The U.S. Securities and Exchange Commission (SEC) got roughed up at Tuesday’s hearing into whether Ripple Labs’ XRP token is an unregistered security.
Tuesday’s phone hearing saw U.S. Magistrate Judge Sarah Netburn of the Southern District of New York weigh arguments on whether Ripple is entitled to eyeball internal SEC communications involving William Hinman, the agency’s former Director for the Division of Corporate Finance.
The communications in question preceded Hinman’s June 2018 speech at the Yahoo Finance All Markets Summit in which he declared that tokens based on networks that were “sufficiently decentralized” didn’t meet the ‘Howey test’ for what federal law considers a security. Hinman singled out BTC and Ethereum as two blockchains that he claimed met this ‘decentralized’ standard.
In December 2020, the SEC filed suit against Ripple, CEO Brad Garlinghouse and co-founder Chris Larsen for offering $1.3 billion worth of unregistered securities (aka selling XRP). Ripple countered that XRP was as much a currency as BTC or ETH—although you can’t actually pay for many goods or services with BTC or ETH, nor is either blockchain as decentralized as they like to claim—and Ripple accused the SEC of ‘picking winners and losers’ in the nascent digital asset space.
A legal tug-of-war quickly emerged over (among other things) what communications Hinman had with the SEC’s legal eagles before he made public his questionable opinions re BTC and ETH. Ripple suspects those communications show SEC officials disagreeing over the security question, which they believe is XRP’s get-out-of-jail-free card.
In January, Judge Netburn ordered the SEC to turn over certain documents related to Hinman’s speech, including an email Hinman drafted regarding ETH. But the SEC stalled the release of these documents, citing (at various times) issues of attorney-client privilege and whether Hinman’s public comments reflected the SEC’s formal policy or his own personal opinion. The unresolved issue prompted Netburn to summon the parties to a phone confab this week.
Swing and a miss
Tuesday’s hearing began with Netburn quizzing the SEC attorney regarding what legal advice Hinman received from the SEC prior to his speech and why he sought such advice. The SEC replied that Hinman wanted to ensure that his speech “wouldn’t conflict” with the agency’s view of how to apply securities law to digital assets.
This prompted Netburn to seek clarity on whether the SEC stood by its previous position that Hinman’s speech reflected his personal opinion. The SEC attorney didn’t respond immediately, eventually arguing that even if the speech was Hinman’s opinion, he’d “still sought legal counsel about the legal issues” that his speech would address.
Netburn said she found a “tension” in the SEC’s argument that attorney-client privilege applied to the SEC’s legal eagles’ communications with Hinman, given that the SEC is the attorneys’ client but the SEC had “distanced itself” from the idea that Hinman’s public comments were “official guidance” from the agency.
The SEC’s case went further awry when its attorney tried to claim that Hinman’s speech may not have been the SEC’s speech but was nonetheless made “in his capacity as Director of Corporate Finance.” Netburn reminded the SEC that during the fight over Ripple attorneys deposing Hinman, the SEC had argued that Hinman wasn’t officially speaking as director.
The SEC’s response was a meandering word-salad, at one point arguing that Hinman sought advice in order to enhance his personal views on the situation in his speech, but since this was advice that only someone in his position as an SEC director had access to, it was protected.
Netburn asked whether this meant the SEC was now arguing that Hinman’s speech reflected the views of the agency’s Corporate Finance department. The SEC concurred, prompting an increasingly frustrated Netburn to challenge the SEC to delineate exactly which parts of Hinman’s speech were policy and which were personal opinion.
Pick a lane
When it was Ripple attorney Matthew Solomon’s turn, he recounted how Hinman’s deposition featured numerous references to ‘my views.’ Moreover, his 2018 speech contained the caveat that his words reflected their author’s views and not necessarily the SEC’s. As such, there would have been no need for Hinman to solicit legal advice and there’s no attorney-client privilege to protect.
The SEC then walked into a door, arguing that the “predominant” purpose of the advice Hinman received was “purely legal advice” for government purposes. Netburn pointed out that the SEC’s position was inconsistent, recalling that in August 2021—when it was trying to block Hinman’s deposition—the SEC stated that the speech was Hinman’s personal view and not that of the government. The SEC now meekly insisted that it wasn’t inconsistent to say that the SEC had taken no position in Hinman’s public remarks.
The hearing concluded with Netburn advising both parties that she’d review the matter further and deliver her ruling “as soon as I am able.”
The Ripple camp clearly came out of this hearing feeling good about their chances of gaining access to the SEC’s archives. They hope these communications will show that the SEC was indeed picking winners and losers by favoring the likes of ETH over Ripple.
The Ripple guys seem to overlook that the SEC might well consider all tokens to be securities, particularly those that conducted extensive pre-mines and reserved vast quantities of these tokens for company principals and early investors before the public was allowed in. You know, like Ethereum.
Regardless of the outcome of this particular legal fight, the SEC’s new commissioner Gary Gensler had made it plain that he intends a far more vigorous approach to reining in crypto excesses. Binance’s BNB is reportedly the latest token to fall under the SEC’s microscope and ETH may well be next in the regulator’s sights, Hinman’s views notwithstanding.
Just because you’re paranoid doesn’t mean they’re not out to get you
Speaking of the erstwhile SEC director, a non-profit watchdog has suggested that Hinman’s 2018 speech may have been spurred by his ties to a law firm with ties to Ethereum.
Hinman left the SEC in November 2020 and promptly rejoined Simpson Thacher & Bartlett LLP—the firm at which he was a partner prior to his SEC stint—as a senior advisor. This type of ‘revolving door’ move is endemic in Washington, with consequences that tend to be very good for the firms involved but not so good for the taxpayer (or the rule of law).
According to a report last month by Empower Oversight, Hinman ignored warnings from SEC ethics officials to (a) avoid any communication with his former firm and (b) recuse himself from any SEC matters that might affect the firm. Instead, Empower says Hinman, who received over $1.5 million in ‘retirement benefits’ from the law firm during his time with the SEC, had “repeated contact with the law firm’s personnel” during his SEC tenure.
Furthermore, Empower said Hinman “failed to disclose Simpson Thacher’s—and by extension his—direct financial interest in the Enterprise Ethereum Alliance, which describes itself as an ‘industry organization whose objective is to drive the use of Enterprise Ethereum’ and its cryptocurrency, Ether, during a speech he gave during his tenure at the SEC.” (Recall that the value of ETH rose following Hinman’s speech.)
Empower has asked the SEC’s Office of the Inspector General to probe Hinman’s alleged conflict of interest, as well as figure out whether this conflict “exacerbated the perception that the SEC’s enforcement actions have selectively targeted some cryptocurrencies while giving others a free pass.”
It’s worth noting that Hinman also joined crypto VC giant Andreessen Horowitz (a16z) as an advisory partner in June 2021. a16z has significant investments in Ethereum-based tokens, many of which are ostensibly intended to fuel ‘Web3’ projects but in reality appear more suited to blatant pump-and-dump schemes.
Turns out that old cliché about a fish rotting from the head down was bang on the money.
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