Good morning and happy March Madness. This week, we review court sanctions against the SEC, a Congressional oversight hearing, and why the SEC says it needs more funding.
Top Points
A federal district court sanctioned the SEC for knowingly making misleading statements in its case against a crypto firm; Republicans in Congress took notice.
At an SEC oversight hearing, Members debated the policy and process behind Chair Gensler's rulemaking agenda, with a few bringing up regulatory uncertainty for digital assets and SAB 121.
The SEC says it needs more funding to address market growth, market changes, and the "Wild West of the crypto markets."
HFSC Chair Patrick McHenry (R-NC) and Senator Cynthia Lummis (R-WY) said stablecoin legislation is still possible this year, but finding a legislative vehicle remains key.
Court Sanctions SEC for Making Misleading Statements
The Order
On Monday, a federal district court in Utah sanctioned the SEC for making misleading statements that led the Court to grant a Temporary Restraining Order against crypto firm defendant Debt Box, LLC.
​Order Text.
In short, at a July 2023 TRO hearing where defendants were not present, an SEC attorney claimed defendants had closed 33 bank accounts in the previous 48 hours in an effort to evade law enforcement. Order at 44-45.
Turns out, the SEC did not have any direct evidence to support this claim (or several others). In fact, no accounts were closed in the 48 hours before the hearing, and there was no evidence that defendants were responsible for closing any of their bank accounts in the past three years. Order at 44-45.
The court admonished the SEC for knowingly making the false statements, failing to correct the record, and then doubling down:
"Thus, in its Opposition the Commission not only exacerbated its misconduct from the TRO hearing by seeking to affirm and reiterate the false statement it had previously made—a statement it knew was false from the time it made it and failed to correct—but it engaged in further misconduct by communicating an additional false and misleading statement to the court after being confronted with irrefutable evidence of its error." Id. at 53 (emphasis added).
The Court described the SEC's conduct as "a gross abuse of the power entrusted to it by Congress and substantially undermined the integrity of these proceedings and the judicial process." Id. at 73 (emphasis added).
The order also describes the harm caused by the SEC's misstatements:
"Relying on the Commission’s representations, the court granted the ex parte TRO, froze Defendants’ accounts and other assets, and appointed the requested Receiver. As a result, companies were seized, assets were frozen, and lives were upended." Id. at 63 (emphasis added).
Perhaps most concerning, Judge Shelby suggested the conduct goes beyond the actions of rogue attorneys:
" [T]hough there are individual attorneys against whom imposition of attorneys’ fees and costs may be warranted, the pervasive misconduct exhibited demonstrates a pattern of organizational bad faith and broadly implicates the Commission itself—not just isolated individuals." Id. at 40 fn. 284.
What's Next?
The SEC now has to pay defendants' legal costs arising from the TRO. Order at 79.
But the case is not over. The SEC had asked the court to dismiss the case without prejudice so it could review the record, take investigative steps, and determine whether to file a new complaint. Id. at 38. The Court denied the SEC's motion to dismiss, noting the SEC failed to provide any "legal authority or argument in support of its request" and that the motion was opposed by defendants. Id. at 77-78.
In closing, the court cautioned that the Order "should not be construed as offering any views on the underlying merits of the case." Order at 79-80.
Congress Responds
Republicans took notice of the decision, including HFSC Chair McHenry.
Senator Bill Hagerty (R-TN), Senate Banking Committee member, also weighed in:
Rep. French Hill (R-AR), Chair of the House Financial Services Subcommittee on Digital Assets, also raised the case in the hearing discussed below.
SEC Oversight Hearing
On Wednesday, the House Financial Services Subcommittee on Capital Markets held an SEC oversight hearing.
Most of the hearing focused broadly on the SEC's rulemaking process and matters unrelated to crypto. The few crypto-focused exchanges are summarized below.
Scope of SEC Power
Rep. French Hill (R-AR) criticized the SEC’s frequent attempts to test the agency's statutory limits:
“Whether refusing to comply with the APA or not providing clear rules for the digital asset ecosystem, it’s clear that the SEC under Gary Gensler blatantly and repeatedly oversteps its statutory authority.”
To support his claim, Rep. Hill cited the SEC’s recent losses in the courts, mentioning Ripple, Grayscale, and the Debt Box case discussed above.
On Debt Box, Rep. Hill emphasized his frustration with the fact that taxpayers will ultimately be stuck with the bill for the SEC’s misconduct (i.e., pay defendant’s legal fees).
