Crypto v. SEC Goes Into Overdrive w/ James Murphy

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1:30Hey, guys, welcome to Real Vision Crypto Daily Briefing. I'm Ash Bennington. Today, I'm joined by James Murphy, better known as MetaLawMan, to talk all things legal and compliance happening in the crypto space. Welcome back to Real Vision Crypto Daily Briefing. Ash, thanks so much. I love your show. And boy, do we have a lot to talk about. We sure do. Before we get started, just a quick follow-up for folks who were looking for our interview yesterday with Hugh Hendry. Unfortunately, last-minute significant issues with his internet meant we were ultimately unable to bring you that conversation live or recorded.

2:05But don't worry, we'll have Hugh back shortly in the coming weeks. Now, let's take a look at some price action to start off the show. Bitcoin trading right now at$25 ,975, a shade below$26 ,000, off on the last seven days, 1.33%. Ethereum trading at$1 ,740 on the trailing to a seven-day basis, performing worse than Bitcoin off, about 5.25 % trading right now on my screen,$1 ,740. I also wanted to show you very quickly a chart of the broader altcoin market. You can see some double-digit drops over the past 30 days, perhaps driven by some of the things that we're about to have a conversation with James about right now, the legal background and context for everything that's happening in crypto.

2:55With that said, James, we couldn't have you back on this show at a better time. So much happening right now. It's really three words, Ripple, Finance, Coinbase. Let's jump in and get started. Give us the 50 ,000-foot overview on how you see the legal context for the crypto space unfolding right now. Well, boy, it's exciting for lawyers and even semi-retired lawyers like me who've spent their careers in this space. You know, a lot of us were counting down the days to see these Hinman emails and see how his speech in 2018, giving the all clear to Ethereum, how that came to happen and what were the internal discussions at the SEC leading up to that.

3:45And there were some surprises there. James, let's begin at the beginning for people who aren't familiar with William Hinman, his role at the SEC and his importance in the conversation right now happening across crypto. Let's go back and explain that speech, what those remarks were and why they were so significant. Well, Bill Hinman was the head of the Division of Corporate Finance. So that's a high role and status within the SEC. and at the time he gave the speech in June of 2018, almost exactly five years ago, there was everything everyone would acknowledge, a lot of confusion as to what among these crypto tokens were securities.

4:35And so the importance of the Hinman speech was that he gave the green light to Ethereum trading trading on the secondary market and declared using factors that he had sort of invented that under the rubric that he was using to analyze whether a token was a security, Ethereum did not qualify as a security. And that was a big deal because it was the only non-Bitcoin token to get this green light and a path cleared in the marketplace for exchanges and individuals to trade it. So it was a very big deal. Well, you know, you mentioned this idea that he constructed this context for it, and that has been subject to numerous questions, folks questioning whether or not it was in fact an official position of the SEC or rather Mr.

5:35Hinman's remarks. I'm just going to read this for you. This was from June 14, 2018. These are the remarks at the Yahoo Finance All Market Summit crypto. And again, this is coming right off the SEC website. Hold on, let me just scroll down to the relevant part. Here it is. But this also points the way to when a digital asset transaction may no longer represent a security offering. If the network on which the token or coins is to function is sufficiently decentralized, where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts, the assets may not represent an investment contract.

6:20In fact, that language from Mr. Hinman, obviously a very experienced securities lawyer, calls back to the Howey test, which we've talked about on this show many times. Talk a little bit about what Mr. Hinman was attempting to delineate there in reference to current case law and USC code around securities. Well, in my view, there is no basis in certainly in the statute around investment contract to add these factors to assess whether something is an investment contract. In the Howey case, in cases that came after it, say no, nothing about sufficiently decentralized. James, can I give a little bit of context here for people who may not know about the basic framework from the Acts of 33 and 34 and how the Howey test extended that for an interpretative context for what is and is not an investment contract and therefore a security?

7:19Yes. So there are definitions in both the 33 and the 34 Act of what is a security. And it starts with a list of things, things that are familiar, stocks, bonds, and other instruments that you would recognize. And then it says investment contracts, but it doesn't define investment contracts, unfortunately. And so therefore it was left to the courts. And so the Howey case in 1946 at the U.S. Supreme Court is the key case that articulated a standard of what is an investment contract that would qualify as a security and therefore be subject to regulation by the SEC. And so that's why everybody trues back to the Howey test.

8:09And we saw that in the Hinman emails where he's receiving input from both another division within the SEC called Trading and Markets, as well as the general counsel's office. General counsel is the lawyer for internal SEC legal issues. And both of them were cautioning strongly Hinman to not go so far as he was going with that speech and declare Ethereum not a security and declare these factors. And they pointed out the factors you are announcing now are not in Howie. You know, they're being made up here. And so that that was a problem. And they said, you know, this is going to lead. There was an acknowledgment.

