The Problem Of The Activist Regulator

Why we should all be concerned with the recent failures of prominent regulators like Gary Gensler and Lina Khan.

Way back at the beginning of 2023, I wrote about how the “Move Fast and Break Things” (MF&BT) era appeared to be at an inflection point (or, more aptly, a nadir, if you fancy yourself a New York Times reader). In that article, I questioned whether we would ever learn from the tumult caused by MF&BT companies:

With 2022 in the rearview, what does the future hold for the MF&BT movement? Although its best days are likely behind it, we have certainly not seen the last of it, and may well see permutations of it for years to come. Thus far, our institutions have been able to withstand unique and material stresses caused by these companies. Our courts held Elizabeth Holmes accountable for the Theranos fraud, Musk accountable for the Twitter deal, and appear poised to hold SBF accountable for the collapse of FTX. Meanwhile, the markets are increasingly reverting to the mean — allocating capital away from ultra-high-growth “story-telling” companies and short-term crazes like meme stocks and SPACs, and towards companies with strong fundamentals and clear paths to profitability. Unfortunately, although the same cannot necessarily be said for our dysfunctional and slow-moving legislature and executive branch, there are signs that Congress (e.g., on antitrust and crypto) and administrative agencies like the SEC and CFTC are looking to catch up.

The real question is whether the next decade will be one of continued resilience (or worse, decay) in the face of the MF&BT culture, or if it we will be one finally defined by corporate antifragility. The key to making sure it’s the latter: implementing effective guardrails that draw on lessons learned from the last decade.

The underlying point was that if the slow-moving and under-resourced government stood a chance of contending with the nimble and well-capitalized private sector (particularly the MF&BT companies), it would have to develop antifragile rules of the road—rules that get better over time. These antifragile rules would serve the dual purpose of circumscribing the harmful effects of MF&BT companies and fostering a robust and innovative private sector.

A key variable in this equation is the need for rule makers who actually want to see the thing that they are regulating succeed. Of course, this isn’t always the case. But history suggests that the most effective rules are the ones crafted by supporters, not detractors.

Remember Section 230, one of the single most important reasons for the Internet we have today? Recognizing that they didn’t know how this “Internet” thing would develop, lawmakers back in 1996 passed Section 230 to “promote the continued development of the Internet… to preserve the vibrant and competitive free market that presently exists for the Internet and… to encourage the development of technologies.”

Fast forward to today: Congress, to its credit, has tried to do just that on a range of topics spanning from antitrust to crypto. True, the antitrust legislation—a bipartisan bill spearheaded by pragmatists wanting to enhance private sector competition, which received a groundswell of support on both sides of the aisle, much of the media, and basically all of the five or so non-lawyers who care about antitrust—was killed by a lobbying effort costing more than $250 million. But, they tried! There also seems to be progress on the two crypto-related bills that are still floating around Congress, both of which are sensible and put forth by proponents of the very thing they’re trying to regulate. And, given that the crypto industry seems understandably more focused on using what funds it has left to defend against litigation rather than lobbying Congress, who knows, the bill(s) may just become law.

Unfortunately, that’s where the success story ends. The recent conduct of a few regulators in particular have highlighted just how detrimental it can be to have rule makers and enforcers who don’t actually believe in the very thing that they’re regulating.

The first culprit is Gary Gensler, a former partner at Goldman Sachs and the current Chairman of the SEC. Gensler, who has loathed crypto for quite some time, made it one of his central missions since taking over the SEC to, first, unilaterally decide that the SEC has jurisdiction over basically all cryptocurrencies and crypto-related companies, and, second, to eradicate all cryptocurrencies and crypto-related companies under his jurisdiction (which, again, is all of them in his view). Gensler brought 11 enforcement actions against crypto players in the second half of last year alone, and the SEC has charged 15 different crypto actors with violating securities laws so far in 2023. One such crypto actor is Coinbase—one of, if not the most, reputable player in the industry (which, granted, is sort of like being the tallest midget). The SEC recently sued Coinbase for failing to register as a securities exchange, even though the SEC allowed Coinbase to go public less than two years prior with full knowledge of Coinbase’s business. Although the case will take some time to play out in the courts, Coinbase issued a compelling response after the lawsuit was announced, and its stock has more than doubled since Gensler announced the suit.

Just as the Coinbase suit was getting going, Gensler received unfortunate news out of the Southern District of New York in a case involving one of the very first victims of Gensler’s “throw shit at the wall and see what sticks” approach to regulating crypto. After a three-year legal battle, the SDNY issued a convoluted opinion that basically boiled down to a finding that Ripple’s cryptocurrency was not a “security” when sold to retail investors through currency exchanges (and so not subject to the SEC’s jurisdiction and not in violation of securities laws), but that it was a “security” when sold directly to institutional investors like venture capital firms. Despite Gensler’s best efforts to spin it as a partial win, the decision can only be seen as a major loss for the SEC in its bellwether case, given that the SEC’s entire mantra is basically “protect naive retail investors and let sophisticated institutional investors fend for themselves.” The real tragedy, though, is that the plainly ass-backwards ruling from a judge who was clearly in no position to make such a consequential decision on the state of a nascent and fast-moving industry she didn’t understand was a bad outcome for the general welfare of United States. Gensler’s spray and pray approach necessarily means he’s not taking as much time as he could to pick the most favorable cases to take on. The result of bringing a bunch of cases with bad facts, is bad law.

