Digital Currency & Blockchain Quarterly Litigation Update

Key Takeaway: Judge William H. Orrick’s denial of Kraken’s motion to dismiss further compounds the divergence of views on whether and to what extent the offer and sale of a digital asset should be subjected to federal securities laws. The decision holds that secondary market transactions for cryptocurrency can be subjected to the Howey framework, although it does not provide any meaningful guideposts for doing so. The decision is also the latest to reject the SEC’s attempts to paint digital assets with the broad brush of being called “crypto asset securities”; it emphasizes the need to focus on the particulars of a transaction.

On August 23, 2024, the US District Court for the Northern District of California became the latest court to weigh in on an exchange-related Securities and Exchange Commission (SEC) enforcement action, SEC v. Payward, Inc. (Kraken), joining the Southern District of New York (SEC v. Coinbase) and the District of Columbia District Court (SEC v. Binance). Largely aligning itself with the Coinbase court, Judge Orrick denied Kraken’s motion to dismiss the SEC’s complaint.

For those closely following the SEC’s enforcement actions, Kraken’s arguments are familiar ones. It argued that (1) there is no “investment contract” at issue in the case because the SEC failed to allege a contract; (2) likewise, the SEC had failed to allege an investment contract under Howey because it did not allege postsale obligations running from the issuer to the purchaser (i.e., that the securities laws do not cover token sales on secondary markets); (3) the SEC failed to satisfy the “investment of money,” “common enterprise,” and “reasonable expectation of profits” prongs of the Howey test; and (4) the major questions doctrine required dismissal of the SEC’s action.

Judge Orrick brushed aside the need for an agreement in fairly short order. He observed, “[i]nvestment contracts are not limited to actual contracts,” citing decisions by “[n]umerous courts [that] have found that crypto assets were properly alleged to form investment contracts in cases where there was no underlying formal written or oral contract.”

In so holding, however, he chided the SEC for confusingly describing crypto assets themselves as “investment contracts,” a “perspective” that “other courts have rejected.” Crypto assets, Judge Orrick explained, can “form the basis of investment contracts,” but to call the assets themselves an investment contract was “a semantics error,” one that the SEC repeated by “referring to the assets at issue as ‘crypto asset securities.’”

On the issue of secondary markets, Judge Orrick concluded that the SEC had sufficiently alleged a claim based on secondary market activity, consistent with Ninth Circuit “guidance on how to determine whether a secondary market transaction is an investment contract.” And in evaluating whether a secondary market transaction is an investment contract, he held, nothing “require[s] the court to ignore anything that happened in a primary market transaction.” If a reasonable investor would expect “representations made during the primary market transactions to carry forward into the secondary market,” Judge Orrick opined, then primary-market activity could be considered as part of the Howey analysis.

Judge Orrick proceeded to address the Howey factors. He discussed the “common enterprise” factor at length, concluding that the complaint had adequately pleaded that factor because “the promoters of some crypto assets on Kraken allegedly retain ownership or control over billions of the tokens they promote” and would profit with development of the blockchain ecosystem.

Returning to the secondary market issue, Judge Orrick recognized that he was departing somewhat from Judge Amy Berman Jackson’s motion-to-dismiss decision in Binance, in which Judge Jackson held that the SEC had failed to allege secondary market transactions that were covered by the Howey framework. But he noted that, unlike the SEC’s allegations in Binance, which focused on representations made as part of the BNB ICO, the SEC’s allegations in Kraken were “more fulsome,” in part because the SEC had departed from its strategy in Binance by not hewing to the view that the crypto assets themselves are securities. The common enterprise in Kraken, Judge Orrick observed, was the fact that the fortunes of token holders were tied together by the success of the token’s underlying ecosystem.

As for “reasonable expectation of profits,” Judge Orrick determined that the SEC had adequately pleaded that Howey factor because it alleged that Kraken had republished and reasserted token promoters’ representations about the development of a token’s ecosystem.

On the major questions doctrine, Judge Orrick gave that argument short shrift, concluding that the crypto industry “falls far short of being a ‘portion of the American economy’ bearing ‘vast economic and political significance,’” a necessary prerequisite for the application of the major questions doctrine. Moreover, Judge Orrick added, the SEC was not attempting to invent a new legal standard; instead, he noted that “the principles driving the SEC’s attempt to assert regulatory authority over [crypto] are not new.”

The Kraken decision is just the latest in a string of increasingly diverging decisions on the application of federal securities laws to the sale of digital assets. It certainly will not be the last word on the subject. Nevertheless, Kraken reinforces at least two important points about the future of crypto-related securities actions.

First, the decision further muddies the line on whether and to what extent secondary market transactions are subject to the Howey framework. Although they do not say it outright, the Ripple summary-judgment and Binance motion-to-dismiss decisions (which are discussed later in this update) are perhaps a result of a perceptible unease in reaching difficult questions about what secondary-market participants are expected to know. (Of course, Ripple did not expressly reach that question at all, but it had no need to do so, given how the case was decided.) The Kraken court, however, plainly demonstrated no such unease, although it also provided no meaningful guidance on the limits (if any) of when secondary-market participants are unaware of what primary-market participants are told.

Second, if courts have reached unanimity on any point, it is that digital assets, standing alone, are not themselves investment contracts. Judge Orrick’s decision is the latest to go out of its way to chide the SEC for attempting to paint digital assets as “crypto asset securities,” emphasizing the need to focus the analysis on the Howey framework.

Key Takeaway: The SEC suffered yet another setback in the Ripple case, this time on remedies. Judge Analisa Torres awarded a civil monetary penalty of less than a fifth of what the SEC had asked for and refused to order any disgorgement.

The merits of the SEC’s enforcement action against Ripple regarding the sale of Ripple’s XRP tokens had largely been decided at the summary judgment stage. After the SEC abandoned the only remaining merits issue (whether two of Ripple’s senior leaders aided and abetted Ripple’s institutional sales of XRP (Institutional Sales)), the case proceeded to the remedies phase.

The SEC’s remedies wish list included three items: (1) a sweeping injunction that would not only forbid Ripple from violating Section 5 of the Securities Act but also forbid Ripple from engaging in further Institutional Sales; (2) disgorgement of what the SEC described as “the net profits gained” as a result of the unregistered Institutional Sales plus prejudgment interest (totaling more than $1.07 billion); and (3) a civil monetary penalty of $876,308,712.

Judge Torres granted only two of these requests, both only in part. On injunctive relief, the SEC had argued that Ripple continued to engage in what the SEC believed to be problematic sales. Partly agreeing with the SEC, Judge Torres noted that Ripple had engaged in post-complaint Institutional Sales of XRP. But she also acknowledged Ripple’s argument that the Institutional Sales that the Company conducted after the SEC’s complaint were perhaps materially different from the Institutional Sales evaluated at summary judgment. She declined to hold that Ripple’s post-complaint sales violated Section 5 of the Securities Act, but nevertheless found a “reasonable probability of future violations.”

As for the terms of the injunction itself, Judge Torres imposed the SEC’s requested follow-the-law injunction, which forbade Ripple and its officers, agents, employees, and attorneys from violating Section 5. But she rejected the SEC’s request for a more specific injunction prohibiting Ripple from “conducting an unregistered offering of Institutional Sales.” In Judge Torres’s view, “the SEC’s proposed language is too categorical and, in any case, duplicative” of the general follow-the-law injunction.

