There have been numerous lawsuits brought against the U.S. Securities and Exchange Commission (SEC) alleging that it has acted improperly and outside the law in regulating the crypto industry through enforcement actions and threats – rather than through regulation. See here (Consensys lawsuit) and here (Crypto.com lawsuit). On November 14, 2024, Attorneys General from 18 states brought their own lawsuit, naming as defendants the SEC, Chairman Gary Gensler, and each of the Commissioners (in their official capacities). Kentucky AG Russell Coleman is lead plaintiff and is joined by Attorneys General from Arkansas, Florida, Indiana, Iowa, Kansas, Louisiana, Mississippi, Missouri, Montana, Nebraska, Ohio, Oklahoma, South Carolina, Tennessee, Texas, Utah and West Virginia. Crypto advocacy group DeFi Education Fund (DEF) is an additional plaintiff. DEF is already the plaintiff in a lawsuit against the SEC in federal court in Texas, along with apparel company Beba, in which it makes similar claims to the ones in this lawsuit.
Chairman Gensler is on record as saying cryptocurrencies, other than Bitcoin (and probably Ether), are securities and fall under the SEC’s purview. At the heart of the lawsuit are issues of federalism. The complaint alleges:
Instead of respecting that constitutional balance of power, and allowing States to develop and enforce their own tailored digital asset regulations based on their own policy priorities … the SEC’s assertion of sweeping jurisdiction without congressional authorization deprives States of their proper sovereign role and chills the development of innovative regulatory frameworks for the digital asset industry.
The SEC’s policy of “treating secondary transactions in common digital assets as uniformly investment ‘contracts,’ and of treating platforms that facilitate such transactions as securities exchanges, broker-dealers, and clearing agencies subject to the registration requirements of the Securities and Exchange Acts,” according to the complaint, exceeds the scope of the agency’s statutory authority and unlawfully wrests primary regulatory authority away from the States. It is this broad interpretation that has resulted in the SEC suing some of the largest crypto platforms, such as Kraken and Coinbase, claiming that selling unregistered securities on their platforms violates securities law.
The complaint points out that multiple SEC Commissioners have observed that, “[u]sing enforcement actions to tell people what the law is in an emerging industry” is not a “fair way of regulating,” as “one-off enforcement actions and cookie-cutter analysis does not cut it” when it comes to providing fair notice of what the law requires. The SEC nevertheless has refused to propose for public comment any regulations setting forth its view on what purportedly brings a digital asset (or a transaction involving a digital asset) within its regulatory domain—and in fact denied a petition for rulemaking imploring the agency to do so.
The complaint alleges that the SEC’s approach to crypto enforcement also runs headlong into the major questions doctrine, as it would require interpreting 90-year-old statutory text to empower the SEC to exercise novel and transformative authority that Congress has never afforded and, in fact, has conspicuously declined to grant. The complaint uses the following analogy:
Someone who purchases limited-run Nike sneakers intending to resell them, for example, may well expect to turn a profit based on Nike’s managerial and promotional efforts to create demand for and otherwise increase the value of those desirable shoes. Under the SEC’s newly minted view of its statutory reach, that would apparently be enough to turn the sale of those sneakers into a securities transaction regulated by the SEC, and any auction house or consignment store that facilitates such sales into an unregistered securities exchange—subjecting them to the onerous and ill-suited requirements of the federal securities laws, and displacing state regulations that should properly govern. That sweeping claim of agency dominion reaches far beyond anything Congress authorized in any statute . . .
The Attorneys General argue that, perhaps recognizing the problems with its “regulatory landgrab,” the SEC has scrupulously avoided promulgating its position in a written rule through notice-and-comment rulemaking and, instead, has operated in “enforcement-only” mode.
The SEC’s conduct creates an additional problem, according to the States, in that it also violates the Administrative Procedure Act. That is, the complaint alleges that the policy the SEC has adopted and enforced with respect to crypto constitutes “final agency action.” And, according to the States, the SEC’s “crypto policy” is also a legislative rule—i.e., “[a]n agency action that purports to impose legally binding obligations or prohibitions on regulated parties” and that provides “the basis for an enforcement action for violations of those obligations or requirements.” The APA requires that these types of actions must meet notice-and-comment procedures so that affected parties have fair warning of potential changes in the law and an opportunity to be heard on those changes, thereby affording the relevant agency a chance to avoid errors and make a more informed decision.
The lawsuit seeks the following relief, plus attorneys’ fees and costs:
a. A declaration that a digital asset transaction is not an investment contract under the Securities Act of 1933 or the Exchange Act of 1934 if it does not transfer any stake in any enterprise that the seller or anyone else has an obligation to manage for the asset owner’s benefit and share resulting profits;
b. A declaration that digital asset platforms that facilitate secondary transactions that lack those characteristics need not register as securities exchanges, dealers, brokers, or clearing agencies under the Securities Act of 1933 or the Exchange Act of 1934;
c. An order enjoining Defendants from bringing enforcement actions premised on the failure of digital asset platforms facilitating such secondary transactions to register as securities exchanges, dealers, brokers, or clearing agencies under the Securities Act of 1933 or the Exchange Act of 1934;
d. A declaration that Defendants violated the Administrative Procedure Act by adopting the policy of treating secondary transactions in common digital assets as uniformly “investment contracts,” and of treating platforms that facilitate such transactions as securities exchanges, broker-dealers, and clearing agencies subject to the registration requirements of the Securities Act of 1933 or the Exchange Act of 1934; and
e. A declaration that Defendants’ refusal to promulgate that policy through notice-and comment rulemaking violated the Administrative Procedure Act.
Finally, one cannot deny the political overlay here. The crypto industry made significant donations to President-elect Trump in the recent election, who spoke often about the Biden Administration’s “war on Crypto.” It is a foregone conclusion that Chairman Gensler’s days at the SEC are numbered. And, the 18 States that are Plaintiffs are historically “red” states. It should therefore not be surprising that the lawsuit was brought nine days after election day.
