SEC Misfires in BlockFi Settlement

The Securities and Exchange Commission (SEC) has a three-part mission: 1) protect investors; 2) maintain fair, orderly, and efficient markets; and 3) facilitate capital formation. Chair Gary Gensler focuses on the first: “Every day, I am animated by working families and what the SEC means to them.”

Yet, his zeal to enforce securities laws in a way that pushes the limit of SEC jurisdiction has had the opposite effect. Far from helping working families, he is quashing their wealth-creating opportunities.

A case in point is the SEC’s widely reported settlement with virtual marketplace and crypto lender BlockFi, which reportedly includes a $100 million dollar fine and promise to stop accepting new accounts. (At the time of settlement, 32 state securities agencies were also investigating BlockFi, collectively they will receive half the fine).

A casual reader might presume the commission had just ended a major scam operation or pie-in-the-sky crypto venture. In speeches, Gensler frames his enforcement push exactly that way:

Without examination against and enforcement of our rules and laws, we can’t instill the trust necessary for our markets to thrive. Stamping out fraud, manipulation, and abuse lowers risk in the system. It protects investors and reduces the cost of capital. The whole economy benefits from that. … It is critical that our enforcement program have tremendous breadth, be nimble, and penalize bad actors so we discourage misconduct before it happens. …

Some market participants may call this “regulation by enforcement.” I just call it “enforcement.” 

Stamping out fraud, manipulation, and abuse sounds great, but BlockFi had done none of that. In a press release the SEC claims that BlockFi failed to disclose the level of risk in its interest-bearing products. But no one was ever defrauded, as Commissioner Hester Peirce noted in a statement:

While penalties this size are intended to deter bad conduct, here there is no allegation that BlockFi failed to pay its customers the money due them or failed to return the crypto lent to it.  BlockFi’s misrepresentations about over-collateralization are serious, but the combined $100 million penalty nevertheless seems disproportionate.

What BlockFi was doing was provide an opportunity for middle class investors to generate passive income on an assets—Bitcoin and other cryptocurrencies—that have seen startling market gains, with the potential for much more. (One investment firm predicts Bitcoin will reach $1 million by 2030).

Working families could park their Bitcoin and other crypto holdings with BlockFi and, depending on the asset, earn between 5 to 10 percent APY. BlockFi relends these holdings at even higher rates and splits the interest with account holders.

Thus, working families benefited in two ways: a) any asset appreciation was theirs after they withdrew their holdings (so was any loss, but that’s a function of supply and demand), and b) the interest earned in crypto was theirs as well.

These are game-changing numbers. Someone buying Bitcoin with a $1,200 stimulus check in April 2020 would have had $11,000 in October 2021; a BlockFi account would have provided an additional 5-10 percent interest. The numbers are below that now, but history suggests they will rebound.

The story has played out across the crypto world in the past four years—pre-dating Gensler’s tenure—as the SEC has gone after companies such as Kik and Telegram without any evidence of fraud and filed lawsuits against XRP/Ripple and LBRY. Non-fungible tokens (NFTs) might be next.

In addressing securities professionals last November, Gensler chided them for their lack of public spiritedness:

You all have our own clients, to be sure. Working in a field such as finance that touches so many lives, though, you also have another responsibility: a responsibility to the public.

A corollary to that is that bureaucrats should not harm the public by using their position to garner media attention and climb the ladder to more powerful positions. Some critics accuse Gensler of using crypto enforcement to do just that. But whatever his motivation, the results only hurt the working families he claims to be working to protect.

P.S.: In a tweet thread by BlockFi’s CEO, the company announced it will register its intertest-bearing products with the SEC and eventually accept new accounts.