Joseph Hall is a partner at the law firm Davis Polk and was the Managing Executive for policy at the SEC. He weighs in on the SEC Ripple XRP lawsuit. Joe recently wrote the article titled “Ripple Token Case Highlights Need For SEC Clarity On Crypto”. Joe also talks about the GameStop short squeeze situation. https://www.davispolk.com/
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Interview Transcription
Tony Edward: [00:00:10] Hi, everyone. Welcome back to the Thinking Crypto channel. I have a special guest with me today, Joseph Hall, who is a partner at the law firm Davis Polk and former managing executive for policy at the SEC. Jo, it’s great to have you.
Joseph Hall: Thanks.
Tony Edward: Jo, I’m excited to speak to you because you recently penned an article about the Ripple SEC lawsuit situation. But before we get into that, I think folks would love to understand more, or get to know you better. We can start with your background. Where are you from? Where did you grow up?
Joseph Hall: I grew up in North Carolina mostly. I went to high school and college in North Carolina. And as a child, I lived in Tehran for a few years, so I was exposed to kind of the rest of the world at a very early age, and my family traveled along.
Tony Edward: Wow. That’s very interesting that you were in Tehran at a young age before.
Joseph Hall: It was before the revolution.
Tony Edward: Wow. That’s very interesting. How did you end up working at Davis Polk and becoming a lawyer and getting into the legal industry?
Joseph Hall: So, after law school, I clerked for a federal judge for a year. And then after I clerked with a federal judge, Davis Polk was the first firm that I started working at. So, I’ve been at Davis Polk or I started at Davis Polk about 32 years ago and have left for government service once and left for an in-house position at once. But it’s the only law firm I’ve ever been in.
Tony Edward: Got it. And then at your tenure at Davis Polk, you left to go work at the SEC. Can you tell us about your time there? And what did you help accomplish at your tenure at the SEC?
Joseph Hall: Sure. I was working for Bill Donaldson, Chairman Bill Donaldson, who came in — this is sort of ancient history at this point, but who came in about a year after the financial or the I bet the IPO, the Dot-com boom and bust. And then the Enron WorldCom scandals, and then the scandals around mutual fund late trading. So, I was there at a very busy time for the agency. And I was his Chief of Staff, the title was Managing Executive for Policy, but it was effectively Chief of Staff. So, my real job was more management. It was more trying to help Chairman Donaldson to get his policy agenda through the commission. And it was great for me because I had been termed a deal lawyer all my life before that. And having that position at the SEC gave me kind of a 360-degree view of what the SEC does. You know, the various statutes that it administers and the various interest groups at play and a much more sort of rounder view of the US Securities Laws than my narrow focus as a deal lawyer.
Tony Edward: Sure. And that’s where I was so excited to speak to you because you have that holistic view, you’ve been in-house at the SEC while also in the legal industry. And I think your perspective is going to be — Well, as you articulated in your article about Ripple, well put. And what made you decide to write the article recently?
Joseph Hall: Well, I think a couple of things. One, there’s going to be a change in leadership at the SEC, and that’s always sort of a good time to look at the SEC’s agenda and sort of make some predictions, or identify some areas where I think it would be useful for the agency to go. And I do think it’s time, as I said, in the article, I do think it’s time for a fresh approach to crypto issues. So, those were some thoughts I’ve been having for a while. But then the day before Chairman Clayton stepped down, they filed a suit against XRP, which I found it pretty astonishing. Again, not because I don’t see the issue, and not because I don’t sort of understand the legal theory behind the case. But there’s a lot of things about the timing and about the decision to take action against Ripple Labs, and about, frankly, some of the statements that the Commission is making in that complaint that were frankly quite surprising to me. So, the two things together just sort of naturally coalesced and I had some time over the holiday so I sat down and wrote about it.
Tony Edward: So, Jay Clayton’s move, in my opinion, seemed like a very crass move. And the timing was weird, as you alluded to. What do you think was the motive behind that? Was it Jay Clayton himself, maybe this is like a personal thing between him and the folks at Ripple. It’s a political thing, or this is a, “Hey, you’re disrupting the status quo. This is to push you back a bit or set you back a bit.”
Joseph Hall: Yeah. Those are not at all sort of motives that I would want to tribute to Jay Clayton or to the commission at all. And I don’t think it was a crass move and I also don’t think it was sort of the empire striking back. You know, I think it reflects some strongly held convictions at the commission, which aren’t, frankly, they aren’t grounded in the law, about what is a security and what do issuers and promoters of securities need to do. And so at some level, it came out of a very natural progression of the way the commission looks at the securities markets from the point of view of how the securities markets have worked over the last several decades, and certainly from the point of view of the way that the securities laws were designed. And really, my point of the article is that, that I think it’s time to move on from this question of, is it a security or not? Because right now, the way the analysis works is, is it a security? And if the answer to that is yes, then sort of the entire weight of the federal securities laws and all the implications of that now applying to it.