Judge Torres also declined Ripple’s request to waive the “bad actor disqualification” of 17 C.F.R. § 230.506(d), which prohibits an enjoined issuer from relying on the exemption provided by Regulation D as to certain private securities offerings.

Next, Judge Torres refused to grant the SEC’s $1.07 billion request for disgorgement. She began her disgorgement analysis by invoking Second Circuit precedent holding that disgorgement requires “pecuniary harm from the securities fraud.” SEC v. Govil, 86 F.4th 89, 102 (2d Cir. 2023). Perhaps pinned down by its prior argument that some participants of Institutional Sales received “deep undisclosed discounts,” the SEC contended that the discounted sales caused harm because those sales caused downward pressure on the price of XRP. Judge Torres rejected that argument, observing that it was entirely speculative regarding whether the participants in the Institutional Sales failed to receive the return on investment that they contemplated—in other words, whether those participants suffered any financial losses.

Finally, on civil monetary penalties, Judge Torres decided to apply “first-tier” civil monetary penalties, the least severe of the three categories of penalties. In doing so, she observed that the SEC had made “no allegations of fraud, deceit, or manipulation” and had not shown “deliberate or reckless disregard of a regulatory requirement.” Acknowledging that “the recurrent, highly lucrative violation of Section 5 is a serious offense,” Judge Torres nevertheless noted that the SEC had failed to establish that “Ripple’s failure to register the Institutional Sales caused substantial losses (or the risk thereof) to investors.” Judge Torres calculated the first-tier penalty by taking the 1,278 sales contracts that were unquestionably contracts for Institutional Sales and imposing a penalty of either $75,000 or $80,000 per contract, depending on the date of the contract, for a total of $125 million.

Either party’s deadline to appeal Judge Torres’s rulings — including her summary judgment rulings on the merits — is October 7, 2024.

The Ripple judgment draws to a close (for now) one of the SEC’s older enforcement actions. The SEC brought the Ripple lawsuit at the end of 2020; its views on whether the offer and sale of a digital asset falls within the securities laws were not articulated to the degree they are now. Perhaps, as a result, Judge Torres was able to give Ripple the benefit of the doubt in finding, for example, that the company did not engage in “deliberate or reckless disregard of a regulatory requirement.”

It remains to be seen whether defendants in other enforcement actions involving digital assets will be afforded the same grace, should they reach the remedies phase of an enforcement action. While the SEC has taken a firmer view on when and whether sales should be registered, that view has come under attack, with crypto companies enjoying some success with challenging that view in court.

And it remains to be seen whether the Second Circuit will agree with any of what Judge Torres had to say, with respect to both the merits of the summary judgment decision and her approach to determining remedies. If the SEC appeals, we may not have certainty from the court of appeals for at least another couple of years.

Key Takeaway: The Supreme Court’s recent Chevron-related decisions in Jarkesy, Loper Bright, and Corner Post may have had a seismic impact on administrative law, but it is too soon to tell what effect the decisions will have on the digital assets industry. If anything, the decisions emphasize the importance of ensuring that digital assets legislation be carefully and thoughtfully developed.

This past Supreme Court term saw a sea change in administrative law. In SEC v. Jarkesy, 144 S. Ct. 2117 (2024), the Court held that the Seventh Amendment requires that courts, not agencies, award civil monetary penalties. In Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024), the Supreme Court declared that Chevron deference is dead. And in Corner Post Inc. v. Board of Governors of the Federal Reserve System, 144 S. Ct. 2440 (2024), the Court determined that agency rules may be challenged long after they have been promulgated, so long as a plaintiff seeks judicial review within six years of injury. (We discuss each of these cases in depth below.)

Some members of the digital assets industry have described these developments as game changers for the industry. But it is too soon to tell. Given the SEC’s current posture of regulation by enforcement in federal court, it is unlikely that this trio of Supreme Court decisions will have any immediate impact on the regulatory landscape for digital assets because the principal question of whether an asset is a “security” has been decided by courts, not by the SEC through rulemaking (which is when Chevron deference typically is at issue). They may, however, play a role if and when Congress and federal regulators decide to develop a more thoughtful framework for regulating digital assets.

The Jarkesy Jack-in-the-Box

Of the three decisions, Jarkesy is unlikely to have much of an impact on the digital assets industry — at least not as to the issue that the Supreme Court decided, because neither the SEC nor CFTC has pursued any of the crypto-related enforcement actions before an administrative law judge. Jarkesy presented the question of whether a federal agency pursuing an enforcement action may seek and obtain civil penalties in an administrative proceeding (presided over by an administrative law judge) or if the Seventh Amendment requires those penalties to be sought before a jury in federal court.

The Court reached the latter conclusion, holding that under the Seventh Amendment, fraud actions for which civil monetary penalties are sought must be heard by a court. It began by observing that civil penalties like the ones sought by the SEC were “designed to punish and deter, not to compensate,” and thus were “a type of remedy at common law that could only be enforced in courts of law.” Id. at 2130. It went on to note that the “antifraud provisions of the federal securities laws . . . target the same basic conduct as common law fraud, employ the same terms of art, and operate pursuant to the same legal principles.” Id. at 2136. As a result, the Court concluded, the SEC’s fraud claims and its pursuit of civil penalties were “legal in nature,” thereby triggering the Seventh Amendment’s right to a trial by jury in civil cases.

The Jarkesy holding is unlikely to have much practical impact on the SEC, because the agency already has been bringing most of its enforcement actions in federal court. With respect to the digital assets industry, Jarkesy’s greatest impact may be on issues that the Supreme Court did not reach — namely, nondelegation.

Under the nondelegation doctrine, “Congress may grant regulatory power to another entity only if it provides an ‘intelligible principle’ by which the recipient of the power can exercise it.” Jarkesy v. SEC, 34 F.4th 446, 460 (5th Cir. 2022). The Supreme Court has not relied on the doctrine to strike down agency action “in the past several decades.” Id. at 462. In Jarkesy itself, the Fifth Circuit held that Congress did not provide the SEC with an intelligible principle by which it was to choose “whether to bring an action in an agency tribunal instead of an Article III court.” Id. at 461. Accordingly, the court of appeals held that the SEC’s statutorily prescribed discretion to choose the forum for pursuing fraud actions violated the nondelegation doctrine. In the Supreme Court’s Jarkesy decision, the Court expressly stated that it was not reaching the nondelegation issue, and the Fifth Circuit has signaled that the nondelegation holding in Jarkesy remains good law. Consumers’ Research v. FCC, 109 F.4th 743, 783 (5th Cir. 2024).

An expansive, robust view of nondelegation could stymie efforts to regulate digital assets under existing federal laws, or even new ones. The industry has already seen a twist on the nondelegation doctrine being litigated in enforcement actions: the major questions doctrine. A revitalized nondelegation doctrine could work in tandem with the major questions doctrine to further restrain federal agencies from attempting to regulate an innovative industry that Congress simply did not (and could not) contemplate when it enacted those agencies’ enabling acts.

