SEC Hearing; Update in SEC v. Coinbase; Consensys v. SEC Dismissed

Congress Blasts SEC’s Approach to Crypto in Oversight Hearing

What happened? 

Last week, the House Financial Services Committee (HFSC) held a hearing conducting oversight of the Securities and Exchange Commission (SEC). The oversight hearing included testimony from all five Commissioners, who have not sat together in front of Congress since 2019. The hearing was aimed at examining the SEC’s focus on digital asset regulation by enforcement in lieu of its responsibilities of capital formation. Several members specifically critiqued the SEC’s lack of clear guidance or rulemaking, which has left the American digital asset ecosystem in a state of regulatory uncertainty. Crypto-related discussion in the hearing also centered on SEC’s flawed application of incompatible securities laws to digital assets and subsequent enforcement actions, SEC’s Staff Accounting Bulletin (SAB) 121, and the Consolidated Audit Trail (CAT). 

Committee Chairman Patrick McHenry (R-NC) opened the hearing by labeling the SEC under Chair Gensler’s leadership as a “rogue agency” that routinely exploits and exceeds its authority to the detriment of capital markets, innovation, and the American people. He called for  legislative action, stating that “without the regulatory clarity and consumer protections in FIT21, the United States will continue to fall behind Europe in technological innovation and adoption.” 

Republican members argued throughout the hearing that the SEC is exceeding statutory authority with digital asset enforcement. Republican leadership noted several times throughout the hearing that Chair Gensler has failed to pass a single rule focused exclusively on facilitating capital formation, which is one of the three central pillars of the Commission’s mission. Many Republican members echoed Chairman McHenry’s assertions that American competitive innovation is under threat due to the lack of regulatory clarity and endorsed FIT21.

Notably, Democratic Ranking Member Maxine Waters (D-CA) publicly stated that she wanted to “strike a grand bargain” on stablecoin legislation by the end of the year. Democratic leadership generally lauded the “good work” the SEC has done under Chair Gensler by “ensuring investor protection” and bringing over 700 enforcement actions and collecting $5 billion in fines. 

In the first question of the hearing, Chairman McHenry highlighted the confusion that the SEC caused by using several conflicting terms to describe its view of the law, such as “crypto tokens,” “crypto security tokens,” “crypto assets,” “crypto asset securities,” “digital asset securities,” and “digital asset securities that are investment contracts.” Chairman McHenry directly asked Chair Gensler if the SEC differentiates between crypto tokens and tokenized securities, to which Chair Gensler repeated his mantra of that the answer to that question is  “facts and circumstances” dependent. Chairman McHenry retorted, “the direct question is about the different terms, and rather than answering that question, you answered a separate question, kudos to you.” Commissioner Hester Peirce said that the SEC has “taken a legally imprecise view to mask the regulatory lack of clarity.” “I think what’s happening is that we are trying to be ambiguous because the legal precision carries with it real implications,” she continued. Commenting on the discussion, Representative Tom Emmer (R-IN) noted the term “crypto asset security” has no statutory basis. 

Representative Ritchie Torres (D-NY) dissected the “Gensler Theory of Investment Contracts” in his questioning. He asked Chair Gensler if a ticket to a Yankees game is a security. Chair Gensler answered saying that he does not believe so. Representative Torres then said that the purpose of a Yankee ticket is to have access to a Yankees game and connected this analogy to the Stoner Cats enforcement action, scolding the SEC for inhibiting artistic expression by claiming that the NFT was a security. Representative Torres then addressed the misleading term “digital asset security,” explaining that “the fictional term ‘digital asset security’ perpetuates the false narrative that digital assets in and of themselves are securities.”   

Representative Wiley Nickel (D-NC) questioned the witnesses on SAB 121 and noted that, despite both parties being against the bill, the SEC continues to implement it. Chair Gensler justified his stance by saying that crypto was a liability for companies and had led companies to bankruptcy, and then proceeded to double down on his stance by saying that the SEC will not rescind SAB 121. Representative Nickel then asked each Commissioner if they agreed that the government should encourage innovations in digital assets while protecting investors and consumers. Four commissioners agreed with that statement, while Gensler hedged his response by agreeing so long as they are “protecting the investors.”  

What does this mean? 

The hearing highlighted the growing bipartisan opposition to the irresponsible and inconsistent digital asset enforcement actions of the Commission under the direction of Chair Gary Gensler. Commissioners Peirce and Uyeda criticized the SEC’s sporadic and unpredictable approach to crypto through its rhetoric, enforcement actions, and lack of clear guidance. It is promising that Members and certain Commissioners are inclined to provide digital assets with legal clarity and hold Chair Gensler’s rogue SEC accountable for their dishonest and untenable approach to the crypto industry. 

SEC v. Coinbase Proceedings 

What happened? 