And my thought is that maybe that does not have to be the approach. Maybe we could still sort of acknowledge that under the Howey test, or under sort of traditional methods of analyzing whether a particular instrument is a security. Maybe that shouldn’t be the end of the analysis, maybe that should just be the beginning of the analysis. And once we have decided that or once we concluded that something is security, then the question is not necessarily less regulated out of existence, which I’m afraid is what kind of happens with crypto right now. I think the question should be, okay. It is a security, but it’s not like what we think of traditionally as security. It’s not like a stock or a bond. It’s not used for the same purpose, necessarily. And that’s the funny thing when you talk about crypto that there’s, obviously, endless flavors of crypto, and there could be some that are very much like a traditional asset, traditional security asset. But there’s others that just aren’t.
And so I think the question is what are the fundamental concerns under the securities laws? And how do we address those with this new asset class without imposing sort of other aspects of the securities laws that ended up making the asset worthless or not being able to be used for its intended purpose? So, that can be done by the SEC. And if I had one criticism of the Clayton approach, it’s that they didn’t take that second step. I mean, I think that it was important, I think, for the Clayton SEC to come out in 2017 and say, there’s a lot of bad stuff going on out there or out here.
There’s a lot of capital raising for speculative business purposes that’s going on that needs to be regulated by capital raising for speculative business purposes. My criticism would be that they didn’t take the next step and say, “Okay. Now that we have sort of put the world on notice that certain kinds of crypto may well be securities,” they had they didn’t take the next step and say, “Okay. How does it make sense to regulate them now that we’re labeling them securities?” And the staff of the Commission has actually given lots of thought to that question. And I saw this a number of different times in my interactions with the staff. They actually do have ideas about how to handle this and they weren’t necessarily given the freedom that they needed to begin to develop those ideas and refine those ideas. And the Commission does have the ability to do that. The Commission does have the ability through notice and comment rulemaking to craft a new regulatory regime or regulatory regime that is appropriate to this asset.
Now, it would be nice, frankly, if Congress would come in and set the ground rules. It really should be Congress that’s doing that. But we’ve seen over the last many years that it’s very difficult for Congress to sort of focus on major pieces of legislation. And particularly, in areas like this, that nobody who’s setting laws really has a deep understanding of it, and a deep familiarity with the issues. But again, I don’t think it’s a partisan issue. I don’t think this is a Democrat versus Republican issue. I think it’s a problem. We have a huge asset class, that at this point, nobody knows how to regulate. And the regulators are not getting clear direction from Congress on how to do it. And so it then ends up being the regulator’s trying to do things piecemeal, without a lot of sort of guidance from above. So, it’s an issue. And the asset classes far too big right now to be left to that kind of nebulous state of regulation.
Tony Edward: Sure. In your article you alluded to, potentially, there was maybe a divide among the commissioners at the SEC. You know, we’ve seen Hester Pierce, in particular, she’s known as crypto mom, she’s very pro-crypto. She’s put out a lot of different legislative ideas and wrote op-eds, and so forth in favor of proper regulations. So, potentially, there was divided among the commissioners, and when Jay Clayton was on his way out, he kind of just, “Well, here it is, and you guys handle it from now on.” Do you think that’s what kind of happened?
Joseph Hall: Well we don’t know because when the SEC takes a regulatory action, when they pass a rule, if one of the commissioners dissented, it’s very common for them to write a dissent and explain what their position was. And Commissioner Pierce has done that in a number of occasions. They follow a different practice in litigation. You know, I think there’s an understanding that if the commission is going to file a lawsuit that you just can’t have the various commissioners going out and criticizing that lawsuit. So, we don’t know, at the end of the day, whether Commissioner Pierce and Commissioner Roisman, in particular, I call them out in particular, we don’t know whether they signed on to the lawsuit. It was just the timing just seemed to be odd to me. You know, it’s a very major step that the Commission took. They made it on J. Clayton’s last full day in office. And the directors, the co-directors of the division enforcement both left soon thereafter. The Director of the Division of Corporation Finance, Bill Hinman had left a few weeks earlier. So, taking such a momentous step like that just looks to me that they felt that they were running out of time, and it takes — the commission acts by majority vote, so they needed to have at least three commissioners vote to authorize the suit. And if there were only three, and not four or five, then that was really the last day that the suit could be authorized. So, I’m speculating, I have no inside information. But just the timing of it just made me think, huh, maybe everybody at the top of the commission was not on board with this. That will come out at some point. It’ll become known at some point, but it may be awhile before we really know what the true politics were there. So, I’m just speculating.
Tony Edward: Sure. And we know Gary Gensler, nominated to be Chairman, appears he’s going to be on his way in given his knowledge of cryptocurrencies. I’ve seen videos of him teaching about crypto and Bitcoin and blockchain, he talked about Ripple and XRP at MIT. Do you think he’s going to come in, and once again, we’re speculating here, and with his knowledge, maybe help bring some clarity here, or put things in line?
