Today’s action, yet again, makes plain that the crypto markets suffer from a lack of regulatory compliance, not a lack of regulatory clarity.

– Gary Gensler, SEC Chairman on April 17, 2023, following yet again another SEC complaint against a crypto exchange in SEC v. Bittrex

This statement would be great, if true. I try hard to not use the common cliches in any writing, but the idea of square pegs in round holes is more apt than ever in the context of 21^st century American alphabet agency regulation, especially that of the Securities and Exchange Commission (SEC). Chairman Gensler is an intelligent man and that makes it all the more infuriating when he pushes a narrative that is undeniably false.

I’m writing this article because of my fascination with decentralization, not because I am a Bitcoin or crypto maximalist. Frankly, I can admit that I have not even scratched the surface of understanding such topics as forking and sharding or fully been able to flesh out the use cases or possibilities of Web 3.0 and crypto in general. But I am curious enough to see that there’s something there that should be left to the open marketplace to work out. I’ll continue to write on these topics as I operate in this space more and more. It’s purely fascinating if you take the time to read even a fraction of the content that’s in circulation. Enforcement via regulation, as SEC Commission Hester Peirce would call it, only stifles this curiosity for all and catalyzes genuine unregulated behavior that inevitably harms the very consumer regulatory agencies are so often claiming they are working to protect. In short, regulators continue to bring actions against parties absent any tangible evidence that consumer harm occurred. They paint with a broad brush because they can’t provide specifics. It must be a fun happy hour in Adams Morgan having a cocktail while explaining that you’re suing Coinbase under the guise of protecting consumers. I have yet to hear a coherent argument for how the SEC in its current actions is fulfilling its statutory mandate.

But putting my philosophical rant to the side, we best turn to the current state of affairs to understand what led to the rant in the first place. Knowing where we are makes the confusion abundantly clear . . . oxymoron heavily emphasized.

Our Good Friend Howey

While the 1933 Securities Act lists a variety of items in defining securities, the test of time has fallen upon the term investment contract. The intricacies of this term were first tackled by the Supreme Court in Howey where they first defined an investment contract as:

“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, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.”

Keep in mind that this case involved offering of units in a citrus farm in the early 1940s.

Following Howey’s conclusion, courts continued to interpret the 3 elements presented with the broadened version limiting the strict interpretation of solely from the efforts of the promoter or a third party to being transitioned to the economic realities of any given situation. The important case in interpreting Howey came in SEC v. Glenn W. Turner Entertainment, Inc. where the Court stated,

“In applying the Supreme Court’s definition of an investment contract, therefore, the efforts of others which are relevant for purposes of the definition are those essential managerial efforts which affect the failure or success of the enterprise.”

While there are many more cases applying these tests to alleged securities and further complicating matters with further confusing analysis such as horizontal and vertical commonality for purposes of defining a common enterprise, this is the comical clarity in which Chairman Gensler believes we may comfortably rest our heads at night.

This clarity is further “understood” with the clear understanding of which regulatory agency has jurisdiction over the world of digital assets.

Jurisdictional Rumble

There’s always been confusion at what agency truly has jurisdiction over this area. The two main contenders, absent further congressional action, has been and will continue to be the SEC and the Commodity Futures Trading Commission (CFTC). The SEC’s mission is to protect investors, facilitate capital formation, and maintain fair, orderly and efficient markets, while the CFTC regulates the commodities and derivatives market within the United States.