SAB 121
Rep. Brad Sherman (D-CA) briefly criticized the crypto industry for asking for rules and then complaining when rules are issued against them, citing industry opposition to SAB 121.
Conversely, Rep. Wiley Nickel (D-NC) expressed his concerns with SAB 121, flagging the SEC's process in issuing the rule, which GAO found violated the Congressional Review Act.
Rep. Nickel said SAB 121 "makes digital asset industry less safe for consumers by preventing well-regulated banks from safeguarding digital assets owned by their clients."
Innovation & Competition
Rep. Zachary Nunn (R-IA) asked how the SEC's current regulatory approach is impacting innovation.
Witness Jennifer Schulp (Cato) opined that the SEC Chair’s statements - particularly in the context of digital assets and AI – are chilling innovation in the U.S. by creating an environment of regulatory uncertainty, if not regulatory hostility.
In comparison, she noted, jurisdictions in Europe, the Middle East, and Far East are establishing more friendly – or at least more certain – rules for digital asset firms.
SEC Submits Funding Justification Request
On Monday, the SEC submitted its Congressional Budget Justification for FY 2025.
The SEC asks for $2.59 billion in funding - $158 million more than last year's request.
The SEC says market growth, particularly in private funds, and changes in the markets, such as increased use of AI, justify a funding boost. The justification also singles out crypto in its Executive Summary:
"We've seen the Wild West of the crypto markets, rife with noncompliance, where investors have put hard-earned assets at risk in a highly speculative asset class." Id. at 8.
Three main points to note regarding crypto:
Enforcement is requesting 33 additional positions. The justification doesn't specify how many new staffers would be devoted to crypto matters - only that additional staff will enhance the agency's ability to pursue "the wide variety of misconduct within the SEC's remit" and "strengthen the division’s capabilities to investigate new and emerging issues." Id. at 19.
Examinations is requesting 23 positions to address several key issues, including “crypto assets and emerging technology." Id. at 21.
Office of Investor Education and Advocacy is requesting 1 additional position to "primarily focus on questions and complaints related to fraud involving crypto asset securities." Id. at 43.
How does GOP Whip Tom Emmer (R-MN) feel about the justification?
Look Ahead
Congress is expected to break for an Easter recess after it clears a government funding bill.
House to return Tuesday, April 9.
Senate to return Monday, April 8.
Senate Banking hearing on illicit finance expected in April.
"Senate Banking invites Adeyemo to illicit finance hearing" (Eleanor Mueller, Politico Pro).
Quick Hits
Stablecoin Legislation
​HFSC Chair Patrick McHenry (R-NC) says it's still possible to get stablecoin legislation enacted this year, but they need a clear legislative vehicle and a deadline to close the deal.
"We need a legislative vehicle, we need a deadline. We can drive the stickier issues if we have a deadline. And so… 'are we going to have legislative vehicles to get signed into law?' I think that those chances have increased once we fund the government, which gives us the opportunity to land a product like a stablecoin bill. If we’re given that deadline. I do think there’s goodwill enough to to answer the President’s Executive Order on a need for a federal stablecoin legislation and further the work that Ranking Member [Maxine] Waters and I have been have been about for the last 20 months – we and our teams." Remarks at Coinbase's Update the System Summit.
Senator Cynthia Lummis (R-WY) agreed, noting daily bicameral and bipartisan efforts on negotiations continue.
​See full scoop in Blockchain Tipsheet discussing Coinbase's Update the System Summit.
Ether
Chair McHenry responds to recent reports that the SEC may try to classify ETH as a security:
In a detailed twitter thread, former CFTC Commissioner Quintenz, now Head of Policy for a16z crypto, explains why ETH is not a security and outside the SEC's remit:
1/ When the SEC allowed ETH Futures ETFs to trade on its regulated security exchanges, it explicitly acknowledged the status of the underlying, ETH, as being a non-security and outside of its jurisdiction.
2,837
CBDCs
GOP Majority Whip Tom Emmer (R-MN) continues to push back on Fed Chair Powell's suggestions that there's no need to worry about a CBDC before Congress grants approval.
Powell said it was "wrong to say" that the Fed has "a secret lab" where central bankers are creating a digital dollar before springing it on Congress. Got some laughs!
Crypto in the Courts
Amicus Briefs flooded in on behalf of Coinbase's case urging the court to require the SEC to write new rules for digital assets.
Thank you for reading and please enjoy your weekend.
Sincerely,
GSL
