Another crypto bull run, another whirlwind of regulatory pressure. But if Terraforms Labs’ lawsuit is any indication, DeFi is better prepared to fight back this time around.
Do Kwon, founder of Terraform Labs (TFL) , the maker of the Terra blockchain and Mirror protocol, received a subpoena from the SEC during Messari’s Mainnet conference in September. But Kwon is pushing back, and on Oct. 22 filed a new lawsuit against the agency, as CoinDesk first reported. The SEC has been said to be pursuing many organizations in decentralized finance (DeFi).
TFL asks courts to throw out the subpoena as failing to follow the SEC’s own procedural rules and violating the Administrative Procedure Act. The federal case brought by Terraform Labs via its counsel at Dentons LLP pulls no punches. The SEC’s media relations director, Aisha Johnson, declined to comment on behalf of the agency.
This suit isn’t happening in a vacuum either. Crypto has gotten politically organized. It’s ready to make its pitch for updated laws and regulations. Crypto was a lamb in 2017, but this time it could be a lion. Still, lambs and lions both end up in zoos sometimes.
At the Mainnet conference by Messari, word was going around that a major DeFi entrepreneur had been served a subpoena by the U.S. Securities and Exchange Commission (SEC) in person, as we previously reported. We reported that Do Kwon had told our team that he and his company had not been served. It turns out Kwon had received papers from the SEC after all, as TFL’s lawsuit shows.
For those who have been around the industry since 2017, the last time U.S. securities regulators got serious about cryptocurrency it threw a pall over the whole industry, causing 2018’s “crypto winter” to kick in. It’s natural to wonder if a similar press could end the long bull run that’s been going in crypto since early 2020, largely driven by DeFi and NFTs; however if the industry has been emboldened enough by their success over the last two years to actually push back against regulators, this time could be different.
Below are the main points of the lawsuit, which also happen to throw considerable shade on the SEC’s work so far:
The SEC doesn’t get DeFi
The Mirror Protocol, a synthetic equities platform that runs on the Terra blockchain and was built by the Terraform Labs team, appears to be the primary objection the SEC has to the company’s work so far. Dentons negotiated a meeting between Kwon and the SEC and it lasted 5 hours, according to the complaint.
The SEC has been particularly focused on synthetic U.S. securities, which Mirror was built to create. The Biden administration’s SEC Chair, Gary Gensler, specifically brought such products up in remarks made this summer.
After its interview with Kwon, the SEC requested a wide array of documents. In fact, the suit contends that the requests were too broad and that they also requested records that didn’t exist.
“The requests evidenced the SEC’s misunderstanding of the Mirror protocol itself, despite Mr. Kwon’s five-hour voluntary interview,” the complaint states.
The SEC has failed to establish that it has jurisdiction over Kwon or TFL
This really appears to be the laser-focus of this suit.
“What it’s about is what steps the SEC has to take in order to secure jurisdiction over recipients of subpoenas and there are procedures in place that they didn’t follow here,” Douglas Henkin, a Dentons attorney and co-author of the complaint, told The Defiant in an interview.
Under SEC rules, when it is interacting with an entity that the agency knows has counsel, it has to try to serve them via counsel. It’s more complicated than that, too, of course, because of international issues, but that’s enough for this next point.
The SEC had already met with Kwon alongside legal counsel, so it knew. In that case, if it wants to directly serve a person, circumventing counsel, staff has to run that by the full commission. It requires a majority vote of the five SEC commissioners to go direct, in that way.
The SEC staff did not do this. Instead, it retained the services of “Cavalier Courier & Process Services” who sought Kwon out on September 20, 2021, at the Mainnet conference, serving him just before he was to go on stage.
The complaint states, “The SEC’s service of the subpoenas was indeed ‘Cavalier,’ as it violated the SEC’s own rules, the APA and the due process clause.”
The SEC’s dramatic approach might have been malicious
The truth is that lawsuits seldom start like they do in the movies, with someone surprising a stranger and handing them papers. The fact that the SEC did it this way this time when it had other avenues open to it forms a key part of TFL’s objection.
“The SEC’s conduct here violated its rules requiring it to keep formal orders of investigation confidential,” the complaint states. “Hiring a ‘Cavalier’ process server to approach Mr. Kwon in public, and announce the purpose of his approach, at a summit attended by more than 2,000 people was, at worst, an intentionally brazen display meant to publicly intimidate and harass, and at best reckless, creating social media and press speculation about the incident within minutes of the attempted service of process.”
Indeed, the action was provocative enough that it contributed to the organizer of the conference, Messari CEO Ryan Selkis, to announce his intention to run for U.S. Senate, where he could take part in writing a new set of rules for the industry
The SEC was playing a kids game at Mainnet, and it was already against the rules
There’s a concept in the law called “tag jurisdiction,” after the game kids play, where one agency will attempt to establish jurisdiction by serving someone when they are physically present in the geographic area where an authority has jurisdiction.
“The subpoenas are also invalid as a means of securing jurisdiction over TFL,” the complaint states. “Indeed, the SEC’s attempt at ‘tag jurisdiction’ flies directly in the face of decisions holding that jurisdiction over a corporation cannot be secured by serving a transiting officer or director. “
Procedure, the complaint contends, is there to protect the rights of people and companies under investigation. “In flouting these procedural safeguards, including the specifically prescribed process for setting those safeguards aside, the SEC deprived TFL and Mr. Kwon of the protection those regulations were promulgated to provide.”