Gensler’s reign as SEC Chair has set us back in our attempts at creating an antifragile corporate ecosystem. But Gensler’s arbitrary and unwavering assault on all-things crypto is only part of the story. Right there with him has been the wunderkind herself: FTC Chair Lina Khan.

Much was expected of Khan when she arrived at the FTC. She was full of trail-blazing ideas, free from the stench of private sector ties, and unmarred by a lengthy career in government. Khan, who was primarily an academic in her short career prior to the FTC, made a name for herself as a law student when she published “Amazon’s Antitrust Paradox” in Yale’s law journal. The paper effectively spelled out Khan’s core thesis. In it, she posited that traditional antitrust laws dealing with monopolies, which really focus on consumer harm, have failed to hold Amazon accountable and, accordingly, new laws should be put in place to break up Amazon’s monopoly power.

Khan’s paper and the myriad public statements she has made about other major tech players she’s now tasked with regulating were enough to cause both Facebook and Amazon to seek her recusal from FTC investigations involving their respective companies. The FTC’s independent ethics official investigated the matters, but Khan ultimately went ahead with leading those investigations, and has since brought enforcement actions against both companies.

Just like Gensler, Khan’s FTC has sought to block more mergers during her two year tenure than any other time in recent history. And, just like Gensler, her track record has been less than stellar. Although the Amazon case is still pending, Khan ultimately lost her suit against Facebook to try to block its attempted acquisition of a virtual reality company.

Adding insult to injury, not only did Khan (like Gensler) lose her first major challenge as Chair, but it subsequently came to light that she had disregarded the non-binding decision of the FTC’s independent ethics official (a fact that Khan had previously denied under oath before Congress), who recommended that Khan recuse herself from the case. According to the ethics official, Khan’s prior comments regarding Facebook raised questions of bias and an appearance of unfairness. Khan’s conduct even caused one of the two Republican FTC commissioners, Christine Wilson, to ultimately resign from her post and publish a scathing op-ed, questioning Khan’s “honesty and integrity”, alleging that her conduct had denied “parties their due-process rights” and accusing her of “lawlessness” by flouting ethical and legal standards. And while Wilson’s comments should certainly be taken with a grain of partisan salt, the op-ed also cites internal data, for what it’s worth:

I am not alone in harboring concerns about the honesty and integrity of Ms. Khan and her senior FTC leadership. Hundreds of FTC employees respond annually to the Federal Employee Viewpoint Survey. In 2020, the last year under Trump appointees, 87% of surveyed FTC employees agreed that senior agency officials maintain high standards of honesty and integrity. Today that share stands at 49%.

Then, just this month, the FTC also lost its high-profile challenge of Microsoft’s acquisition of Activision Blizzard, and even lost its challenge to Illumina’s acquisition of Grail in its own administrative court. But none of these losses seem to be wavering Khan and the FTC. Just last week, the FTC opened an expansive investigation into OpenAI, the company behind ChatGPT and the new face of the MF&BT movement. There is an obvious need to regulate and oversee ChatGPT and other rapidly developing LLMs, which are learning on an exponential scale from widespread public use and have demonstrated the propensity to hallucinate, defame, and infringe on the intellectual property rights of others. But, given Khan’s track record, it’s hard to think that the folks at OpenAI are particularly concerned about the investigation.

The overarching problem with all of this is that the personal animus driving both Gensler and Khan has blinded each of them from objectivity and prohibited them from regulating with an unbiased and dispassionate hand. More than simply failing on the merits of the cases they bring, both regulators have failed because they’ve taken binary stances on the multifaceted issues that fall within their jurisdiction. The result of this squandering of precious government resources on fruitless actions is that they and their agencies appear biased, political, and devoid of nuance, not to mention toothless in the face of real misconduct by MF&BT companies.

More damaging in the long term, though, is the impact that these activist regulators will have on the companies and sectors they regulate. One potential outcome is that the MF&BT companies will be emboldened to, well, move faster and break more things in light of the general perception that these agencies are unable to hold bad actors accountable. As one executive said, “All these court losses are making their threats look more like a paper tiger.”

Another plausible outcome is that these activist regulators will, in a roundabout way, indirectly achieve the very thing they’ve sought out to do—destroy the companies and industries they are going after (at least, insofar as they exist in the US). See, the US may be the center of gravity for these companies today, but we take for granted that the status quo won’t change because of the lack of regulatory clarity and a government that seems to act in an entirely arbitrary manner towards the private sector. For those very reasons, Coinbase’s CEO has alluded to potentially moving its business overseas. In a similar vein, the co-founder of Ripple recently said:

In the U.S., we have really screwed up blockchain tech and crypto policy. Everywhere else, it's booming. And so we've actually lost our leadership role. It has now moved to Singapore, London, Dubai. They're kind of the three majors that are fighting out. Japan also is a player. Brazil, you know, everywhere basically is kind of welcoming this. And most of our people that we're hiring now are overseas.

Such seismic changes, in turn, have sweeping implications on the country—not just for innovation and job creation, but for geopolitics and national security.

After a lengthy period of moving fast and breaking things, it’s unsurprising that the pendulum has swung heavily in the opposite direction. But while the overcorrection may be expected, it isn’t productive. Here’s hoping we’ll be able to find a happy medium before we’ve gone too off course to right the ship.