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Crypto Exchange Challenges SEC’s Jurisdiction Over Sale Of Digital Assets
10/16/2024On October 8, 2024, a crypto exchange (the “Exchange”) sued the Securities Exchange Commission (“SEC”), the Chair of the SEC Gary Gensler, and four SEC Commissioners, challenging the SEC’s jurisdiction over the secondary sale of network tokens, a type of digital asset, on the crypto platform. Foris DAX Inc. v. U.S. Securities and Exchange Commission, Case No. 6:24-cv-00373 (E.D. Tex. Oct. 8, 2024). Essentially, the Exchange is challenging the SEC’s jurisdiction to regulate the cryptocurrency industry. The Exchange, as a secondary-market purchaser, seeks declaratory and injunctive relief to estop the SEC from “expanding its jurisdiction” to reach the sale of network tokens on the platform.
The Complaint follows close on the heels of a Wells notice sent by the SEC to the Exchange on August 22, 2024, and alleges that the SEC indicated that it intended to bring an enforcement action in connection with the sale of network tokens sold on the platform.
According to the Complaint, the SEC lacks jurisdiction to bring an enforcement action because the network tokens fall outside the scope of the Securities Act of 1933 (the “Securities Act”) and of the Securities Exchange Act of 1934 (the “Exchange Act”). First, according to the Complaint, the SEC has “conceded” that the particular network token at issue in the suit is not a security under the Securities Act or the Exchange Act in “multiple administrative and federal court cases involving the Exchange’s competitors.” To get around this, the Complaint alleges that the SEC conjured a “newly defined financial instrument called a ‘Crypto Asset Security’” that allegedly has “no foundation in the Securities Act or Exchange Act.” ¶4–5.
The Complaint highlights the SEC’s disparate treatment of the network tokens by likening them to Bitcoin, arguing that “[d]espite the functional similarities . . . the SEC does not treat” the secondary sale of the network tokens as it does the secondary sale of Bitcoin and instead acts in an arbitrary and capricious manner toward the network tokens. The Complaint further asserts that the sale of the network tokens mirrors the sale of Bitcoin because each transaction lacks the “additional commitments, promises, or expectations from the issuers or promoters[.]”
The Complaint attacks the SEC’s justifications for its enforcement actions in the cryptocurrency space, arguing that the SEC’s use of an “embodiment” concept to defend its jurisdictional grab is antithetical to the current legal framework by referencing the United States District Court of the District of Columbia’s decision in SEC v. Binance Holdings Ltd., No. 23-1599, 2024 WL 3225974, at *21 n.15 (D.D.C. June 28, 2024). Moreover, the Complaint argues that the SEC lacks congressional authority to regulate this secondary market of network token sales as the current laws “are not capable of regulating network tokens or the platforms on which they are sold.”
Specifically, the Complaint alleges that the SEC (i) exceeds its statutory authority by threatening enforcement action in this secondary-sales market; (ii) violates the Administrative Procedure Act (“APA”) in excess of its statutory authority because the sale of the network tokens is not a securities transaction in this secondary market; (iii) violates the APA for arbitrary or capricious action because of the disparate treatment between Bitcoin and the network tokens; and (iv) violates the APA for failure to observe rulemaking procedures by attempting to expand its jurisdiction through litigation rather than through notice and comment rulemaking.
This pre-enforcement action is the latest in a series of challenges to the SEC’s jurisdiction in the cryptocurrency space and highlights the difficulties the SEC is facing as it continues to use an almost century-old legal framework to regulate this nascent and dynamic space.