Joseph Hall: Well, I hope so. You know, I think whoever was going to be President Biden’s nominee to lead the SEC, I think was going to have to confront this issue. And I think it may well be the case that Jay Clayton didn’t have to confront it because when Jay Clayton came in in 2017, four or five years in the crypto space, as you know, is an eternity. I don’t know what the market cap of crypto and ether was in 2017. But I’m sure it had nothing comparable to what it is today. There was also, as I said, there was a lot of bad activity that was going on in the 2016, 2017, 2018 timeframe. There was a lot of crap that went on. There were a lot of assets that were launched, that were just kind of a joke. They just seemed much more interested in getting money out of people’s pockets than they were solving a real issue. And one of my very good clients, we were down talking to the SEC about crypto, and he’s somebody who’s very prominent in the space.
And I think his inbox was anytime somebody was doing an ICO, his inbox was going to receive a copy of the white paper. And he made a comment to the staff that in 90% of these cases, he doesn’t see what problems the token is solving. In fact, if anything, the token seems to be adding more friction than it seems to be solving a problem. And I think that was very true about that activity that went on in the middle of the — sort of in the middle of the decade. And therefore, it’s natural that the SEC’s approach would be more of an enforcement forward approach. But I think we’re past that now and things have shaken out. And there are legitimate businesses that need to be able to operate, need to be able to attract capital and they can only do that with regulatory certainty. So, I think whoever was going to be appointed by President Biden to fill this role was going to have to deal with it, maybe in a way that Chairman Clayton didn’t have to.
Now, when you then sort of just tee it up that way, I think it’s much better to have somebody who understands the asset and understands the space being that regulator. And Gensler was a very proactive regulator at the CFTC. That was historically an agency that took a much lighter touch to regulation than the SEC did. But that’s probably just my bias as a securities lawyer. But Gensler sort of turned that around and was quite active in implementing the Dodd-Frank rules and dealing with security-based swaps, and the whole swaps and derivatives market and everything. So, he’s clearly, activist is the wrong word, but he’s clearly somebody who’s not afraid to tackle big problems. So, you have the combination of somebody who knows the space deeply and is not afraid to tackle problems. So, I’m hoping that that means that he will approach this not from a regulatory perspective and sort of what’s the right kind of regulation for this space, as opposed to just the — what’s derogatorily referred to as the regulate by enforcement approach. And so I think the signs are good that we’ve got somebody who can do that, and who knows how to do that. But it’s going to be a heavy lift. If he does decide to make this one of the centerpieces of his tenure, my prediction is that it gobbles up a hell of a lot of his time.
Tony Edward: Sure. And this asset class is on the rise. We’re seeing a lot of companies are setting up shop, a lot of big players, traditional financial players are getting into the market. So, I do want to ask, do you personally own cryptocurrencies? Are you a holder of XRP? If you can — [crosstalk]
Joseph Hall: I don’t. I’ve never owned cryptocurrencies. I’m a securities lawyer and I don’t own securities. I invest in Vanguard and Fidelity mutual funds, and that’s been the way I’ve been since I was a very young lawyer. It’s just when you’re a securities lawyer, and you’re constantly dealing with different companies, and different products, you can find yourself very quickly, not being allowed to trade them because of the conflict, or because you might have inside information or something like that. So, I’m a very plain vanilla investor. Now, I wish I bought crypto. But no, I don’t invest in the space that I practice in.
Tony Edward: Sure. And I respect that. That totally makes sense. So, you penned the article, so in your mind, I know I’m asking maybe a moot point here because you kind of let your thoughts be known. Do you see XRP as a security and what do you see the outcome being potentially moving forward?
Joseph Hall: When you examine it against the Howey test, one can make arguments on each prong of the Howey test as to why it is a security. That’s frankly, one of the problems of the Howey test. It’s just too elastic. And when the staff came out with their — the SEC staff came out with their framework for analyzing assets under Howey, the framework just included multiple questions. Maybe 30, 35, 40 questions and came along with the standard disclaimers that no one factor is dispositive. And that’s the issue with a judge-made test like this is you can argue all these points. So, yes, I see the argument as to why it’s a security. Now, I will tell you, I have argued the opposite to the SEC in terms of XRP on behalf of clients who have been doing things with it going back several years now. So, again, to me, that’s not the interesting question. To me, the interesting question is, okay. Let’s say it’s an investment contract under the Howey test, but that shouldn’t be the end of it. It should be okay. I’ll give it to you. It’s an investment contract.
Now, let’s talk about the smart way to regulate it as a security. There might be some elements, there are some elements of the way we approach securities regulation in this country, that could well be appropriate, including SEC review of an offering document of some sort. Probably not using the standard protocol of questions or standard protocol of topics that the issuer of a share of common stock needs to disclose. But there are things that probably would be useful for a purchaser of a crypto asset to know. For example, how much of the asset do the promoters control? Something like that. There are things that may well be relevant, and so I don’t have a problem with that. But then the second step of then saying that all transactions in that asset have to be routed through regulated intermediaries, whether that’s regulated broker dealers, or clearing houses such as DTC.
