Regulation
Crypto Counteroffensives Highlight Need for Regulation
A potential new trend in crypto litigation has begun to emerge as private companies and industry-related nonprofits begin filing complaints against the Securities and Exchange Commission. Complaints aim to protect complaining companies from coercive measures. Importantly, they also highlight the need for regulation.
Ultimately, it is the SEC and the Commodity Futures Trading Commission, not the courts, that are best positioned to provide clarity to businesses in this complex and evolving space.
The plaintiffs seek declaratory and injunctive relief in complaints filed in Texas federal courts by Lejilex and Crypto Freedom Alliance of Texas and by Beba LLC and DeFi Education Fund. Lejilex describe itself as “a non-custodial digital asset exchange platform that allows users to trade digital assets through the use of underlying smart contracts” in “blind bid/sell transactions “.
It seeks to avoid being required to register “as a securities exchange, broker or clearing agency”. And the complaint in Beba LLC describes the lead plaintiff as a small online clothing company that has “incorporated digital assets into its business” and distributed its BEBA token for free via an airdrop.
This complaint alleges that the SEC will “take the position that BEBA tokens are investment contracts and that the airdrop is a securities transaction.” Both complaints argue that the SEC lacks jurisdiction to take enforcement action against them.
The main allegations in these two cases are similar to arguments made by defendants in recent cases in the U.S. District Court for the Southern District of New York, including SEC vs. Ripple Labs, SEC vs. Terraform LabsAnd SEC vs. Coinbase. The plaintiffs’ choice of federal courts in Texas means the U.S. Court of Appeals for the Fifth Circuit will likely have the opportunity to decide these central questions, potentially creating a divide within the federal appeals courts and inviting review by the Supreme Court of the United States.
Politically, the complaints demonstrate an unusual “offensive” against the SEC and put under scrutiny the regulatory approach chosen by the SEC, which has been criticized as “regulation by application.” The fight against fraud is undoubtedly an essential pillar of our securities and derivatives markets. On the other hand, enforcing the rules as a policy is not the most effective way to regulate these markets.
One of us has trace how the SEC began enforcing antifraud law in crypto, protecting investors in primary market transactions. His contributions in the cases against fraudulent initial coin offerings, or ICOs, have been undeniably positive.
Yet the SEC has moved slowly toward enforcing the mandatory registration provisions of the securities laws, first against issuers and then against exchanges and broker-dealers. This progression has led to questionable results in terms of investor protection, particularly when the projects are not fraudulent and the companies are profitable. This course of action has also failed to ensure clarity in prospective regulation, which is an important element of sound regulation.
The recent complaints are a natural corollary of these enforcement trends and highlight the critical need for certainty in primary markets and secondary trading. At the heart are questions of jurisdiction and a complex doctrinal inquiry: Are cryptoassets and transactions with cryptoassets within the jurisdiction of the SEC? Are these titles?
The Lejilex and Beba complaints challenge, as overly broad and unconstrained, the SEC’s likely assertion that the BEBA token and the tokens to be traded on the Lejilex exchange are “investment contracts” and therefore “securities.” » pursuant to the case SEC v. Howey. Both complaints suggest that an underlying contractual relationship between asset creators and investors is key to Howey.
After a primary distribution of crypto-assets, secondary trading of the underlying assets follows. Secondary Market Traders are not anymore parties to the initial contractual agreement between the crypto-asset issuer and the initial investors. So, what is the nature of the assets they acquire? Are assets still investment contracts or just unsecured assets in the form of lines of code?
In ruling on the parties’ cross-motions for summary judgment in the Ripple Labs case, Judge Analisa Torres held that Ripple’s institutional sales were investment contracts, but that Ripple’s programmatic sales to public purchasers on crypto exchanges were not. In Terraform, Judge Jed Rakoff “refused to draw a distinction” between Terraform cryptoassets sold “directly to institutional investors and those sold via secondary market transactions to retail investors.”
Similarly, in Coinbase, Judge Katherine Polk Failla held that the SEC correctly argued that certain cryptoassets traded on Coinbase were investment contracts, even though the investors had not purchased those assets directly from the transmitter.
If Texas courts decide that cryptoassets, particularly those traded on secondary markets, are not securities, then the SEC cannot claim jurisdiction over the trading platforms on which those assets are listed. This outcome could, in theory, conflict with a future decision by Coinbase, among others.
Congress or the SEC and the Commodity Futures Trading Commission (by developing joint rules) could address these and other related issues more effectively than the courts. The justice system is not a useful regulatory tool for modern markets, and research supports the need for reform.
One of us evaluated how investors perceive enforcement by the SEC and CFTC. SEC enforcement, particularly against stock exchanges, generates a more negative investor response than CFTC enforcement, suggesting the need to modernize U.S. securities laws. The global crypto-asset market appears more receptive to anti-fraud enforcement, indicating that investors appreciate the commissions’ efforts to eliminate fraud, resulting in quality improvements that offset a negative reaction global regulation through application.
Regulatory reforms are urgently needed. Litigation can take years, while technology evolves rapidly. Additionally, the EU, UK and other countries have already introduced or are about to introduce concrete legal frameworks for crypto-assets and the infrastructure necessary for their issuance and trading. In doing so, they distinguish between securities and cryptoassets.
In the future, a cryptoasset permitted to trade in Europe as a non-financial instrument could be found to be in violation of U.S. securities law. As a result, we may not be heading so much towards a division of circuits as towards a conflict of jurisdiction between the major markets on both sides of the Atlantic.
This article does not necessarily reflect the views of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author information
Douglas S. Eakeley is a professor and founder/co-director of the Center for Corporate Law and Governance at Rutgers Law School.
Yulia Guseva is a professor of law and director of the fintech and blockchain research program at Rutgers Law School.
Write for us: Guidelines for authors