The Securities and Exchange Commission has come under fire from a federal judge for the way it handled a cryptocurrency company. The judge expressed worry that the agency had made “materially false and misleading representations” in order to freeze project assets worth millions of dollars.
The action, which was filed in federal court in Utah, is about a company known as Digital Licensing Inc., or DEBT Box. The SEC claimed in its complaint, submitted this summer, that the initiative had sold unregistered securities known as “node licenses,” which had defrauded investors out of about $50 million.
Through a so-called ex parte application, the SEC was able to successfully secure a temporary restraining order and asset seizure as part of the original procedure. This means that the crypto business was not made aware of the proceedings and was not able to contest them in court at the time.
These kinds of one-sided court cases are rare and usually occur when a government agency is afraid that if it notifies the defendant, they will destroy evidence or take assets abroad. A party seeking a temporary restraining order must, however, establish a strong probability of “irreparable harm”—a difficult standard to meet.
U.S. District Judge Robert Shelby stated in his order on Thursday that he had granted the SEC’s request because the agency’s attorney, Michael Welsh, had claimed the cryptocurrency company was actively closing bank accounts—33 of them in the last 48 hours—in an effort to relocate the business to Abu Dhabi and out of the jurisdiction of American regulators.
However, this proved to be incorrect. Some of the SEC’s claims, Shelby claimed in his order, were “entirely without merit and misstate the record.” He said that later court actions showed that the business had moved most of its operations months earlier and that no bank accounts had been frozen during the 48-hour period. Additionally, he discovered that banks, not the business, had terminated several accounts and that a purported $720,000 international transfer—which the SEC had utilized to support the ex parte seizure—had in fact been a domestic transfer.
Because there was another attorney on screen and two investigative staff members off screen who did not contradict or clarify the SEC attorney’s assertion, nor did it receive any attention in subsequent filings, Shelby noted that he was “troubled” by the attorney’s misrepresentation of the account closures.
The judge further contended that the SEC, which has accused the cryptocurrency corporation of preventing investigators from accessing its social media accounts, has not shown any proof that the company was aware of the inquiry.
After considering all of this, Shelby came to the conclusion that the SEC may have misled the court about the details of the case that supported the previous rulings.
Shelby cited a federal court rule stating that any written evidence she provided to a judge must support those facts. Shelby expressed the court’s worry that the Commission lied and broke Rule 11(b), damaging the fairness of the process.
SEC faces sanctions
The document that Shelby released was in the form of a “show cause order,” which, in this instance, requires the SEC to give justifications for why the Utah court shouldn’t penalize the agency for its actions. Although these directives are frequent, they are almost always issued to private individuals and infrequently to governmental organizations.
The Thursday order ends with a series of questions posed to the SEC in response to particular instances of what appear to be inaccuracies, such as the agency’s assertions on the social media ban and the shuttered bank accounts.
Despite Shelby’s order having a restrained tone, the judge appears to have been furious about the SEC’s submission of the alleged misstatements in an ex parte setting and for a temporary restraining order—legal procedures that courts are typically reluctant to grant since they deny defendants due process. The judge expresses his concern in his filing that the SEC “undermined the integrity of the proceedings.”
The federal law that Shelby quoted suggests a variety of alternatives, ranging from a monetary punishment to a directive that “suffices to deter repetition of the conduct,” rather than offering specific sanctions for particular violations.
The SEC is now involved in several high-profile cases against well-known cryptocurrency companies, such as Coinbase and Ripple, at the same time as the show cause order. The afflicted sector will probably take advantage of Shelby’s directive to reiterate long-standing complaints about how the agency, under Chairman Gary Gensler’s leadership, has been holding a personal grudge against it.
The SEC’s main allegations that DEBT Box deceived investors about mining tokens are supported by a report released in August by the blockchain analytics company TRM Labs. The defendants’ attorney opted not to comment.
“We are in receipt of the order to show cause and will respond to the court as directed,” an SEC representative stated in response to a request for comment.
Shelby has given the agency two weeks to reply to her directive.