Examining the SEC’s Approach Towards Crypto

[Music and Narration]

 

Introduction:  Welcome to the Regulatory Transparency Project’s Fourth Branch podcast series. All expressions of opinion are those of the speaker.

 

Colton Graub:  Good afternoon, and welcome to this Regulatory Transparency Project webinar. My name is Colton Graub. I’m the Deputy Director of RTP. As always, please note that all expressions of opinion are those of the guest speakers on today’s webinar. 

If you’d like to learn more about each of our speakers and their work, you can visit regproject.org where we have their full bios. After discussion between our panelists, we will go to audience Q&A. So please enter any questions you have into the Q&A function at the bottom of your Zoom window. 

This afternoon, we’re pleased to host a discussion on the SEC’s ongoing lawsuit against Coinbase—a case that will no doubt influence the legal landscape of crypto asset trading and securities laws well into the future. We’re very thankful to J.W., who is an Associate Professor of Law at George Mason University and counsel at Lawrence Law, LLC for moderating today’s conversation. J.W., I’ll pass it off to you to introduce Paul and Stephen and kick things off. 

Prof. J.W. Verret:  Thank you so much. I really appreciate the opportunity to be here with you and the opportunity to be here with Paul Grewal and Steve Palley for a discussion today about the future of the SEC’s regulation of crypto digital assets in the wake of particular cases, high-profile cases, including SEC v. Ripple, in which the SEC has partly lost and the defendant partly won—the ongoing litigation of SEC v. Coinbase. 

We have a perfect group today to discuss those issues I want to introduce. Paul Grewal is the General Counsel of Coinbase. Paul is a former federal magistrate. So I think it’s a powerful thing when you have in your corner in the GC suite a former federal judge. And he brings some perspective unique here. If you’re involved in crypto, you understand that Coinbase’s place in this litigation has implications for everyone developing in the crypto space and owning crypto assets. 

I welcome Steve Palley today from Brown Rudnick. Steve is a great person to have on this panel. The Federalist Society webinars have tradition and a policy of balance. Balance is essential to our discussions. I really like having Steve here today. I’m looking forward to this discussion because Palley is who I go to for balance. 

After the Ripple case, I got very excited. I was ready to go to the moon, buy Pepe and Dogecoin and everything. And Palley was the sober voice saying, “Well, hold on. This is interesting, but let’s think through the doctrine. Let’s think through the appellate risk, the risk of SEC overturning on appeal,” and all that. 

But, at the same time, Steve is crypto native, and I watched him defend — fight for an amicus brief in the Ooki DAO case, and I watched him fight like a lion for DAOS. So, Steve, welcome, and welcome for that. And thank you for that balance that you bring to our discussion.

Stephen Palley:  It’s a pleasure to be here.

Prof. J.W. Verret:  Yeah, good to be here. Good to be here with both of you. We’ll start the discussion a little bit with an intro, and then we’ll jump straight into a question. And then as we go through our questions, I’m really hoping all of you can ask some questions, some continued questions to put in the chat, and we’ll jump to those as soon as we can. Already one that’s jumped in about Bored Ape Yacht Club. So awesome. Here we go. 

To set up a little bit of the history—and this is a very limited history, and I’ll move it to Paul to elaborate on that—Coinbase was the first crypto exchange to go public. So it filed an S-1 with the SEC. It’s listed on the national stock exchange. It’s a publicly traded company subject to audit, subject to Sarbanes Oxley. 

When they filed the registration statement, they described their business. They described their business model. They said, “We’re going to be a crypto exchange.” Of course, they said a lot more than that. It was a big registration statement. But they said, “This is our business model.” 

A few years later, the SEC makes some speeches. SEC leadership makes some speeches and says, “We need legislation to have jurisdiction over crypto exchanges.” And then, particularly after FTX happened and that particular exchange — offshore exchange went down, the speeches from the SEC changed. And they said, “We have all the authority we need, and they need to come in and register.” 

And then we saw—along with the SEC v. Ripple where the SEC partly lost and partly won—we saw the SEC earlier this year file a case against Coinbase. The SEC has an outgoing — an outstanding case as well—a number of different cases against exchanges. They’ve just settled one with Bittrex. But a lot of that is kind of tangential. At the core, I think, of these issues is the Coinbase case. 

Fascinating. I recommend to everyone a brief recently filed. So representing Coinbase, Wachtell, Lipton and Sullivan & Cromwell—two leaders in litigation of all types—has a fascinating motion — for I’m going to forget now. Was it summary judgment or a motion to dismiss? One of those two. 

Stephen Palley:  A motion for judgment on the pleadings, if I recall. 

Prof. J.W. Verret:  There you go, a motion for judgment. 

Stephen Palley:  Somewhere sort of in between-ish.

Prof. J.W. Verret:  Right. A fascinating motion that I recommend to everyone. So that’s the set up for kind of where we are. Let me start with a question and just kind of alternate between my panelists here. Let’s start back from the history. 

Starting with Paul, was there anything from the S-1 filing process? I’m kind of familiar with how that goes. You get a bunch of comments from the SEC. You try to respond to what you can respond to. It’s always useful to try to respond to everything adequately and fully. Was there anything from that process—that S-1 process—that led you to believe that they were later going to sue you for the business model that was described in the S-1? 

Paul Grewal:  So, J.W., first of all, let me just say thank you for having me. And Stephen, it’s always great to speak with you as well. I’ve admired each of your writings on all of these topics for a while, and it’s just a pleasure to have a chance to kick around and debate some of these issues real time with others interested in these topics. 

J.W., just to answer your question directly, no. There was literally nothing from the S-1 process that suggested that a short while later, Coinbase would be sued for operating essentially the same business as was subject to extensive and exhaustive review as part of the S-1 process—in fact, quite the opposite. Over the course of the registration process, as one might expect, we received a number of questions and comments from the SEC. I think it was something like over 80 separate questions and comments. 

