.”

Coinbase claims that, since the SEC is asking the Second Circuit to review whether Ripple violated Howey, “the SEC has conceded … that the issues presented by Howey’s application to secondary-market digital asset transactions are of ‘industry-wide significance.’”

Coinbase argues that Failla should grant the exchange’s motion “so that the Second Circuit may have before it as complete a picture as possible in adjudicating the SEC’s position respecting Howey’s application to secondary-market digital asset transactions.”

Oral arguing

Coinbase squared off against the SEC in a different federal court last month. This tiff was triggered by the regulator’s refusal to humor the exchange’s 2022 ‘request’ for the SEC to develop crypto-specific regulations. The SEC rejected Coinbase’s demands last December, calling them “currently unwarranted” as existing securities regulations applied to digital assets just fine.

The two sides faced off in oral arguments before a three-judge panel of the U.S. Court of Appeals for the Third Circuit on September 23. Coinbase attorney Eugene Scalia—son of the late Antonin Scalia—told the panel it was currently impossible for any crypto operator to accept the SEC’s invitation to ‘come in and register’ under the current regs.

SEC attorney Ezekiel Hill insisted that existing securities regulations were adequate to cover digital assets. Even if Coinbase “wants to arrange its business in a way that does not comply with the existing regulatory framework, that does not establish a right to have the framework adapted to meet their business.”

One judge asked Scalia what Coinbase felt was the minimum the SEC could do to right this alleged wrong. Scalia appeared to overplay his hand by saying the court should order the SEC to craft bespoke digital asset rules, leading one judge to call that “an extraordinary remedy.”

However, the SEC also took a few blows, with the judges expressing unease with the SEC’s curt two-page rejection of Coinbase’s request. While acknowledging that the regulator has discretion in how it crafts its rules, Judge Thomas Ambro called the brief arguments made to support the denial “pretty darn close to vacuous.”

Judge Stephanos Bibas noted the growing number of enforcement actions the SEC has taken against crypto operators, suggesting it showed that “it’s not that the agency isn’t interested in the area, it’s just interested in picking off wrongs without giving higher-level guidance.” Ambro concurred, saying “it almost looks, to an outside observer, as if you’re going after platforms in a way that will crush the industry without really getting into rulemaking.”

The panel also showed impatience when Hill was asked to clarify whether specific tokens—including BTC and ETH—were commodities or securities. Hill responded by saying the SEC’s focus wasn’t on specific tokens, rather transactions involving those tokens. No date has been set for when the panel will issue its decision.

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