Jake Chervinsky: I’m Surprised There Haven’t Been More Enforcement Actions This Year

This post is part of CoinDesk’s 2019 Year in Review, a collection of 100 op-eds, interviews and takes on the state of blockchain and the world. Jake Chervinsky serves as general counsel at Compound and an adjunct professor at Georgetown University Law Center.

Jake Chervinsky is a lawyer, but not yours.

Now general counsel for Compound, a decentralized lending protocol, Chervinsky began his early career investigating and litigating white-collar financial crimes. This experience, coupled with having graduated law school during the midst of the most recent global recession, soured his view of the banking industry.

“When I learned about bitcoin, it struck me as an engineering solution to what I saw as a whole group of intractable political problems – misaligned incentives, rent-seeking behavior, disrespect for privacy rights,” he said. In 2018, he joined the crypto team at Kobre & Kim, a boutique law firm that specializes in fraud and misconduct, and “never looked back.”

Cryptocurrency may well prevent financial crimes in the future, but for now, the industry is still figuring out its own legal concerns. I sent a few questions to Chervinsky over email, to get his take on what the regulatory actions of 2019 mean for tomorrow.

Do you think 2019 brought clarity to any open legal and regulatory concerns for the industry?

This year did provide some clarity regarding how US laws and regulations apply to digital assets, thanks largely to important guidance from the SEC on investment contract analysis, FinCEN on anti-money laundering compliance, OFAC on trade sanctions compliance, and the IRS on taxation. Unfortunately, we still have many more open questions than we have answers. It’s become increasingly clear that some of our financial regulations – which were designed for a pre-internet age – aren’t well-suited to the novel and unique issues raised by the crypto industry. Alas, these issues can’t be resolved by non-binding guidance from regulators and enforcement agencies either. Without formal rule-making or crypto-specific legislation, I expect that we’ll continue to struggle with regulatory uncertainty.

There are a lot of conflicting opinions about the sanctions weighed against Block.One. I know this is a case you kept a close eye on. Do you think there’s room for further litigation?

I think the penalties assessed by the SEC against Block.One were reasonable in light of the complexity of the case and helpful for clarifying the SEC’s views on how and when digital tokens can evolve from securities to non-securities. Some have criticized the SEC for accepting what looks like a small penalty compared to the amount of money Block.One raised, but that criticism ignores the reality of settlement negotiations in government enforcement matters. By definition, settlement requires the government to discount the defendant’s maximum potential liability to account for the chance of losing in litigation.

Considering the time and resources required to pursue a contested enforcement action, combined with all the arguments and defenses that Block.One could have advanced, I think the settlement was appropriate for both parties. Perhaps more importantly for the future, as I explained before, the settlement implies that the SEC does not view EOS tokens as securities based on the current state of the EOS network. I’d be surprised if the SEC goes after Block.One again, but it’s possible that other regulators or enforcement agencies could pursue separate enforcement actions.

The term 'scam' has been greatly overused in the context of ICOs, most of which were simply doomed-to-fail business concepts.

At what point should an ICO be deemed a scam?

I believe we should only use the term “scam” to describe outright frauds – that is, the intentional use of trickery, deceit, or other dishonest means to deprive people of their rightful money or property. In my view, the term “scam” has been greatly overused in the context of ICOs, most of which were simply doomed-to-fail business concepts rather than overtly fraudulent schemes.

Do you think the SEC be over reliant on sanctions?

I don’t think the SEC has been overly reliant on enforcement actions, and in fact, I’m surprised that the SEC hasn’t launched more enforcement actions against ICO projects that sold tokens in 2017. The ICO bubble involved hundreds (or thousands) of unregistered securities issuances in which US investors lost millions (or billions) of dollars, but most of them have escaped SEC enforcement up to this point.

When do you suppose a security becomes a commodity and escapes the SEC’s purview?

To be precise, securities don’t “become commodities” – securities are a type of commodity regulated by the SEC instead of the CFTC. A security of the “investment contract” variety becomes a non-security when the facts and circumstances change in a way that negates one or more prongs of the Howey Test. For example, if the financial success of a digital token no longer depends on the managerial or entrepreneurial efforts of a specific third party or promoter, the token should cease to be classified as a security.

Why might the SEC be delaying a bitcoin ETF? 

The SEC refuses to approve a bitcoin ETF due to market manipulation concerns. The law only allows the SEC to approve ETFs that are “designed to prevent fraudulent and manipulative acts and practices.” For years, the SEC has said that a bitcoin ETF sponsor can only satisfy this requirement by entering “surveillance-sharing agreements with regulated markets of significant size,” but unfortunately no sponsor has been able to clear that hurdle yet. There is some dispute about whether the SEC is interpreting this requirement correctly, but unless someone decides to challenge them in court, their view will remain the law of the land.

What was the biggest event of the year, crypto-wise?

The most influential event of this year was the announcement – and ensuing regulatory persecution – of Facebook’s Libra project. Before Libra, crypto wasn’t on the radar of most US government officials, but Facebook’s attempt to cloak its pivot to financial services in the language of decentralization brought an unprecedented level of attention to our industry. We’re now seeing efforts in Congress to advance legislation that targets Libra without fully considering the collateral damage to crypto. For example, the recently-proposed “Managed Stablecoins are Securities Act of 2019” could have catastrophic consequences for US crypto companies as well as the nation’s ability to compete in this global industry.