On September 24, the Court of Appeals for the Third Circuit heard oral arguments in Coinbase v. Securities and Exchange Commission (SEC) from Eugene Scalia, representing Coinbase, and Ezekiel Hill, representing the SEC. The issue at hand is whether the SEC should be mandated to establish new securities regulations for digital assets, providing much-needed clarity for digital asset exchanges such as Coinbase. Coinbase alleges that the SEC has “never provided a clear or definitive statement of how, in its view, the securities laws apply to digital assets.” The SEC rebutted that claim, arguing that “Coinbase asked this court to order the Commission to undertake the requested rulemaking despite the Commission’s denial, but this case does not present the rare circumstances that could potentially merit such an extraordinary remedy.” The three-judge panel seemed skeptical that regulation by enforcement  was the right approach, grilling Hill throughout the proceedings.

Coinbase opened its arguments by claiming that “the Commission provided zero explanation for rejecting Coinbase’s demonstration that the current SEC rules make it unworkable for digital asset companies to register with the SEC and for digital assets to function as designed.” According to Coinbase, this creates an environment in which digital asset companies are prosecuted for not performing the impossible: registering under the current framework. One judge accused the SEC of “seeking to penalize people who don’t comply with things they don’t know.” The judges repeatedly acknowledged that regulating through enforcement rather than rulemaking can be detrimental to the industry.

The SEC, however, maintained that the existing regulations are not only clear, but workable for digital asset companies. The SEC claimed that Coinbase is violating long-standing laws, established under the Securities Act of 1933 and further defined by the Supreme Court in SEC v. W.J. Howey. However, one judge added that, “In rulemaking, the SEC has its own set of obligations, and the fact that something might be a defense in enforcement is not a defense for the SEC to simply abandon its own rulemaking obligations.”.

The three-judge panel also brought up inconsistencies between official statements made by the SEC, those made by chairs of the SEC, and actions that the SEC has taken. One judge pointed out that “the fact that different chairs of the SEC have taken markedly different positions on what is or isn't covered” by securities regulations could be a major point of confusion for digital asset companies attempting to achieve compliance. 

Later in the hearing, the SEC emphasized that it has other priorities it plans on pursuing instead of rulemaking for digital assets. One judge rebutted this claim by mentioning that the SEC had the time to bring numerous enforcement actions against the crypto industry. “It’s not that the agency isn’t interested in the area,” he claimed, “It’s just interested in picking off a lot of individual ones without giving higher-level guidance.”

Coinbase ended the hearing on a strong note, reminding the court that “industry is forced to comply. It must comply, it will be prosecuted, and yet it can't know how to comply. It can't even ascertain what the law is, because the SEC keeps changing it.”

What does this mean? 

DEF commends the critical attitude that the three-judge panel maintained towards the SEC’s approach of regulating the digital asset industry through enforcement actions rather than rulemaking. The panel clearly understood that this practice has caused confusion and harm to the industry rather than providing a clear regulatory regime. 

Consensys v. SEC Dismissed

What Happened?

Earlier this month, in the District Court for the Northern District of Texas, Judge Reed O’Connor issued an order granting the Securities and Exchange Commission’s (SEC) motion to dismiss Consensys’s lawsuit seeking a declaratory judgment and injunctive relief. 

Three of Consensys’s four claims were centered around the SEC’s investigation into ether (ETH) from the Ethereum network. After Consensys filed the suit, however, the SEC informed them that the investigation into ETH had concluded and no enforcement action would be taken. Accordingly, the ETH claims were dismissed as moot. 

Consensys’s fourth claim, relating to the SEC’s investigation of and enforcement action involving MetaMask Swaps and MetaMask Staking, was dismissed as unripe. Ripeness is a legal concept intended to separate cases with issues that are ready for judicial review from those that are speculative or may never occur. The court's ripeness analysis involves two key factors: (1) whether the issue is ready for judicial review; and (2) whether withholding a decision would cause significant harm to the parties. 

On the first factor, the court’s holding that the MetaMask claim wasn’t ready for judicial review was premised on the court’s finding that—(1) enforcement actions against firms deploying software similar to MetaMask; (2) the Wells Notice relating to MetaMask; and (3) the SEC’s ultimate decision to bring an enforcement action relating to MetaMask—do not constitute “final agency action” by the SEC. 

On the second factor, because of the ongoing enforcement action relating to MetaMask, the court determined that delaying a decision would not cause substantial hardship for Consensys, as there was an adequate opportunity to litigate the matter elsewhere. 

Why it Matters?

While the dismissal is an unfortunate result, Consensys will have the opportunity to fully argue their MetaMask-related arguments as defenses in the ongoing enforcement action. We look forward to the court properly assessing these claims and recognizing the flaws in the SEC’s reasoning and putting a stop to their overreach.