Are Digital Assets’ Post-Chevron Future (Loper) Bright?

For 40 years, federal agencies charged with administering federal statutes received deference under the Chevron framework. Under that framework, if a federal statute was unambiguous in its meaning, courts would apply that meaning; otherwise, courts would apply the interpretation supplied by the agency (“deferring” to it), as long as the agency’s interpretation was “reasonable.”

In Loper Bright, the Supreme Court did away with the Chevron framework. It held that judges, not agencies, are charged with resolving statutory ambiguities, and that courts should exercise “independent legal judgment” in “determining the meaning of statutory provisions.” 144 S. Ct. at 2262. Under Loper Bright, it is the responsibility of courts, not agencies, to provide that meaning, and courts should not bind themselves to an agency’s interpretation. Only in instances in which a statute “expressly delegate[s] to an agency the authority to give meaning to a particular statutory term” or the power “to prescribe rules to ‘fill up the details’ of a statutory scheme” does an agency interpretation have binding effect. Id. at 2263.

The Loper Bright decision marks a watershed moment in administrative law — but perhaps not for the digital assets industry. Federal agencies seeking to regulate digital assets (mostly by enforcement) have never really relied on Chevron deference. In securities enforcement actions, for example, the SEC has asked that courts determine whether digital assets are “investment contracts” under Howey or are otherwise “securities”; it has never articulated its own interpretation of “security” with the expectation that the interpretation will receive deference and carry the force of law. Indeed, federal agencies generally have not put out any new interpretive pronouncements in their attempts to holistically regulate digital assets. (That said, as the industry challenge to the Dealer Rule might suggest, the industry is not shy about challenging generally applicable interpretations of statutes that might have an outsize impact on the industry.)

If anything, Loper Bright provides a few cautionary lessons for the future of digital assets regulation. Should Congress enact a statute specifically designed to address federal regulation of digital assets, the default presumption under Loper Bright is that courts will be left to interpret the statute’s terms. Accordingly, if Congress wants an agency (or agencies) to interpret what its new law would require, it needs to expressly delegate that authority — and provide the responsible agency or agencies with the power to exercise discretion in giving meaning to statutory terms.

Absent such delegation, it is unlikely that a federal agency charged with regulating some aspect of the digital assets industry will receive any kind of “respect” for its interpretations of a digital-assets statute. While the Court did recognize that, under Skidmore v. Swift & Co., 323 U.S. 134 (1944), agencies get “respect” when they interpret statutes by relying on “a body of experience and informed judgment,” Loper Bright, 144 S. Ct. at 2259, there is no federal agency with a comprehensive “body of experience” regulating digital assets.

These concerns reinforce, in a post-Loper Bright world, the importance of developing digital assets legislation with precision and careful calibration, but they may present significant challenges for a technology so nascent and nuanced because we can no longer rely on agency experts to interpret and reinterpret statutes as the technology grows, evolves, and expands.

Sizing Up Corner Post’s Potential Impact on the Future of Digital Assets Regulation

At first glance, Corner Post appears to have a fairly straightforward holding: Under the Administrative Procedure Act, when an agency promulgates a rule, a plaintiff has six years from the time that it is injured by the rule to challenge it. But combined with Loper Bright, Corner Post has a potent impact on administrative law. As the US Solicitor General’s office explained during the Corner Post argument, Corner Post’s holding “magnif[ies] the effect of” overruling Chevron. 144 S. Ct. at 2482 (Jackson, J., dissenting) (quoting the assistant to the solicitor general).

Corner Post’s current impact on digital assets regulation is limited, mostly because there is no comprehensive federal framework regulating digital assets. (There may be rulemakings in discrete areas such as tax, but no regulatory scheme governs the ecosystem as a whole.)

But if and when Congress enacts comprehensive digital assets legislation — and charges a federal agency (or agencies) to administer it, presumably by engaging in rulemaking to create comprehensive regulatory frameworks — Corner Post could pose a problem (or provide a solution). Given the rapid evolution of digital assets technology, it is entirely possible that a regulatory framework created immediately following Congress’s enactment of digital-assets legislation may be entirely obsolete (and ill-equipped to regulate) digital assets that are developed a decade after the framework’s enactment. Corner Post would allow new developers — who enter the industry long after rules are first promulgated — to test and challenge those rules.

* * *

The Supreme Court’s recent administrative law decisions may have eased the path to creating a regulatory environment that is more conducive to promoting innovation. But they also create potential pitfalls that might frustrate efforts to meaningfully regulate the digital assets industry. The impact that these decisions will have on the industry will depend on actions not yet taken — by Congress, by federal agencies, and by industry players themselves.

Key Takeaway: Under a recent ruling from the US District Court for the District of Columbia, stablecoins fully backed with reserves and redeemable on a 1:1 basis with a fiat currency are not in and of themselves “investment contracts” and are thus not likely to be subject to the regulatory authority of the SEC.

The decision in SEC v. Binance Holdings Limited, et al. (Binance) has cast further doubt on the SEC’s attempts to exercise jurisdiction over stablecoins. On June 28, 2024, the US District Court for the District of Columbia granted the defendants’ motion to dismiss the SEC’s claim that Binance’s stablecoin BUSD was a security. Shortly thereafter, the SEC stated it would not recommend an enforcement action against Paxos for its involvement in issuing BUSD, providing further proof of what the stablecoin industry has been asserting for years: Sales of fully fiat reserved 1:1 redeemable stablecoins are not investment contracts.

Background

The SEC brought suit against the digital-asset-trading platform Binance Holdings Ltd.; its founder, Changpeng Zhao; and two related US entities (collectively, Binance), asserting that Binance: (1) offered and sold crypto assets and related programs, including its stablecoin BUSD, without a registration statement; (2) operated cryptocurrency trading platforms without registering as an exchange, broker-dealer, broker, or clearing agency; and (3) made false statements to investors and engaged in acts and practices that operated as fraud upon purchasers. Binance filed a motion to dismiss, which the court granted in part, including as to Binance’s stablecoin token BUSD.

The Court Rejected the SEC’s Embodiment Theory

The SEC alleged that Binance’s offering and selling of BUSD stablecoin tokens constituted an investment contract and therefore was a security under the Supreme Court’s test in SEC v. W.J. Howey Co., which requires (1) an expectation of profits arising from (2) a common enterprise that (3) depends upon the efforts of others. The court disagreed with the SEC and granted Binance’s motion to dismiss vis-à-vis BUSD, endorsing a holistic and contextual analysis:

[T]he SEC’s suggestion that the token is “the embodiment of the investment contract” . . . as opposed to the subject of the investment contract, muddied the issues before the Court [and] ignored the Supreme Court’s directive that the analysis is supposed to be based on the entire set of understandings and expectations surrounding the offering . . . . In short, no one should read this case as deciding that crypto assets themselves are or are not “securities[”;] that is not the question presented.

The court also expressed its frustration with the SEC’s inability to articulate how to distinguish crypto assets from crypto asset securities. Although the SEC agreed that a “crypto asset . . . is simply a line of code” and a determination of whether the asset was a security would turn on “the economic realities and the totality of circumstances of how they’re offered and sold,” the court also noted that “the SEC seemed to [be] speaking out of both sides of its mouth” on the issue of whether “once the assets were sold as securities, they retained that character forever.”