That wasn’t a terrible surprise to us. After all, we were the first major crypto company to go public or attempt to go public in the United States. And really, the only feedback we received at all from the SEC was a request for our legal analysis of our staking product and services. And, of course, we provided that. And shortly thereafter, they closed out the issue. We, of course, included language about the uncertainty of our products and the legal status of our products and services, which is, of course, rather normal, rather typical in S-1 process. 

But as a result of all that, at the end of it all, we were allowed to list as a public company. And, of course, when our registration statement was declared effective and, in fact, accelerated, the SEC necessarily made a determination, as they are required to by statute, that the registration and its effectiveness was in the public interest and consistent with the protection of investors. 

You mentioned, J.W., that a few years later, the SEC changed its tune. I have to correct you. It wasn’t a few years. It was really remarkable that just a few weeks after the SEC allowed us to list publicly, the chair of the SEC testified before Congress and in that testimony stated unequivocally that there are no regulatory authorities applicable to cryptocurrency exchanges, like Coinbase, and specifically noted and urged that Congress act to fill that regulatory gap. 

So the change in tune would be remarkable under any circumstances. But particularly in light of the fact that we were allowed to list, particularly in light of the fact that after that listing decision and while Mr. Gensler served as chair of the SEC, he told Congress that he didn’t have the power that he’s now claiming a short while later. 

Prof. J.W. Verret:  Steve, the SEC’s response is something to the tune of, “Look. When we bless your S-1, we’re not blessing your business model. We’re just saying the disclosures are accurate as far as we can see, or we don’t see any inaccuracies” or something like that. But they’re not blessing your business model. They say, for example, “A marijuana business is listed, and there’s a whole morass of federal issues with marijuana businesses. So we’re not opining on that. We’re the SEC. We’re not giving you legal advice.” It’s another way they often like to describe what they’re doing. 

But this is also unique on the other hand because this is about the very thing that they regulate, the specific thing they regulate. So that analogy is not quite appropriate either. This seems like it would implicate kind of equitable defenses, fair notice, or something along those lines. 

But usually when you throw those into a defense—in an SEC enforcement defense—that’s like a long shot, right? We know that historically. So what do you think about all this, about how the — what’s the significance of the S-1 filing and the about face in policy and all that for the enforcement case? 

Stephen Palley:  The concept of regulatory estoppel comes to mind too. So here’s what’s interesting to me. I have to admit, when I first read that, I thought, “Well, the SEC is going to say it doesn’t approve of a business.” There’s sort of a difference between what’s maybe technically, in a narrow sense, correct and what’s fair. 

And one of the things that I noted from the hearing—one of the hearings—is the judge looked at the SEC and said, “Come on. You saw the filing. You’re really going to tell me?” because it’s not in the interest of people who own the stock and have purchased it for suddenly for the company to be taken out. So there’s kind of an equity and fairness issue that I think makes the SEC’s argument. 

It’s one of those things. If you stand up in court and argue—I mean, I’m sure, Paul, that you’ve done this before—you might have a sort of technically correct statement, but it just doesn’t make any sense. And in some instances, that will give a judge a reason to find a way to rule against you because it is doesn’t — it is actually an absurd result for the SEC to say that the very business that it — whose S-1 it approved is actually unlawful when it had all of that information originally, including staking, which it has challenged in the lawsuit, including the listing of the assets. 

You could also say, “Look. The part of the SEC that governs approval of S-1s is not the same as the part that handles enforcement.” It’s apples and oranges. But you’re just going to deal with a federal judge looking at you and saying, “Really? How is that fair?” 

I also think about the composition of the Supreme Court and how this particular Supreme Court might look at that argument. Even if it weren’t — even if the question of fairness to Coinbase were relevant, there’s a question of fairness to people know are investors. So I think that’s a hard one. I’m not sure I’d want to be the SEC lawyer arguing that. So again, there’s this difference between technically correct and fair and equitable. That’s how I come down on it. 

Paul Grewal:  Yeah. If I can just quickly respond. Stephen, I obviously agree with what you’ve said. It would be one thing, for example, if the nature of our business were to involve ourselves in gambling or gaming activities or offer marijuana dispensaries all over the country where the legal status is unknown. Literally, the issue in our business that the SEC now takes exception to is securities, which is literally in their name and their primary responsibility. 

So I do think that this is certainly an equitable issue but also an issue that goes to the heart of just what makes good sense. And I think that what we saw in our first appearance before the judge—in our case, Judge Failla—is that judges are responding and reacting in the same way. 

Stephen Palley:  Yeah, it’s a tough one. I mean, the question is—and, of course, I hope things go Coinbase’s way—the question is, is that going to overcome the arguments to which great responses have been set forth? Great arguments have been made. But is that in and of itself going to overcome arguments about the Exchange Act and compliance with the Exchange Act? And I think the jury is maybe still a little bit out on that, but it definitely makes it harder, for sure. 

Prof. J.W. Verret:  All right. Let’s talk about how Coinbase approaches listings on the exchange. You face an impossible problem. In a normal world, the SEC would say, “Here’s the clear rules for what is and is not a security. We have a situation. We know where the CFTC and the SEC chairman are saying different things. Gensler seems to say that Ethereum is a security, though in the past, he said it is not before he was chairman. 

CFTC’s chairman has said it is a commodity, not a security, in the sense of those commodities that are not also securities. I also should have mentioned earlier, speaking of the CFTC, that today, there’s news about Coinbase getting approved for a futures product for Bitcoin and Ethereum. Is that correct, Paul? 

Paul Grewal:  That is correct. We’re very excited about that announcement. 

