In a huge reversal for the Securities & Exchanges Commission (SEC), 18(!) states have joined with advocacy group DeFi Education fund in asking a Federal Court to restrain the SEC from bringing further actions against crypto-company defendants, saying that the lawsuits brought by the SEC under Chair Gensler's:
'crypto policy' is 'unlawful executive action'
The Attorney General of Kentucky, where the lawsuit was filed, was quick to highlight the media picking up the story:
The lawsuit's filing argue:
the SEC has sought to unilaterally wrest regulatory authority away from the States through an ongoing series of enforcement actions targeting the 3 digital asset industry, premised on the theory that practically all purchases and sales of digital assets are “investment contracts”—and so qualify as securities transactions under the Securities Act of 1933 and the Exchange Act of 1934—because some digital asset buyers expect those assets to increase in value based on the efforts of their creators...and subjects the entire digital asset industry to a single ill-fitting regime that Congress enacted for an entirely different kind of financial instrument.
This is a reference to the famous Howey test which the SEC has applied very expansively to crypto-assets, previously calling them 'crypto asset securities' but pivoting recently to now call them 'crypto-assets sold as securities'. Importantly the lawsuit highlights the key policy issue which does not get as much light as it should - it is presently impossible for crypto-asset projects issuing tokens to comply with existing financial services laws.
Those who are in favour of bespoke regulation argue that consultative rule-making should be undertaken to address this issue and provide a pathway to compliance. Those against either ignore the issue, leading to criticism of Chair Gensler's invitation to "come in and register" given registration is impossible, or argue that crypto projects must modify their entire business operations to retrofit into the existing laws, which would, projects argue, mean removing everything novel or innovative about their operations / projects.
The lawsuit goes on to argue:
The SEC’s logic would empower the agency to regulate (and displace State regulation of) not only all transactions in digital assets but also a boundless array of other assets as well, from collectibles to luxury goods and beyond.
There is plainly a delicate line to be walked, the use of blockchain or crypto technology should not permit a product which is presently regulated from escaping regulation by becoming tokenised, but nor should that choice of technology transform a digital good into something which cannot comply with securities regulations.
Regulators have been grappling with this problem for some time, trying to avoid an erosion of control over traditional financial markets while recognising crypto-systems are creating a 'financialisation' of products which was not previously possible.
The risks posed by crypto-systems also differ in fundamental ways from those in traditional financial marketplaces, all of which highlights the urgent need for bespoke and fit for purpose regulation which is innovation enabling, so as to protect consumers and investors who clearly want to access this market. Recent comments from the ASIC annual forum in Australia show that there is limited understanding of crypto-products, with the ASIC Chair raising the "greater fool theory" and the Reserve Bank of Australia Chair saying she doesn't understand bitcoin. The mantra of "same activity, same risk, same regulation" has been raised as a guiding principle for crypto-asset regulation, and this time-tested approach is an excellent guide, so long as there is sufficient fit to the unique technical aspects of crypto-assets which simply do not function the same as traditional products. For example, in 2002 Coinbase identified 50 questions needing guidance or exemptions under the US regulatory framework when crypto-assets were being considered and sought engagement and rule-making. That has been rejected by the SEC so far, leading to Coinbase suing the SEC to try and require rulemaking. In Australia, proposals for licensing of crypto exchanges do not address when tokens may or may not be financial products, and there is no guidance given as to how a token which IS a financial product could be offered for sale in a way compliant with existing laws. It is unfortunate that the situation of an absence of rule-making coupled with regulation by enforcement has led to a point where US states must sue the Federal regulator but with the recent US election and a likely change in leadership at the SEC there seems to be a focus on lawsuits where fraud has occurred, rather than a regulation-by-enforcement approach continuing. Which jurisdictions follow this potential change will be revealing as crypto continues to grow and regulators must make hard decisions around what controls they can put around access to the crypto markets.
By Michael Bacina
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