8:57There was existing confusion. And they said, if you give this speech, there will be more confusion, not less. And so is it likely then that SEC attorneys will then argue that position, that this was not included in the view of SEC at the time, something that was coherent and consistent with the Howey test and with the Supreme Court decision? The SEC itself has flip-flopped a little bit over time on whether Hinman did articulate the position of the SEC. Their problem is, shortly after that speech, the chairman, Jay Clayton, speaking to a large audience, said, market participants need to go read the Hinman speech because it shows how we, we, meaning the SEC, analyze whether a digital asset is a security.

9:57He endorsed the Hinman speech and encouraged everyone to go look to find the answer to, wow, is my particular token a security? So how is all of this relevant to what's happening in the unfolding case right now with Ripple?

10:17Well, that's a good question. There are a lot of dimensions to this. The fact that the one thing that surprised me about the Hinman emails was I naively thought what we would see is that there was an emerging consensus within the SEC that, yes, Ethereum is not a security. Well, it turns out there was no such consensus. And it was Bill Hinman himself, individually, who really was pushing for calling out Ethereum by name as not a security, while everybody else who was weighing in was cautioning him about doing that. You know, the general counsel said, hey, wait a minute, this is going to limit our flexibility going forward should we choose to change our mind and say that Ethereum is a security.

11:09And that's certainly the case. But with respect to Ripple, the argument is this is totally unfair, and there are people who believe that there may be some element of corruption at play because of Hinman's connection to his law firm and the Ethereum Alliance, et cetera. I don't know anything about that. Explain that for people who haven't heard that charge. Okay, well, the idea here is Bill Hinman was paid$15 million from his law firm, Simpson Thatcher, while he was at the SEC. That's a lot of money. Now, it is said that that was some sort of pension payout, but that's an extremely generous pension, even by the standards of large New York law firms.

12:07But in any event, whether that's true or not, the argument is he had an interest in the success and well-being of his law firm. And his law firm was a member of this enterprise Ethereum alliance and a promoter of their clients' interests with respect to working on Ethereum. And so therefore, the idea is he had a conflict and he was motivated to declare Ethereum not a security because that certainly was a boost for the entire Ethereum ecosystem. Hey, everyone, we're going to take a quick pause and hear a word from our partners. We'll be right back.

12:56I should say Real Vision has not independently verified or validated those facts. But, you know, it's interesting because there's a great deal of complexity around this. You have the Hinman speech, the Hinman emails behind it that show the general counsel of SEC was skeptical of the claims. And then in the opposite direction, you have Chair Clayton coming forth with those statements roughly contemporaneously suggesting that it was, in fact, SEC positive. This is a lot for people to get their heads around and a lot for folks to vet when trying to understand where this case is likely to shake out.

13:30Yes, indeed. And some of the defenses, particularly to fraud claims, but to all of the securities claims is it was not clear that any particular token was a security. And I can tell you the commentary on the draft of the Hinman speech really supports that point of view, that there is confusion, that the SEC might want to change its mind about whether Ethereum was or wasn't a security, and that Hinman's speech would add to existing confusion in the marketplace. He was warned, but proceeded nonetheless to give that speech. let's move on to what's happening right now with binance so civil charges being filed by cftc and fec against binance then we've got some recent news flow in terms of a request for an asset freeze let's start at the very beginning here and tell the story of what the legal activity is against binance from civil regulatory authorities in the united states and then we and talk a little bit about what's happened with the request for freezing funds.

14:43Right. So last week, the SEC filed a civil complaint against Binance, let's call it Binance International, CZ personally, and the two entities that manage and run Binance US, which is the US crypto exchange. All of them were sued, alleging that they are engaging in trading of unregistered securities, and therefore they should have registered as a national securities exchange, as a broker-dealer, and as a clearing agent under U.S. law. With respect to Binance, they also alleged that Binance issued an unregistered security twice, that being the BNB token, which was the exchange token of Binance, as well as the stablecoin BUSD issued by Binance.

15:43The SEC alleges that both of those are unregistered securities that were issued by Binance. And it's really important for people to understand that this is a key distinction between the Binance case and the Coinbase case, where Coinbase did not issue any security that is at issue in the case. They simply provided a platform for the trading of tokens in a secondary market. Binance did that, of course, but they also have this risk associated with the issuance of BNB and BUSD. as well as a bunch of other allegations of fraud and evading, lying to regulators, evading U.S. regulation by hiding the fact that they had U.S.