Prof. J.W. Verret:  Congrats on that. So can you tell me a little bit about how you approach the listing process in that framework of uncertainty and how that will change? It seems like the Ripple case has some tidbits that you’d want to include in that framework going forward that are favorable to your position. 

And then there’s a weird scenario of, if you make a listing determination while the Ripple case is still good law but then it gets overturned later but you relied on the lower case in the listing decision, this could get very meta very quickly and result in liability, even though you’re trying to do the right thing. So how do you approach that? And what are the risks? And how is it going to change going forward, especially post-Ripple? 

Paul Grewal:  Well, we are trying to do the right thing. And before I explain how we think about reviewing assets before we list them on our exchange, I have to point out, J.W., that the absurdity of the SEC chair’s position on ETH is even worse than what you described. 

The chair of the House Financial Services Committee in a hearing asked the SEC chair point blank, “Is ETH a security or not?” And he refused to answer the question over and over again. And particularly against the backdrop of the chair of the CFTC taking the opposite position and the history of the SEC chair’s own statements before he became the SEC chair, this becomes, I think, sort of a comedy at some point for regular people just trying to understand, “How do I comply with the law?” 

Now, as to our own listing process, the fact of the matter is that we do review each and every asset that we consider for listing rigorously. And we examine not only the asset’s legal status, but also whether or not we’re able to apply our compliance frameworks effectively to the asset. And, of course, we consider the cybersecurity and information security risk of each asset before we allow our customers to trade in it. 

That entire process of reviewing assets involves dozens and dozens and dozens of professionals in compliance in cybersecurity and, of course, many, many lawyers. And as a result of that process, we fundamentally and ultimately reject something like 90 percent or more of the assets that are listed. 

So when the SEC chair and others suggest that, just as a matter of straight math, there must be some securities among the couple of hundred assets that Coinbase and perhaps other exchanges list, he utterly ignores the denominator of that equation and focuses exclusively on the numerator. 

Now, you highlight the fact that given this uncertainty, our substantive legal analysis is challenged and challenging, to put it gently. It is certainly the case that when it comes to Howey, we now have, I think, important case law coming from the Ripple case that we must consider when it comes to evaluating whether or not listing these assets on a secondary exchange, like Coinbase, somehow implicates the 33 Act or the 34 Act or anything else under the federal securities laws. 

Up until this point, we have done the best that we can with the guidance, the paltry guidance that the SEC has put out and the very limited cases that have been issued largely in the context of primary issuances. But I think it’s fair to say that Judge Torres’ decision—and to be fair, other more recent decisions—call into question whether many or any of these assets can be considered part of securities transactions when listed on secondary exchanges like ours. 

Stephen Palley:  I actually have a question. I don’t know if this is something you can speak to, and if you can’t, I guess you can say so. I don’t mean to take over the commentator role, J.W. But I’m curious. 

It seems like one of the things that the SEC does in its complaint, it says, “Well, you had this crypto ratings counsel that gave out numbers, and it uses that against you.” And I guess there’s a question of I don’t doubt, and I know for a fact that Coinbase does a very comprehensive and thorough analysis of assets before listing. 

But I guess the question is, is this something that at some point in the future would be more appropriately done through some sort of self-regulatory organization? And by an SRO, I mean something that has basically delegated statutory authority. The problem, if you try and do it on your own, I mean, I guess the analogy is underwriter’s laboratory, which for those who don’t follow it, it’s basically something created by insurance companies to rate things like light bulbs or electrical appliances. 

And there’s a benefit to everyone following the UL standards and testing. It means you have fewer fires. If you have fewer fires, you have fewer losses. So there is some, like in the construction business. There’s some precedent for private organizations. But how do you come out on that? Does it make more sense for these things to be done in a coordinated way privately? There may be some antitrust issues, I suppose. Or would you be — do you think something like an SRO, like FINRA or the NFA, make more sense? 

Paul Grewal:  I think an SRO, Stephen, could work and maybe should work on a going-forward basis. As you point out, SROs do require delegated authority by statute, so it would be contingent upon Congress acting. And as we all know, that can be challenging at times, particularly when it comes to digital assets and cryptocurrency. 

But the concept makes a lot of sense because, of course, there are digital assets that are securities. I think sometimes the industry’s view is caricatured as rejecting the premise entirely that at least certain assets could qualify as investment contracts or securities under certain circumstances. Coinbase certainly rejects that view. It’s one of the reasons why we reject 90 plus percent of the assets that we consider. 

But I have to also point out that you mentioned the Crypto Ratings Council and our other efforts to evaluate the legal status of the different assets that we review. It is curious, I’ll put it gently, that Coinbase or anyone else, in my mind, would be criticized for carefully vetting and evaluating assets for their legal status and then have that process or commitment thrown back in its face in a federal complaint or in some other setting. 

I thought, as good lawyers, our job was to study the law and give our clients advice on whether or not a particular action might violate the law. To somehow now use that as evidence that an issuer, a project, or, God forbid, an exchange was somehow looking to evade the law, I find, creates all sorts of horrible incentives to avoid the law and avoid scrutinizing assets before trading in them.

Stephen Palley:  It makes the concept of a “yes” or “no” much easier because the thing I wondered about at the time was like, “Okay, it’s a three.” If I were an SEC-enforcement lawyer taking a deposition of somebody, I’d say, “So you didn’t know? You thought it might be?” So having an SRO give an up or down, it — or giving an up or down, I suppose, institutionally, the challenge that you run into, you have a Hobson’s choice, right? 

If you do a thorough analysis and there’s any little bit of doubt, unless you’ve got sort of blanket privilege protection or work product protection, you run the risk of in your analysis tilting things to either be unambiguous when the world is full of ambiguity or creating an evidentiary record that you’re going to get subpoenaed in an investigation. 