That’s where I then come in and say, okay. Maybe those aspects of the regulation of the securities are just not appropriate for this kind of asset. And that’s the question, again, that’s the question that I know the staff has thought about. And that’s also the kind of question that the FCC does have the tools to address if they’re prepared to go through the arduous process of notice and comment rulemaking. That involves the SEC sort of proposing a regulatory framework for the asset class, and then getting comments on it. Putting it out for public debate and then on the basis of bad public debate, the SEC should, in my view, what the SEC should do is come out and propose a regulatory framework for crypto.
Now, Commissioner Pierce, she’s come up with an idea, which is a very interesting idea of basically giving promoters of the asset sort of three years to make it appropriately decentralized. That’s something that would be quite useful. I would actually go further than that, though, and not necessarily require — I don’t think decentralization itself needs to be the watchword on this because I think that you — I don’t know why we force blockchain technology and tokens that are used on a particular network to necessarily be decentralized. Today, you have to do it that way because that’s the only way to get it not to be a security. But I think one could just as easily take the approach that okay, it is a security Let’s stop arguing that question. Let’s stop drawing analogies to oranges and whiskey warehouse receipts and Manhattan condos. Let’s just cut it out with those analogies and just say, okay, it is a security. What’s the best way to regulate this security so that we can get the benefit of the technologies that are going to employ this asset, we can encourage innovation in this field. And yet, we’ll still be able to address the consumer protection or investor protection concerns that are at the heart of the US federal securities laws.
Now, this will not be easy. As I said earlier, Congress, ideally, frankly, should be holding hearings and should be making these decisions and should be drawing lines and coming up with ideas about how to regulate it and giving the regulatory agencies very clear directions on what Congress believes that the policy should be. But you tell me, I don’t see that happening anytime soon, unfortunately, and it is unfortunate. But the SEC does have the tools to do it if they’re willing to use them. And we can’t discount the fortitude that it will take a commission to address these issues to bite off an issue like this and to really see it through. It literally could consume major parts of any chairman’s tenure. So, I think that’s, to me, a huge question as to whether there’s a lot of issues that Mr. Gensler is going to need to face on day one. That’s always the case with the chairman of the SEC. There’s always a long list of things that need to be done. And so prioritization is a huge part of his role, any chairman’s role. And the question is going to be where in that list of priorities is crypto? And again, with Chairman Clayton, I can understand why crypto was not at the top of that list because of the nature of the industry. You know, four years ago? I think that has changed now.
Tony Edward: Absolutely. The industry has matured, and you alluded — Well, you mentioned that there were a lot of scams, and I remember seeing a lot of it myself was back in 2017, and a lot of hype around that. But I think there has been some maturity, and there are some quality projects in the market. And it seems the determination that will be made around Ripple and XRP is going to affect the rest of the market for sure. So, I’m hoping Gary makes it a top priority.
Joseph Hall: Well, it could. I mean, this is another reason why I was so surprised that the lawsuit was filed. Because the SEC just hasn’t brought that many litigated cases. Telegram was obviously pretty huge, and Kik was pretty huge. But in both of those cases, I think the SEC’s position, and the SEC’s chances of prevailing in both of those cases, I think, were much higher than they are in this case. And the SEC could have — Rather than bringing a case against XRP at this time, the SEC could have continued to proceed with the easier cases, the cases that are more clearly a security under the Howey test. And they could have developed a track record and gotten some appellate court decisions. Because of course, both Kik and Telegram never made it to the appellate level.
So, they are just a couple of District Court decisions. They’re persuasive but they’re not binding on too many other courts. The SEC could have chosen a path of trying to develop case law in their favor in a lot more cases, before taking on something like XRP. Because when the SEC gets into federal court, it happens all the time that they go into federal court, with cases that I as a securities lawyer think should be a slam dunk, that the SEC’s position is clearly right. And yet, they don’t prevail in federal court because they are going from a world where we all understand what the securities laws are trying to do, and we understand what the conduct is. And we see how the law applies to the conduct.
But when you’re in front of a judge, an Article III Judge who one day is hearing a criminal case involving cocaine smuggling, the next day, is hearing a breach of contract case, the next day’s hearing an EEOC case; you’re getting in front of a generalist who may have no background in any of this at all. And the facts end up mattering a lot in situations like this. And so the facts here are, we had an asset that was in the $30 billion market cap range, that was the brainchild of a unicorn, a Silicon Valley unicorn. And I think the facts of this are going to be — What the judge is going to see is a case that doesn’t seem to have been involving any imminent investor harm. The Telegram case, of course, was brought as an injunction right before they distributed the gram. So, you can sort of see that unless we act right now, investor harm’s going to happen.
The judge just might say, “If XRP was a problem, you’ve known about XRP since 2012. Why now? What is going on here?” So, I think we start out with a XRP case with a factual posture that may not be the best for the SEC. And so I think that there is a good chance, I can’t give you a percentage on that, I think there’s a good chance that the SEC loses this one. And if they lose it whether that’s at the district court, or frankly, if they lose it at the district court, and then don’t settle it, they’ll surely appeal it to the Second Circuit. They could end up with a ruling that makes it very difficult for them to exercise any authority at all over the entire crypto space. And I don’t think that would be a great thing. Because as I said earlier, I think there are some interests that the US Federal Securities Laws are designed to protect that would make sense here. You just have to be very thoughtful about what kinds of requirements you put on this industry.
