Shining a Light on Would-be Cryptocurrency Regulators
Challenging the SEC to Comply with its Own Disclosure Obligations is a Challenge
UPDATE: On the afternoon of Friday, February 11, 2022, the government filed a motion (PDF) in the litigation referenced below, asking the judge for an extension of time to file its answer to the suit.
Healthy financial markets need clarity and transparency to function properly. Financial regulators are supposed write clear rules so that markets can operate on a level playing field. Instead, they sometimes make arbitrary enforcement decisions that look unfair and undermine public confidence in their integrity.
Among the safeguards against the kind of government overreach that distorts markets and hinders innovation, the Freedom of Information Act (FOIA) is a vital tool for Americans to enforce transparency and accountability on the government—but it takes a lot of persistence to make FOIA work the way it should.
Here’s an example to illustrate my point.
In August 2021, Empower Oversight, a nonprofit public integrity group that I founded last year, filed requests under FOIA with the Securities and Exchange Commission (SEC) seeking documents related to three SEC officials and alleged conflicts of interest. For seven months, the SEC has delayed and stonewalled, failing to cough up a single page. It has taken two administrative appeals and a federal lawsuit to get the agency to even admit that it has the documents we are seeking. At first, it issued a letter claiming that no such records could be found, which turned out to be false.
What is this controversy about and why should you care?
Developers and users of digital currencies have sharply criticized the SEC for its failure to enact clear rules for digital tokens while taking selective and inconsistent enforcement actions. Whether these digital assets, known as cryptocurrencies, should be treated as “securities” that are subject to the SEC’s jurisdiction, or as “commodities,” which like traditional currencies fall outside of its jurisdiction, is a controversial and unresolved question.
Rather than adopting clear rules based on neutral principles to guide innovators, investors, and regulators in the crypto space, critics say that the SEC has instead arbitrarily tried to enforce securities regulations against developers of some digital currencies while allowing others to operate unmolested. Critics also point to an appearance that conflicts of interest may have tainted these SEC enforcement decisions.
Empower Oversight’s FOIA requests are aimed at learning whether any SEC documents might support the widespread claims of apparent conflicts that are undermining public confidence in the SEC’s neutrality and objectivity.
Specifically, three former SEC officials had a direct hand in crypto enforcement actions that moved the markets: former Chairman Jay Clayton, former Director of Corporation Finance William Hinman, and former Director of Enforcement Marc Berger. The fact that all three have personal financial ties to entities that benefited from the SEC’s enforcement priorities has naturally raised suspicions—particularly among holders of the digital assets impacted directly by the SEC’s actions.
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Was the SEC aware of these financial ties, and what, if anything, did it do to mitigate the appearance of conflicts of interest? Did any of these men communicate while inside the SEC with those who paid them before, during or after they were involved in these enforcement actions? These are some of the key questions that the SEC needs to address in order to restore public faith in its integrity.
Why have so many lost faith in the SEC’s objectivity?
On the last day of Clayton’s term as SEC Chairman, Berger’s division filed a lawsuit against the crypto industry giant Ripple Labs. The SEC alleged that the token XRP has been an unregistered security since its inception and that all of its sales since 2013 had violated section 5 of the Securities Act. At the time of the enforcement action, XRP was the third largest cryptocurrency on the global market behind Bitcoin and Ether. The December 2020 lawsuit immediately crashed XRP’s trading price on exchanges which then delisted the token out of fear of further SEC retaliation.
The SEC’s action essentially wiped out $15 billion in value for tens of thousands of retail holders around the world. That didn’t exactly further the SEC’s official mission of protecting investors.
Adding insult to injury, the SEC unsuccessfully opposed allowing those holders of the token to file amicus briefs in the case.
Immediately after filing the Ripple lawsuit, Clayton and Berger left the SEC to work for companies that have financial interests in promoting Bitcoin and Ether, the two leading competitor digital currencies to XRP.
Clayton returned to the Wall Street firm of Sullivan & Cromwell, where he’d made his fortune before his SEC service and where one of its clients, ConsenSys, is a direct competitor to Ripple. Clayton also joined the advisory council for cryptocurrency hedge fund One River Asset Management, which had consolidated a $1 billion investment in Bitcoin and Ether shortly before Clayton’s agency filed the Ripple lawsuit.
For his part, Berger joined the Wall Street firm of Simpson, Thacher & Bartlett, which is a member of the Enterprise Ethereum Alliance, a coalition built by ConsenSys to promote and market Ether. Hinman’s ties to Simpson Thacher, to which he returned after leaving the SEC, were much deeper. He’d been a partner at the firm before joining the government, and during his tenure at the SEC, Hinman received more than $15 million in payments from the Ethereum-linked firm.
Perhaps the most glaring questions arise from a high-profile speech that Hinman gave in 2018 where he declared that “putting aside the fundraising that accompanied the creation of Ether,” the token was not a security, and its sales were not securities transactions. Ether’s market value subsequently rose by more than 600%. Evidence made public in the Ripple case reveals that Hinman met with ConsenSys on multiple occasions before giving the speech, as well as a group of lawyers organized by venture capital giant Andreessen Horowitz to present a “safe harbor” regulatory white paper that exclusively mentioned Ether.
Three months before the Ripple lawsuit was filed, Clayton’s firm Sullivan & Cromwell assisted ConsenSys in its acquisition of the Quorum platform, designed to directly challenge Ripple’s cross-border payments business. And in addition to returning to Simpson Thacher days after the Ripple case was filed, Hinman became an advisory partner to Andreessen Horowitz’s multi-billion dollar crypto investment fund.
With all of this evidence raising questions about the objectivity of the SEC’s enforcement agenda, critics are pointing to Clayton, Hinman, and Berger as the latest examples of the classic “revolving door” between regulatory agencies and the companies they regulate.
This is understandably frustrating to citizens who are fed up by a lack of transparency in how enforcement actions are taken and a lack of oversight by agency ethics offices that are often toothless and by Congress, which is the last resort for Americans who want meaningful oversight of the regulators by its elected representatives.
The SEC has yet to answer Empower Oversight’s FOIA lawsuit. We had asked for communications between Clayton, Hinman, and Berger and those outside the SEC with a financial interest in the SEC’s enforcement decisions. At first the SEC claimed it could not find any. But, following our appeals and questions about how the searches were done, the agency recently admitted that around a 1,000 pages of communications between Mr. Hinman and Simpson Thatcher turned up after all.
As of this writing, though, the SEC has still failed to turn over any of those pages.
Today, February 11, 2022, was the deadline for the SEC to answer our lawsuit in court. On Thursday, February 10, we agreed to a one-week extension—on condition that the SEC provide the documents it has already located. We are also sending the SEC some additional search terms to inform the additional searches it agreed to conduct.
Empower Oversight expects the full measure of legally required transparency from the SEC, and we will continue to press the SEC to find and produce the documents it is required by law to disclose to the public.
Cases like this are why FOIA is so crucial to our democracy and why transparency throughout government is critical to keeping the powerful in check.
But it sure ain’t easy.
Jason Foster is the founder and president of Empower Oversight. He was previously chief investigative counsel to then-Senate Judiciary Committee Chairman Chuck Grassley (R-IA).
Empower Oversight works for public integrity and accountability thanks to the help of courageous whistleblowers and generous donors who help fund our research and litigation. If you would like to make a tax-deductible contribution, please click here. We sincerely appreciate anything you can give to support our work.