Until the new presidential administration took office, the digital asset industry was embroiled in an existential showdown with the U.S. Securities and Exchange Commission. For years, the SEC waged a scorched-earth regulation-by-enforcement campaign against the digital asset industry and its most-used platforms for failing to adhere to confusing — or non-existent — rules about what constitutes a security and who must register to buy and sell them. Now, under new leadership, the SEC has confirmed the end of its regulation-by-enforcement era.
While this shift has dramatically reduced (though not eliminated) exposure to regulatory suits by the agency, the industry must prepare for private plaintiffs to exploit the enforcement void and perpetuate, at least in the near term, ambiguities in the application of federal securities laws by bringing suits in U.S. courts alleging that particular digital assets are securities and seeking to hold businesses and their leaders responsible for withholding material information or other alleged misconduct, in violation of the securities laws.
The SEC’s Enforcement U-Turn
Under its new leadership, the SEC has confirmed the end of the regulation-by-enforcement era and taken significant steps to progress its policy goals, including a focus on prosecuting bad actors and fraud in the digital asset space. The most significant regulatory shifts include:
Crypto Task Force: Just one day into his tenure as SEC Acting Chair, Commissioner Uyeda announced the formation of a “Crypto Task Force” and, in doing so, publicly recognized what so many had long been saying: the SEC’s refusal to promulgate rules and instead regulate by enforcement sowed “confusion about what is legal” including “who must register” to trade digital assets and, importantly, how to register. The Crypto Task Force’s stated mission is to provide clarity to these questions and develop a regulatory framework for digital assets. It is hosting a series of industry roundtables, with the first to focus on how to define which digital assets are securities. .
Enforcement Action Dismissals: The SEC has dismissed (or agreed in principle to dismiss) nearly all non-fraud cases concerning allegations that a defendant failed to register as an exchange or broker-dealer.
Cyber and Emerging Technologies Unit: The SEC replaced the Crypto Assets and Cyber Unit with the Cyber and Emerging Technologies Unit (“CETU”), which is focused on protecting “retail investors from bad actors.” The SEC announced that CETU and its 30 fraud specialists and attorneys (down from more than 50) would focus on “[f]raud involving blockchain technology and crypto assets” among other priorities.
These changes indicate that SEC enforcement in the digital asset space will undoubtedly decline, given that the agency will no longer use its enforcement arm as the primary means to create regulatory policy and its associated reduction in staff focused on blockchain and crypto matters. According to the SEC, its staff remains committed to prosecuting bad actors and fraud-based claims, with Commissioner Hester Peirce clarifying that the shift in priorities and resources is not an end to SEC enforcement and that “statutes already on the books do not allow a free-for-all.”
Unsettled Law is an Opportunity for Litigation
In the face of the SEC’s enforcement retreat, individuals and firms should be prepared for private plaintiffs to exploit the enforcement void. Historically, the private plaintiffs’ bar has stepped in to pursue litigation in the wake of decreased regulatory enforcement (or at least the perception of it), whether it be suits alleging violation of the federal antitrust laws or financial misconduct in violation of the securities laws following the 2008 crisis. Such private suits, often brought as class actions, can be an expensive nuisance for businesses and their founders (often named as defendants themselves) — even for those who prevail at an early stage.
In the digital asset space, private plaintiffs may still use the federal securities laws as a basis to bring a variety of allegations, including:
selling unregistered securities;
engaging in the sale of securities by means of a prospectus (e.g. white paper) containing untrue statements or omissions of material facts;
securities fraud and other misconduct (e.g. rug pulls or pump-and-dump schemes);
violations by individuals who have decision-making control over the seller, such as founders or company leadership
Private plaintiffs may also pursue alleged violations of state securities laws and other common law causes of action.
Although the SEC’s new interpretation of the securities laws is more aligned with industry thinking, it does not bind courts analyzing the question of whether a digital asset is a security. For instance, private plaintiffs pursued the TRON Foundation and its founders, alleging that they misled investors by promoting, offering, and selling TRX — an alleged security — in violation of the federal and state securities laws. Late last year, the U.S. District Court for Southern District of New York denied in part the defendants’ motion to dismiss, and in doing so, explained that the SEC’s previous framework for determining whether crypto assets were securities was a “nonbinding interpretation of a legal standard.”
And while decisions from appellate courts are binding on the courts below them, the SEC recently dismissed a suit (involving Coinbase) that was pending appellate review on the issue of whether crypto asset transactions qualify as securities. Another similar suit is rumored to be dismissed soon. This means, for now, that lower courts will continue to lack guidance from a higher court on that issue, leaving private plaintiffs free to argue that the federal securities laws apply.
As a result, companies should expect an increase in private litigation. One area to watch is meme coins. While there are persuasive arguments for why meme coins should not be considered securities, private plaintiffs are sure to argue that the circumstances of a particular meme coin bring it within the ambit of the federal securities laws.
This year has been mostly positive for the digital asset industry. It has escaped the grip of an agency that was seemingly determined to crush it. But businesses and their founders re-evaluating their legal risk should confer with their legal teams on whether they may be targets of increased private litigation, so they can create strategies to mitigate such exposure.