1:1 Stablecoins Are Not Investment Contracts

The court concluded that the SEC failed to plausibly allege that Binance offered and sold BUSD as an investment contract, pointing to the absence of allegations that purchasers were “informed that the proceeds from BUSD sales were to be deployed, through the issuers’ managerial and entrepreneurial efforts, to generate a return for their benefit.” The issue was whether BUSD “was offered and sold as a package, as an opportunity for purchasers to participate in [Binance’s] other profit-making programs.” The court held that there was no such expectation of participation, noting that the SEC failed to adequately allege that individual purchasers of BUSD tokens, as opposed to Binance itself, “reasonably expected to share in the companies’ profits in the form of a return on their investment.” Because there was no expectation of profit, the offering and sale of BUSD stablecoin tokens did not constitute an investment contract and therefore was not a security requiring registration with the SEC.

Not Every Profit-Making Opportunity Is an Investment Contract

The court also dismissed the SEC’s allegations regarding another Binance product, Simple Earn. In doing so, the court clarified that even certain profit-making schemes offered through crypto assets will not qualify as investment contracts if the Offeror disclaims any connection between input and return:

Not every “profit-making opportunity” is an investment contract, and the allegations concerning Simple Earn do not describe a scheme or transaction in which investors were urged to put their money in Binance’s hands so that they could share in the return that Binance would generate through its managerial or entrepreneurial efforts. The holders of crypto assets simply agreed to loan them to the company for a specified period of time at a specified rate of interest . . . and the company explicitly disavowed any relationship between the interest rate to be paid and the company’s profitability.

Court Identifies Other Factors in Determining Investment Contracts

In discussing another Binance token, BNB, which is a fungible crypto asset that was first issued pursuant to an initial coin offering, the court identified several factors that might affect whether a digital asset is an investment contract:

• Circumstances of the sale and the purchaser’s reasonable expectations: The court noted that it matters “how the asset was sold and what a purchaser in the marketplace would have reasonably understood it to be.” These contextual factors might make a digital asset either more or less likely to be deemed an investment contract, depending on the circumstances.
• Issuer’s actions in deliberately increasing demand or reducing supply: If an issuer destroys or “burn[s]” quantities of the pooled digital asset, it might boost the “efforts of others” component of the Howey analysis and make it more likely that the asset is being offered as an investment contract. 
• An extended lockup period undermines consumptive intent: A lengthy “lockup” period in which the asset cannot be used would make it more likely that the asset is being offered as investment contract. The court noted other courts’ recent holdings that such lockups are inconsistent with a consumption purpose (“a rational economic actor would not agree to freeze millions of dollars for up to 18 months”) but also remarked that the absence of a lockup period should not be taken as proof of consumptive intent. 
• Other uses of the token, including for payment of platform fees: The court pointed out that other potential uses of the token, such as redemption of tokens for discounted exchange, withdrawal, or listing fees on the platform, may make it less likely that the tokens are being offered as investment contracts.

Applying these factors to stablecoins, a court would likely find that (1) stablecoins are not purchased with an expectation that the stablecoin will generate profits for the purchaser; (2) stablecoins are issued and redeemed by buyers, as needed, with no limits imposed by the issuer; (3) stablecoins are used to facilitate transactions, not to simply hold and sell, and there are no lockup periods on stablecoins; and (4) stablecoins are often used to pay for goods and services, including for the authors’ services.

This Decision Is Consistent With Another Federal Court’s Holding That Fully Reserved 1:1 Stablecoins Are Not Investment Contracts and With the SEC’s Decision to Not Pursue Paxos

The court’s decision in Binance aligns with what Judge Jed S. Rakoff of the Southern District of New York said about stablecoins in SEC v. Terraform Labs. The case concerned, in part, Terraform’s stablecoin, UST, which was purportedly permanently and algorithmically pegged 1:1 to the US dollar.

The Terraform court noted in its July 31, 2023, motion-to-dismiss decision that “where a stablecoin is designed exclusively to maintain a one-to-one peg with another asset, there is no reasonable basis for expecting that the tokens — if used as stable stores of value or mirrored shares traded on public stock exchanges — would generate profits through a common enterprise.” Later, in its December 28, 2023, decision granting summary judgment to the SEC, the court held that the offering and sale of Terraform’s UST token (unlike Binance’s BUSD token) was in fact the subject of an investment contract, relying chiefly on the Anchor Protocol on Terraform’s website, which stated that “[d]eposited stablecoins are pooled and lent out to borrowers, with accrued interest pro-rata distributed to all depositors.”

Taken together, the Binance and Terraform rulings likely played a role in the SEC’s decision to close its investigation of Paxos regarding BUSD. Paxos, which launched BUSD in partnership with Binance in September 2019, had been operating under the cloud of a potential enforcement action since the SEC served it with a Wells notice in February 2023. However, on July 9, 2024, in the wake of the Binance holding, Paxos was advised by the acting chief of the SEC’s Crypto Asset and Cyber Unit that he would no longer recommend an enforcement action against Paxos regarding BUSD. That non-enforcement decision was likely prompted by what has emerged as a judicial consensus on stablecoins in the wake of Binance and Terraform: Stablecoins will not be deemed the subject of investment contracts without an expectation of pro rata profits.

Key Takeaway: In our last publication, we provided an overview of the landscape of affirmative cases seeking to challenge the SEC through a series of federal lawsuits in Texas challenging the SEC’s authority to regulate digital assets. We provide a brief update on those cases here.

The LEJILEX Lawsuit

In February 2024, LEJILEX, the operator of a proposed decentralized exchange, joined forces with the Crypto Freedom Alliance of Texas (CFAT), a Texas-based digital-asset trade organization, to file a declaratory judgment action against the SEC in the US District Court for the Northern District of Texas, Fort Worth Division. LEJILEX v. SEC, No. 24-cv-168 (N.D. Tex. filed Feb. 21, 2024). The plaintiffs have asked the district court to declare that “secondary-market sales of digital assets . . . are not sales of securities” under US securities laws, and to enjoin the SEC “from bringing an enforcement action against LEJILEX or similarly situated CFAT members premised on any purported failure to register as securities exchanges, brokers, or clearing agencies.”

On May 24, 2024, the SEC moved to dismiss the complaint for lack of jurisdiction, arguing that the suit is barred by sovereign immunity and otherwise is not justiciable. The SEC argued that, while the Administrative Procedure Act (APA) would ordinarily waive sovereign immunity, the APA did not apply to the plaintiffs’ claims because they are not challenging a “final agency action” as the APA requires. The agency further argued that even if there were such an action, LEJILEX and CFAT have not adequately alleged that an injury was actual or imminent, depriving them of standing to bring their challenge. The SEC also contended that the plaintiffs’ suit was not ripe, given the “infancy” of LEJILEX’s business and the lack of allegations of an impending enforcement action.