Paul Grewal:  Yeah, I think that’s right. And again, speaking as candidly as I can, I think what it naturally does is it pushes exchanges and others to adopt the most conservative view possible such that if there is any question or any doubt, as you point out, the default will be not to list. 

And I think the fact that 90 percent or more of assets that we consider are rejected is certainly consistent with that. I don’t think that’s ultimately consistent with the legal status of many of these assets under the law. But, of course, we’re going to act prudently and cautiously until we get some clarity. 

It’s one of the reasons why for several years now we’ve been begging the SEC for simple rules that would tell us what the standards are and allow us to make much more thoughtful, considered judgments than we’ve been able to make up until this point. 

Prof. J.W. Verret:  That’s a great segue to the next thing I want to talk about. So Coinbase filed for a request for rulemaking last summer with a lot of really substantive, thoughtful questions. I’ll toot my own horn for a second. 

So six months earlier, I did the same thing. So I’m a comment-request junkie—rulemaking-request junkie. But to your credit, mine was not nearly as thorough or thoughtful. Mine was just throwing a few things at the wall. But you guys really ran with it and had an extensive set of questions that a normal SEC would have been willing to engage in. 

I mean, over the 80 plus years of its history, normally, no matter who the chairman is, which party — normally, the way the process works is twofold: First, issues come up. You go to corp fin. You ask for a no-action letter, and you say, “Look, I’m not trying to defraud everyone. I’m not trying to evade regs. Here’s how I interpret the regs. Here’s what I’m building.” 

And as long as it all seems good faith, generally speaking, corp fin would say, “Here’s your no-action letter. As long as you do exactly what you said, we’re not going to take action against you.” That’s what a good-faith regulator does. 

And then as issues would bubble up and become more comprehensive, then the SEC would do an interpretive release, take the old rules, adapt them for something new. They’ve done it with Reg AB. They’ve done it for master limited partnerships. They’ve done it for — in the IC space. They’ve done it for REITs. I mean, there’s all kinds of examples of this adaptation. 

But that’s not what we got. What we got is if you go to corp fin, they say no, and then they immediately refer your project to enforcement, which is the opposite of the “no,” actually. It’s an action. It’s the opposite just dynamic of the SEC’s history. So you asked for some rulemaking. 

I’ve been on different lawyer groups, crypto lawyer groups, SEC alumni, big law alumni, where we think, “What should the right listing regime look like?” And we think it through, and we come up with model agreements and model disclosures. None of this is going anywhere despite the brain power ready to do it. And I understand some groups inside the building that have done projects like that that have just not bubbled up to the tenth floor. 

Can we get past this? How do we get past this and get either an exempted path for exempt offerings or an adapted path for 33 Act listings but adapted, like Reg AB? The chairman has mentioned Reg AB, but he hasn’t done anything. What’s it going to take to get us over the finish line, I guess? Is it possible?

And maybe even without asking you for politics of the current situation, what would it look like? Building on your prior request for public rulemaking, what sort of components would an optimal exempt regime or a listing regime kind of look like? I’m throwing a lot at you guys and seeing what you think about all that.

Paul Grewal:  Well, I’ll jump in, and I suspect Stephen has some thoughts about this as well. First, J.W., just to recount a bit more of the history, you referenced our own petition for rulemaking. I will note that we were not the first. You were ahead of us in that regard and full credit to you for seeing that this was an issue that required rulemaking well before many others. 

We filed our petition in July of 2021 and asked, as you point out, something like 50 or more specific questions that we thought needed to be answered in order for there to be a comprehensive or at least effective registration framework adopted here in the United States that would allow cryptocurrency exchanges and others to come inside of the regulatory perimeter and register, which is what the SEC has said it wants for some time. 

It was, I will put it gently again, disappointing that after many months, we received no response, no reaction whatsoever to our petition. And, of course, in parallel with that public petition, as I’ve talked about in many other settings, Coinbase engaged in private conversations with the SEC to lay out our views on what a constructive registration framework might look like. We had something like 30 separate conversations and other engagements with the SEC over many, many months. 

And yet when it came time in those private discussions for the SEC to react to what we had shared and to offer its own views on what issuer disclosures might look like, how we might look to models, like Reg AB and others and apply them in the digital asset context, we were politely thanked for our time and escorted out of the building. 

It was shocking to me that the Commission would operate in this fashion. And it was one of the reasons why, J.W., that after well over a year, almost now two years have passed—over two years, if I’m doing my math right. We felt we had no choice but to file a petition with the Third Circuit Court of Appeals requiring the SEC to give us a simple yes or no answer to our yes or no question of whether rules will issue for digital assets. 

And it was extraordinarily gratifying to Coinbase that rather than simply dismissing the petition, as one would expect, the bar is high. The agencies are generally given great discretion on how to manage their docket. The Third Circuit started asking questions and, in fact, put it to the SEC to explain when is an answer going to come. 

And in response to that, the SEC made some loose commitments to provide recommendations by October. And so the Third Circuit said, “Great. We’re going to hold you to that. You’re going to tell us where things stand in October.” 

So all of this suggests that everything we have observed and experienced is hardly normal and hardly consistent with the mandate of the Commission to promote efficient markets and protect investors and all of the things that the chair loves to spout in every one of his speeches. It’s just not possible to square those high minded references to the SEC’s goals with the reality of what companies like ours are facing when we try to come in and have a conversation. 

Stephen Palley:  I got to say, I’m kind of a civil procedure junkie, and I’ve litigated mandamus and prohibition cases in the past. I did win one in Missouri State Court years ago involving a zoning issue. It was a cool tactical move. 

So for those who are on the call who aren’t familiar with the practice, basically, what Coinbase did was, I’m sure—and, obviously, you can’t say this—you probably had a pretty good idea that a lawsuit was going to get filed. So before that happened, Coinbase said, “We asked you to make the rules. It’s been two years.” 

