Regulation by Enforcement Isn't Just a Meme

This SEC today under Chair Gensler is not the same SEC as it used to be.

• It uses the courts to litigate policy issues instead of writing rules.
• It preys on individuals with limited resources and incentives to establish precedent on token issuance actions.
• It targets intermediaries in an effort to front-run Congress in addressing market structure, including for DeFi.

The industry has long felt the anecdotal truth of the SEC’s approach, but until now, no one had collected the data to show it. This analysis aims to close that gap.

Background

Since bringing the first crypto-related enforcement action in 2015, the SEC has taken legal action against 171 projects and individuals, across three presidential administrations and three Senate-confirmed SEC chairs. Roughly half of these actions (88) took place under Chair Gensler.

September and August have been the two busiest months for Chair Gensler’s SEC; the SEC’s fiscal year ends at the end of September. Chair Gensler appears to be running his agency like a police department setting speed traps at the end of the month to meet a quota.

Item 1: Since Chair Gensler took office on April 17, 2021, the SEC has increasingly gone to court to establish its policy positions—confirming what the industry has long known regarding regulation by enforcement.

While refusing to issue clear regulations detailing how the securities regulatory framework applies to crypto,1 Chair Gensler has increasingly relied on the court system to attempt to establish the regulatory perimeter.

In contrast to the two SEC Chairs that preceded him, Chair Gensler has taken action against crypto projects with lower frequency in administrative courts, and to an extent in the U.S. District Court for the Southern District of New York (SDNY), opting instead to bring cases across a much broader range of jurisdictions than before. This shift could signal the increased constitutional limits on the use of administrative courts2 and an attempt by the SEC to forum shop for more favorable courts in the face of the significant defeat suffered in the Ripple case which was heard in SDNY.3

In general, it should be no surprise that a closer look at legal actions involving the SEC turned up a large number of court cases. Litigation has always been one of the SEC’s primary tools for enforcement, after all. What is novel here is that the SEC is using litigation to decide policy, instead of going through the process of finalizing rules after they have gone out for public comment. We suspect a closer look at rulemaking activity under prior administrations and closer documentation of the facts associated with each case under Chair Gensler would further underscore the shift in the SEC’s approach.

Item 2: Chair Gensler’s SEC has seen a 9 percentage-point decrease in actions against companies and a 5 percentage-point increase in actions against individuals.

There’s nothing inherently wrong with the SEC going after individuals. What’s problematic is that the SEC under Chair Gensler is is pursuing a “barbell” strategy of pairing its actions against the largest and most successful companies in the industry on issues related to institutional registration (see Item 4 below) with an increased focus on going after individuals who lack the resources and incentives to defend themselves on matters pertaining to the issuance of alleged securities.

It’s obvious that the issuer of a successful token is going to be in the best place to litigate the token’s status against the government. By trying to establish that tokens are securities in orthogonal cases against individuals who are more likely to settle, the SEC is not pursuing justice as it claims.

Item 3: 92% of the SEC’s actions against the crypto industry under Chair Gensler have involved registration violations, compared to roughly 87% of actions under the preceding SEC Chairs.

Despite the fact that Gensler’s SEC has failed to provide a viable path to registration for token issuers or other intermediaries—as we’ve previously documented—the agency has continued to bring enforcement actions focused on registration violations. This data evidences that instead of policing the market for the worst violators who are defrauding investors, the SEC has chosen to target firms who in many instances have engaged in good faith efforts to comply with an impossible regime.4

Item 4: There has been a 12 percentage-point increase in actions under the ‘34 Act, driven by large increases in actions against crypto platforms for allegedly operating as unregistered exchanges, brokers, or clearing agencies.

The first wave of enforcement was largely focused on ICO issuers that conducted large public distributions of tokens, or actors engaged in fraudulent activities. Under Chair Gensler, there has been a marked shift away from token issuers and fraudsters and an increased focus on intermediaries, which are seen by the agency as a higher point of leverage over the entire crypto ecosystem.

The SEC has used this approach to take action against the largest exchanges in the industry, such as Coinbase, Kraken, and Binance, charging each of them with acting as unregistered exchanges, brokers and clearing agencies. In doing so, the SEC is attempting to maximize its leverage to bring the entire ecosystem to heel and litigating the legal status of specific tokens in the absence of the token issuers, which are the parties best positioned to defend the claims.

Summary

Despite Chair Gensler and his advocates saying nothing has changed about the SEC’s approach to crypto, the empirical evidence is suggestive of the opposite. There are a number of shifts in the SEC’s approach.

Overall, we continue to be concerned about the chilling effect of Chair Gensler’s approach on the development of the crypto ecosystem in the United States. And it’s too difficult to get good data on what the government is actually doing. The SEC should have to provide these data in usable form. Until then, if you’re interested in helping us clean and maintain our database, please reach out.