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Former SEC attorney warns investors: Get out of crypto platforms now

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(Kitco News) - John Reed Stark, a former attorney for the Enforcement Division of the U.S. Securities and Exchange Commission (SEC), has issued a stark warning to crypto investors in the wake of the regulator's lawsuits against Coinbase and Binance: “Get out of crypto platforms now, I can't say it any plainer.”

Stark made his plea via Twitter on Thursday. “Having worked as an attorney in the SEC Enforcement Division for almost 20 years (including 11 years as Chief of the SEC Office of Internet Enforcement), I believe that we now know for certain that crypto trading platforms are under a U.S. regulatory/law enforcement siege which has only just begun,” he said.

In an effort to get past the expected pushback, Stark noted that he is “typically an outspoken and dedicated SEC critic,” has “no stake of any kind in the cryptoverse,” and is “100% objective, independent and neutral.”

From there, Stark went on to say what many in the industry have been trying to avoid: “My take is that the SEC is spot-on with their crypto-related enforcement efforts. No matter what the carnival barkers promise, it is axiomatic that crypto trading platforms are high-risk, perilous and inherently unsafe.”

After reviewing what the SEC’s registration process requires of financial firms – including mandates that investor funds and securities be handled appropriately without conflicts of interest and the requirement for adequate disclosures regarding their trading policies, practices and procedures – Stark emphasized that “entities providing financial services must carefully handle access to, and control of, investor funds, and provide all users with adequate protection and fortification.”

While the SEC has “unlimited and instantaneous visibility into every aspect of operations” with traditional financial firms that are registered with the regulator, with crypto trading platforms, “the SEC lacks any sort of oversight and access – and has scant ability to detect, investigate and deter fraudulent conduct,” he said.

This results in an unsupervised crypto marketplace that lacks the protections that are afforded to participants in other financial markets that fall under the purview of the SEC, he said.

The list of protections that are unavailable in crypto includes “a transparent surveillance program provided by an SEC-registered broker-dealer or investment advisor; the ability to detect individual misconduct and enforce violations; the ability to analyze or verify market trading and clearing activity, customer identities and other critical data for risk and fraud; traditional accountability structures and fiduciaries of financial firms; and the compliance systems, personnel and infrastructure that allow the SEC to know where crypto came from or who holds most of it.”

Stark said that the lack of crypto regulations has led to “a chasm” in customer protection on cryptocurrency exchanges.

“Crypto trading platforms have no record-keeping and archiving requirements with respect to operations, communications, trading or any other aspect of business; no requirements regarding the pricing or order flow of transactions or the use internal platforms and payment systems by employees; no reason to abide by U.S. statutes and rules prohibiting manipulation, insider trading, trading ahead of customers and other fraudulent behavior by customers or employees; and no obligation to have in place internal compliance, customer service and whistleblower teams to address and archive customer complaints,” he said.

These firms also have “no minimum financial standards for operation, liquidity, and net capital, and no U.S. governmental team of objective auditors and examiners to inspect and scrutinize the fairness, execution and transparency of transactions,” which presents an extreme risk to investors on these platforms.

SEC to Coinbase: No need for new crypto regulation, enforcement actions will continue

“It's all straight-forward and commonsensical,” Stark said. “SEC registration establishes critical requirements that protect investors from individual risk and protect capital markets from global systemic risk. The requirements also make U.S. markets among the safest, most robust, most vibrant and most desirable marketplaces in the world.”

Despite the objections put forward by many in the crypto space, Stark argues that the crypto industry has been operating outside the bounds of what financial markets in the U.S. have traditionally had to adhere to, and if the asset class wishes to become established and widely accepted, it will need to come into regulatory compliance.

This helps to explain the uptick in enforcement actions by the SEC against crypto firms in the six months since the bankruptcy of the FTX cryptocurrency exchange. The agency saw a rapid escalation in its efforts to regulate the industry in the second half of 2022 as compared to the previous five years. The total number of enforcement actions in the years 2018, 2019, 2020, and 2021 were 5, 3, 6, and 5, respectively, as compared to 12 enforcement actions in the second half of 2022 and 17 enforcement actions in the first half of 2023.

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