The SEC and the CFTC Vie for Digital-Asset Supremacy
Recent events suggest that the SEC and CFTC are waging an intense battle for regulatory supremacy. It is not yet clear which agency will prevail, or whether they will find a third, cooperative path.
Observers from nearly every corner of the digital-asset markets have asked, “When will clear regulations be passed in the United States, and who will enforce them?” On the first question, the digital-asset community has frequently complained that the only “regulation” to date has been by enforcement, giving crypto companies no advance warning of the applicable rules.
As to the second question, thus far, the U.S. Department of Justice has primarily handled criminal enforcement, while the Securities and Exchange Commission (SEC)—and, to a lesser extent, the Commodity Futures Trading Commission (CFTC)—have led civil enforcement. Recent events, however, suggest that the SEC and the CFTC are waging an intense battle for regulatory supremacy. It is not yet clear which agency will prevail, or whether they will find a third, cooperative path. But the regulatory battle was on full display in late July. After the SEC brought an enforcement action suggesting broad SEC jurisdiction with respect to digital assets, one CFTC commissioner responded with outrage, going as far as to suggest that the SEC’s actions exceeded the bounds of the U.S. Constitution.
On July 21, 2022, in SEC v. Wahi, the SEC charged a former Coinbase employee, the employee’s brother, and his friend with insider trading in connection with the purchase and sale of certain crypto assets. The SEC’s insider-trading charges seem straightforward at first blush: They allege that, in violation of Coinbase’s policies, the former employee helped his brother and friend use Coinbase’s material, nonpublic information regarding which assets would be added to the company’s digital-asset exchange, with a goal of front-running the market for their personal profit. The SEC alleges that when a crypto asset is added to Coinbase’s exchange, it typically goes up in value. The employee, the SEC alleges, would tip his brother and friend to which assets Coinbase would add to the exchange before that information became public, allowing them to invest in at least 25 crypto assets and make illicit profits totaling more than $1.1 million.
Less straightforward and more controversial is the SEC’s allegation that nine of the crypto assets the defendants traded are securities under the Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). According to that ruling, an investment contract exists where, among other things, a reasonable investor would look to the efforts of the issuer and/or its promoter to increase the value of his/her investment. In the face of that allegation, Coinbase has forcefully maintained the position that it carefully vets the crypto assets listed on its exchange prior to listing them, to ensure that they are not securities. The federal government itself does not appear to be completely aligned on this point. Notably, federal prosecutors who charged the former Coinbase employee in a criminal case parallel to the SEC action allege insider trading under the wire fraud statute but not securities fraud.
CFTC Commissioner Caroline Pham took offense at the SEC’s unilateral assertion in Wahi that many of the crypto assets at issue are securities. In a public statement, Pham quoted from Federalist No. 49, asserting that “‘[t]he people are the only legitimate fountain of power, and it is from them that the constitutional charter … is derived.’” She continued: “The case SEC v. Wahi is a striking example of ‘regulation by enforcement.’ The SEC complaint alleges that dozens of digital assets, including those that could be described as utility tokens and/or certain tokens relating to decentralized autonomous organizations (DAOs), are securities.”
Wahi is not the first instance of the SEC launching an enforcement action involving crypto assets that the SEC alleges are unregistered securities. In fact, a major legal fight is currently playing out in federal court, where the SEC claims that Ripple Labs and two of its executives raised over $1.3 billion through an unregistered digital-asset securities offering. The SEC brought suit seven years after Ripple started selling the targeted crypto asset, a token called XRP. The case could have major implications for the application of Howey’s investment contract framework to digital assets.
The SEC continues to aggressively pursue cases involving crypto assets on the theory they are unregistered securities. In fact, the SEC recently indicated that the Crypto Assets and Cyber Unit has brought more than 80 crypto enforcement actions since its creation in 2017, resulting in monetary relief exceeding $2 billion. Meanwhile, many digital assets available for purchase or sale today have yet to be designated securities, and the legal uncertainty has produced calls for a legislative solution.
CFTC Chairman Rostin “Russ” Behnam has pointed to his agency’s regulation of derivatives on digital assets (e.g., bitcoin futures)—and the numerous enforcement actions the CFTC has brought for fraud and manipulation in connection with digital assets—as evidence that the CFTC would be well-positioned to exercise regulatory authority over spot market trading of digital assets. In a recent keynote address to the Brookings Institution on “The Future of Crypto Regulation,” Chairman Behnam touted his agency’s enforcement bona fides noting that,
[i]n the digital asset space, since 2014, the CFTC has aggressively exercised its enforcement authority, bringing more than 50 enforcement actions. As the digital-asset markets have grown in size and retail participation, so has the number of CFTC enforcement actions. In FY 2021, the CFTC filed more than 20 enforcement actions alleging digital-asset–related misconduct, including numerous cases charging retail fraud involving digital assets and cases charging platforms with illegally offering off-exchange trading in digital assets.
