SEC Accused of “Regulation by Enforcement”

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  • The SEC has been accused of “regulation by enforcement” over the Coinbase insider trading affair
  • The agency listed nine coins it says are securities in a filing, without any prior discussion of them
  • CFTC commissioner Caroline Pham criticised the approach as an improper form of regulation

The Securities and Exchange Commission (SEC) has been accused of “regulation by enforcement” in the case against a former Coinbase product manager. In the filing, the SEC listed nine coins that it says the ex-employee used as part of a scheme to earn over $1 million with two accomplices and called them unregistered securities. This, according to Commodity Futures Trading Commission (CFTC) Commissioner Caroline Pham, is a “striking example of regulation by enforcement” which could have “broad implications beyond this single case”, given that the coins themselves have never been assessed as potential securities before this filing.

SEC Defined Nine Coins as Securities

The SEC case against Shan Wahi, Nikhil Wahi and Sameer Ramani is allied to a criminal case which involves Shan Wahi allegedly passing information on new coin listings to the other two, from which they profited by buying and selling coins to tie in with the pump.

The charged cite 25 coins as being used for this purpose, with nine labelled as securities by the SEC:

  • AMP (AMP)
  • Rally (RLY)
  • DerivaDEX (DDX)
  • XYO (XYO)
  • Rari Governance Token (RGT)
  • LCX (LCX)
  • Powerledger (POWR)
  • DFX Finance (DFX)
  • Kromatika (KROM)

In the filing, the SEC classes securities as:

A digital token or crypto asset is a crypto asset security if it meets the definition of a security, which the Securities Act defines to include “investment contract,” i.e., if it constitutes an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others. As described in greater detail below, during the relevant period, Ishan provided material, nonpublic information about, and Nikhil and Ramani traded in, at least nine crypto asset securities that meet this definition.

This rather sneaky way of classifying the nine coins as securities before they have even had a chance to argue their case is, Pham says, a sign of how the SEC is now approaching this issue. In a tweet posted yesterday, she argues that many of the coins “could be described as utility tokens and/or certain tokens relating to decentralized autonomous organizations (DAOs)” but they are classified as securities:

Pham adds that the allegations over the classification of these coins as securities “could have broad implications beyond this single case” and says that regulation by enforcement is not how the system should work:

Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input—through notice-and-comment rulemaking pursuant to the Administrative Procedure Act. Regulatory clarity comes from being out in the open, not in the dark.

She also seems aggrieved that the CFTC was not consulted on the matter of the 25 coins, which is understandable when plans are being drawn up that would give the CFTC much more control over the crypto sector, and took the opportunity to remind the SEC both of the CFTC’s remit and who serves who:

This responsibility has been entrusted to us by the Congress and the American people. The CFTC must not break that trust, and we must remember whom we serve.

SEC Accused of Being “Power Hungry”

The thorny issue of cryptocurrencies being securities has of course been a long running saga, with the SEC refusing to offer a blanket policy to help blockchain project creators stay on the right side of the law. Instead, they have preferred retroactive action, often making arbitrary decisions that have little consistency.

Interestingly, Pham’s criticism comes in the same week that Congressman Tom Emmer criticised the SEC during a U.S. House of Representatives Committee Financial Services’ subcommittee on Investor Protection, Entrepreneurship, and Capital Markets, saying that it has become “power hungry” under chair Gary Gensler and is “cracking down on companies outside its jurisdiction”, most notably in the digital asset space:

Emmer summarised by saying that the SEC “is not regulating in good faith”, something that Pham clearly agrees with but that doesn’t look likely to change any time soon.