On June 26, 2024, both sides moved for summary judgment. In LEJILEX and CFAT’s motion, the plaintiffs argue that the SEC lacks statutory authority to regulate the digital assets transactions that will occur on LEJILEX’s platform because those transactions do not involve the offer and sale of securities. The plaintiffs also reiterate that the SEC’s digital-asset enforcement activities create undue burdens and uncertainty for the industry, further emphasizing the need for regulatory clarity from the SEC.

In the SEC’s cross-motion (styled as a second motion to dismiss or, in the alternative, a motion for summary judgment), the agency reiterated the arguments from its first motion to dismiss, including its jurisdictional arguments that the suit is barred by sovereign immunity and otherwise is not justiciable. The SEC also contended that the complaint does not state a valid claim and that the relief sought would interfere with the agency’s enforcement duties. The SEC contended that the court could not issue a sweeping declaration about all digital assets, given Howey’s instruction that whether an asset is an “investment contract” turns on the specific fact and circumstances surrounding the transaction.

Briefing on the pending motions will be complete by October. It is unlikely the court will reach a final decision on the merits of the motions before the end of this year.

The Beba Lawsuit

Approximately one month after the LEJILEX lawsuit was filed, Beba LLC and the DeFi Education Fund filed a lawsuit in the US District Court for the Western District of Texas, Waco Division, captioned Beba LLC v. SEC, No. 24-cv-153 (W.D. Tex. filed Mar. 25, 2024). Like the LEJILEX lawsuit, the Beba action seeks a declaratory judgment that the SEC lacks the authority to regulate digital assets. But the Beba challenge tacks on an additional claim: that the SEC has a “policy” of treating digital assets as securities, and that the SEC adopted that “policy” without undertaking notice and comment rulemaking, as required by the APA.

Beba sells duffel bags, backpacks, and wallets handcrafted by tailors in Kenya. Beba developed and gave away a digital asset, the BEBA token, to use in conjunction with Beba’s sales of merchandise. For example, individuals holding more than 200 BEBA tokens could buy a Beba-produced Ndovu Duffel at a discounted price.

In the past, Beba has distributed its tokens through an “airdrop” giveaway. Beba would like to conduct another airdrop but fears that the BEBA token, which is tradeable on third-party exchanges, might be viewed as a security in light of the SEC’s enforcement actions. Beba contends that its tokens are not securities because they are not “investment contracts” within the meaning of the securities laws, and that the SEC lacks clear authority under the major questions doctrine to regulate digital assets.

Like the plaintiffs in LEJILEX, Beba seeks a declaratory judgment that states: (1) “Beba’s first airdrop . . . is not an unlawful sale of securities”; (2) Beba’s “planned second airdrop . . . is not an unlawful sale of securities”; and (3) “BEBA tokens themselves are not investment contracts.” Beba has also asked the district court to conclude that the SEC violated the APA by “adopt[ing] a new unwritten policy that nearly all digital assets are securities and the majority of transactions involving digital assets are securities transactions,” and to vacate that “policy.”

The SEC moved to dismiss the complaint on July 8, 2024, adopting essentially the same sovereign immunity and justiciability arguments as it made in LEJILEX. The plaintiffs responded by explaining that they intended to file an amended complaint, which would moot the SEC’s motion to dismiss.

Consensus on Consensys? A Case of Dueling Lawsuits

Consensys filed a pre-enforcement challenge in the Northern District of Texas, Fort Worth Division, seeking a declaratory judgment that the SEC lacks jurisdiction over ETH because ETH is not a “security” — specifically, an “investment contract.” Consensys Software Inc. v. Gensler, No. 24-cv-369 (N.D. Tex. filed Apr. 25, 2024).

Consensys seeks both declaratory and injunctive relief that prevents “the SEC from continuing any investigation or commencing an enforcement action against Consensys based on the premise that Consensys’s transactions in ETH are securities transactions.” It also asks the court to hold that the SEC violated the APA by characterizing ETH as a security, despite its prior position that ETH is a commodity. It also asks the court to conclude that the SEC has no statutory authority to investigate or bring an enforcement action against Consensys regarding the Swaps or Staking features of its MetaMask software.

In a roller-coaster turn of events, the SEC informed Consensys on June 18, 2024, that it did not intend to pursue an enforcement action on the basis of a Wells notice that it had previously issued, which originally prompted Consensys’s preemptive lawsuit. The apparent victory was short-lived, however, because the SEC filed an enforcement against Consensys in the Eastern District of New York, alleging that the company serves as an unregistered broker of securities by offering its MetaMask Swaps service. SEC v. Consensys Software Inc., No. 24-cv-4578 (E.D.N.Y. filed June 28, 2024).

In light of these events, the future of Consensys’s Texas lawsuit is unclear. Other than filing a notice of related cases, the SEC has remained silent about Consensys’s preemptive challenge. The SEC intends to file an answer on July 29, and the parties will file dispositive motions on or before September 20, 2024, with briefing completed by the end of November 2024.

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Given the continued lack of regulatory certainty in this rapidly evolving industry, these challenges represent the industry’s latest efforts to obtain some clarity from the SEC and highlight the need for clear guidelines.

Key Takeaway: On June 25, 2024, two executives were sentenced to prison for securities fraud based on the manipulation of cryptocurrency prices. The February 2024 jury conviction of one of the executives, Shane Hampton, marked the first time a federal criminal jury found that a cryptocurrency was a security and that the manipulation of that cryptocurrency constituted securities fraud. Hampton and two of his co-conspirators, Michael Kane and Tyler Ostern, will spend years behind bars for their actions.

A federal indictment alleged that Michael Kane, cofounder and CEO of Hydrogen Technology (Hydrogen), and Shane Hampton, Hydrogen’s chief of financial engineering, directed a South African self-described “market making” company, Moonwalkers Trading Limited (Moonwalkers), to design and run an automated trading system or “bot” that manipulated the price of Hydrogen’s cryptocurrency, HYDRO, on an unnamed US cryptocurrency exchange. The indictment charged both executives with one count of conspiracy to commit securities price manipulation (18 U.S.C. § 371), one count of conspiracy to commit wire fraud (18 U.S.C. § 1349), and two counts of wire fraud (18 U.S.C. §§ 1343 and 2(a)). That indictment also charged George Wolvaardt, the chief technology officer of Moonwalkers, with the same counts. Two other conspirators, Tyler Ostern, the CEO of Moonwalkers, and Andrew Chorlian, an engineer at Hydrogen, were each charged in different actions (United States v. Ostern, 1:23-cr-20165-CMA, Doc. 1 (S.D. Fla. Apr. 19, 2022)) and United States v. Chorlian, 1:23-cr-20171-PAS, Doc. 1 (S.D. Fla. Apr. 20, 2022)) with one count of conspiracy to commit wire fraud and manipulation of security prices.

The indictment alleged that the Hydrogen defendants used Slack and Telegram to place thousands of “spoof orders” (orders placed without a legitimate intent to execute) and also execute thousands of “wash trades” (trades in which the same beneficial owner is both the buyer and the seller) using bots to complete the trades. During the course of the scheme, the bot allegedly placed approximately $300 million in spoof orders and approximately $7 million in wash trades, thereby creating the false appearance of a high volume of demand for HYDRO. This manufactured market activity, per the indictment, “caused other market participants to trade at prices, quantities, and times that they otherwise would not have traded.”

