Continued Terra/Luna Fallout
The SEC vs. Do Kwon
On February 16th, the US Securities and Exchange Commission (SEC) filed a complaint against Terraform Labs (Terraform) and its founder Do Hyeong Kwon (Kwon) for alleged securities fraud related to the collapse of the TerraUSD (UST) stablecoin in May 2022. The event caused a wave of crypto market contagion and led to $42 billion in losses to investors. The SEC alleges that Terraform and Kwon misled investors by marketing UST as a stablecoin while also claiming that it could generate up to 20% interest for holders through the Anchor Protocol, making it a high-risk investment (link to the complaint).
The charges against Terraform and Kwon reflect the continuation of the SEC's recent enforcement wave, which has targeted several crypto exchanges and products. The regulator's enforcement posture has raised concerns in the crypto industry, with some feeling that the agency is relying too heavily on enforcement rather than issuing guidance through public rulemaking. The SEC's aggressive stance may also reflect an attempt to restrict crypto activity more broadly.
The SEC's enforcement-first posture is not without detractors. SEC Commissioner Hester Peirce has dissented from many of the recent enforcement actions and has called the agency's approach "unimaginative." She suggests that the SEC should create a clearer pathway for crypto industry participants to register their products and services.
Regulatory Action: Worldwide
Meanwhile, the Financial Stability Board (FSB), a global collective of central banks and financial sector supervisors, has turned its attention to decentralized finance (DeFi). The FSB has identified risks that DeFi applications present, such as liquidity mismatches, leverage, and interconnectedness of services and platforms. While the FSB believes the risks of instability in the DeFi space spreading beyond the crypto ecosystem are minimal, it recommends that the FSB should monitor DeFi-related risks and work to fill data gaps to assess the interconnectedness of DeFi with traditional finance and the real economy.
In Norway, authorities seized 60 million Norwegian kroner ($6 million) as part of an investigation into money laundering from the March 2022 hack of the Ronin DeFi bridge that was part of the Axie Infinity video game. The hack was later attributed to the North Korean cybercrime group the Lazarus Group. The seizure demonstrates the ability of law enforcement to identify and confiscate crypto from major cybercrime events.
In France, the proposed upgrades to the current opt-in crypto registration scheme would mandate registration going forward and would require that cryptoasset service providers demonstrate strong internal controls, meet enhanced cybersecurity requirements, and avoid conflicts of interest. Meanwhile, the Canadian Securities Administrators (CSA) intends to bolster standards for registered crypto exchanges in the country in the wake of the collapse of the FTX exchange.
What Does it All Mean?
Overall, the recent developments in the crypto space suggest that we are not going to see any slowdown in the enforcement schedule. Regulators are paying close attention to the industry and, while ostensibly seeking to strike a balance between protecting investors and allowing innovation, are continuing to embrace an enforcement-first posture. In response to criticisms that these enforcement actions are heavy-handed to some, the SEC insists that they are not doing anything other pursuing their mandate to protect investors and maintain fair and orderly capital markets.
This, of course, rings hollow, when the refrain “come into compliance” is consistently coupled with a lack of guidance for what that actually means for builders, investors, and operators. When filings continue to sit unreviewed for sometimes more than a year, the staff is not presenting themselves as open for business, and are instead encouraging the cavalier behavior that these enforcement actions are meant to dissuade.
If there is a good-faith desire for the crypto industry to better align with existing regulatory regimes, particularly securities regulations, regulators must engage with the industry in good faith and, once there has been an establishment of clear rules of the road that promote innovation while also protecting consumers, follow through on the implicit commitment to then actually allow market participants to avail themselves of these rules.
What kind of lawyer would I be without a disclaimer?
Everything I post here constitutes my own thoughts, should only be used for informational purposes, and does not constitute legal advice or establish a client-attorney relationship (though I am happy to discuss if there is something I can help you with). I can be reached via email (dlopezkurtz@crokefairchild.com or david@bsl.group), telegram (@davidlopezkurtz), twitter (@lopezkurtz), and on LinkedIn here.
