On Monday, a federal judge took the unprecedented step of imposing sanctions on the Securities and Exchange Commission related to a lawsuit the agency brought against the Utah-based crypto company DEBT Box in July.
The case drew widespread attention after the defendants accused the SEC of misrepresenting key facts when the agency obtained a temporary restraining order to freeze assets on the crypto platform. After U.S. District Judge Robert Shelby ordered the SEC to explain its actions, lawyers for the agency admitted the SEC had committed errors, but asked Shelby not to issue a formal punishment.
In Monday’s decision, Shelby denied the SEC’s request, citing multiple instances of “bad faith” conduct and finding the agency responsible for a “gross abuse of power.” In the 80-page filing, Shelby imposed a sanction in the form of a requirement for the agency to pay for DEBT Box’s attorneys’ fees and costs related to the restraining order. The judge also denied the SEC’s motion to dismiss the lawsuit without prejudice, which would have meant the agency could bring the lawsuit again at a later date.
“[The SEC’s conduct] substantially undermined the integrity of these proceedings and the judicial process,” Shelby wrote.
‘Bad faith conduct’
DEBT Box is a little-known crypto firm that offered investment vehicles in the form of “node software licenses” that allowed customers to mine different digital assets. The SEC first sued the firm in July, alleging the project had defrauded investors out of nearly $50 million by selling unregistered securities. Before the case was unsealed, the agency took the drastic step of requesting an ex parte temporary restraining order—an extraordinary step that does not even notify the defendant of the proceedings, and is typically granted only when there is a serious risk they will destroy evidence or flee the U.S. In the DEBT Box case, the SEC claimed the company was actively closing its bank accounts and seeking to move out of the country.
While Shelby initially granted the SEC’s request, lawyers for the defendants later flagged that the agency had misrepresented information in its request for the restraining order, including that the firm was aware of the investigation and was taking steps to flee the country. In a December order, Shelby asked the SEC to provide evidence to back up the restraining order.
A few weeks later, the agency filed a response admitting to mistakes, with SEC enforcement chief Gurbir Grewal apologizing for the “shortfall” in the case. Still, agency lawyers asked Shelby to waive sanctions, arguing that its staff had not engaged in “bad faith conduct.” In January, the SEC moved to dismiss the case without prejudice, once again arguing that sanctions were not appropriate and that case law dictated the agency could not be on the hook for monetary penalties.
Despite the agency’s apology, the case quickly became a lightning rod for both the crypto industry and sympathetic politicians who have long complained about the zealous campaign of enforcement against the blockchain sector under Chair Gary Gensler. In February, a group of Republican senators sent a letter to Gensler expressing concern over the lawsuit, arguing that trust in the agency was “undermined.”
Shelby’s ruling on Monday is a vindication for DEBT Box and the SEC’s critics, with the judge finding that the agency understood the critical evidence used to obtain the restraining order “lacked any basis.”
Still, Shelby wrote, “The Commission nonetheless advanced that evidence in deliberately false and misleading ways.”
In his decision, Shelby took particular issue with the SEC’s position as a federal agency, with agency lawyers citing its “special standing” when requesting the restraining order. By granting the initial order, Shelby wrote, “lives were upended.” Furthermore, he argued that the SEC not only repeated the factual errors in later representations but presented “new falsehoods to the court.”
“The court cannot write these issues off as non-willful, inadvertent mistakes,” he wrote, concluding that the agency made “strategic decisions” to present questionable information because the lawyers knew they would not have otherwise secured the restraining order and asset freeze.
With leading crypto companies embroiled in lawsuits with the SEC, the strongly worded decision will add to the scrutiny of Gensler’s approach to policing the industry. “The Commission just foisted a bill onto every one of us for their litigation misconduct,” tweeted Coinbase chief legal officer Paul Grewal, whose company is currently seeking to dismiss an SEC lawsuit alleging that the exchange’s business model violates securities law.
“We are reviewing the decision,” said an SEC spokesperson in response to a request for comment from Fortune.