Even with that lengthy and successful track record, the CFTC has faced resistance to its enforcement efforts, with some defendants contending that crypto tokens which are not the underlying asset for a futures contract are not commodities within the meaning of the Commodity Exchange Act and thus lie outside the CFTC’s jurisdiction. Giving the CFTC regulatory jurisdiction over crypto assets would thereby not only give the agency novel authority to make rules for spot market trading, but would also shore up its anti-fraud and anti-manipulation authority with respect to digital assets that do not underlie derivative contracts.
Not surprisingly, plaintiffs’ lawyers have jumped into the fray too. In April, a class-action lawsuit was filed against the developers and venture capital firms behind Uniswap, the popular decentralized crypto exchange. The action alleges, among other things, that the exchange failed to register as a broker-dealer and lists unregistered securities. More recently, a class-action lawsuit was filed against Terraform Labs and its founder, Do Kwon, related to the widely publicized collapse of the Terra stablecoin and its related LUNA token, which many blame for the recent crypto market decline. Relatedly, the world’s largest crypto exchange, Binance, is in the midst of defending a class-action lawsuit filed in June that alleges the exchange misled consumers surrounding the collapse of Terra. All these suits seek damages against the defendants for allegedly conducting business in unregistered securities.
Congressional Action May Favor the CFTC
Competing agency jurisdictional claims, multiplying lawsuits, and massive investor losses have prompted calls from all corners for a legislative response. Congress has heeded the calls, with both the House and Senate developing thoughtful proposals to bring some regulatory clarity and investor protection to crypto asset markets.
The first major legislative proposal to emerge this Congress came from the U.S. House of Representatives. That bill, entitled the Digital Commodity Exchange Act of 2022, proposes, among other things, to authorize the CFTC to register and regulate trading platforms for spot or cash digital assets as “digital commodity exchanges,” much like the agency currently does with designated contract markets and swap execution facilities.
Not to be overshadowed on such a high-profile issue, the U.S. Senate has produced two major bi-partisan bills. In June, U.S. Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced the ambitious Responsible Financial Innovation Act (RFIA), which would address issues ranging from taxation of digital assets and energy consumption to core financial-markets matters such as stablecoin reserve requirements. Moreover, like the House bill, RFIA would assign novel spot market jurisdiction to the CFTC by granting the CFTC “exclusive jurisdiction over any agreement, contract, or transaction involving a contract of sale of a digital asset in interstate commerce, including [so-called] ancillary assets.”
Two months later, in early August, U.S. Senators Debbie Stabenow (D-MI) and John Boozman (R-AR), the chair and ranking member respectively of the Senate Agriculture Committee—the Senate committee with primary jurisdiction over the CFTC—introduced the Digital Commodities Consumer Protection Act of 2022 (DCCPA). Like the other two bills, the DCCPA would give the CFTC a prominent role in regulating the crypto asset spot markets by assigning the agency jurisdiction over a “digital commodity,” which would include bitcoin and ether but exclude securities (which would remain under the purview of the SEC).
It is not yet clear whether the SEC or the CFTC will be the primary digital-asset regulator, or whether they will act cooperatively. What is clear is that congressional action to set clear rules and regulatory responsibility is needed. While each of the current legislative proposals leaves open questions about how certain aspects of the digital-asset markets will be regulated, we should not let the perfect be the enemy of the good. In the face of profound regulatory uncertainty, confusion will continue to reign, and digital-asset innovators and the public alike will continue to pay the price.
Mark Bini is a partner in Reed Smith’s global regulatory enforcement practice in New York. He served as an Assistant U.S. Attorney in the Eastern District of New York (EDNY) and the Middle District of Florida, and before that as an Assistant District Attorney in the Manhattan District Attorney’s Office.
Jonathan Marcus is a partner in the firm’s energy & natural resources practice in Washington, D.C. He served as general counsel of the CFTC.
Julia Nestor is a partner in the firm’s global regulatory enforcement practice in New York. She was an Assistant U.S. Attorney in the EDNY and served as Deputy Chief of the Business and Securities Fraud Section.
Associates Roger Gibboni and Kaela Dahan assisted in the preparation of this article.
From: New York Law Journal