In November 2023, Kane pleaded guilty to one count of conspiracy to commit securities price manipulation, one count of conspiracy to commit wire fraud, and two counts of wire fraud. Two other alleged conspirators, Ostern and Chorlian, also pleaded guilty in 2023.

Hampton, who allegedly participated in conversations with the other co-conspirators to coordinate spoof orders and wash trades, pleaded not guilty and proceeded to trial. On February 7, 2024, after a seven-day trial in the Southern District of Florida, a jury convicted Hampton of one count of conspiracy to commit securities price manipulation and one count of conspiracy to commit wire fraud. Among other things, the government had alleged that Hampton’s sales of HYDRO were investment contracts. Through its unanimous verdict, the jury agreed, thus making Hampton’s conviction the first time that a criminal jury found that a cryptocurrency was a security.

Hampton was sentenced to two years and 11 months’ imprisonment for his two-count conviction. The sentence was relatively on par with what his co-conspirators received: Kane was sentenced to three years and nine months’ imprisonment; Ostern was sentenced to two years’ imprisonment; and Chorlian was sentenced to three years and four months of home detention.

Many issuers use market makers to help build liquidity in the market for their tokens. While the Hydrogen indictment was based upon strong evidence of market manipulation that goes well beyond traditional market making, it serves as an important reminder for companies to remain vigilant about building liquidity in a manner that is not aimed at influencing the value of the token. In addition, where law enforcement is increasingly focused on trading activity involving market makers, companies can protect their officers and employees by developing market integrity policies and conducting trainings aimed at avoiding trading activities that could lead to criminal liability.

Key Takeaway: The judicial split over whether XRP constitutes a crypto asset security foreshadows further conflicts as courts of different jurisdictions seek to apply the fact-specific Howey test to digital assets. This underscores the need for legal certainty from either appellate courts or Congress.

A recent decision from the Northern District of California has created an apparent split over whether sales of XRP should be considered offers and sales of securities, departing from a previous decision rendered out of the Southern District of New York. In re Ripple Labs, Inc. Litig., No. 18-cv-6753, 2024 WL 3074379, at *8-*10 (N.D. Cal. June 20, 2024). As alleged, Ripple Labs Inc. (Ripple) sold XRP, the native token of the XRP Ledger, to institutional investors directly through its wholly owned subsidiaries from 2013 to 2020; XRP was also traded on centralized digital asset exchanges to retail customers.

As outlined earlier in this update, on July 13, 2023, Judge Torres in the Southern District of New York determined on summary judgment that sales of XRP to the retail customers through centralized digital asset exchanges did not lead customers to reasonably expect profits derived from the efforts of others, thereby failing the Howey test, because: (1) retail customers purchased XRP in blind bid/ask transactions and did not know whether they were purchasing XRP from Ripple or from other sellers; (2) there was no evidence that promotional materials explaining the relationship between XRP and Ripple’s business model were distributed to public investors; (3) retail customers were less sophisticated and unlikely to be able to parse publicly disclosed documents posted on Ripple’s website and the various, sometimes inconsistent, statements made by Ripple’s senior leaders on social media websites and news platforms over an extended eight-year period; and (4) sales to public buyers were not made pursuant to lockup provisions such as resale restrictions, indemnification causes, or statements of purpose. SEC v. Ripple Labs, Inc., 682 F. Supp. 3d 308, 316-18 (2023).

In a putative class action brought in the Northern District of California, plaintiff Bradley Sostack, a purchaser of XRP tokens, sued Ripple and its CEO, Brad Garlinghouse, alleging violations of federal and state securities laws by failing to register XRP as a security and by making certain allegedly misleading statements relating to XRP. On summary judgment, the Ripple defendants argued that XRP is not a security under the Howey test because most individuals who purchased XRP on secondary market exchanges did not have an expectation of profit due to the efforts of others, pointing to Judge Torres’s prior decision. In re Ripple Labs, Inc. Litig., No. 18-cv-6753, 2024 WL 3074379, at *8-*10 (N.D. Cal. June 20, 2024).

On June 20, 2024, Judge Phyllis Hamilton concluded on summary judgment that there was a triable issue of material fact as to whether Ripple violated securities laws by making misleading statements relating to the offer and sale of XRP. While acknowledging Judge Torres’s decision and agreeing that certain promotional materials were distributed on a limited basis, Judge Hamilton also noted that the evidentiary record contained numerous promotional materials that were distributed to the general public via widely spread internet posts and videos, including not only the promotional materials analyzed by Judge Torres (documents on Ripple’s websites and statements made by Ripple’s senior leaders on social media and in the news) but also additional evidence presented by plaintiffs, such as Garlinghouse’s statements linking XRP’s performance to Ripple solving a multitrillion-dollar problem around cross-border payments; and Ripple’s efforts to answer questions directly from XRP purchasers in “Ask Me Anything” interviews conducted by Schwartz and Garlinghouse on YouTube that garnered more than 46,000 and 52,000 views, respectively. Accordingly, Judge Hamilton concluded, “given the relative novelty of cryptocurrency, and given the lack of any controlling law regarding the motivation of a reasonable cryptocurrency investor,” the court thought it best to “decline[] to find as a matter of law that a reasonable investor would have derived any expectation of profit from general cryptocurrency trends, as opposed to Ripple’s efforts to facilitate XRP’s use in cross-border payments, among other things.” Id. at *10.

Judge Hamilton’s decision was not a total loss for Ripple, however, because the court did dismiss Sostack’s putative class claims as either barred by the statute of repose (federal claims relating to Ripple’s failure to register) or because Sostack failed to prove the necessity privity with the defendants to proceed on the claim (state-law failure-to-register claims).

The decision formally creates a split over XRP’s status as a security, although it remains to be seen whether the split requires resolution.

Key Takeaway: The second quarter of 2024 saw blockbuster settlements with state and federal government agencies, which emphasize the interconnectedness of the crypto markets and the continued focus on investor harm as a driver of regulator activity.

SEC’s Settlement with Terraform

On June 13, 2024, following a jury verdict in its favor, the SEC announced a settlement with Terraform Labs PTE, Ltd. (Terraform), and its CEO, Do Kwon, to resolve allegations of securities fraud and the offering and selling of securities in unregistered transactions. The SEC alleged that Terraform and Kwon orchestrated a multibillion-dollar fraud involving a suite of interconnected “crypto asset securities,” while also misleading investors about the strategic partnerships on the Terra blockchain and the stability of its algorithmic stablecoin, Terra USD (UST).

The SEC’s allegations focused largely on the collapse of two crypto assets, UST and LUNA. UST, Terra’s algorithmic stablecoin, and LUNA, Terra’s primary backing asset, were linked algorithmically as a mechanism to keep UST pegged 1:1 with the US dollar. As explained in the Terra white paper, the mechanics of the algorithm worked as follows: In the event UST depegged from $1, traders could purchase UST at a “discount” (less than $1) and exchange it for LUNA tokens at a ratio of $1 worth of LUNA for every UST. Thus, Terra’s algorithm was designed to financially benefit traders while simultaneously reducing the supply of UST and raising its value back to $1.

