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The SEC’s Ripple Lawsuit Reeks of Regulatory Capture


When I was a student at university, my International Relations professor told us a story about corruption in the Soviet Union. When he was young, he visited the Soviet Republic and wound up getting arrested and spending time in a Soviet holding cell. One of the guards demanded a bribe and promised they’d be released once he received it. His friend — a principled American youth — refused. My professor was more familiar with the culture there, and so he gave the officer the money and was promptly released while his friend languished in the cell until he paid up. His friend didn’t understand that corruption in the Soviet Union was integral to the functioning of the state. In America, it’s a bit different.

Luigi Zingales of the Stigler institute described the revolving door between the SEC and the private sector as a form of soft corruption. Companies aren’t explicitly paying a bribe — like the professor to the Soviet guardsman — they’re offering incentives. And these incentives can represent a conflict of interest for a lawmaker. There’s no softer way to say that. If a regulator is jumping into a lucrative industry position after their tenure is over, like Clayton did with One River’s newly minted crypto hedge fund, and Hinman did with the Enterprise Ethereum Alliance Foundation affiliated law firm, Simpson Thatcher, it’s hard to say definitively that these connections didn’t have an impact on their decision-making.  John E. Deaton illustrates the problematic nature of these financial connections:

On January 12, 2021, Bloomberg reported that Hinman would be returning to the law firm Simpson Thacher, which continues to sit on the Enterprise Ethereum Alliance. Government documents indicate Hinman received over $15 million in payments from Simpson Thacher over the four years he served at the SEC.

These conflicts of interest manifest in peculiar ways, like unregistered initial coin offerings (ICOs) built on the Ethereum network being pursued by the SEC, but the Ethereum network’s actual unregistered ICO gets overlooked. Consider that for a second. The biggest platform for unregistered cryptocurrency ICOs — which have been tenaciously litigated by the SEC under Clayton and Hinman’s tenure — had its own unregistered ICO, which the SEC was unwilling to formally pursue. They’ve even gone so far as to give ETH the regulatory green light in “informal” speeches – only classified as such because the SEC indicated, after they were pressed by Ripple’s attorneys, that they were merely the speaker’s opinion and not the SEC’s actual position. Oddly enough, an XRP community member dug up an email he received from the SEC indicating exactly the opposite:

Cryptoglobe reports that this email is cited as evidence in one of Ripple’s court filings.

These kinds of ethical issues aren’t uncommon in western governments; they’re endemic. Typically, the revolving door between industry and government remains behind the scenes. But with the SEC’s enforcement action against Ripple, the dirty underwear is hanging out on the clothesline in full display — largely because the SEC’s actions caused immediate financial losses to an otherwise healthy market. People were upset enough to dig up some rather sketchy financial connections between prominent regulators at the SEC and the private sector.

Ultimately the SEC may simply be guilty of being too obvious with their regulatory pillaging. Billions of dollars of financial losses are more immediately noticeable than something like the gradual deterioration of a national healthcare and eldercare system that culminates in the military needing to be deployed to take care of the institutionalized elderly — something we saw in Canada early on in the pandemic.

Most of the time, it takes twenty years before people start feeling the effects of regulatory capture, and by that time, everyone has forgotten whose fault it is. Regulatory capture is supposed to adhere to the “boil the frog” methodology rather than jackbooted thugs showing up demanding the shirt off your back. That’s not the way things are done in the West. Authorities are supposed to be more subtle.

Perhaps that’s why Gary Gensler took to Twitter for the first time in an attempt to put a positive spin on the SEC’s activities, trying to frame the organization as protecting investors and the public.

But it’s hard to convince someone that they’re being protected when they’ve been explicitly harmed due to a regulator’s actions. The XRP community is right to ask probing questions — why is a blockchain like ETH, which had a formal ICO (something XRP did not have), being ignored? Why not go after a project that demonstrably broke the law and helped birth the ICO craze, which fleeced investors and tied up regulators for years? If this was just a “figure things out at court” approach, then why go after Larson and Garlinghouse? Why attack the utility of the chain? Why frame Ripple’s institutional incentives and sales as dumping on the market? Could it be that they were trying to harm a competitor to firms they were formally associated with? It was Elon Musk who asked a similar question earlier in the year by pondering why the SEC wasn’t taking action against SPACs (special purpose acquisition companies).

Luigi Zingales of the Stigler institute suggested paying members of the SEC more in exchange for a “cooling off period” to avoid having them immediately join the industries they were regulating in the private sector — something eerily similar to Jay Clayton leaving the SEC and diving headfirst into an Enterprise Ethereum Alliance foundation affiliate law firm. Perhaps it wouldn’t be so peculiar if ETH hadn’t been such a problematic project for the SEC during the ICO craze. But as it stands now, the SEC’s enforcement action against Ripple reeks of regulatory capture.

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2 comments on “The SEC’s Ripple Lawsuit Reeks of Regulatory Capture”

  1. Interesting analogy. For the longest time, so many American companies have had this “revolving door” policy. For example, what happens very frequently is that a career specialist within an “energy company” say, retires after being within that company for maybe 30 years. After retirement, this “energy specialist” gets elected or appointed to a political office (or quasi-political office) & is then tasked with working at “regulating” that industry, where he/she used to work. However, the energy specialist politician now has a lot of ‘connections’ within the industry they are supposed to be regulating & so they might “go easy” on the industry insiders they are supposed to be regulating… (Or, they might get “kickbacks” &/or perks from the industry in order they don’t go so hard on the energy company they’re supposed to be regulating.) Then, after a time in this political post, they go back into the ‘same’ industry but now at a higher level. (They used to go to the EPA) Then perhaps they get hired onto the Board of Directors at another “energy company” for higher pay and the “Game Is ON”….. (Corruption?? “Oh no, we don’t have that here. This is America”) Yup, It’s just like you said so well in your great article. Thank you.)

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