Tony Edward: So, let’s say, to your point, they potentially lose this case, but would it then force them to put together a Howey test 2.0, or one that’s specific to crypto and digital assets? Okay. We can’t use the 80-year-old Howey test. It doesn’t align. Maybe there’s a second version.
Joseph Hall: So, it’s just in the nature of things courts and agencies move very incrementally. They’ve been moved and this is — I’m assuming that a world where Congress doesn’t step in and act. For now, we’ve got securities laws that were written in the 1930s that have a list of things that are securities that runs several lines long. And one of those things is investment contract. And the Supreme Court gave meaning to that term in 1946. And courts have continued to give meaning to that term over the years. The SEC has an interpretation of that term, grounded very clearly in what the courts have said over the years. In my view, there’s some cases where I think they push the definition further than the courts do. But that’s what people do. That’s what lawyers do. Lawyers are always interpreting things in ways that achieve a result that they want to achieve. That’s just normal. If a court comes out, if what whether the district court or the appellate court, so whether the judge setting in the Southern District of New York or the judge on appeal at the Second Circuit, they’re not going to come out and say, “We don’t like the Howey test for digital assets, we’re going to create our own test.” That’s just not the way our system works.
What the courts will do is they will interpret the Howey test, if the SEC is to lose, does lose this case, they will interpret the Howey test in a way that gives more weight to the arguments that favor XRP not being a security than XRP being a security. And that is possible, because, as I said earlier, the Howey test is ultimately very elastic. And I can argue this side of it, or I can argue that side of it. And I could make arguments both ways. The court is ultimately going to have to decide which side it comes down on. And that was my point about the proposition that XRP brings to the table here. XRP is not like the Mnuchin token, which is one of the first SEC enforcement actions where you just read the facts, you’re like, this is kind of silly. XRP is a legitimate business, or I’m sorry, Ripple Labs operates a legitimate business solving a real problem. And XRP is actually integral to solving that real problem. And it’s a huge market.
And it’s just this, there’s just something that when you bring that in front of a generalist judge, and they’re going to say, wait a minute, if I — and the SEC complaint kind of ignores this, the SEC’s complaint just sort of says they should have had disclosure, and they should have been registered, and they deprived investors of this registration. The SEC’s complaint does not go the next step and say, “Wait a minute, what if this was a security? What if they had registered it and provided all this disclosure, what happens next?” And the answer is, what happens next is you’ve suddenly got an asset that just can’t be traded on a peer-to-peer basis on a blockchain because we don’t have any rules for that yet. And I obviously haven’t seen what Ripple Labs is going to say, in response to the SEC’s case. But I would expect that one of the things that they’ll point out is, look, it’s not just so easy to say, they should have registered this. Because once you do register it, once you start going down that route, suddenly, you can’t use the asset anymore. And that’s missing from the SEC’s complaint.
And I think when they get in front of the judge, the judge is then going to look at this and say — I have no idea how the judge [inaudible 00:35:57]. If I were the judge, I would look at and say, “Okay. SEC, I hear your arguments. But what are the consequences of finding that this thing is a security? I find it’s a security and I have to shut down this very substantial, very credible, good company? What kind of policy sense does that make?” So, because of that and the SEC could have, if they had world enough in time, they could have brought you a number of different cases and more firmly gotten judges to sign off on their particular approach to the Howey test, before going after XRP. And they didn’t, and it’s going to be very interesting to see how that plays out. I would have been happy with a settlement in the XRP case, that sort of picked up on a concept that Bill Hinman talked about back in 2017 or 2018; the idea that an asset can morph from being a security to a non-security. I would have been happy with a settlement. And I still can’t.
I mean, I think Gensler’s arrival at the SEC will obviously present an opportunity for a settlement. I would be happy with a settlement where XRP on the one hand sort of — or it’s always no no deny. I’d be happy with a settlement where the SEC asserts that XRP was a security back in 2012. And from those — some of those early sales, but then just leaves open the question of whether it currently is today. And just let Ripple Labs sort of live to fight another day. Not get into the question of whether it’s a security today, and that was the number of things that surprised me about the case, that was probably the most surprising, frankly. And it’s — I even know the paragraph number, paragraph number eight, right at the — basically, on the first page of the complaint asserts that XRP is a security today. It’s one thing to say XRP was a security five years ago, and they should have registered it.
But I frankly, thought it was too bad that the SEC asserted that it is one today. Because to me that’s just saying there’s no, in the SEC’s view, we’ve got to shut this company down. If they had left it at it was a security several years ago, and we’re just not going to even touch whether it’s one today, then, to me, that would have been an easy argument to make in front of the court. And so whatever you think about the status of XRP today, it was clearly a security back then. They should not have sold it without registering it or putting in the kinds of restrictions that one needs to have for a private placement of securities. But the fact that they went ahead and they went there, and they said it’s a security today I think is a warning sign. Unless they take the approach that I would advocate for, which is to say, quit asking that question, just quit bothering me with that question. Let’s just say it’s a security, let’s just both agree that it’s security. And then let’s ask what’s the smart way to regulate this thing if it’s a security?
