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It’s hard to believe that 7 years have passed since the SEC issued its report declaring that digital assets were “securities” and former Chair Jay Clayton cautioned investors to be wary of unregistered offerings of tokens (or “ICOs,” as they were called back then). This WSJ article calls the SEC’s fight with the crypto industry the agency’s “forever war.” They might be right! The saga isn’t showing signs of wrapping up anytime soon.

Later this month, a judge will hear the Commission’s most-watched crypto case – against Coinbase. The SEC recently shot down the crypto exchange’s rulemaking petition (despite disagreement from Commissioners Peirce & Uyeda). The SEC’s letter reiterates the view that the existing securities law framework will work just fine for digital assets and coming up with a special framework is not a regulatory priority at this time:

The Commission disagrees with the Petition’s assertion that application of existing securities statutes and regulations to crypto asset securities, issuers of those securities, and intermediaries in the trading, settlement, and custody of those securities is unworkable.

Although the formal letter denying the petition was brief, the supporting statement from SEC Chair Gary Gensler was not. Here’s an excerpt:

Existing laws and regulations already apply to the crypto securities markets.

There is nothing about the crypto securities markets that suggests that investors and issuers are less deserving of the protections of our securities laws. Congress could have said in 1933 or in 1934 that the securities laws applied only to stocks and bonds. Instead, Congress included a long list of 30-plus items in the definition of a security, including the term “investment contract.”

As articulated in the famous Supreme Court decision, SEC v. W.J. Howey Co., an investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. The Howey Court said that the definition of an investment contract “embodies a flexible, rather than a static, principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” This test has been reaffirmed by the Supreme Court numerous times—the Court cited Howey as recently as 2019.

But wait, there’s more. The Coinbase hearing will follow a recent court victory for the SEC in its case against a token issuer – Terraform – in which the Commission alleged that token sales violated Section 5 of the Securities Act. The company’s defense turned on whether the tokens were “securities” – and the case is going to a civil trial after US District Judge Jed Rakoff issued this 71-page opinion in late December. Judge Rakoff applied the “Howey test” to UST, LUNA, wLUNA, and MIR and found they passed “with flying colors.” Here’s an excerpt (see this Coingeek article for more commentary):

Defendants’ first argument in effect asks this Court to cast aside decades of settled law of the Supreme Court and the Second Circuit. In the seminal decision of SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), the Supreme Court held in no uncertain terms that “an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” Id. at 298-99, 66 S.Ct. 1100. Defendants urge this Court to scrap that definition, deeming it “dicta” that is the product of statutory interpretation of a bygone era. The Court declines defendants’ invitation. Howey’s definition of “investment contract” was and remains a binding statement of the law, not dicta. And even if, in some conceivable reality, the Supreme Court intended the definition to be dicta, that is of no moment because the Second Circuit has likewise adopted the Howey test as the law. See, e.g., Revak v. SEC Realty Corp., 18 F.3d 81, 87 (2d Cir. 1994).

There is no genuine dispute that the elements of the Howey test — “(i) investment of money (ii) in a common enterprise (iii) with profits to be derived solely from the efforts of others” (id.) — have been met for UST, LUNA, wLUNA, and MIR.

The WSJ article says it’s unlikely we’ll see a resolution this year to the Coinbase litigation or the bigger question of whether & how SEC regulations apply to digital assets. There are very bright & experienced lawyers on both sides of the SEC’s battle to regulate crypto, and it looks like they’re all digging in for a long fight.

– Liz Dunshee