Sorry crypto world, but the SEC isn’t backing down on ‘regulation by enforcement’
By Alison Frankel
(Reuters) – For as long as I have covered US Securities and Exchange Commission litigation against crypto targets, the industry has harshly criticized the commission for enforcing actions one at a time as a way to set crypto regulatory policy, rather than engaging in formal rulemaking or waiting for Congress to pass legislation clarifying when US securities laws apply to digital assets.
In the latest example, a former Coinbase Global Inc executive who was accused of insider trading last year by both the US Department of Justice and the SEC moved this week to dismiss the SEC’s complaint, arguing among other things that he did not know that Ethereum-based crypto- the tokens he traded would be defined as securities by the SEC. Former Coinbase employee Ishan Wahi pleaded guilty Tuesday to conspiring to commit wire fraud, but even during the plea hearing in his criminal case, Wahi insisted the relevant tokens were not securities.
“The only safe feature of the SEC’s approach to digital asset regulation is its uncertainty,” Wahi’s defense attorneys from Jones Day, Greenberg Traurig and Harris St. Laurent & Wechsler argued in Monday’s motion to toss the SEC’s case against Wahi and his brother.
Coinbase expressly said the tokens Wahi and his brother traded were not securities, his lawyers said, and Congress has not told crypto investors which digital coins may be regulated by the SEC. Right now, Wahi argued, crypto users are simply left guessing about their exposure to SEC enforcement — and that’s not sustainable.
“At some point,” the letter said, “the SEC’s Delphic strategy of disclosing lump sums via enforcement actions must meet the fundamental protections of the legal system.”
The SEC seems to think otherwise. Based on the commission’s filing this week in a crypto law firm’s declaratory judgment lawsuit seeking a ruling that the Ethereum blockchain network and its native Ether cryptocurrency are not securities under U.S. law, it appears the SEC is in no rush to change its “Delfic strategy” which has infuriated crypto defendants.
Hodl Law, which describes itself as focusing on “legal services for digital assets and cryptocurrency,” sued the SEC in November in federal court in San Diego, alleging that the SEC has engaged in “years of purposeful delay and obfuscation” for to expand its regulatory reach over cryptocurrencies. That strategy, Hodl Law argued, did not give token holders fair notice of whether their coins are securities.
Citing the SEC’s Wahi case, Hodl Law argued that due to the SEC’s alleged refusal to provide “concrete guidance”, millions of Ethereum users, including the law firm, are in dire need of a declaratory judgment that Ether is not a security and Ethereum contracts are not securities transactions. Otherwise, Hodl Law said, Ethereum users have no idea whether the SEC will step in with an enforcement action.
In Monday’s dismissal letter, the SEC offered technical arguments to toss the case, arguing before U.S. District Judge James Lorenz that because there is no direct case or controversy between Hodl Law and the commission, the law firm lacks constitutional standing and the court does not have jurisdiction under the Declaration Act.
But that wasn’t all. The SEC also said it is not obligated to warn crypto users about their interpretation of securities laws.
“Hodl Law has not alleged that the SEC has an obligation to explain Hodl Law’s rights to it under the federal securities laws or to promise not to prosecute it in the future, nor has it pointed to any law that would impose such an obligation,” it said SEC. “At its core, the complaint merely demonstrates Hodl Law’s desire for the SEC to promulgate rules around crypto/digital assets.”
The law firm’s “general anxiety about the potential for an SEC investigation and speculation about the SEC’s views on crypto/digital assets,” is not a case, the SEC said. Simply put, the commission argued, Hodl Law and all other Ethereum users will just have to wait for the SEC to do whatever the commission decides to do.
This stance is bound to anger the crypto industry, regardless of the strength of the SEC’s other arguments for rejecting the Hodl Law case.
The SEC declined to comment on the Wahi or Hodl cases. Wahi adviser James Burnham of Jones Day declined to comment.
Hodl Law partner Frederick Rispoli said via email that the SEC’s motion to dismiss “did not address” the many cases in which the commission “has attacked users of digital assets with subsequent enforcement actions.” These cases – including the Wahi lawsuit – show the imminent danger that Ethereum users face, according to Rispoli.
Several SEC cases, as you may recall, have sought to convince federal judges that the cryptoassets at issue in their cases did not meet the definition of a security under the US Supreme Court’s 1946 SEC v. WJ Howey Co. test. To the best of my knowledge, no judge has sided with the SEC, including a federal judge in New Hampshire who delivered a notable victory for the commission last November when he adopted the SEC’s theory that a digital currency is a security when buyers expect that the crypto issuer shall use its own staff of coins to increase the total value of the currency.
The next major test of the SEC’s cryptoregulatory power is expected to come in the closely watched case against Ripple Labs Inc, where both sides have briefed on dueling summary judgments to US District Judge Analisa Torres in Manhattan.
The Wahi dismissal letter filed on Monday contains many of the same arguments as Ripple’s summary judgment motion. However, it also provides the first robust explanation of an argument I expect to see more often in SEC crypto cases: SEC enforcement, according to Wahi, is precluded by the Supreme Court’s newly articulated main issue doctrine.
Wahi argues that the new doctrine, outlined in West Virginia v. Environmental Protection Agency last June, precludes the SEC from using enforcement action to regulate the uncharted crypto industry without any guidance from Congress.
I doubt the argument will change the SEC’s mind. We’ll see if the judges buy it.
Read more:
Ex-Coinbase CEO pleads guilty in insider trading case
Until Ripple’s decision, the crypto industry will not know the impact of regulatory ownership over LBRY
The US Supreme Court just gave federal agencies a big reason to worry
(Reporting by Alison Frankel; Editing by Leigh Jones)
