The SEC kicks Kik back or: How to lose friends, spend money and aggravate regulators

Link to motion to dismiss

Link to joint discovery letter

If you’re litigator or trial lawyer, sometimes people will call you and say they want a “junkyard dog” to go fight for them. Sometimes they are just mad and need to be talked down to earth. Sometimes what they mean is that they want someone who barks loud, drools profusely while doing it, and whose response to everything is a high level of aggression, even if it will lead them straight into the jaws of one of those junkyard car-crushing machines. It’s not that there isn’t a time and place for focused aggression in dispute resolution, but the word “focused” is important. Tactical too. It’s true that junkyard dog litigators often generate huge bills, and they don’t always get the best results for their clients. It depends. (Personally, I find incessant barking a sign of weakness. Also, the drool is gross).

On to the canine case at hand.

As a reminder, for those of you who haven’t been following closely, the SEC sued Kik Interactive, Inc. earlier this year in Federal Court in New York. The SEC says that the Kin token, which Kik sold a lot of, was actually an unregistered securities offering. This followed on the heels of a lengthy SEC investigation, capped by a Wells letter response written by Kik’s lawyers which said that the SEC was totally wrong, that half-century old jurisprudence applicable to investment contracts didn’t apply to crypto, and a follow-on fundraising effort to “fight this all the way to the Supreme Court if necessary” (I paraphrase, but that is the gist). Unamused, and unsurprisingly, the SEC sued Kik almost immediately after Kik said, in so many words, “go ahead and sue us.” (cue the barking and drool.)

Before I get to the latest development in this case, and at the risk of repeating myself, I still think that the SEC’s response was totally reasonable and — although it’s not a popular view in certain circles of the inferno, I mean crypto-twitter — the SEC hasn’t treated Kik any worse than other crypto projects. Not to beat a dead herring, but while it’s true that block one raised a kajillion dollars, they didn’t tell the SEC “come at me bro” and (at least as far as I can tell) they at least kinda-sorta tried to avoid taking money from Americans. Every time I go to a blockchain event I hear people whining about the SEC treating crypto companies unequally and this is just hooey. At least from the outside — and, yes, I am writing this from the outside — this seems like further evidence of the same howling that got Kik in a twist with the SEC to begin with.

To be clear, I am not saying the government is always right or that the SEC doesn’t make bad calls. But let’s take a look at Kik’s latest gambit and the SEC’s response, for further evidence of how to really piss off a massive and well-funded part of the U.S. Government and the generally well-educated and highly skilled lawyers who work for them.

When you file a lawsuit in federal court in the United States, that’s called a complaint. The complaint contains all of your allegations in numbered paragraphs. The defendant may file a motion to dismiss right away or they may file an answer (sometimes both; it depends). The answer admits or denies the allegations and also includes affirmative defenses. Here’s a really simple example of an affirmative defense: in a slip-and-fall case the defendant could plead contributory fault as a defense (i.e. — IT WAS YOUR OWN DAMN FAULT). In this case, the SEC filed a Complaint and Kik filed an Answer. One of Kik’s defenses is that the term “investment contract” as applied to the Kin offering and sale in 2017 is “unconstitutionally vague.”

The SEC earlier this week filed a motion to dismiss “on the pleadings” the “it’s unconstitutionally vague” affirmative defense, with a supporting brief explaining all the reasons why the SEC thinks it’s a bogus defense. SEC says contemporaneous evidence shows Kik was aware that the token sale had a high risk of being considered securities offering and had “constitutionally fair notice” of this. The DAO report provided additional notice. Kik understood the risk and didn’t go the SEC for clarification (a no-action letter, for example). You can read the SEC’s full argument, in all of its briefish glory, here. (A lot of this repeats what’s in the SEC complaint, with caselaw, but the constitutional arguments are new matter).

Now, it happens from time to time, but you don’t usually see motions to dismiss individual affirmative defenses, and this is a 26-page brief with a couple of dozen case citations. Solid legal work that took more than a couple of hours, I’d say.