The reason that Coinbase asked for a writ was because you can’t appeal the denial of the request for rulemaking. I have this happening in another case involving loan forgiveness. If the government doesn’t act, how am I supposed to appeal? So there’s this interesting parallel thing happening. And I think the answer — the SEC is saying no, then Coinbase could then take an appeal and could raise APA issues and could take it up to the Supreme Court and then maybe be able to squarely address things like the Major Questions Doctrine and sort of more fully litigate the issues. 

But I don’t know. I thought it was — as a rules guy, the writ process is really interesting because you can use these things. If the government doesn’t act, you can ask a court to order an agency to act, or if the government is acting in a way that it’s not supposed to be or doesn’t have the authority to do that, you can get a court to prohibit that. 

I don’t think I’ve seen this particular fact pattern before procedurally. It’ll be interesting to see how it plays out. And I’ll also say I was surprised that the Third Circuit said, “We’re going to need you to come back to us and tell us what the deal is.” 

There is this—and I guess maybe it goes beyond this—but one of the questions I know this — we’ll be talking about is the Major Questions Doctrine and how that played out in a recent case involving the EPA and power plant emissions. It would certainly be interesting to see that litigated here with the current composition of the Supreme Court that we have. 

Prof. J.W. Verret:  Yeah. Paul, I’ll let you say whatever you feel comfortable saying, but I want to be sensitive that I don’t want to ask you questions about your private trial strategy because that would be inappropriate.

Paul Grewal:  Yeah.

Prof. J.W. Verret:  Just to keep with Steve. So, Steve, I’ve been trying to theorize my own armchair of theorizing—though I’m not as accomplished in civil procedures as you are—about the strategy behind the early mandamus. Are you saying you think that could be a vehicle for faster challenge up to SCOTUS than the enforcement action is? 

Stephen Palley:  I can’t really speak to speed, but certainly, it makes it — it maybe puts the issue more squarely before the Court. I’m not sure. But it’s kind of like you have two ways of getting that issue in front of the Supreme Court. 

You have this individual case where a trial court judge and an appellate judge and the Supreme Court will have an opportunity to evaluate whether that doctrine applies here. And then you have the same issue potentially raised in a challenge to the procedure being used under the Administrative Procedure Act to issue rules. So it’s kind of like you get two bites at the apple. 

It gives Coinbase the ability to essentially be a plaintiff and to create and craft the narrative in the mandamus action and in a potential Administrative Procedure Act appeal. I don’t know. Tactically, it’s an interesting way to approach it. 

Paul Grewal:  There’s so much I’d love to be able to share, but I can’t for obvious reasons. But I will say that I do think that it’s important that the SEC’s actions be as much on trial in this dispute as anything Coinbase has done or failed to do. And I do think that, again, to put it charitably or generously, very odd procedural responses or lack of responses from the SEC are relevant and do matter to understanding what’s happening here. 

Prof. J.W. Verret:  After this is all over, we’ll do another one, Paul, and we’ll post-game. 

Paul Grewal:  Sign me up. Sign me up. 

Prof. J.W. Verret:  Yeah, I certainly did notice. I mean, I followed Gene Scalia’s work for a long time. And when it was first filed, there was a lot of chatter among our crypto law friends that said, “Oh, mandamus never works.” And I said, “Guys, Gene has defeated the SEC at the D.C. circuit like three times or something. I wouldn’t count him out.” He’s got a plan. He always has a plan. So it’d be fascinating to watch that component of this as it plays out. 

So another thing that occurs to me—and I wonder if anybody wants to speak to this—is that one of the talking points I’ve heard the SEC say and the chairman say about SEC v. Coinbase is that—and this was true before they brought the case—we only need to win on one claim token, that is, a security to then show violations of the Exchange Act and to win our case or whatever. 

And he would threaten this earlier. He said, “Surely, one token on the exchange is a security.” Now that he’s named specific securities and now that, unlike most of the time, it’s pretty clear you’re not going to settle, all it takes is one alleged token that’s shown to not be a security to create some real problems for the SEC’s use of how we’re going forward well into the future. 

That’s something that hasn’t been talked about a lot. But that’s a risk for the Commission and the Commission’s institutional interest in having a flexible Howie test going forward, not just for crypto, but for everything that they use that flexible cudgel for. They might want to speak to that risk on the Commission side. 

Paul Grewal:  I’ll say a couple things, J.W. And obviously, I can’t speak for the Commission or claim to understand what anyone at the Commission is thinking as they adopt and execute this strategy. But does anyone seriously believe that long-term institutional concerns are anywhere near top of mind for the SEC chair as they pursue this regulation by enforcement strategy? 

I certainly see no evidence of that, and I do think that there are significant risks to the flexibility and the general ability of the Commission in the future to adapt to new technologies, new markets, new facts and circumstances that are being put at serious risk by this case and by the series of cases. 

The other thing I’ll just observe on one token alone being enough to vindicate or validate the SEC’s views. I have to just remind everyone that when we asked as part of the Wells Process, “Tell us what tokens you’re concerned about. Identify the areas of concern that you have so we can speak to them.” Over and over again, the SEC refused to tell us what tokens they believe were securities. 

Now, what kind of Wells Process is that? I understand that the SEC’s view is that there are many tokens listed on exchanges like ours that qualify as securities. But to refuse in the face of a specific—as much as we could be—humble request to simply tell us what it was that we were doing that violated the law, the Commission refused to even identify that. And it only identified assets for the first time in a federal district court complaint. 

That’s just a broken process. I don’t care what you think about crypto or what your views are on the meaning of an investment contract under the 33 and 34 Act and so forth. That’s a broken administrative process. And I think something else that we all have to ask serious questions about regardless of our views of the merits of any one case. 

