Cryptocurrency companies, industry groups and seven states filed five amicus briefs last week in a federal case in Fort Worth, accusing the U.S. Securities and Exchange Commission of overstepping its authority and bringing unfair enforcement actions.
The SEC has wrongfully categorized cryptocurrency coins and tokens as securities, departing from its earlier stance, the amici say, and is ignoring pleas for notice-and-comment rulemaking, forcing industry participants into an “impossible” situation.
The pending case is brought by Texas company LEJILEX, which seeks to launch a trading platform called Legit.Exchange, and non-profit industry organization Crypto Freedom Alliance of Texas, known as CFAT. The lawsuit, filed in February in the Northern District of Texas, names the SEC, the regional director of the Fort Worth Regional Office, Eric R. Werner, SEC Chair Gary Gensler and each of the four SEC commissioners as defendants.
The plaintiffs are asking Judge Reed C. O’Connor to rule that digital assets are not securities and to prevent the SEC from bringing an enforcement action against LEJILEX and other “similarly situated” CFAT members who don’t register as securities exchanges, brokers or clearing agencies. The plaintiffs’ legal team includes former U.S. Solicitor General Paul D. Clement of Clement & Murphy.
In its motion to dismiss, the SEC called the lawsuit “fatally premature” and argues the agency’s sovereign immunity bars the suit. The SEC did not respond to The Lawbook’s request for comment.
Plaintiffs have put the major questions doctrine front and center, said Chris Davis of Gray Reed’s Dallas office. Davis, a former SEC trial lawyer, authored an amicus brief for non-profits Texas Blockchain Council and Investor Choice Advocates Network.
“That’s where the rubber hits the road,” Davis said. “This is a major question that needs to be addressed by Congress, not a regulatory agency that’s not accountable to the voters. All those types of questions, to me, are the key questions the court’s probably going to be looking to answer here.”
The agency has gone “rogue,” as the states describe, and is “on an indiscriminate enforcement crusade,” Coinbase, a crypto trading platform, wrote in its amicus brief. LEJILEX is “right to fear an (unlawful) enforcement action from the SEC,” said Coinbase, whose lawyers include former assistant solicitor general Jonathan C. Bond of Gibson, Dunn & Crutcher.
The SEC took enforcement action against Coinbase last year because it did not register its trading platform as a national securities exchange, broker and clearing agency. The SEC also charged Coinbase with engaging in an unregistered securities offering through its staking program, which offers service providers to crypto users.
But Coinbase was founded more than a decade before the SEC brought its action, and the company has trained thousands of law enforcement agents and analysts in blockchain analytics and other investigative techniques, Coinbase pointed out in its brief.
The SEC’s regulation of cryptocurrency threatens to preempt dozens of state laws, according to the amicus brief filed on behalf of Iowa, Arkansas, Indiana, Kansas, Montana, Nebraska and Oklahoma. The states wrote in their brief that they are not in support of either party in the lawsuit but oppose the SEC’s actions in this space.
The amici argue that the SEC has made contradictory statements about whether digital assets constitute securities and whether the agency can regulate digital asset exchanges, the amici argue. The plaintiffs pointed to the following statements in their complaint, which some amici re-emphasized.
- In 2018, then-director of the SEC Division of Corporation Finance, Bill Hinman, speaking to the Yahoo Finance All Markets Summit in San Francisco, said a coin or token “all by itself is not a security.” (He said, however, that how something is sold is central to determining whether that thing is a security, as well as the reasonable expectations of purchasers.)
- In May 2021, SEC Chair Garry Gensler testified before Congress that “only Congress” could address the regulation of digital assets because of a lack of regulatory framework at the SEC and the Commodity Futures Trading Commission. “Right now, there is not a market regulator around these crypto exchanges,” Gensler said.
Industry participants have asked for the SEC to provide explicit regulation, but the SEC has not, the amici say. Coinbase petitioned the agency in July 2022 to propose and adopt rules for identifying which digital assets are securities and for regulating them on digital methods. The SEC responded with a two-page letter denying the petition “with virtually no rationale,” Coinbase wrote. Coinbase is challenging the denial in the Third Circuit.
“To be clear, Coinbase strongly disagrees that the SEC has the statutory authority it now claims over digital assets,” Coinbase wrote in its amicus brief. “But if the agency is going to assert that authority, the [Administrative Procedure Act] and fundamental principles of fair notice and due process require the agency to articulate and explain its revised position in advance through notice-and-comment rulemaking — resulting in regulations subject to judicial review before the SEC attempts to enforce its new view.”
The result is digital asset firms are caught in a Catch-22, Coinbase wrote, because the crypto companies are expected to comply with rules “designed for legacy financial institutions” that would nullify their function or face punitive SEC enforcement actions “for failing to achieve the impossible.”
Coinbase suggested the SEC’s “ultimate goal is to drive the industry out of business.”
Congress would be exceeding its constitutional authority if it did authorize the SEC to regulate securities, the states contend.
“The Securities Act is unconstitutional as applied to cryptocurrencies,” unless Congress enacts a new law or limits the statute’s reach, the states wrote.
The other amicus briefs were filed on behalf of investment firm Paradigm Operations and non-profit trade group The Digital Chamber.
Although it is hard to say how successful an amicus brief may be, Davis says they can be influential and pointed to one that his client ICAN submitted in another case over the SEC’s private funds rule, which the U.S. Court of Appeals for the Fifth Circuit vacated last month. The judges’ opinion seems to indicate they gave weight to ICAN’s brief, Davis said.
Davis’ approach to the amicus brief before the Fort Worth judge was to provide an additional, practical perspective for the judge to consider, rather than re-hashing case law the plaintiffs already pointed out in their filings.
“Frankly, people’s livelihoods are legitimately on the line,” Davis said. “We’re trying to represent that perspective and I do think it’s helpful to the court. I think that kind of stuff, generally speaking, is more helpful than just piggybacking off the legal arguments.”
Coinbase is represented by Stephen James Hammer, Denis Nicholas Harper, Eugene Scalia, Jonathan C Bond and Zach Young of Gibson Dunn & Crutcher.
Texas Blockchain Council and Investor Choice Advocates Network are also represented by Joshua Smeltzer of Gray Reed.
Paradigm Operations is represented byKyle D. Hawkins of Lehotsky Keller.
The Digital Chamber is represented by Ambika Behal Singhal and Teresa Goody Guillen of Baker & Hostetler.
The SEC is represented by in-house counsel: Jason J. Rose in Fort Worth and Jeffrey A. Berger, Ezekiel L. Hill and David D. Lisitza in Washington D.C.
LEJILEX and Crypto Freedom Alliance of Texas are represented by Randy D. Gordon, John S. Polzer, Christopher A. Brown, Joakim G. Soederbaum of Duane Morris and Paul D. Clement, Erin E. Murphy, C. Harker Rhodes IV and Nicholas M. Gallagher of Clement & Murphy.
The states are represented by Brenna Bird, Eric H. Wessan and Patrick C. Valencia of the Attorney General of Iowa. The case is LEJILEX et al. v. Securities and Exchange Commission et al., 4:24-cv-00168.