In May 2021, however, the algorithm failed, and UST lost its peg. In the days that followed the depegging, Kwon allegedly met with Jump Trading LLC (Jump Trading) — one of Terra’s institutional market makers — to discuss strategies for restoring UST’s value. Following those discussions, Jump Trading allegedly purchased large swaths of UST in an effort to “rescue” Terra and restore its peg. But rather than disclosing that the peg had been restored by Jump Trading’s market activity, Terra and Kwon instead attributed the return of the peg to the algorithm’s efficacy in regulating the price of UST automatically.¹ One year later, in June 2022, following a large sell-off of UST by an institutional trading firm (among other reasons), UST depegged again. This time UST failed to recover its peg and it, along with its sister token LUNA, plummeted to a value of nearly zero, wiping out more than $40 billion in combined market value.

The SEC proceeded to trial against Terraform and Kwon in March and April of 2024. After being found guilty following a nine-day jury trial, Terraform and Kwon entered into a settlement with the SEC, agreeing to pay more than $4.5 billion to settle the jury’s determination of liability for securities fraud. Terraform, which filed for Chapter 11 bankruptcy, agreed to pay $3,586,875,883 in disgorgement, $466,952,423 in prejudgment interest, and a $420,000,000 civil penalty. It also agreed to “stop selling its crypto asset securities, wind down its operations, replace two of its directors, and distribute its remaining assets to investor victims and creditors through a liquidation plan.” Kwon agreed to pay $110,000,000 in disgorgement and $14,320,196 in prejudgment interest on a joint and several basis with Terraform, as well as an $80,000,000 civil penalty. He is also prohibited from serving as an officer or director of any public company.

New York Attorney General’s Settlements with Genesis and Gemini

On May 20 and June 14, New York Attorney General Letitia James secured two settlements from a group of codefendants — one settlement from Genesis Global Capital, LLC, Genesis Asia Pacific PTE, LTD, and Genesis Global Holdco, LLC (together, Genesis), and the other from Gemini Trust Company, LLC (Gemini) — for their roles in connection with the failure of an investment program called Gemini Earn, which cost 230,000 investors more than $3 billion in losses. According to the amended complaint, Gemini Earn was marketed as a safe “high-yield investment program” through which investors could “profit by passively investing their cryptocurrencies with Genesis Capital” and earn an annual percentage yield of up to 7.4% on their holdings. Genesis and Gemini allegedly collaborated to pool investors’ assets for use in Genesis’s lending business.

In its amended complaint, the Attorney General’s Office alleged that Gemini provided assurances of Genesis’s financial health to those who invested in Gemini Earn, despite contradictory internal analyses concluding that Genesis was a risky investment. Specifically, Gemini determined that Genesis (1) was highly leveraged with low liquidity; (2) maintained an undercollateralized loan book; and (3) overconcentrated its loans in its affiliated entities and in Alameda Research. The complaint further alleged that Genesis concealed $1.1 billion losses that it experienced in its portfolio arising from the default of two of its borrowers (Three Arrows Capital and Babel Financial), resulting in Genesis suspending all withdrawals from Gemini Earn and precluding investors from accessing their investments. The collapse of Three Arrows Capital was precipitated by (among other things) the crash of the price of LUNA, as described above, which wiped out an estimated value of as much as $560 million of its portfolio. When Three Arrows Capital then defaulted on its debts, this caused a ripple effect within the crypto community, including allegedly with the Gemini Earn project.

When Genesis filed for bankruptcy in January 2023, the Attorney General’s Office submitted a proof of claim in the United States Bankruptcy Court for the Southern District of New York to cover the losses claimed in its lawsuit. On May 20, 2024, Genesis and Attorney General James entered into a settlement to resolve the Attorney General’s Office’s claims. On June 7, 2024, the bankruptcy court approved a settlement that resolved the action against Genesis. Among other terms, the settlement provides for the allowance of general unsecured claims in the amount of $1.1 billion against Genesis. Under the plan of reorganization, which was confirmed in May 2024, the New York Attorney General’s allowed claims will be paid only after secured creditors and holders of other general unsecured claims are paid in full. In addition, the plan prioritizes customer recoveries over governmental claims, such as those allowed by the New York Attorney General’s settlement. Any recovery received by the New York Attorney General’s Office on the office’s proofs of claim will be allocated to a victims’ fund. On July 30, 2024, the debtors filed a notice stating the plan would become effective on August 2, 2024, following which distributions under the plan would commence. The actual amount that the Attorney General James will recover on her proofs of claim will not be known for some time.

A few weeks later, on June 14, 2024, the Attorney General’s Office and Gemini entered into a separate settlement agreement arising out of the same underlying case. The settlement provides for restitution and cooperation with the Attorney General’s Office in the ongoing litigation, and imposes injunctive and conduct-based relief. In particular, under the terms of this settlement, Gemini is required to make Gemini Earn investors whole, provide full and complete restitution to Gemini Earn investors on an in-kind “coin-for-coin” basis, and provide the Attorney General’s Office with proof of payment.

The settlement also bans Gemini from operating a lending program in New York and requires Gemini to make certain disclosures to its United States customers, including disclosures: (a) that it is not registered as a national securities exchange with the Securities and Exchange Commission; (b) that it has not been designated as a contract market by the Commodity Futures Trading Commission; (c) of the risk factors outlined in investor alerts provided by the Attorney General’s Office; and (d) of any fees or commissions Gemini receives from a third party in connection with the listing of a digital asset or with the trading of a digital asset on its platform by a Gemini customer.

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These settlements mark examples of government agencies’ aggressive pursuit of penalties and fines against companies in the crypto space, with a continued focus on remedying consumer harm. After the Terraform and Do Kwon settlements, for example, the director of the SEC’s Enforcement Division, Gurbir S. Grewal, stated, “despite the vast resources that crypto asset defendants deploy against us, the dedicated staff of the Division of Enforcement will not stop until they achieve justice for the victims of these breathtaking frauds.” Following the Genesis and Gemini settlements, New York Attorney General James similarly remarked that there are “real-world consequences and detrimental losses that can happen because of a lack of oversight and regulation within the cryptocurrency industry” and “deceiving investors is illegal and will not be tolerated by my office.” It bears noting that fraud was not alleged against Gemini or Genesis and that Genesis, did, in fact, return 100% of Gemini Earn investors’ funds in kind.

^[1] The SEC also alleged that Terraform and Kwon also committed securities fraud by misrepresenting to investors that Chai, a popular Korean electronic mobile payment application, planned to use the Terra blockchain to process and settle commercial transactions, when in fact there was no such commercial arrangement.

Key Takeaway: The US House passed the Financial Innovation and Technology for the 21st Century Act (FIT21), a far-reaching bill aimed to establish regulations for digital assets markets, with broad bipartisan support. FIT21’s passage presents the first time major legislation concerning digital assets has been approved in one of the chambers of Congress, a major boon for digital assets policy in the US and for those seeking regulatory clarity in the industry. But because of inaction from the Senate and headwinds from the executive branch, it remains to be seen whether FIT21 becomes law with the current Congress.

On May 22, 2024, the US House of Representatives voted 279 to 136 to approve FIT21, marking legislative progress for the digital assets industry. According to the House Financial Services Committee, the bill, which passed with bipartisan support, seeks to “provide[] the robust, time-tested consumer protections and regulatory certainty necessary to allow digital asset innovation to flourish in the United States.”