Prof. J.W. Verret:  Steve, any thoughts?

Stephen Palley:  I mean, I think the SEC and the administrative state writ more broadly are, I think, under a little bit more of a spotlight than they may have been in the last 30 years. There’s another case in which the use of administrative courts or tribunals is being questioned. I think there’s an interesting balance. 

In order for a large, complicated, industrial — post-industrial country to operate, it’s unrealistic to assume that 435 legislators — 535 legislatures, that you can have Congress create laws that have all of the individual specifications that go into them unless you broadly increase the size of the committees and you move agencies into committees. 

At the same time, there are some serious, I think, constitutional issues about delegating authority to people who have no accountability. I think one way that the SEC and other agencies could protect their remit is that kind of transparency. Personally, I don’t understand why they wouldn’t say, “Yes, these three are definitely securities, and these are not. And here’s why.” 

The notion that, “Well, you’ll just have to wait until we sue you,” how is that a good use of taxpayer money? Why not just say it if you’re going to put in a lawsuit? If I’m negotiating and trying to resolve something, I generally tell people what the claims are so they can see, and I’ll explain why. It’s not unreasonable to ask that here instead of putting the onus on the other side. 

One of the very frustrating things about SEC inquiries and investigations, too, is they can go on forever, and they’re enormously expensive. And the notion of due process in that context is pretty limited. And I think that’s the issue that we face here is the enormous power of the administrative state and maybe pushing at the boundaries of what people are willing to put up with.

Prof. J.W. Verret:  Which is why the Wells notice process was developed to make sure to use that power responsibly. And the tone of the Wells Process has changed under the current enforcement director. It just has. And that’s where we are. 

Stephen Palley:  Well, and we were talking about this before offline. There’s this interesting dynamic, too, which litigators—and I guess deal people see this too—often, the way a matter is resolved or the way a deal is handled depends on the personalities of the people involved. 

And I’m not sure when it comes to state power that should come into play. I think that individual personalities should not be a decisive or a determinative factor, and it’s difficult to say that isn’t the case here. 

Paul Grewal:  Well, I’m actually quite certain, Stephen, it should not come into play. We are, after all, supposed to be a nation of laws and not men. Yet it seems like, in this particular context, personality really is driving so much of the agenda. 

J.W., you mentioned earlier that just this morning, Coinbase was approved to list certain futures contracts for U.S. customers, and we’re very excited about that. That was a review process that was at the behest of the CFTC—the Commodity Futures Trading Commission—and the NFA. 

And I will say that as rigorous and as exacting as that examination was, at the end of the day, we had a regulator in the CFTC that was interested in regulating, that was fundamentally focused on what makes sense for consumers, what makes sense for investors. Let’s hold this company and others accountable and to exacting standards. But at the same time, let’s work to develop these markets in ways that will keep the U.S. competitive, that will allow Americans to have access to products and services they want. 

It’s just an entirely different dynamic than the one we see at the SEC, where even after 30 or more separate conversations, I’m still waiting to understand what was wrong with what we proposed and what ideas the SEC had for bringing some semblance of normalcy to these — to digital asset securities markets. 

Stephen Palley:  Yeah. Actually, I have a question. I don’t know. Maybe, J.W., if you don’t mind, I’d be interested in your take on this as well. But I guess for both of you — 

Prof. J.W. Verret:  Always running a deposition, Palley. 

Stephen Palley:  I can’t help it. I don’t know what the answer to this is. So, basically, the SEC’s complaint is, in part, you’re doing three things that in traditional securities markets are required to be separated. 

You’re acting as an exchange, which is a marketplace, a place where people can basically trade securities. You’re also acting as a broker dealer, someone who traditionally connects buyers and sellers to the exchange in relation to that. And you’re acting as a clearing agency, which is the entity that closes the deal and keeps a record. 

Now, I guess the question is, if we look at the way — if we look at crypto and we look at crypto trading, these are concepts that we have from a hundred years ago where technology was different. And the law is what it is now. 

But I guess the question is, do we need — should the law — if we’re spinning forward 10 years from now, should we be in a place where you don’t need that? You need one license because it creates a certain kind of inefficiency. It creates needless friction, and it creates additional cost because everybody is taking a piece. Why not just have one license that allows you to do all of that? Am I missing something? 

Paul Grewal:  I don’t think you’re missing anything at all, Stephen. Look, I think there are historical reasons why we are approaching regulation in this market here in the United States, the way that we are. And there are also technological reasons why that approach, if it ever made sense, no longer makes sense, right? 

The U.S. is somewhat unique, after all, in dividing jurisdiction between securities and commodities into separate agencies, even just at the federal level, right? When you talk to folks in the U.K. and across Europe and all over the world, they sort of scratch their head that you would divide up jurisdiction in this way. But that’s largely a function of history. 

And, of course, when you layer on top of the agencies fighting over turf, the congressional committees that sometimes get bent out of shape when one agency’s authority is usurped or believed to be usurped by another, it just becomes, I think, a political fight in a much more tangible way than would be the case in many other countries. 

As far as the technology goes, look, distributed ledgers and blockchains do work in fundamentally different ways that matter. The fact of the matter is that blockchain-based protocols offer insights and information to purchasers and investors in ways that are simply impossible with traditional securities, whether they are equities, bonds, or anything else. 

And another technological element of this market that I think is utterly irreconcilable with the securities laws as were drafted 80 years ago or more is that the assets can exist and do exist independent of any initial issuer or developer of those assets. And that creates, I think, some different dynamics here that the current laws don’t accommodate. 

Again, we’ve always taken the view that this market needs to be regulated. These assets do need and require disclosures in order for investors and purchasers to have adequate protections. But all that suggests that we should adapt our general frameworks to the particulars of this market and technology and do so through rulemaking and through a consultative process, not through backwards-looking court cases that provide only limited guidance years after the underlying facts have taken place. 