“So what gives?” I wondered. And what gives is this — in support of this purported affirmative defense, Kik issued a bunch of discovery that the SEC really didn't like, to wit, and per the SEC's brief:  

Such discovery includes subpoenas to three high-ranking officials in the SEC’s Division of Corporation Finance, a notice of deposition against the agency under Federal Rule of Civil Procedure 30(b)(6), and requests for the production of many thousands of documents concerning digital assets from throughout the agency, including other investigations and litigations, that are unrelated to the complaint’s allegations. By all appearances, Kik is trying to create an irrelevant sideshow about the SEC’s regulation of digital assets that diverts attention from Kik’s illegal conduct.

I read this and thought that there was little chance of a federal judge ordering the SEC to produce investigative materials from other ICO is, as we say in the business, “slim to none and slim just left town.” I was also skeptical that the court is going to order high-ranking SEC officials to be deposed to support what this brief lays out in rather convincing fashion is a defense that can be best be described as a thin Hail Mary.

It's true that the SEC can be deposed, under Rule 30(b)(6) of the Federal Rules of Civil Procedure, which governs dispositions of organizations, which is defined to include a government agency. The agency is not, as one court put it, “categorically exempt” from the rule.  However, the cases that have addressed this significantly restrict the scope of such notices — it’s unlikely that their testimony will have any bearing on this investigation; whether or not their testimony on the constitutionality of the term “investment contract” as applied to Kik is really relevant. You generally have to show in a very narrow and tailored fashion how the testimony would be specifically related to defense of the investigation (and do so without violating attorney-client privilege and work product protections — you can’t depose the other side’s lawyer, as a general rule). The constitutional vagueness argument is all Kik had and, weak tea or not, this is why the SEC was apparently intent on knocking the defense out now.

And this deposition gambit is probably why the SEC just filed a nearly 30-page brief about a single affirmative defense. Look, lawyers do things all the time in the name of aggressive defense. After the motion was filed Kik and the SEC filed a letter with the Court dealing with these discovery requests. Kik argues that it needs to take the depositions of (1) William Hinman (Director of the SEC’s Division of Corporation Finance), (2) Valarie Szczepanik (Associate Director of the SEC’s Division of Corporation Finance), and (3) Jonathan Ingram (Deputy Chief Counsel of the SEC’s Division of Corporation Finance) and a corporate designee. It says that it needs deposition "to shed light on the SEC’s inconsistent (and apparently arbitrary) application of securities laws in this area and its affirmative decision not to provide clear guidance. It also seeks to depose three of the individuals who were most involved in, and thus aware of, the development and execution of this approach.”

This is thin gruel, and the SEC pointed out the deposition request when examined is absurdly overbroad and includes (as a for example) a request that one of these people apparently testify about

"Communications between the SEC and distributed ledger industry stakeholders or other groups representing the interests of entities working with Virtual Currencies and/or Digital Assets, from January 1, 2013 to June 1, 2019, concerning the application of federal securities laws (including, but not limited to, the Securities Act of 1933) to Virtual Currencies and/or Digital Assets and the offer and sale of such Virtual Currencies and/or Digital Assets."

Anyway, the judge in this case had the same conclusion as me, mostly. None of these depositions are happening. Per the Court, in a docket entry (without a written opinion): “Defendant seeks discovery relating to its affirmative defense that section 5 of the Securities Act is void for vagueness. The affirmative defense raises an issue of law, not of fact. The SEC’s motion for a protective order, striking defendant’s notice to take depositions of SEC officials, is granted. Defendant’s request for document production relating to the affirmative defense is denied.”

The motion to dismiss is denied “without prejudice” to renewal when “substantive motions” are later filed. In other words, the SEC didn’t get the affirmative defense dismissed but, honestly, who cares because the plaintiff doesn’t get its discovery requests. At this point, as far as I can tell, all Kik got out of this gambit was one more opportunity to explain its theory of the case to the Court. Kik, on the other hand, got … well … a lot of barking and a puddle of drool.

Woof.