Tony Edward: So, to your point let’s say the outcome is it is a security, but given that it’s a utility token to be used by banks and different payment companies and so forth, there’s a leeway there that okay, the banks can go without needing certain bells and whistles and all that stuff, yeah, to make it easier.
Joseph Hall: Yeah. And that concept, that term utility token is not a term that’s recognized in our law. But that is a term that if the SEC were to embark on a regulatory project, they could make distinctions between different types of security or between different types of crypto. You could clearly say, this is a payment token, this is a utility token and this is some other form of token and they could all be regulated differently. And I believe that’s sort of similar to the approach that you’re going to find in Switzerland and Singapore and other jurisdictions where they’ve looked at it. And I think you would regulate a token that is meant to be used for payments, but that ends up being a security under the investment contract test differently from the way that you would regulate security or a security that’s a piece of crypto that’s a utility token that ends up being an investment contract under the Howey test.
Now, I should step back and say, I’m not at all saying that all crypto are investment contracts. I’m not saying that at all. I think there are plenty of kinds of crypto that clearly are not securities. Bitcoin is the obvious example. I think there are stablecoins, well-designed stablecoins that are just not securities under the federal securities laws. And those should stay outside of the federal securities laws. What I’m arguing for is an approach where we’re two lawyers sort of acting in good faith can sort of say, “Look, we can both make reasonable arguments over whether or not this thing is an investment contract.” That’s where I’m saying we need a new approach because now the stakes are too high. You know, I can argue it’s not an investment contract, the SEC attorney can argue it is. And the stakes are enormous because depending on which one of us wins, it’s either unregulated, or it’s regulated to death. And that doesn’t make sense. It shouldn’t be that binary choice between being regulated to death, and unregulated.
So, let’s, on these close cases, let’s stop having that argument. Let’s quit putting our resources, again into making use of metaphors and analogies to oranges and whiskey warehouse receipts and Manhattan condos. Let’s stop that. It’s not productive. Let’s say okay, it falls under the banner, let’s figure out what the best consequences are for that. And I don’t think the best consequences for that are to apply the full panoply of federal securities regulation to it, because it just won’t work. You know, the securities laws were not designed with these things in mind. And so you’re trying to get a round peg into a square hole, it just doesn’t work. You need a new approach. And that’s what I would hope Mr. Gensler will take the time to do it. And again, there’s a lot of different things on his plate. And it would require prioritization, and as I said, it would suck up a lot of his energy and effort at the commission. And I did see that with Bill Donaldson, you know, Bill Donaldson, the guy, the chairman that I worked for had founded Donaldson, Lufkin & Jenrette, which was sort of the leading independent investment bank and broker dealer. He had been the Chairman of the New York Stock Exchange, he had been the founding Dean of the Yale School of Management. I mean, that he had been a soldier or an officer in the Korean War.
This was a guy who came to the commission with an enormous amount of credibility, like Mr. Gensler has, and he tried to tackle the big problems. And he did it. He did tackle some really big problems. Problems that have been out there festering for years, if not decades, about market structure issues, the regulation of hedge funds. And you can’t imagine what a slog it is. Because for everything that you want to do, there’s always an industry on either side of the issue, and then it gets into Congress. One thing that I loved about Bill Donaldson is, we were dealing with an extremely contentious issue that involved — seems quaint to talk about it now, that is called the trade-through rule that had to do with how securities exchanges are regulated. And there was the so-called New York Stock Exchange model with, back then, 15 years ago was a lot of floor brokers. And there was the NASDAQ market that was all electronic. And it was just sort of a clash of the titans between these two business models.
And Congress got involved in it because everybody had their lobbyists talking to Congress. And so I walked into Donaldson’s office one day, and he was just hanging up the phone and he had this sort of bemused smile on his face. And he had just been called by the Chairman of the Senate Banking Committee who had read him the Riot Act, to try to tell him not to do what was pretty clear that the SEC was about to do. And it just didn’t faze Donaldson one bit. He can have the Chairman of the Senate Banking Committee call him up and screaming at him, and Donaldson just says, “Yeah, thank you for your views. I’ll take them into consideration.” Didn’t faze him one bit? And I think Gensler, I think, has that kind of credibility. And I think he’s got that kind of intelligence and I think he will do the right thing. I think sort of the biggest question that I would have is, if he takes this on, as I said, I’ve said this two or three times now, it’s going to consume a lot of his tenure as Chairman of the Commission.
Tony Edward: So, Jo, let’s say, Gary gets in there, he gives you a call and say, “Jo, come work for me, help me out here.” Would you head back to the SEC?
Joseph Hall: I’d say, “Been there done that.” [crosstalk] I would love to go back to work on the staff at some point. But I’m 57 years old, I don’t have that much longer as a practicing lawyer. I will retire at some point in the next few years. But I don’t think I’ll be going there now. I hope I have some role in whatever they do by representing my client’s interests, and commenting on their proposals. And I know all the folks at the SEC who deal with this, I’m in regular contact with them. They are a wonderful group of people, frankly, the staff members who work on crypto. So, I hope I’m part of the dialogue, but it’ll be from the outside and not from the inside.