If enacted, FIT21 would provide the Commodity Futures Trading Commission (CFTC) with primary jurisdiction over “digital commodities” and limit the SEC’s jurisdiction to digital assets offered as part of an investment contract (referred to in the bill as “restricted digital assets”). The bill’s proposed framework contemplates certain factors that would drive a digital asset’s designation as a digital commodity or restricted digital asset, including whether the asset’s underlying blockchain is certified to be a “decentralized system”; whether the asset holder is affiliated with or related to the issuer; and how the asset was acquired. The bill would also establish a process permitting the secondary trading of digital commodities if those commodities were initially offered as part of an investment contract. And the bill would impose on all entities required to be registered with the CFTC, the SEC, or both “comprehensive customer disclosure, asset safeguarding, and operational requirements,” per the press release.

The passage of FIT21 would mark a major milestone in the US approach to regulating digital assets and financial technologies. This legislation could combat the SEC’s current practice of regulation by enforcement, creating a clear and consistent regulatory framework for cryptocurrencies, blockchain technology, and other fintech innovations. By providing regulatory clarity, FIT21 would encourage innovation in the financial sector and put the United States a step closer to the developments in other jurisdictions, such as the European Union’s Markets in Crypto-Assets regulations, which have already established a comprehensive regulatory regime for digital assets across EU member states. Such clarity could cement the United States’ position as a global leader in the digital economy.

While the promise of FIT21 has invigorated many across the industry, it is unclear whether the Senate will take up FIT21 in this Congress. The relevant Senate committees have not formally engaged through the committee process with digital assets policy to the same extent as their counterpart committees in the House, though a number of different senators are said to be interested in various versions of crypto legislation, whether through revisiting previously proposed bills, working with the FIT21 framework, or generating a hybrid approach of existing and new frameworks. The legislation is likely to face headwinds from the executive branch, which has vocally opposed the bill,² although the shifting election landscape could influence the Biden administration’s position because crypto policy has emerged as a potential economic platform issue for both parties.

^[2] President Biden expressed his opposition to the bill in a policy statement, calling instead for further collaboration with Congress on developing digital assets legislation that “includes adequate” protections for consumers and investors “while creating the conditions needed for innovation.” SEC Chair Gensler was even more critical of the legislation, asserting that its passage would “create new regulatory gaps and undermine decades of precedent regarding the oversight of investment contracts,” thereby “putting investors and capital markets at immeasurable risk.”

Key Takeaway: On May 1, 2024, Judicial Arbitration and Mediation Services Inc. (JAMS) unveiled mass arbitration procedures to take immediate effect, which could have an impact on retail crypto-related arbitrations. These new procedures, which include revised fee provisions aimed at making mass arbitration more cost-effective and streamlined as well as new declaration requirements to prevent fraud, and require mutual agreement on new procedures, stand to affect the nature, volume, and cost of arbitrations in the cryptocurrency space.

Cryptocurrency companies, including major players such as centralized exchanges and token issuers, often include alternate dispute resolution clauses in their terms and conditions or other commercial contracts, which include the rules that will govern any disputes, including the seat of the arbitration. Such provisions allow for disputes to be resolved efficiently and confidentially, and also provide the parties an opportunity to have their dispute heard before a fact finder with experience in crypto.

As discussed in a recent Goodwin Alert, JAMS recently unveiled specific procedures for mass arbitrations: the Mass Arbitration Procedures and Guidelines (cited here in as JAMS Procedures). These rules, which took effect upon their publication, can apply to all JAMS arbitrations that qualify as mass arbitrations. But how, when, and whether they will be used in crypto-related arbitration is another question. We discuss below four major aspects of the new rules and how they might affect arbitrations in the cryptocurrency space.

In the first section of the JAMS Procedures, JAMS instituted a numerosity requirement for mass arbitration. To qualify as a mass arbitration, there must be “75 or more similar Demands for Arbitration, or such other amount as is specified in the Parties’ agreement(s)” that are “filed against the same Party or related Parties by individual Claimants represented by either the same law firm or law firms acting in coordination.”³ This numerosity requirement is not likely to be a barrier to use of mass arbitration in cryptocurrency-related cases, given that many cryptocurrency disputes tend to arise in the retail context.

In addition to numerosity, the first section states that the JAMS Procedures will apply only if the parties have a written agreement to use them. This mutual assent requirement can likely be satisfied via contractual wrapper agreements, so long as such an agreement meets the standards for a valid agreement to arbitrate in a designated jurisdiction.⁴ As with all arbitration agreements, the enforceability of that agreement may vary by jurisdiction.

In the second section of the JAMS Procedures, JAMS implemented additional filing requirements that are tied to identity verification, requiring names and both physical and email addresses of claimants.⁵ Each claimant is also required to submit a separate demand that is accompanied by a “a sworn declaration from counsel averring that the information in the Demand is true and correct to the best of the representative’s knowledge.”⁶ These requirements are intended to prevent filing by fictitious persons or individuals who have no standing to file a claim. Such requirements may have a chilling effect on mass arbitrations because many retail purchasers of cryptocurrency buy digital assets precisely for the anonymity such assets provide. On the other hand, many retail purchasers also buy through exchanges, where they surrender some personally identifying information, such as a user’s name, date of birth, and address, and government-issued documentation.

Finally, certain new fee provisions will make mass arbitration more affordable and thus more accessible to both parties. JAMS Procedures 6 and 7 significantly reduce the up-front filing fees for mass arbitrations no matter the number of cases to $7,500. This serves as a boon to defendants who, prior to this change, may have faced exorbitant fees in individual arbitrations based on the same or similar set of facts. The change benefits claimants, too. For consumers bringing claims in a mass arbitration arising under pre-dispute arbitration clauses between companies and consumers, fees are capped at $2,500 in the aggregate, making the filing of such an action much more cost-effective for claimants. A further incentive for consumer-claimants to proceed under the mass arbitration procedures is that the defendant company is required to bear the remainder of the consumers’ share of the filing fee and case management fees. While capping the fees for defendants will provide less leverage to claimants at the outset of an arbitration, ultimately, claimants can take advantage of collective low fees at filing and the shifting of case management fees to defendant corporations over time.

It is unclear whether and to what extent crypto companies will seek to implement these new procedures as part of their arbitration agreements. But what is clear is that if and when they do, attorneys representing claimants will have many considerations to contend with, including whether to challenge the validity of the arbitration agreement (or the application of the procedures), whether there are ways to identify and contact potential claimants, and whether it serves their interests to take advantage of the reduced filing fees.

^[3] JAMS Procedures at 1(c).
^[4] It is noteworthy that the question of jurisdiction itself is likely to be determined by the arbitrator in the first instance, per the express section relating to that issue that allows a “Process Administrator” to determine “threshold jurisdictional and arbitrability disputes . . . subject to final determination by the Arbitrator(s) or a court.” Id. at 4(b).
^[5] Id. at 2(b) requires the submission of “the first and last name, physical address and email address of the Claimant, as well as representative information.”
^[6] Id. at 2(c).