16:37customers and moving around assets in ways that are hard to explain, et cetera, et cetera. You don't have that in the Coinbase case. So the Binance case is certainly more complicated. Yeah, there was also some mention in the complaint about other entities associated with Binance that were affiliated with Binance. I believe Merit Peak Limited, as well as Sigma Chain, looking at the press release right now. Yeah, that's right. So these are entities that were alleged to be market makers, which provide liquidity for customers wanting to trade on the platform. That's the idea of having active market makers is you've got a ready buyer or seller when you want to do something with an asset.

17:35And that can be a good thing. Now, there are allegations that they engaged in WASH trading to increase the reported trading volume on the exchange and used that data to attract investment in Binance itself. So this is not acquiring BNB tokens, but rather getting VCs and others to invest in Binance the entity. And it's good to show volume and revenue and profits and all of that. So there was an allegation that these wash trades were not only market manipulation, but also used to mislead investors looking to consider investing in Binance itself. I'm just going to read this right from the SEC website.

18:33This is from their press release at the time that the complaint was published. Quote, the SEC's complaint further alleges that BAM Trading and BAM Management U.S. Holdings, BAM Management, misled investors about non-existent trading controls over Binance U.S. platform, while Sigma Chain engaged in manipulative trading that artificially inflated the platform's trading volume. Further, the complaint alleges that the defendants concealed the fact that it was commingling billions of dollars of investor assets and sending them to a third party, Merit Peak Limited, that is also owned by Zhao. This, again, is the allegation that you just named.

19:17So let's talk a little bit about where we are in terms of current news flow, this emergency request to freeze assets, and what happened just yesterday. Yeah, so at the end of last week, the SEC filed for something called a temporary restraining order asking that certain things happen immediately, way, way before any trial, but right up front. that the assets of Binance US be frozen, that all access, including keys and shards, be transferred to US personnel at one of the BAM entities, and that they give a full accounting very, very quickly to the SEC of all of the customers and the customer asset balances and where that is and agreed to a number of other restrictions that were pretty draconian because the SEC was asking for all of the assets of Binance US to be frozen.

20:23Now, if you think about that for just a moment, what would that mean for any company? Your assets are frozen, you can't pay your employees, can't pay your rent, can't pay your taxes, can't pay anything. You're out of business pretty much immediately. And that was what the SEC was going for. And so Binance US pushed back and said, that's not appropriate here. By any stretch of the imagination, we should be allowed to defend ourselves and not be put out of business on day one of this lawsuit. And so it was very, very high stakes at the hearing yesterday. You know, the overused phrase is existential threat.

21:08Well, the TRO there was an existential threat to finance the U.S. If it had been granted, they would have been functionally out of business pretty much immediately. And so the judge didn't buy it, was not satisfied with the answers that she was getting from the SEC lawyers and expressed a lot of frustration with the fact that she asked very simple questions like, you allege that the SEC, you allege that the U.S. assets have been moved overseas. Great. Do you have any proof that that actually happened? And she went to ask every single SEC lawyer the same question, and none of them could answer.

21:57None of them had any evidence that that actually happened, and she really didn't like it. She felt, I can't speak for her, but she may have felt that she was a little bit misled about, is there really an emergency here? And so what she did is said, look, parties need to get together. I agree. We want to secure the customer assets, U.S. customer assets of Binance U.S. Let's figure out a way to do that. But there's no reason that Binance US needs to be put out of business today. They should be allowed to continue operating and pay their vendors in the ordinary course. Hey, everyone, we're going to take another quick break and hear a word from our partners.

22:36We'll be right back to the Real Vision Crypto Daily Briefing.

22:44Yeah, I want to move on and talk about Coinbase. But first, very quickly, talk about the structure between Binance and Binance U.S. and whether anything that might be perceived as an existential threat to Binance U.S. also affects the parent company. That's a really good question, Ash. It's not crystal clear. There's a lot in the complaint saying that CZ and executives at Binance International were controlling the Binance US platform. So therefore, if the SEC does have jurisdiction over Binance US, and the reason they would is if they can prove that there were securities traded on Binance US, then they have jurisdiction under the law.

23:34Well, then if someone controls that, then they can also assert jurisdiction over that controlling party. And they specifically alleged that CZ controls Binance US and Binance. And so therefore, there is an avenue. And so there is some commentary out there on Twitter that I don't quite disagree with that says there's no way the SEC can do anything to Binance U.S. Well, if they prove that there's a control, there's control over Binance US, then they suddenly will have jurisdiction and can take action and impose fines and other kinds of relief. It is, as you pointed out at the very beginning, a civil authority, not criminal, so they can fine or prevent executives from engaging in the same conduct in the future, can prevent them from serving as an officer or director of a public company for a period of time or forever.

