The SEC has been busy, both in bringing actions against digital industry participants and in defending against affirmative lawsuits brought against the agency regarding the lack of notice and rulemaking for digital assets under the Administrative Procedures Act (“APA”). Financial privacy was also front and center the past few weeks, as a new bill aimed at preserving financial privacy was proposed in the Senate and there was an important ruling in the criminal case against certain digital asset mixing service developers.

These developments and a few other brief notes are discussed below.

SEC and Coinbase Face Off in Third Circuit Over the Agency’s Rejection of Rulemaking: September 23, 2024

Background: The SEC and Coinbase had oral arguments heard by the Third Circuit in Coinbase’s appeal of the SEC’s denial of rulemaking for digital assets. This case follows a separate mandamus action in which Coinbase successfully sought to compel the SEC to rule on Coinbase’s Petition for Rulemaking so that Coinbase would have standing to appeal should the SEC deny Coinbase’s request (which it did, in a 2-page letter).

Analysis: The SEC has vast deference to setting its rulemaking agenda, so Coinbase’s requested relief (an Order from the Court for the SEC to engage in formal rulemaking on digital assets) has a slim (but not zero) chance of being granted. Notably, though, the Judges expressed some criticisms of the agency’s approach, stating, “[The SEC doesn't] have the time to [rulemake], but you have time to bring 80 enforcement actions against cryptocurrency people. So it's not that the agency isn't interested in the area. It's just interested in picking off a lot of individual ones without giving higher-level guidance.”

All SEC Commissioners Testify in Front of Congress: September 24, 2024

Background: While the SEC Chair regularly testifies in front of various Congressional committees, for the first time since 2019, all five commissioners were present for the SEC’s testimony to the House Financial Services Committee on September 24, 2024. The hearing covered many aspects of the SEC’s actions over the past year outside of digital assets, but a large portion of questions did focus specifically on cryptocurrency and the agency’s approach to rulemaking by enforcement rather than more traditional rulemaking and comment procedures.

Analysis: There were some notable clashes between Chair Gensler and Representatives Torres (D-NY), Emmer (R-MN), Nickel (D-NC), McHenry (R-NC), and others regarding the SEC’s treatment of the digital asset industry under Chair Gensler’s leadership. Also notable was an exchange between Committee Chair McHenry and Ranking Member Waters regarding outstanding stablecoin legislation, which both agreed should be passed this year (while acknowledging there is still some disagreement on what that stablecoin bill will entail).

SEC Responds to Declaratory Judgment Action in Texas: October 2, 2024

Background: The SEC has filed its reply in support of the Agency’s two motions to dismiss a declaratory judgment action brought by cryptocurrency exchange hopeful LEJILEX. This lawsuit started in February of this year, and since then various amicus were filed in support of LEJILEX, including an amicus filed by a coalition of seven state Attorney Generals (including the AG’s of neighboring states Oklahoma and Arkansas). The Agency’s primary argument is that regulation by enforcement is not challengeable in court and shielded by sovereign immunity under the Administrative Procedure Act ("APA"), while LEJILEX argues the APA is inapplicable as this is a case brought under the Declaratory Judgment Action ("DJA"), not the APA.

Analysis: The SEC’s claim that there is no concrete or imminent threat that the agency would bring a lawsuit against a cryptocurrency exchange while currently suing the three biggest cryptocurrency exchanges in the U.S. is... interesting. Generally, the Commission is correct that the law prevents bringing a lawsuit against a federal agency for fear of future lawsuits by that agency. However, the APA was “designed to provide guarantees of due process in administrative procedures,” and those guarantees are skirted when an agency engages in regulation by enforcement rather than rulemaking. LEJILEX cited solid case law in Bear Creek for the proposition that one can bring a pre-enforcement challenge when an agency brings lawsuits against others for the conduct that the challenging party plans to engage in itself. As stated by Commissioner Peirce, “[u]sing enforcement actions to tell people what the law is in an emerging industry is not an efficient or fair way of regulating.”

Crypto.com Sues SEC in Texas: October 8, 2024

Background: Foris DAX Inc. (“Crypto.com”) has gone the route of Consensys and sued the SEC for declaratory judgment after receiving a Wells notice from the agency. According to the company’s press release, “Our lawsuit contends that the SEC has unilaterally expanded its jurisdiction beyond statutory limits and separately that the SEC has established an unlawful rule that trades in nearly all crypto assets are securities transactions no matter how they are sold, whereas identical transactions in bitcoin (BTC) and ether (ETH) are somehow not.” The company also took the rarely used option of filing a petition for joint rulemaking by the CFTC/SEC under the Dodd-Frank Act to determine whether certain (undisclosed) digital asset products are "swaps," “security-based swaps” or “mixed swaps,” which is a creative way of starting the clock and forcing the agencies to put out some rationales on what digital assets are commodities vs. securities.