Prof. J.W. Verret:  I know on the technology front, I’ve had my own frustrations trying to talk to PCAOB staff and leadership about Merkel root reserve proofing. And when I mention that, their eyes are like — it’s like I just said. There’s a flying elephant, and you can ride him. I mean, they have no clue what I mean. 

Even though I’m like, “This is a subtle thing.” On the one hand, it doesn’t resolve everything. And there have been some comments from CZ that — or not substantiated. But at the same time, the way Kraken has done it for the asset side, it allows for crowdsourcing, allows for on-chain sleuths to do things like ZAC, OXT, and all these great on-chain sleuths in a way that replaces so much of what was intended to be created by Sarbanes Oxley but does it better. 

Is it fair to say — I mean, the simple talking point you’ll get in D.C. is, “Oh, well, FTX happened. Therefore, we must regulate and sue anyone who doesn’t comply.” Is it fair to say that if two years ago, three years ago, SEC had sat down and done what you asked them to do in the request for rulemaking? I’ll say it. 

I think maybe FTX wouldn’t have happened, or it wouldn’t have been as bad if there was a clear SEC-registered platform, not just SEC somewhat approved through the S-1 process, but a fully registered platform under a new adaptive regime. I think we could have stopped some of the fallout of the bad actions in 2000. 

Stephen Palley:  I got to push back just a tiny little bit on that because bad actors have existed. There have been regulated — Enron, Madoff. Being regulated doesn’t prevent people from being total dipshits and criminals. So I’m not sure that — I think it’s fair to argue that maybe the government was asleep at the switch. 

I think we also know people who — there are certainly people who were aware through their own open-source research that some of the collapses that we see now were inevitable. And if you had a regulator who’s focused on that, maybe it might be different. 

But I think the problem with saying, “If we had different laws, SBF would have been caught” takes the focus away from the fact that as long as there are safes or banks, you’re going to have people who try and break in. 

Prof. J.W. Verret:  Fair enough. Let me just modify my claim. If we had a regulatory regime adaptive to the forensic tools available on chain, we could reduce some of the damage. How about that? 

Stephen Palley:  I think that’s fair.

Paul Grewal:  Yeah. If I can jump in, I agree with that, J.W. And I think Stephen is right that no set of laws can guarantee that a criminal or a dipshit isn’t able to do what they might otherwise do. 

But in this particular case, how many criminals and dipshits are meeting with the chair of the SEC at the same time as they’re perpetrating their scheme? That’s where I sort of am slack-jawed that there hasn’t been more of a human outcry even beyond what has taken place. 

And at the same time as the chair is meeting with this criminal—I’ll call him for what he is—others in the industry are saying, “Can you please work with us to give us rules? Here’s a petition. Here are questions that we think ought to be resolved. Here are proposals that we think could work,” and we’re met with silence. 

I just think that contrast is impossible to ignore and hopefully impossible for the American investing public to accept if they look at this situation for what it is. 

Prof. J.W. Verret:  Well, I don’t want to discourage the chair from meeting with anybody in good faith or considering requests for no action or anything, even if it turns out they aren’t what they said they were. But I think you’re right. I agree with you that he should be meeting with everyone in good faith and considering no action requests and adaptive interpretive release requests from a large group of people in this industry. 

Stephen Palley:  I think the problem — I want to raise this too. This has been on my mind. I don’t necessarily love the term “regulation by enforcement,” not because I don’t appreciate the frustration that it channels. I think the problem with sort of judicial resolution of these things is you can’t — it’s difficult to coordinate. 

So basically, if you’re a defense lawyer, you have to defend based on the case that you have in front of you. And so you’ve got Coinbase litigation. You’ve got UST litigation. You’ve got Ripple litigation. You’ve got different judges who have different facts. In an ideal world, people in the industry could all coordinate on these things. 

But there is an overlap with a criminal case for Terra, with the Do Kwon case, and there are some privilege issues too. So the challenge with regulation by enforcement is it’s not a fair fight because there’s — you can’t easily coordinate an industry response. I mean, I saw that happen in part in the Ooki DAO litigation. I won’t get into it. 

But the people who were — the individuals who were named had different interests than the industry itself. So I think that’s the reason why, in part, sort of ad hoc decisions by courts, it’s just — it’s never going to give us a — it’s never going to be a real regulation, I think. It’s just going to create more and more confusion. 

Paul Grewal:  It’s certainly not going to be an effective regulation. I think that much is clear. 

Stephen Palley:  Yeah. 

Prof. J.W. Verret:  So we have a few questions. We have a number of questions about Bored Ape Yacht Club and Mutant Ape Yacht Club, but I’ll defer those for our BYC webinar in the future. 

One question if you want to jump in—if not, that’s fine—one question that’s just sort of a general question, “Thoughts on the special purpose broker dealer Prometheum?” Obviously, that approval has been contentious. 

We want to encourage the SEC to approve legitimate requests for special purpose broker dealers and their related ATS requests. But obviously, there was some contention around that particular one and whether it could follow through on any actual listings at the end of the day. Anybody want to comment on Prometheum? 

Paul Grewal:  Well, I’ll offer at least the observation that, certainly, the House Financial Services Committee—or at least the Republican majority of that committee—has serious questions about that approval. 

I believe Chair McHenry and others sent a letter just yesterday to the SEC asking a number of, I think, very probing questions about that process and how it could be that this entity, which doesn’t list anything, doesn’t trade anything, doesn’t have a particular expertise in this area, could jump ahead of many others in securing that special prepper broker dealer approval. 

