Do Kwon’s huge fine shows that the SEC is stepping up its penalties against crypto companies

By Daniel Kuhn, CoinDesk; Translated by Tao Zhu, Golden Finance

The SEC is seeking its heaviest fine yet against a cryptocurrency project, a $5.3 billion fine against Do Kwon and Terraform Labs, the man and company behind a fatally flawed algorithmic stablecoin whose implosion set off a multibillion-dollar industry-wide contagion.

Earlier this month, after a protracted investigation and relatively short two-week trial in New York, Kwon and Terraform were found liable for fraud—obscuring the clear dangers lurking in a trading scheme that would allegedly keep its UST stablecoin solvent, as well as the unsustainable 20% yields offered by Terraform’s Anchor lending platform. Kwon, who was arrested in Montenegro last year for possessing a fake passport, did not attend the trial. He is currently awaiting extradition to the U.S. or his native South Korea.

The fine is not set in stone; the court will decide the ultimate penalty. But according to an April 19 court filing, the SEC said it was seeking to send a “clear message.”

For experts, the huge fine is a sign that the SEC is not playing around anymore, as the SEC has proposed a $1.8 billion fine against Ripple. (That came after U.S. regulators fined Binance $4.3 billion, though the SEC apparently had no role in that settlement, and prosecutors this week asked Binance’s former CEO Changpeng Zhao to go to prison for three years .) “The recent high-profile cases against Terra/Do Kwon and Ripple, with penalties in the hundreds of millions or even billions of dollars, really signal a change in strategy on the part of the SEC,” Andrea Tosato, an assistant law professor at the University of Pennsylvania, said in an interview. “Overall, I would say the SEC seems to be trying to send the message that … the rewards are not worth the risks.” While SEC Chairman Gary Gensler has more or less been against crypto since taking office in 2021, the financial carnage caused by the collapse of Terra, Three Arrows Capital, and FTX in 2022 has made trying to get the industry on board a national priority . For example, the Biden administration sent out a memo stating that regulating cryptocurrencies will be a “whole of government” matter.

As a result, Binance, Ripple, and now Kwon and Terraform are feeling the weight of this.

While Terraform lawyers argue that the U.S. lacks jurisdiction, they are now advocating for a capped fine of $3.5 million. Kwon’s defense committee recommended a maximum fine of just $1 million. Ripple, for its part, is asking for a civil penalty of no more than $10 million, arguing that the SEC’s recommended penalty is excessive because it’s more than 20 times what it has collected from cryptocurrency settlements to date.

In a way, it is. The SEC collected more than $1.2 billion from Telegram, but nearly all of that amount will be returned to investors, with the popular messaging company only having to pay a $18.5 million civil penalty. That’s in line with Block.one’s $24 million civil penalty in 2019. (CoinDesk is owned by Bullish, which in turn is majority-owned by Block.one.) In 2022, the SEC earned the most from enforcement actions, at $6.4 billion. The average civil penalty was just over $9 million.

So what’s driving the SEC’s seemingly aggressive turn? Yuliya Guseva, a professor at Rutgers Law School, said it’s likely a combination of factors, including the fact that as cryptocurrency projects get bigger, so does the potential for illicit gains. But there’s also the legal strategy of “fear,” which is designed to instill fear in the industry as a whole to incentivize compliance.

Guseva said in an interview: “The latter approach suggests that the SEC’s choice may be strategic as it seeks to bring the cryptocurrency industry within the ambit of securities laws.”

Tosato said disgorgement of ill-gotten gains isn’t actually mentioned in securities laws, but disgorgement has been standard operating procedure since the 1970s as a way to return funds to investors and deter future violations. Civil penalties, on the other hand, are supposed to follow a rulebook that includes the extent of the violation, the actual (or potential) harm to investors, and the extent to which the defendant complied with the regulator.

In practice, however, the process “does involve a degree of discretion exercised by the SEC within the established legal framework,” Tosato added. While raising the company’s fines is certainly intended to send a message to others, Tosato said he doesn’t do that. Don’t think the SEC is “particularly unruly compared to what it does in other industries” when it comes to clear cases of fraud and securities violations — there are plenty of them.

“What’s different, in my view, is that the applicability of regulatory frameworks in the cryptocurrency space is much more uncertain than in many industries,” Tosato said. “Recent case law still leaves a lot of questions unanswered.”