By Lene Powell, J.D.
A small crypto-focused law firm is fighting to keep its lawsuit alive demanding that the SEC take a public stand on the Ethereum crypto network and Ether token. In a new filing, the law firm urged the court to deny the SEC’s motion to dismiss, arguing that due process requires the SEC to give fair notice of conduct that is forbidden or required with regard to crypto assets (Hodl Law, PLLC v. SEC, February 27, 2023).
“The SEC continues to assert its jurisdiction over a trillion-dollar industry for which it admittedly has no congressional authorization and no desire to engage in any rulemaking or even constructive dialogue with industry participants,” said Fred Rispoli, attorney for Hodl Law Cali, in a statement to Securities Regulation Daily.
Rispoli is the managing attorney for both Hodl Law, the Arizona firm that filed the lawsuit, and Hodl Law Cali, the California firm representing Hodl Law.
The SEC did not respond to a request for comment by time of publication.
Request for declaratory relief. Hodl Law PLLC is seeking declaratory relief to clarify the legal status of Ethereum and Ether under the federal securities laws.
The firm sued the SEC last November, arguing it is at risk of imminent harm because the SEC may exert jurisdiction over Ethereum and Ether and bring enforcement actions relating to lack of securities registration. The firm is concerned it might have legal liability because it transacts on the Ethereum Network and uses the Ether digital currency unit (DCU) for various purposes.
The SEC has moved to dismiss, arguing that Hodl Law has not shown any “actual or imminent injury” or hardship, only a hypothetical concern that it may be violating federal securities laws. According to the SEC, the court lacks subject matter jurisdiction to hear the claim due to a lack of “case or controversy,” standing, and ripeness. The SEC also argues the claim does not meet Administrative Procedure Act (APA) requirements for review of agency actions.
Are Ethereum and Ether securities … or not? Fundamentally, the firm says it is just trying to find out if the SEC considers Ethereum or Ether a security or not.
“Hodl Law is simply asking the Court to determine—identically as the SEC has asked courts to determine in over one hundred federal cases previously regarding other DCUs [digital currency units] and networks—whether the Ether DCU and Ethereum Network fall within the Securities Act.,” the firm wrote in a memorandum in opposition to the motion to dismiss.
The firm added that it will stop using the Ethereum Network and Ether DCU if such use constitutes unregistered securities transactions under the Federal Securities Act of 1933 (the “Securities Act”).
As evidence of regulatory uncertainty, the firm said that SEC Chair Gary Gensler recently stated in an interview with New York Magazine that “everything other than bitcoin” is a security—seemingly reversing previous statements by SEC officials that the Ethereum Network and Ether DCU are not securities.
In that interview, Gensler stated, “Everything other than bitcoin …you can find a website, you can find a group of entrepreneurs, they might set up their legal entities in a tax haven offshore, they might have a foundation, they might lawyer it up to try to arbitrage and make it hard jurisdictionally or so forth … But at the core, these tokens are securities because there’s a group in the middle and the public is anticipating profits based on that group.”
Regulation by enforcement. Hodl Law asserts that it has standing and that its claim is ripe. First, the firm argues that the SEC has no jurisdiction over the Ethereum Network and Ether DCU and cannot point to any statute or regulation conferring such authority.
Yet the SEC has brought enforcement actions against other crypto entities. The firm says the SEC is testing its authority by bringing lawsuits instead of by adopting regulations.
“[T]he SEC has zero regulations, zero rules and zero intent to engage in public rulemaking regarding which DCUs it considers securities,” Hodl Law states.
Risk of immediate harm. According to the firm, this potential for enforcement action raises the risk of immediate harm if the SEC decides to target the Ethereum Network and Ether DCU. Once the SEC targets a particular crypto token with an enforcement action, the market value of that token plummets, the firm said. As an example, the firm said the XRP token lost 50 percent of its value less than 24 hours after the SEC brought an enforcement action against XRP’s creator, Ripple Labs.
Hodl Law firm says it “suffers the certainty” that the value of its Ether DCUs will be wiped out if the SEC initiates any enforcement lawsuit alleging security status. Moreover, the value of other DCUs that Hodl Law utilizes for transactions over the Ethereum Network would likewise be crushed. The firm also uses the Ether DCU to purchase digital property in the metaverse to offer services, build its brand and strengthen its reputation as a digital asset-based firm. The firm’s transactional practice of law involves the use of the Ethereum Network and its smart contract functionality, the firm said.
Any loss in value of the Ether token if the SEC exerts jurisdiction would be a “taking” of that value, said the firm.
Risks for lawyers. Hodl Law raised the further concern that if the Ethereum Network and Ether DCU are subject to the Securities Act, Hodl Law could face disciplinary action by the state bar for violating federal law in connection with simply adhering to the rules of professional conduct regarding client payments and even custody of client property.
“The professional livelihood of any lawyer at the firm would be at stake,” wrote Hodl Law.
Constitutional rights. Hodl Law also argues that enforcement against its secondary use of the Ethereum Network and Ether DCU would violate its First and Fifth Amendment rights. The firm says that one of its uses of the Ethereum Network and Ether DCU is engaging in constitutionally protected commercial speech in a digital metaverse on an Ethereum Network-based application.
APA and the major questions doctrine. The firm also cited to a legal doctrine much in the news lately: the major questions doctrine. In West Virginia v. EPA, the Supreme Court recently held that a federal agency “must point to clear congressional authorization when it seeks to regulate a significant portion of the American economy.”
Here, Hodl Law asserts that the market capitalization of Ethereum alone is in the hundreds of billions of dollars. The firm states that the SEC, in statements by agency officials, has disavowed jurisdiction over the Ethereum Network and Ether DCU. Under these circumstances, the APA simply cannot apply where the agency seeking its protection has no administrative role, said the firm.
Alternatively, the SEC’s actions permit judicial review under the Administrative Procedure Act, the firm argued. It asserts that the SEC has not cited a statute that precludes judicial review of whether any digital asset is a security under the Securities Act. The court may also determine that the SEC has reached a “final agency action” sufficient for judicial review, said the firm.
Leave to amend. Hodl Law requested leave to amend its complaint if the court determines jurisdictional issues are present.
Declaratory relief appropriate. In conclusion, the firm argued that the court should exercise its discretion under the Declaratory Judgment Act.
“Ultimately, given that the SEC’s only attempt at regulating the nascent digital asset space has been by lawsuit, we continue to struggle with the SEC’s attempt to dismiss this action, given we are only following the SEC’s admitted “policy” of getting answers to its beliefs on security status for digital assets—by lawsuit,” said Rispoli.
The case is No. 22-cv-01832-L-JLB.