Tony Edward: That’s a bummer. I hope you change your mind. So, I do have to ask in 2015, the Ripple settled with the, I believe it was the FinCEN. And FinCEN categorized them, XRP, as a virtual currency. Do you think that helps Ripple in this case, given that, once again, the SEC was nowhere to be seen?
Joseph Hall: No, not really. I mean, that’s the way, you know, the way we regulate the financial markets in the United States is we divide up-regulation among a lot of different regulators. And each regulator has its own mission and its own set of concerns, its own set of priorities. That’s not the way other countries do it. There are other countries where you have a unified financial services regulator. But in the US, in the regulation of financial services, we divide it up. And I think that’s a good idea, frankly. There are good things that come out of regulatory competition. There are good things that come out of having different regulators having different agendas and different priorities because it can make sure that those important concerns are not overlooked. And you don’t have a single agency subordinating one set of concerns to another set of concerns. So, I think the way we do it in the United States, you might call it a federalized system of financial regulations actually makes a lot of sense.
But FinCEN’s issues are not the SEC’s issues. FinCEN’s issues are, are financial assets being used to commit crimes? Are financial assets being used to fund bad? Those are FinCEN’s concerns. And so FinCEN has categorized digital assets, FinCEN does categorize digital assets, based on what they mean in terms of the priorities that FinCEN has. Completely different priorities at the SEC, not completely different, but quite different. The SEC’s concern is the protection of investors and the health of the market, sort of the two things. They want robust, fair, honest trading markets and financial assets and they want to make sure that investors’ interests are protected.
Now, there’s clearly an overlap between FinCEN’s concerns and the SEC’s concerns but they’re not the same. So, if you went to the CFTC, they would say it’s a commodity because they treat FX as commodities. Again, who’s the right person to solve these things? Congress. Congress could easily come in and say we want digital assets regulated by FinCEN. We’re going to divest the SEC have jurisdiction over them. I don’t think that would be the right thing to do. But Congress could come in and say that we’ve created these regulatory fiefdoms. It’s not entirely clear where crypto goes, maybe it makes sense to not even talk about crypto. Maybe it makes sense to talk about this kind of crypto and that kind of crypto and give this kind of crypto over here and that kind of crypto over there. Congress is ultimately the body that can come in and make those decisions. But in the absence of doing that, the regulator’s themselves are going to have to figure it out. It’s like two kids sitting at a table fighting over the last piece of pizza or a last piece of cake. It would be very easy for the parent to come in and say we’re going to split it in half. But if that doesn’t happen, instead, you’re going to have both — it’s the exact same situation in the United States.
Tony Edward: Sure. And I’ve seen Congressman Tom Emmer come out and say XRP is not security. I know him, Darren Soto, and a few other folks, Warren Davidson have been trying to push things forward and hoping they make progress on that front and get the other folks on board.
Joseph Hall: I hope they do. I hope that — I would like it. I think it would be wonderful if the House Financial Services Committee and the Senate Banking Committee would sort of both say this industry has gotten too big and too important for us to not step in, and do what we can do here, you know, hold hearings, take evidence, listen to the lobbyists on both sides and craft a solution and then give the regulator’s a clear green light on what to do. My fear in the absence of that kind of proper functioning of the legislative branch is that if I were the chairman of the SEC, and let’s say I went in, and then I was going to make crypto a priority, I can guarantee you that pretty soon I’m going to get a request to come testify in front of the HFSC, the House Financial Services Committee, or the Senate Banking Committee, and I’ll be roasted by legislators, some of them will yell at me for not doing enough to regulate it. And a bunch of others will be yelling at me that I have no jurisdiction and how dare I regulate it. I saw this happen when I was at the SEC, it happened over credit rating agencies.
And I happened to be at the SEC before there was any formal federal regulation of credit rating agencies. And I had to prepare Chairman Donaldson for these hearings. And sure enough, you go in and you’d have half the members screaming that we’re doing too much with credit rating agencies, the other half is screaming that we’re not doing enough. And the answer is always folks, it’s in your hands. You can pass the rules here. You can create the rules that will then tell us what you want us to do. And sure enough, in 2006, Congress did pass a law on the regulation of credit rating agencies. And so that is really what should happen here is Congress should do it. But if Congress doesn’t do it, for whatever reason, I don’t think that, given that how big the industry is now, at some point, I think the SEC has to approach it as a regulatory project, as opposed to just playing whack a mole with the enforcement approach.
Tony Edward: Sure. Absolutely. Makes sense. So, I want to switch gears a bit for the last topic that I want to touch on. And that is the GameStop short squeeze. I want to get your take on it. Obviously, it’s pretty analogous to crypto and DeFi and so forth. What is your take on the whole situation?
