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The SEC’s Selective Enforcement

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Shortly after the SEC’s enforcement action, I replied to a tweet by a popular XRP community YouTube personality Alex Cobb where he alleged nefarious motives by SEC officials. In my reply, I stated that it would probably be hard to find regulatory officials without any affiliation to the industries they were tasked with regulating.

Whenever something like this happens, and people begin making peculiar connections and arguing that these are indications of malice, I like to consider Hanlon’s Razor – “never attribute to malice that which is adequately explained by stupidity.” We had an SEC enforcement action launched against Ripple during the twilight of Jay Clayton’s tenure at the SEC – something odd enough that it led to a letter being released by Joseph A. Grundfest cautioning Clayton against filing suit mere weeks before he was to transfer power to a new official. At the time, there were whispers about the lawsuit being a parting shot by a Trump administration appointee at a progressive left-leaning firm like Ripple. Trump appointees were also not known for their stability, so alleging fraud at that point seemed premature.

But it looks like Alex Cobb had the right idea. As the years dragged on and a new SEC chairman was sworn in, the regulator’s behavior became stranger and stranger. SEC officials Hester Pierce and Elaid Roisman published a statement expressing disappointment that a settlement with the crypto firm Coinschedule did not explain specifically which assets sold by the firm were securities, and that the omission of this information was “symptomatic” of the SEC’s reluctance to provide guidance to the industry at large.

So reluctant was the SEC to provide clarity that it threatened to sue Coinbase over an upcoming program called Coinbase Lend – without telling Coinbase why they were being sued.

“Despite Coinbase keeping Lend off the market and providing detailed information, the SEC still won’t explain why they see a problem. Rather they have now told us that if we launch Lend they intend to sue. Yet again, we asked if the SEC would share their reasoning with us, and yet again they refused.”

The SEC could have simply been hesitant to give firms a clear set of guidelines to follow while they were locking horns with Ripple. But if this were the case, wouldn’t it make more sense to avoid enforcement actions against crypto firms like Coinschedule and Coinbase until the lawsuit had been settled so they wouldn’t be required to tell firms they’d violated securities laws without actually telling them why or being forced to settle lawsuits in ways that provide no market clarity for participants.  The threat of a lawsuit against Coinbase seems like a panicked attempt to kill a product that had the potential to compete with offerings from big banks. The SEC was clearly unwilling to wait until after the Ripple lawsuit had concluded to attack a product that would have no doubt attracted a large portion of domestic and foreign cryptocurrency activity. Once a service like Coinbase Lend gained enough popularity domestically, enforcement action would have been unpalatable.

A few days before a press release by the watchdog organization Empower Oversight, SEC Chair Gary Gensler gave a speech at the University of Pennsylvania where he announced a push towards a broader cooperative framework with the CFTC, making many in the cryptocurrency community wonder what had caused this change. After all, this was the same organization tenaciously litigating crypto firms for violating rules it was refusing to explain.

The Empower Oversight press release uncovered correspondence via FOIA requests between Hinman and the Office of Government Ethics, not just cautioning him about “potential” conflicts of interest, but cautioning him against his demonstrable conflicts of interest.

“Among other things, the documents show that the SEC ethics office cautioned former SEC official William Hinman that he had a direct financial interest in Simpson Thacher, and thus, he must recuse himself from any matters that would affect the firm. Additionally, the ethics office explicitly told Hinman, per the documents, to not be in any contact with Simpson Thacher for any reason. However, Hinman met with Josh Bonnie, a partner at Simpson Thacher, at least three times after that warning. Hinman also met with the co-founders and investors in Ethereum ahead of a market-moving speech he gave in 2018 declaring the digital asset Ether to not be a security, despite Simpson Thacher’s participation in the Enterprise Ethereum Alliance, which is dedicated to promoting the commercial use of Ethereum. This raises questions as to whether Hinman fully disclosed Simpson Thacher’s role in Ethereum from SEC ethics officials and whether they would have approved the meetings or his speech if he had.”

It’s difficult to imagine that this sudden shift in attitude by the SEC wasn’t somewhat motivated by Empower Oversight’s acquisition of the shocking emails between the ethics office and Hinman. For such flagrant acts of corruption to be ignored for so long points to a much deeper problem at the SEC, and it all but confirms the accusations of favoritism and corruption leveled against the regulatory body by prominent members of the XRP community.

The lack of regulatory clarity, haphazard enforcement, and clear conflicts of interest are reminiscent of something Bret Weinstein described as a mechanism of corruption present in American electoral politics, with selective enforcement perpetuated by both Democrats and Republicans to shut down calls for a third party:

“The whole thing runs through selective enforcement. They want rules, you don’t understand them, they’re not clear, you can’t therefore follow them and that gives them discretion to enforce them against people they don’t like and not enforce them against people they do.”

This might explain why the SEC fought so hard to maintain a tyrannical grip on the cryptocurrency industry with selective enforcement of rules they refused to explain to market participants, even through a regime change. Industry connections like the ones between Hinman and Simpson Thatcher and the connections between cryptocurrencies like Ethereum and JPMorgan transcend individual regime changes. Regulators and the industries they’re regulating can become so hopelessly intertwined that a regulator will perpetuate structures of selective enforcement to aid incumbents — a behavior that to outsiders and participants seems nonsensical but is designed to maintain an incumbent’s stranglehold on regulatory enforcement mechanisms and ward off potential competitors who cannot hope to follow the rules because they are never explicitly made clear.

If a cryptocurrency firm is only guilty of a crime when SEC officials dislike them, I can’t think of any message this sends other than, “be our friend at all costs.” And God help you if you’re a competitor to one of their darling projects. Perhaps the most unsettling thing about this is that the SEC is tasked with “protecting investors,” and it’s becoming increasingly difficult to dismiss allegations of corruption, especially when an SEC official who has been cautioned by the Office of Government Ethics for demonstrable conflicts of interest launches a lawsuit which clearly benefits a firm they are connected to and harms a multitude of other investors. If the SEC hopes to maintain any remaining shred of credibility, it needs to divest itself from selective enforcement of vague rules and pursue punitive measures against officials who violate ethical standards and harm investors.

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