John Reed Stark, a former SEC official, recently criticized the crypto industry at a U.S. House Financial Services Committee hearing. He completely disagrees with the industry's claims that the SEC practices "regulation by enforcement." He argued that the SEC is merely enforcing existing laws, which he considers very necessary considering the crypto industry's reluctance to comply with already established legal standards.
As all of this happens, the SEC still continues its strict enforcement by rejecting Terraform Labs' plea for reduced penalties. Additionally, Adam Todd, the former CEO of Digitex Futures Exchange, has pleaded guilty to failing to establish necessary Anti-Money Laundering protocols, making him one of many well known figures in the crypto industry dealing with legal challenges.
John Reed Stark Calls Out Crypto Industry
John Reed Stark, a former Securities and Exchange Commission (SEC) official, recently criticized the crypto industry for starting myths that try to hide its lack of transparency and accountability. During a U.S. House Financial Services Committee hearing on May 7, Stark argued that the crypto industry’s accusations of the SEC using “regulation by enforcement” are completely unfounded. He believes that the agency is only performing its regulatory duties by enforcing existing laws.
Stark also pointed out that the term “regulation by enforcement” is used in the crypto sector to criticize the SEC's approach to implementing rules and regulations. Instead of crafting clear regulations through legislation or rulemaking, the industry claims the SEC is setting precedents through enforcement actions. However, Stark countered these claims by describing the regulatory actions as standard law enforcement that is, in fact, necessary because of the crypto industry’s unwillingness to comply with already established legal frameworks.
He talked about the challenges in valuing digital assets, touching on their lack of traditional financial indicators like cash flow, management, or a proven track record. Stark firmly believes that the crypto industry needs to adapt to the laws rather than expecting legal norms to adjust to its needs.
During the hearing, there were also discussions about the SEC’s enforcement practices and its impact on businesses and people. Nick Morgan, founder of the Investor Choice Advocates Network, criticized the SEC for creating legal uncertainty through inconsistent litigation practices across different jurisdictions. He argued that this approach forces people who are not accused of fraud to litigate policy matters on a case-by-case basis, even when federal appellate courts have ruled against the SEC on specific policies.
The overall tone of the hearing suggested a need for the SEC to improve its enforcement practices, balancing effective regulation with clearer guidelines.
What is the SEC and What is It Responsible For?
The SEC is a federal regulatory agency that was established by Congress in 1934 to oversee the securities markets and protect investors. Its main responsibilities include ensuring fair and orderly functioning of the securities markets, promoting full public disclosure, and protecting against fraudulent practices. The SEC is crucial for the registration of securities offered through interstate commerce, and it requires financial firms and their representatives to register for conducting business.
The SEC operates under the guidance of five commissioners who are appointed by the President of the United States. Gary Gensler currently serves as, and has served as, the chair since April of 2021.
To maintain nonpartisanship, no more than three commissioners can belong to the same political party. The agency is divided into five main divisions—Corporate Finance, Enforcement, Investment Management, Economic and Risk Analysis, and Trading and Markets—each with specific roles in the regulation and oversight of the securities industry.
While the SEC can only initiate civil actions, it works closely with the Department of Justice for criminal cases, assisting with evidence and court proceedings. In civil suits, the SEC seeks injunctions and monetary penalties, and in administrative proceedings, it can issue sanctions like cease and desist orders or suspend licenses.
The SEC also interacts with self-regulatory organizations like FINRA or the New York Stock Exchange for appeals. Additionally, the SEC’s Office of the Whistleblower, which was established by the Dodd-Frank Act, incentivizes whistleblowers by offering money for information leading to successful enforcement actions.
SEC Rejects Terraform's Penalty Proposal
Meanwhile, the U.S. SEC has hit back against Terraform Labs' proposal for lesser penalties in a recent civil case judgment. In a filing on May 6 in the Southern District of New York, the SEC contested Terraform’s arguments for reduced disgorgement amounts after a jury found the firm and its co-founder, Do Kwon, liable for fraud.
The SEC also contested Terraform's claims that the commission improperly applied U.S. federal laws to activities that actually happened outside the United States. The filing pointed out that Terraform also did not raise these concerns during the trial. The SEC also shed some light on several U.S.-based activities of Terraform that are, in fact, relevant to the case, including the involvement of a U.S. company, Jump, which secretly helped stabilize Terraform’s digital currency, TerraUSD (UST). Additionally, Terraform’s former communications head in California posted misleading information on social media.
Do Kwon himself promoted UST at a conference in New York and actively engaged with U.S. media, which just ended up further tying their activities to U.S. jurisdiction. Contrary to Terraform's suggestion of a $1 million civil penalty and no disgorgement, the SEC is fighting for $3.6 billion in disgorgement from Terraform and Kwon, in addition to $1.7 billion representing the “ill-gotten gains” from UST sales.
Do Kwon is currently entangled in legal issues in Montenegro for using falsified travel documents, and he was unable to attend the trial.
Adam Todd Pleads Guilty to AML Failures
The results of the crypto crackdown in the U.S. is very evident in the fact that quite a number of crypto industry big-names have their hands full with legal battles at the moment. This includes Adam Todd, founder and former CEO of the Digitex Futures Exchange.
Todd has pleaded guilty to federal charges of failing to establish an Anti-Money Laundering (AML) program at his company, according to a recent announcement from the U.S. Attorney’s Office for the Southern District of Florida. Todd's guilty plea came after he was indicted in February, where he was charged with operating an unregistered futures platform catering to U.S. customers from 2018 to 2022 without implementing necessary AML and Know Your Customer (KYC) protocols.
The indictment reveals that Todd made a public declaration in 2020, stating that Digitex would not require any KYC identity verification, after a security breach where a former employee stole substantial user data, including details from passports and driver's licenses.
Despite efforts to block U.S. IPs and verify that users were not U.S. based, the U.S. Commodity Futures Trading Commission (CFTC) was still able to successfully pursue legal action against Todd and Digitex. This led to a 2023 verdict that imposed $16 million in disgorgement and penalties on them.
Todd stepped down as CEO in October of 2022 and has since been involved as the lead developer at Digitex Games. He now faces up to five years in prison and a $250,000 fine.
As many people would notice, this case sounds very similar to that of former Binance CEO Changpeng Zhao, who also pleaded guilty to similar charges in November 2023 and was sentenced to four months in prison in April. The sentencing hearing date for Todd has not been announced just yet.
Digitex is a cryptocurrency futures exchange that allows traders to buy and sell futures contracts for Bitcoin, Ethereum, and Litecoin without any trading fees. This commission-free trading model is made possible through the use of Digitex’s proprietary cryptocurrency, the DGTX token. All trading profits and losses on the platform are denominated in DGTX tokens, which means traders must possess DGTX tokens to trade. Instead of charging transaction fees, Digitex covers operational costs by annually minting and selling a limited quantity of new DGTX tokens.