Analysis: We have seen how this played out for the Metamask developer when Consensys took a similar strategy and lost with the judge punting on the Texas action in light of the later case brought by the SEC pending in New York, which would reach a decision on similar issues. This case takes a different route, framing the SEC’s actions of treating everything except BTC/ETH as a “Rule” without following APA comment and rulemaking procedure and stating the Commission’s king making of two digital assets vs. substantially similar assets without explanation is arbitrary and capricious. Commissioner Uyeda, while not commenting directly on the case, criticized the Agency’s enforcement without rulemaking the digital asset space. “Our agenda is directed by the Chairman, Gary Gensler, and so the staff all follows his lead.”

DOJ and SEC Bring Charges Against Digital Asset Market Makers: October 9, 2024

Background: The DOJ and SEC have brought separate actions against individuals and entities that the agencies accuse of market manipulation of a digital asset created at the direction of the FBI in a sting effort against “wash trading” of certain digital assets to inflate transaction volume and encourage parties to buy. The FBI created their own coin called "The NexFundAI Token" (aka, "NFA," a common term in crypto-circles for “Not Financial Advice"), which the Commission claims is a security.

Analysis: The background on the DOJ’s case on the seedy underbelly of market makers is worth digging into. Apparently, the government directed these coins to be sold on publicly available markets (like Uniswap), so members of the public at large bought tokens that were created at the direction/assistance of the FBI and which the DOJ and SEC claim to be securities. This raises interesting questions on when the government can engage in unregistered securities transactions with the public in efforts to prosecute others involved in those transactions. Like Wahi before it, the DOJ is making traditional common law fraud claims that don’t require the tokens to be securities to garner a conviction. Unlike Wahi, the DOJ and SEC appear to have been working in concert with each other. These will certainly be cases worth monitoring.

Briefly Noted:

Tornado Cash Criminal Case Will Go to Trial: Judge Failla was less sympathetic in the Tornado Cash criminal matter than she was in the Uniswap matter (which is currently being appealed), rejecting the Motion to Dismiss and Motion to Compel production of documents filed by Roman Storm’s attorneys in a 1-hour oral ruling from the bench. It is unclear if there will be a written decision to follow, but this was an expected (but still disappointing) result based on the standard of being required to accept the Government’s accusations as true.

Mango Markets Settles Matter With SEC (kind of): The SEC entered a judgment against MNGO DAO, Blockworks Foundation, and Mango Labs. We knew the DAO settlement was coming, so this isn’t a surprise. However, in a twist, the DAO failed to reach the quorum required to release the coins needed to pay the settlement after a last-minute withdrawal of yes votes.

Opporty Denied Summary Judgment in ICO Case: The court denied summary judgment for the defendants and partially granted summary judgment to the SEC in this case, alleging an unregistered securities offering, among other things. A distinguishing factor of this case versus many others is that the defendants argued that the ICO was indeed made pursuant to exemptions from registration, with U.S. sales being made pursuant to Rule 506(c) (crowdfunding to accredited investors) and Regulation S (offshore offerings). Rule 506(c) permits general advertising and solicitation, while a requirement of Regulation S is that there be no “directed selling efforts” towards the US. The court’s finding that solicitations pursuant to Rule 506(c) were also directed selling efforts could have unintended consequences in foreign private placements and seems to be inconsistent with some of the SEC’s own guidance on the issue.

Both Parties Will Appeal Ripple Ruling: The SEC and Ripple have each filed a notice of appeal in the Ripple litigation, where the District Court ruled that certain sales of $XRP tokens on secondary platforms failed to satisfy Howey.

Saving Privacy Act Introduced in Senate: Senators Mike Lee (R-UT) and Rick Scott (R-FL) introduced the Saving Privacy Act, which would dramatically pair back the power of government officials to obtain Americans’ financial information without a warrant under the Bank Secrecy Act (“BSA”).

Stablecoin Bill Proposed in Senate: Senator Hagerty (TN-R) has introduced a stablecoin bill in the Senate that mirrors the House bill. The legislation now has a slightly better chance of passing this year, while still having a slim chance as there is dispute on whether the primary regulator of stablecoin issuers should be state or federal authorities.

Staking Rewards Lawsuit Filed: A new lawsuit was filed by an individual (with the backing of Coin Center) regarding the tax treatment of staking rewards. This is the second such lawsuit, after a prior lawsuit was mooted when the IRS agreed to the requested refunded overpayment for payments of staking rewards as income.

SEC Charges Prominent Market Maker With Securities Law Violations: The SEC has brought a new suit against Cumberland DRW LLC for “operating as an unregistered dealer in more than $2 billion of crypto assets offered and sold as securities.” Cumberland issued a staunch open-letter response, which included a reference to a prior case the market maker won against the CFTC when Gary Gensler was chair of that separate agency.

 Conclusion:

The flurry of regulatory and legislative actions in the digital asset space highlights the complex and evolving nature of this industry. As the SEC continues its aggressive enforcement approach, courts and lawmakers alike are grappling with the broader implications of these actions, both in terms of administrative law and the future of financial innovation. The recent developments underscore the urgent need for clear, formal rulemaking rather than regulation by enforcement, as well as the importance of balancing regulatory oversight with the preservation of financial privacy. With high-profile lawsuits, legislative proposals, and enforcement actions, the legal and regulatory landscape for digital assets remains as dynamic as ever, with significant implications for industry participants and regulators alike.