I’m not writing here to make a determination for jurisdiction either way, but the lack of any direction is making it impossible for consumers, companies, and even lawyers to understand how to navigate the endless rules and winks and nods provided within numerous, and oftentimes, conflicting enforcement actions. Take for example the numerous statements, or refusal to state anything, by Chairman Gensler when it comes to what is a security. It continues to be a case-by-case basis with zero distinction. I could personally argue everything in existence is a security in taking the Howey test to its literal conclusion. The economic reality needs to be returned. As for the CFTC, they’re just doing their thing and explicitly taking a stand on the markets. This has become ever more evident in the CFTC’s most recent filed complaint against Binance (a crypto exchange) where the agency alleges,

Binance . . . has solicited and accepted orders, accepted property to margin, and operated a facility for the trading of futures, options, swaps, and leveraged retail community transactions involving digital assets that are commodities including bitcoin (BTC), ether (ETH), and Litecoin (LTC) for persons in the United States. (emphasis my own).

CFTC Commissioner Caroline Pham has discredited the idea of a turf war between the SEC and CFTC opting for a more measured assessment that aggressive regulatory activity is necessary to set regulatory guidelines.[1] Perhaps, the CFTC is using this approach by specifically enumerating digital assets as commodities to lay the groundwork, but the SEC disagrees with such a reasonable approach. The SEC will either sue and claim something is a security by reaching a conclusion and walking backward, or, my personal favorite, acting as it has proceeded to do with Coinbase and Bittrex in saying that an exchange is acting illegally through the facilitation of trades of unregistered securities without identifying any underlying digital asset as a security in itself (while the SEC did identify 6 assets they found to be securities on the Bittrex exchange and the complaint details numerous issues Bittrex had internally, the securities confusion remains the same). An action against Coinbase has not yet occurred, but we can all read the tea leaves. The Wells Notice was a shot across the bow and the SEC is taking further enforcement actions in the attempt to add precedential rulings to its arsenal. There should be a seamless, understandable process to determining whether or not these assets are securities as opposed to being made aware at the whim of regulators. When a definition flows with the wind, it’s hardly a definition. Nothing the SEC is doing makes it clear that any of the three enumerated provisions within the SEC’s mission is being honored faithfully.

It’s Abundantly Clear That Nothing is Clear

Whack-a-mole is no way to govern. Recent statements from Coinbase and Bittrex have followed along the lines of “we’ve reached out to the SEC on multiple occasions about this clarity, yet such attempts have continued to be rebuffed.”  Of course, we cannot verify what has been said behind closed doors, but the recent enforcement through regulation calls for a warranted dose of skepticism when trusting anything regulators say . . . as if this shouldn’t already be the default for any governmental statements. To reiterate, this has become ever more the case where the SEC, for example, claims that an exchange is facilitating the trade of numerous unregistered securities, yet has zero action proving any of those were securities. If that’s what is meant by clarity, then I’m scared to see what regulators find to be nuanced.

I’ll continue to believe that Howey is not the problem. The problem is the failure to permit innovation in the age of Howey. The free market should leave companies to prosper and to fail. A Commission placing its hand on the scale has proven time and time again throughout history that decline is on the horizon. Anyone arguing that clarity is present in 1930s statutes and decades of conflicting case law is doing nothing but a tremendous disservice to American consumers and the American marketplace. Mikhail Gorbachev, the former President of the Soviet Union, once stated in an interview,

“Imagine a country that flies into space, launches Sputniks, creates such a defense system, and it can’t resolve the problem of women’s pantyhose.”

American regulators have a pantyhose problem. Instead of creating an environment that promotes innovation and marketplace determination, regulators are quickly approaching a top-down enforcement approach that leads to nothing but stifling innovation and capital flight. Consumers will not stop, and companies will not stop, they will just find friendly jurisdictions that will permit them to rise and fall.

MLM & Crypto?

All I can say is good luck because you are entering two of the most regulated, yet least understood sectors of administrative law. We love to see innovation in both of these spheres, but the level of unknowns makes it a dangerous game, if not an outright impossibility. Remember too much curiosity killed the cat. We’ve discussed this dangerous combination before as we’ve seen countless attempt it, but zero come close to being successful at it. But that’s a story for another day.

[1] https://www.bloomberg.com/news/videos/2023-02-17/cftc-says-there-is-no-tug-of-war-over-regulating-crypto-video

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