In defending against an SEC enforcement action for alleged registration violations, Coinbase received support from two recently filed amicus briefs on SEC crypto asset regulation and enforcement. As the co-sponsor of proposed crypto legislation, Sen. Cynthia Lummis (R-Wyo) took a skeptical view of SEC activities in the crypto arena and drew the court’s attention to bipartisan legislative efforts regarding crypto assets. In another amicus brief, six securities law scholars offered a historical perspective that would give a narrower legal meaning to “security” and potentially exclude many crypto tokens (SEC v. Coinbase, Inc., August 11, 2023; Lummis; Securities Law Scholars).
Senator Cynthia Lummis (R-Wyo) argues the SEC is trying to “circumvent the political process” and commandeer authority that many legislative proposals would grant to other agencies.
“Crypto asset related concerns … are not confined to the securities markets, and the SEC is not their sole protector,” wrote Lummis.
The securities law scholars argued that the term “investment contract” has a relatively narrow meaning, based on an analysis of the development of the law from state blue-sky laws through Howey.
“That analysis makes clear that an arrangement is an ‘investment contract’ only if the investor receives, in exchange for an investment, a contractual undertaking or right to an enterprise’s income, profits, or assets,” the scholars wrote.
SEC enforcement action. The SEC has charged Coinbase with registration violations including failure to register as a national securities exchange, broker-dealer, and clearing agency. The SEC contends that the securities laws apply to Coinbase’s conduct, while Coinbase argues that they do not.
Senator Lummis. The senator’s brief describes her as “among the principal crypto asset policy leaders in Congress.” Lummis is a member of the Senate Banking Committee and co-sponsor with Sen. Kirsten Gillibrand (D-NY) of the Lummis-Gillibrand Responsible Financial Innovation Act, S. 2281, 118th Cong. (2023).
According to Lummis, the SEC’s enforcement action against Coinbase is “no run-of-the-mill enforcement case.” Via SEC v. Coinbase, the SEC seeks to exert “primary influence over economic, political, and legal questions under active consideration by Congress and multiple agencies,” said Lummis.
Lummis made two main points. First, the SEC’s enforcement stance in this action runs counter to ongoing legislative efforts. Existing law is inadequate to the task of addressing crypto assets, and the SEC’s assertion of authority in this case is out of step with active legislative efforts. Lummis noted that many current bills would give primary or exclusive authority over crypto assets to the CFTC, not SEC.
“While some pending bills may be different, the SEC’s expansive, novel interpretation of its own authority is inconsistent with most of the pending bills,” said Lummis.
Also, the SEC’s approach of classifying almost all crypto tokens as securities is inconsistent with other jurisdictions, said Lummis. For example, the European Parliament has passed a regulation that introduces a disclosure regime for crypto asset issuers reminiscent of securities regulation, but “adapted to the distinct features of digital assets” and without need to classify the tokens as securities. This is “much like” the Lummis-Gillibrand legislation, said Lummis.
Second, the SEC’s attempt to treat crypto assets themselves as securities improperly expands the statutory definition of “securities” and violates the separation of powers, said Lummis.
“Whether dubbed ‘the major questions doctrine’ or basic preservation of the separation of powers, Congress has not conferred on the SEC wholesale regulatory power over this industry, and accepting the SEC’s theory encroaches on Congress’s legislative role. This agency action should therefore be treated with skepticism,” wrote Lummis.
Lummis stated that crypto assets have been valued between $1 trillion and $3 trillion.
Both pillars of the major questions doctrine favor judicial caution, said Lummis. First, there is vast economic and political significance to the SEC’s assertion of authority to define crypto assets as securities. Second, Congress did not speak clearly to confer such power on the SEC.
Lummis looked askance at the SEC’s position that crypto tokens may be securities in the secondary market.
“If the SEC has the power to graft its view of an investment transaction onto non-security financial assets themselves, the same reasoning could apply to other asset classes for which a secondary market develops,” Lummis wrote.
In conclusion, Lummis recommended the court dismiss the SEC’s action against Coinbase.
“This Court should decline the SEC’s novel effort to regulate crypto asset secondary markets on the theory that crypto assets are securities, and defer to Congress to enact a proper regulatory scheme,” wrote Lummis.
Securities law scholars. Turning to the legal scholars, they are a prominent group including Stephen M. Bainbridge, Tamar Frankel, Sean J. Griffith, Lawrence Hamermesh, M. Todd Henderson, and Jonathan R. Macey.
According to the scholars, the court must determine whether these “unusual instruments not easily characterized as ‘securities’” are “investment contracts,” and, as such, are one of the enumerated types of “securities” covered by the Securities Act of 1933 and the Exchange Act of 1934.
The scholars argue that an arrangement is an “investment contract” only if the investor receives, in exchange for an investment, a contractual undertaking or right to an enterprise’s income, profits, or assets. This is because in the seminal Howey case, the court held that by including “investment contract” in the federal securities statutes, Congress used a term with a well-settled meaning based on judicial interpretations of state blue-sky laws.
When Congress included the term “investment contract” in the definition of “security,” that term had a well-settled meaning from the blue-sky laws that required a contractual undertaking to deliver future value, said the scholars. As the law has developed following Howey, federal cases recognize that “investment contracts” require an expectation in the income, profits, or assets of a business.
The scholars made the following points:
- The Howey test requires consideration of whether an offering resembles the ordinary concept of a security;
- Every “investment contract” identified by the Supreme Court involves a contractual undertaking to grant a surviving stake in the enterprise;
- Every “investment contract” identified by the Second Circuit involves a contractual undertaking to grant a surviving stake in the enterprise;
- No Supreme Court or Second Circuit decision has found that a “scheme” without accompanying contractual undertakings qualifies as an “investment contract.”
This is case No. 1:23-cv-04738 (Lummis, Securities Law Scholars).