The other thing I’ll observe is that if we are to believe that somehow that particular firm has cracked the nut of how to offer digital asset securities in a fully compliant, fully regulated way, that no other company, no other firm has been able to figure out, why is it that so many respected, serious scholars and practitioners of securities law are scratching their heads that somehow the rest of the field missed this and only the principals of that particular firm have been able to solve the issues raised by the SEC? It doesn’t make any sense. 

Stephen Palley:  I think there’s a — INX is an — has a — is an ATS, right? There are some platforms that allow for trading of digital asset securities. And this is no knock against any of them. I think the challenge that you see—and this is more of a business issue—is not a lot of assets to list and not a lot of liquidity. 

And people buy crypto for different reasons than people buy traditional equities. You might be buying crypto to be a participant in some sort of decentralized community, to participate in gaming, maybe just to make money and speculation. But it’s not speculation that is ever going to lead to a dividend paid directly by the issuer. 

So I think part of the challenge whether or not Prometheum or anyone else succeeds is that maybe the model — maybe we shouldn’t be thinking of these things with a securities law lens, which would be gratifying for me because I didn’t start out as a securities lawyer. And it’s crypto that has really turned my focus to these issues, frankly. 

But securities law as a way of regulating trading of interest in things is not the only way. It’s not the only way to regulate these things and to protect people. I think sort of looping back, I’m not sure if — I’m not sure functionally what — if these things actually make sense from Ethereum or otherwise. 

Prof. J.W. Verret:  I could make a three-hour securities law exam with one question: The SEC chairman has said Ethereum is a security and must — Ethereum must register. Can you think of any complications with Ethereum registering? And then they would have three hours to write an answer, and I think they would run out of time. 

Paul Grewal:  I think they run out of time if you gave them three days, Professor. There’s so much to unpack, 

Prof. J.W. Verret:  Right. We didn’t talk much about Major Questions Doctrine. Does anybody want to jump in on that? My view is I think it’s very fascinating and it has good chances, but I think it probably will be something that a district court judge will be reluctant to really dive into much. But I think the odds are pretty good at SCOTUS. But maybe you all have a different view because you all are practicing a lot more than I am. 

Stephen Palley:  I mean, it seems like we — I think we’ve all been expecting Chevron deference to be up for discussion and reconsidered soon. So whether it’s the Major Questions Doctrine—which is, I think — others might disagree. It’s a Roberts Court thing—whether that’s the thing that limits regulatory agencies or sort of a clawing back of deference under Chevron deference, I think we’re going to see that litigated. Whether it’s in the context of crypto or otherwise, I think we’re going to see more of that limiting agency power. 

Paul Grewal:  We’re certainly going to be litigating that. We are litigating it as we speak, as you both know. I will just suggest that if you look at the Biden v. Nebraska case, which dealt with student loans and find and replace student loans with digital assets or cryptocurrencies, the logic applies on all fours 100 percent, period, end stop. 

I don’t think there’s any way to distinguish what is happening in this regulation by enforcement campaign of the SEC. And what the Supreme Court has said violates the Major Questions Doctrine in a fundamental way in that case. 

Prof. J.W. Verret:  Well, we’re coming near our time. We’ve had our questions. One clever DeFi lawyer says, “Are any of you interested in being the next chairman of the SEC?” I won’t ask that one seriously, but I think you would be — both be great candidates. Let’s close it out. 

[Crosstalk]

Prof. J.W. Verret:  Yeah, that’s right. Just a street lawyer. Let me give you each a chance for the last word, and then we’ll close it out. Paul, go ahead.

Paul Grewal:  I’ll just end where I began, which is that I do think that the process by which the SEC has gone about attempting to set standards in this industry and for these particular markets is absolutely as important and critical to pay attention to as the facts and circumstances in any one case. Again, we can all have a good-faith disagreement about the merits of cryptocurrencies or digital assets, whether they actually do anything for real people in real ways or not. 

But the fact of the matter is, if you’re a student of administrative law or just someone concerned about how our government is acting in our name, I think the issues when it comes to digital asset securities are absolutely worth paying attention to. It’s one of the reasons why we’ve taken a somewhat unusual approach in our case and trying to be as transparent as we can about what’s going on, what the SEC is saying, what we’re saying back to the SEC throughout this dispute. 

And I hope that folks with an interest in these issues that go far beyond just the price of bitcoin or the Bored Ape Yacht Club will take that interest forward because it’s critical that we all pay attention. 

Prof. J.W. Verret:  Palley, you get the last word. 

Stephen Palley:  I feel like I should mention dumpsters or Colesville Road. I might have had a bet about that. But I think the issue is this is not just about crypto. This is about government power and the administrative state writ large. Obviously, for Paul and for Coinbase, it is about crypto. But I think the questions are broader, and it’s important to situate this issue into sort of a broader cultural and economic and political context. 

Prof. J.W. Verret:  And in that way, it is similar to every webinar we’ve done with The Federalist Society, I think. Thank you all for joining so much. Paul, Steve, such great insights. Colton and The Federalist Society, thank you all so much for putting this together for a great discussion. Back to you, Colton. 

Colton Graub:  Well, I just want to echo what J.W. said. Paul and Stephen, we’re very grateful to you for your time today for the fascinating discussion on these critically important issues. 

 

For those of you in the audience who joined the conversation midway through, you can watch the recording via YouTube or listen to it via our podcast feed, which is available everywhere you listen to podcasts. We welcome listener feedback by email at [email protected]. Thank you all for joining us. This concludes today’s discussion.

 

Conclusion:  On behalf of The Federalist Society’s Regulatory Transparency Project, thanks for tuning in to the Fourth Branch podcast. To catch every new episode when it’s released, you can subscribe on Apple Podcasts, Google Play, and Spreaker. For the latest from RTP, please visit our website at www.regproject.org.

 

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This has been a FedSoc audio production.

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