Last week, a House Financial Services Subcommittee held an oversight hearing focused on the Securities and Exchange Commission's (SEC) enforcement division. Despite the norm that ongoing enforcement cases are not discussed at these hearings, Subcommittee Chairman Representative Brad Sherman (D-CA) took it upon himself to put his thumb on the scale of the largest enforcement case in crypto: SEC vs. Ripple. Rep. Sherman's off-base remarks underscore the urgent need for sensible crypto legislation from Washington.
The case against Ripple, a U.S.-based crypto solutions company, has emerged as the bellwether to get clarity on how to classify and regulate digital assets in the U.S. A brief recap: in 2020, the SEC filed a misguided lawsuit against Ripple, its chairman, and CEO, alleging that XRP was a security. Ripple uses XRP (a cryptocurrency that exists on an open, permissionless, decentralized blockchain ledger) in its product offering to facilitate faster, cheaper, and more transparent cross-border payments.
During his opening and closing remarks at last week's hearing, Rep. Sherman asked why the SEC had not, in addition to suing Ripple, brought cases against the crypto exchanges that had traded XRP. Rep. Sherman stated: "the fact remains" that "XRP…clearly is a security."
Here's the real fact: The filing of a lawsuit determines nothing.
Rep. Sherman, a Harvard trained lawyer, knows that. He knows that the SEC can't determine XRP to be a security. He knows that no country in the world has determined XRP to be a security. He knows the issue needs to be decided in the court. In short, he knows better.
As a Judge made clear last year: XRP is "no more a security after the SEC filed the enforcement action than it was before it," because "a determination resolves the question of whether XRP is a security. The enforcement action, by contrast, asks that question. The question is not yet resolved, so a determination has not yet been made. And when it is made, it will be made by the Court."
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Rep. Sherman's comments also come fresh on the heels of the SEC recently being called out by another Judge in the Ripple case for its "hypocrisy" and for "adopting its litigation positions to further its desired goal, and not out of a faithful allegiance to the law."
Rep. Sherman's behavior highlights the pernicious effect of regulation by enforcement. Rather than provide regulatory clarity through rulemaking, the SEC seeks to bully the market by filing, or threatening to file, enforcement cases. Unproven allegations masquerading as regulation is bad policy that hurts consumers and markets who are whipsawed by the whims of an unchecked regulator. As a result, American innovation — and the jobs created — are fleeing the U.S.
But despite Rep. Sherman's comments, voices of reason do prevail. At the same hearing, Rep. Tom Emmer (R-MN) criticized the SEC for, "using enforcement to unconstitutionally expand its jurisdiction."
This is all precisely why Congress needs to fix this mess and provide a comprehensive legislative framework for crypto. Two bipartisan proposals (the Digital Commodity Exchange Act and the Responsible Financial Innovation Act) that seek to define the line between securities and commodities in the digital asset space are a good start. The Wall Street Journal said it best last week when it urged Congress to "exercise its oversight authority over the SEC by demanding that Mr. Gensler halt his high-speed regulatory attack." Rep. Sherman and his comments do the opposite — with destructive effect.
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