24:40Things of that nature are possible if they prove up their case. So let's shift gears here and talk a little bit about what's happening with Coinbase. Like the other two stories, we have recent news flow on this yesterday and the day before. But I want to break the context down for what's been happening with the suit with Coinbase and SEC before we start and talk about what's happening with the new news flow. Give us the big picture, 50 ,000 foot, what's going on with SEC's suit against Coinbase? So there are two suits. First of all, Coinbase has maintained this position forever, that they have contacted the SEC trying to open up dialogue about what is a rational way to register and comply and run our business and have been rebuffed by the SEC is what they've said.

25:34And so they filed something called a writ of mandamus in the Third Circuit Court of Appeals asking the Third Circuit to order the SEC to answer a simple question. Will you engage in the rulemaking that we have asked around this digital asset ecosystem? We just want an answer, yes or no. And the SEC has so far refused to answer yes or no to that question. And so that is pending. The SEC has filed a brief saying we haven't made up our mind and we may not make up our mind anytime soon. In fact, it could be years before we decide whether we will even begin to engage in rulemaking around digital assets and digital asset exchanges.

26:17And so then the Third Circuit saw that the SEC sued Coinbase and issued an order to the SEC saying, hey, you need to tell us that this means you're not going to engage in rulemaking because it looks like you're going full bore with litigation with whatever rules you have now. And so that's going on at the Third Circuit. So the big case is the SEC has sued Coinbase. And this is a very simple lawsuit. It alleges that there are securities, that some of the tokens on the platform are securities. And therefore, Coinbase should have registered as a national securities exchange, a broker-dealer, and a clearing agent.

27:13One, two, three, those claims. And this is all going to turn on the question of are those securities or aren't they these tokens that are traded in the secondary market? There's one additional claim, and that is that Coinbase hosts a staking as a service offering for its customers to stake their tokens for Ethereum staking or maybe some others as well. And the SEC contends that that is an investment contract as well. So, you know, primary allegation being that these are, in fact, unregistered securities. And then secondary to that, two other points, the idea that staking as a service represents security as an investment contract.

28:04And additionally, this question of segregation of activities between exchanges and clearing agents. We'll delve into that in just a second. But it seems that one of the central, perhaps the central, irreconcilable difference we see between SEC and the cryptocurrency industry right now, Whenever we have folks on from the crypto industry, chief compliance officers, other attorneys, they always make the case that essentially there is not a clear path forward for folks who are engaged in digital assets to have guidance. They complain about this idea of regulation by enforcement. And I shouldn't say complain.

28:40They make the case that that's the case, that we're in this period where essentially the SEC doesn't tell you where the line is. They only tell you after you've stepped over it. SEC, for their part, essentially has argued, sure, of course there's a process. Look at the 1933 Securities Act of 1933, the Securities Exchange Act of 1934. It's all spelled out for you there. Digital assets are no different. What's your view on that sort of core central dispute that we see in the space right now? Well, there is no avenue to register a crypto exchange like Coinbase. Remember, the SEC's position is that virtually all tokens are securities.

29:20And therefore, if Coinbase wanted to register as a national securities exchange, the first thing they would have to do is delist everything except Bitcoin and maybe Ethereum. Because all of the rest, in the view of the SEC, are unregistered securities. So therefore, the business model as it exists now cannot be registered. This is very, very different from what they have in the EU under the MECA legislation, where you can operate as a crypto exchange, offering many of these tokens in a very well -controlled, highly regulated environment that requires segregation of customer assets, segregation of functions and accounting, and all of the things that you would want to have confidence in a crypto exchange and its operations.

30:18Here, it's not possible. The SEC has said they're all securities. The 10 or 13 identified in the complaint in Coinbase and the others in Binance are simply examples that they think are their best examples, their strongest arguments for proving that these tokens are securities. But if they were to win on the dozen, then it logically follows that virtually all of them would be securities. So this really is for the whole ballgame, all the marbles here. If tokens trade on the secondary market are securities, then the exchange function will go away in the United States. I happen to believe that they are not securities.

31:10There's no contract. When I trade a whatever token on an exchange, I'm not engaging in a contract with the counterparty, and I'm certainly not investing in whatever the underlying entity is. They're not going to share their profits with me if I happen to own their token for a while. So it's not an investment contract in my view, but that's my view, not legal advice of metal law, man. But it is my view, and I feel like that that's the better view and likely to be vindicated, maybe, maybe not at the trial court, but on appeal to the Second Circuit Court of Appeals or DC Circuit, and certainly at the US Supreme Court.