Joseph Hall: I think that’s the — I’ve been scratching my head over this, like, everybody’s been scratching their head over it. My first thought frankly when this sort of broke into the news a couple of weeks ago was this is going to be the Hilaria Baldwin story, just something that was kind of weird and funny and diverting. It seems to be getting to be bigger than that. There’s no clear obvious — it’s not a crypto story, right? GameStop is anything but a crypto company [inaudible 00:54:19] a brick and mortar mall retailer. To me, the echoes that I see do involve DeFi and the way decentralized finance, and the way financial regulators need to start thinking about the new world that we’re in. You know, one, I’ve read a lot of criticism of the SEC over the past week. I think Senator Warren said something like, “At the SEC you need to get off your duffs.” When I look at what’s happening, I don’t necessarily see any violations of the securities laws. There’s something wrong with shorting. Shorting is an investment technique. There’s nothing wrong at all with shorting. In fact, I think shorts have sometimes been our most important sentinels in the marketplace in terms of like pointing out real problems with companies.
I think, go back 20 years ago, the shorts were kind of onto Enron, before the regulators. There’s nothing wrong with shorting. So, that’s the kind of the institutional Wall Street actors in this. And then I look at the folks on Reddit, and I don’t see coordinated activity the way that that concept is really used in the federal securities laws. I see people expressing their views and other people agreeing with them or not agreeing with them, but then starting to act based on what they’re saying, in a very decentralized way. And so if the policymakers decide that something like what’s going on with GameStop should not happen, then they should start regulating it. And the Senate Banking Committee, and the House Financial Services Committee should get together, and they should define what conduct they don’t like and tell the SEC to get rid of it. But again, I haven’t necessarily seen any conduct that’s so clearly illegal.
Now, there may be stuff, there could easily be plenty of stuff going on behind the scenes that none of us know yet. Like, there’s going to be a lot of people looking into this to see whether there actually is some sort of hidden coordination or something going on. And that could certainly be the case. I think this will be investigated. But I think that the takeaway for regulators is, we live in a very different world from the world we lived in five or 10 years ago, let alone in 1933 when the securities laws were written. And it’s very easy now for people to — I don’t want to use word coordination because that has a meaning in the securities laws. But it’s very easy now for large groups of people to start sort of taking cues from a few and start moving in a particular direction. You know, it was a big joke, flash mobs, flash mob proposal, it was a big joke a few years ago. That’s basically the same kind of behavior that you’re now seeing here. And the world has changed and it’s really up to Congress, and the regulators to look and see how the world has changed and to say, do we need to adapt our regulatory approach?
But when I read those comments that were attributed to Senator Warren, I just kind of thought it was unfair. I thought it was a bit of a cheap shot at the SEC, to say they should get off their duffs. They’re off their duffs. They are off their duffs and the world changes and yet, they are dealing with the tools that they have, and those tools may need to be updated.
Tony Edward: Sure. And I think technology is moving at a rapid pace where these things are popping up because of the internet, the decentralized nature of the internet, and you can’t really see them coming sometimes. You have to, sure, react to it as it happens. But who would have thought that crowdsource information could have led to this?
Joseph Hall: Yeah. And look, regulation and legislation is always going to be a lagging indicator, or it’s always going to follow, it’s never going to be able to lead. But that’s sort of the point. It’s up to the legislature and the regulator to, as best as they can, try to keep up with what’s going on in the market. And not reactively say that every problem that pops up, we need to figure out a way to solve that with the constructs that we already know. It’s a big lift. It’s a really big lift, but I think we could use a lot more legislative policymaking here as well as a lot more policymaking and regulatory focus at the various regulatory agencies.
Tony Edward: Sure. Jo, we covered a lot today. I want to wrap it up with some quick rapid-fire questions for you. What’s your favorite food?
Joseph Hall: Anything Mediterranean from Spain all the way to Israel and Lebanon.
Tony Edward: Very nice. Favorite musician or band?
Joseph Hall: I’m too old for your audience. You know, I go back to REM and things like that.
Tony Edward: REM, I listened to some REM. Your favorite movie?
Joseph Hall: Yeah, I should probably you know say something intelligent like [inaudible 01:00:14] But I kind of — I’m a James Bond fan myself.
Tony Edward: Awesome. I can’t wait to see the new — I know it got delayed because of COVID but the new Craig movie. Favorite book?
Joseph Hall: My favorite author is a Canadian novelist who died 15 or 20 years ago by the name of Robertson Davies. He wrote probably 15 or so novels. My favorite one of all of them is called What’s Bred in the Bone. And I’ve always said I wish I could find another Robertson Davies. So, for those of you who haven’t heard of Robertson Davies, and you’ve never read a Robertson Davies book, then there’s a treasure waiting for you.
Tony Edward: Awesome. And when you’re not at the law firm or looking at securities and things like that; what are you doing for fun as far as a hobby?
Joseph Hall: Eating and drinking.
Tony Edward: That sounds good to me. And I know you’re down in Miami, so that’s awesome. Jo, pleasure chatting with you. Thank you so much for taking the time to join us today.
Joseph Hall: Thanks, Tony. [01:01:31]
