TheCorporateCounsel.net

Targets of SEC enforcement proceedings and advocacy groups have long complained about “regulation by enforcement.” Crypto evangelists have been particularly vocal with regulation by enforcement claims in recent years, but it looks like at least one of them may have effectively figured out how to use regulation by enforcement to its advantage, Check out Matt Levine’s take on the SEC’s recent enforcement action against BlockFi:

If a crypto startup went to the U.S. Securities and Exchange Commission and said “we want regulatory clarity about what we need to do to run crypto lending programs, so you should write some rules about it,” the SEC would say “sure, we’ll give that some thought in like 2036.” If it went to 50 different U.S. states and asked them for clarity it would get even more confused. If it went to the SEC and said “look, to speed this process along, why don’t we pay you $50 million to prioritize writing these rules,” that would be a very bad crime and it would go to prison. But BlockFi will give the SEC $50 million, and it will give some states another $50 million, and now it has clarity about crypto lending programs.

That’s a classic example of being handed a lemon and turning it into a very expensive glass of lemonade, and it’s also a unique twist on the problem of “regulation by enforcement.”  BlockFi had the resources to use regulation by enforcement to its advantage, but that’s not typically the case.

Now, here’s where I should note that the current director of the SEC’s Division of Enforcement says that regulation by enforcement is a problem that doesn’t exist. That’s a view that he shares with many of his predecessors, but it’s one that’s not always shared by SEC commissioners or the courts. Here’s an excerpt from the 2nd Circuit’s 1996 opinion in SEC v. Upton:

Due process requires that “laws give the person of ordinary intelligence a reasonable opportunity to know what is prohibited.” Grayned v. City of Rockford, 408 U.S. 104, 108 (1972). Although the Commission’s construction of its own regulations is entitled to “substantial deference,” Lyng v. Payne, 476 U.S. 926, 939 (1986), we cannot defer to the Commission’s interpretation of its rules if doing so would penalize an individual who has not received fair notice of a regulatory violation. See United States v. Matthews, 787 F.2d 38, 49 (2d Cir.1986). This principle applies, albeit less forcefully, even if the rule in question carries only civil rather than criminal penalties.

In the current environment, it seems fair to say that regulation by enforcement concerns are by no means limited to issues surrounding digital assets. The SEC is under enormous pressure to move forward on its current regulatory agenda, and enforcement actions may be seen as an attractive shortcut in some areas. As I’ll explain with a couple of examples below, the risk of regulation by enforcement is heightened by the increasing influence on the SEC and other regulators of novel academic interpretations of what the securities laws require – interpretations that run counter to longstanding and well-known business practices.

– John Jenkins

Programming note: our blogs will be off Monday for Presidents’ Day, returning on Tuesday.