The Supreme Court may have recently tried overreach by the Environmental Protection Agency, but on the Securities and Exchange Commission, Chairman Gary Gensler has not hesitated to extend the agency’s powers beyond constitutional boundaries.
We don’t need a better example than his all-out assault on the crypto space to prove it.
You don’t need a constitutional expert to understand that the SEC has limited jurisdiction over the cryptocurrency industry. Absent congressional action, front-line regulation of digital assets belongs to the Commodity Futures Trading Commission, the primary regulatory body for investments that are not considered traditional securities.
Still, Gensler, whom President Biden chose to run an agency aimed at focusing on stock scammers who defraud unsuspecting people, has gone head-to-head, like Elliot Ness chasing Al Capone. Dive into cryptocurrencies. If successful, nearly 80 years of U.S. securities law will be overturned in Gensler’s first two years as chairman.
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The Securities Act of 1933 lists the types of securities regulated by the SEC, including investment contracts. In 1946, the Supreme Court ruled on the landmark Howey test, which provides a four-part test for determining what constitutes an investment contract. Now, 76 years later, Gensler is trying to reverse the challenge with a promise to regulate digital assets. More than his predecessor Jay Clayton, he promises to regulate in a more intrusive way (more on that later).
Howey was involved in the provision and sale of orange groves invested in the orange harvest by hotel guests at a Florida resort owned and operated by the WJ Howey Company. The company pitched to guests that it would do all the work required to grow and sell oranges. Apart from buying land and signing contracts for services, investors did nothing but raise money. The Supreme Court has established the so-called “Howey test” which has established standards for decades, certifying that this business scheme constitutes an investment contract.
According to the Howey test, an investment contract occurs when a person occurs. 1) Invest money. 2) within a common enterprise; 3) be guided to expect profit; 4) solely through the efforts of the Promoter or a third party; All four prongs must be met.
Since Howey, Congress has failed to pass new legislation directly related to regulating cryptocurrencies. This should mean that it is Congress’s intention that the de facto regulator of cryptocurrencies be the CFTC, which fears it will stifle the emerging technologies that blockchain and its digital assets represent. However, Gensler used this lack of clarity to launch a regulatory campaign with law enforcement to expand Hawi beyond recognition. As Gensler looks to cryptocurrencies, he sees an opportunity not only to regulate how contracts for land and services are sold, but also to regulate oranges. As a legal theory, it should scare everyone far beyond the crypto space.
The SEC has two significant pending cases. First, his Ripple case launched by Jay Clayton in his final days as SEC Chairman, but being advanced by Gensler, involves the digital asset XRP. Clayton prosecuted Ripple executives, perhaps fearing that Gensler would take credit for what he thought was a government crackdown. The method is to sell XRP in a way that classifies it as Mr. Howie’s securities. We will contribute to the expansion of Ripple’s business. Therefore, it must “disclose” information about the sale to investors as if it were a publicly traded company.
The case is now being heard in federal court, where Gensler’s attorneys are arguing the merits before a skeptical judge who handed down a series of rulings in favor of Ripple (full disclosure: I I serve as a court hearing officer representing 72,000 XRP holders.When I acquired the token, I had never heard of a company called Ripple.) Then there’s his LBRY case, which is also said for lack of disclosure. This is his Gensler brainchild, including the digital token LBC, further emphasizing his Gensler intent to designate the SEC as the primary regulator of crypto. Note that these are two wildly different cryptocurrencies that operate on separate blockchain networks, testing the same dangerous theory.
For comparison, blockchains are orange groves, but instead of producing oranges, each blockchain produces a native cryptocurrency. The Bitcoin network produces Bitcoins. The Ethereum network produces Ether. The XRP Ledger generates XRP. and so on. Starting with Bitcoin, tokens in all networks perform whatever function blockchain was invented to provide. The XRP Ledger, where Ripple and other unrelated companies operate various businesses, uses the network’s native currency, XRP, to settle transactions in other currencies. LBC, on the other hand, works on his LBRY blockchain like dollar bills on a server’s restaurant table by tipping artists on his platform for decentralized multimedia content.
Most importantly to recognize, the SEC’s allegations are not limited to when or how Ripple or LBRY sold their tokens. The SEC maintains that both of these unique tokens are securities in their own right, no matter who sells them or for what reason. There is no distinction between Ripple or his LBRY executives selling tokens and those who later just traded cryptocurrencies. If true, the SEC could regulate secondary market sales independently of these companies, including sales by exchanges and retailers. It’s like saying that the Howie oranges sold by the grocery store are unregistered securities after all. Imagine the economic impact of innocent consumers.
While securities law governs investments, as in the Howey case, the SEC is currently not allowing anyone to acquire these tokens, even if the purchaser intends to use the tokens to access technology for reasons other than investing. It doesn’t matter why. His recent LBRY hearings revealed Gensler’s ridiculous theory in a nutshell. Blockchain When a person buys tokens on the secondary market for use in his network, every token is an investment contract with that company without knowing there is another company using it in the same network. .
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With memetic stocks attracting a lot of novice investors and SPAC crashing, you might think Gensler has too much to play with in a cryptocurrency that has been trading for over a decade. Still, he calls cryptocurrencies the “Wild West” of investing, as digital assets are known to fund illicit activities. However, the majority of money laundering is done using US dollars, and many bad things happen on the unregulated internet.
Moreover, seizing power seems to be Gensler’s job. He limited public comment on SEC rulemaking and expanded the broadest environmental (ESG) data disclosure requirements ever proposed in the United States. This could advance a progressive social agenda and, as reported by Fox Business’s Eleanor Telletto and Charles Gasparino, could help secure a bigger job in the Biden administration, perhaps Treasury Secretary. I can’t.
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In any case, Gensler’s war on crypto may be his most ambitious and dangerous insult to constitutional norms. Every case since Howey found that security involves an actual contract, or some degree of privacy between buyer and seller. Without Congressional action, Gensler is set to overturn nearly a century of precedent with his forced bulldozers.
John Deaton is the founder of Deaton Law Firm and CryptoLaw. He is currently serving as Amici Curia representing over 70,000 XRP investors in a class action lawsuit against the Securities and Exchange Commission. Deaton, a former Marine, is a cryptocurrency investor and owns a farm in Rhode Island.