One ICO Lesson From Recent Unchained Podcast: Live With Uncertainty, Skipping False Comfort
Coming out of SXSW last week was an Unchained podcast interview of former Department of Justice prosecutor Kathryn Haun on recent regulatory developments, including the SEC’s wave of ICO-related subpoenas — we look here to add some helpful color. Haun is now on the board of Coinbase and teaches a crypto course at Stanford’s Graduate School of Business. I highly recommend the Unchained podcasts for informative interviews on crypto — kudos to host Laura Shin for what she has done — and Haun certainly appears to know her stuff on DOJ practices, giving helpful explanations of many law enforcement practices. Those in crypto should be informed consumers of what Haun said about the SEC on the podcast, and to that end, we provide a bit more context for some of what was said.
To put the SEC subpoenas into context, Haun said that subpoenas are “just the government’s way of gathering information,” noting that it is “not like the SEC can just go and get people to voluntarily hand over documents and talk to the SEC.” The reality is that the SEC often makes requests for voluntary production of documents and interviews, without resorting to subpoenas. The SEC’s Division of Enforcement actually has to obtain subpoena power from the Commission itself, usually pursuant to delegated authority. The receipt of subpoena power in a particular matter is done through what is called a formal order of investigation. Multiple subpoenas can be issued under a single formal order.
Haun said that the reported issuance of 80 SEC subpoenas does not mean that we should expect the SEC to bring “80 different ICO actions.” This is correct as far as it goes, but let’s go a bit further. Haun said that, regarding the many subpoenas she issued as a federal prosecutor, “very few of those actually turned into investigations or cases.” For the SEC, although subpoenas often precede regulatory actions, subpoenas do not really “turn into” regulatory actions, and, assuming the figure of 80 is accurate, the ultimate number of SEC actions against ICOs could be greater or less than 80. First, all subpoenas are not created equal, with some potentially turning up information supporting multiple new actions, and others resulting in evidence supporting an action already being contemplated. For example, a single subpoena to an ICO intermediary could result in evidence supporting multiple actions relating to several ICOs. On the other hand, a subpoena to a telecom provider might turn up records merely confirming (or disconfirming) a theory in an existing ICO investigation. Second, should the SEC take the position that most utility token offerings required registration or exemption therefrom under the securities laws, the SEC might look to pursue a larger number of actions with fewer subpoenas. For example, the Division of Enforcement might reach out to those utility token ICO projects with a relatively standard offer to enter into a settlement requiring the ICO organizers to make a rescission offer or like remedy. Finally, one possible clue about the number of likely actions is whether the subpoenas are issued under the same formal order of investigation, or under multiple formal orders of investigation. An SEC subpoena indicates the formal order pursuant to which it is issued. If there are different formal orders, perhaps naming different ICOs, that is a clue to the possibility of a number of actions.
Haun said that she expected the SEC to largely focus regulatory action on the “worst of the worst,” to better manage its limited resources. Although the SEC will likely focus on what it considers more major violations of law, do not be surprised if it takes some actions against minor ones. There is a rationale for taking action against more minor, although clear, violations — it discourages people from believing that there is a “de minimis” exemption from complying with the law. Thus, for example, the SEC has in the past taken action against insider trading even when the alleged profits were relatively small (in the thousands of dollars).
Haun opined that it was unlikely that the SEC would take action in “gray areas,” referencing her experience at the DOJ where she assessed taking action through the lens of being able to win a jury trial. As a civil law enforcement agency, the SEC has a lower burden of proof than the DOJ in a criminal prosecution, and encounters jury trials much more rarely. Moreover, as a regulatory agency, the SEC’s mandate is different from the DOJ’s. The SEC has a mandate to provide guidance to market participants, whether through advisory means or regulatory enforcement. This may entail taking enforcement action in “gray areas” — in fact, it is in some of these gray areas where regulatory actions could provide leverage on the expenditure of enforcement resources.
Relatedly, Haun said she thought that the SEC would shy away from taking action in gray areas because it would not want to lose its first litigated action against an ICO. There is no question that the SEC wants to avoid embarrassment — which erodes its influence, tarnishes the reputation of its personnel, and potentially subjects it to tighter congressional oversight — and losing court or administrative actions can be embarrassing. However, as discussed above, it is also embarrassing to leave gray areas that inhibit the proper functioning of markets. This can tip the scales to bringing an action, even if there is a greater chance of loss, so that there can be more certainty. For example, the SEC may not have an unblemished record in the Supreme Court with insider trading cases (e.g., its loss in Dirks), but it has survived nevertheless, and the clarity in this area of the securities law, even at the expense of the SEC’s track record in court, has provided important guidance to market participants.
Here’s our bottom line: SEC subpoenas raise the likelihood of regulatory actions; the SEC may well take action against minor violations, although possibly on a more selective basis; and the SEC’s regulatory mandate may tip the scales to its taking action in some gray areas which DOJ prosecutors might avoid. There is legal uncertainty in the ICO market, particularly in the U.S. Nevertheless, many crypto market participants had, and have, good reasons for their actions in token sales, and those reasons — along with the advice of legal counsel — are the best source of comfort going forward.
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