Tag: SEC Overreach

The Irony of Interlocutory Appeal

Posted on

By John E. Deaton.

Following Ripple’s victory in July, the Securities and Exchange Commission (SEC) scrambled to save face by filing an appeal that fits their narrative. In August, the SEC sent a letter of intent to move for interlocutory appeal to Judge Torres. The letter outlined the agency’s intent to seek interlocutory appeal on the Judge’s ruling that the defendants’ programmatic sales and other sales of XRP failed the Howey test.

As I wrote when the letter was sent, I expected Judge Torres to grant the motion, and that is exactly what she did. I believe the move allows the judge to fully explain her reasoning in the case, further making it “appeal-proof,” as well as providing her the opportunity to address anything Judge Jed Rakoff has said. Judge Rakoff, presiding over the SEC v. Terraform Labs case, rejected the company’s motion to dismiss, and disagreed with Judge Torres’ approach regarding Howey. The SEC alleges that Torres’ ruling could impact their other lawsuits, which are of a similar nature. However, this is the weakest of their arguments.

With the right to file a formal motion for an interlocutory appeal granted, Judge Torres can now distinguish between her actual ruling in the Ripple case, versus what Judge Rakoff purported it to be. It was the SEC who categorized the different sales, not Judge Torres.

Recently, the SEC has filed its reply memorandum in further support of its motion to certify interlocutory appeal, now claiming that it is only interested in an efficient adjudication of the case, unlike Ripple, who the SEC contends wishes to prolong litigation. (Laughable, I know).

The facts are as follows: the SEC is asking for a stay on everything—which by definition and operation, would automatically prolong the entire litigation. Similarly, as there is still a trial that needs to take place, an interlocutory appeal would not end litigation and would add an appeal to the overall process. Should an early appeal be granted, it will take another year and a half to two years for the U.S. Court of Appeals for the 2nd Circuit to rule on the issue.

If the SEC were to win at the 2nd Circuit, which I believe they won’t, then the case gets remanded back to Judge Torres, who would apply the facts of the case to the other Howey factors not yet analyzed.

In other words, even if the 2nd Circuit disagrees with Judge Torres’ analysis of Howey’s third prong, the SEC does not win at summary judgment. Instead, Judge Torres would then apply the investment prong and the common enterprise prong of the Howey test, again, further prolonging the case.

I believe Judge Torres could, should, and would, give the same result even after a successful SEC interlocutory appeal. The SEC then could ask for a second interlocutory appeal to the 2nd Circuit on Torres’ common enterprise analysis.

Now, if the SEC loses at the 2nd Circuit, the case comes back to Torres for trial. Then after the trial, there would be the usual appeal on all issues. The SEC’s claim that it wants faster adjudication than Ripple does, might be the dumbest argument I’ve heard yet. It flies in the face of its request for an early appeal, while asking for a stay!

This irony is exactly what the motion for interlocutory appeal boils down to. The SEC has attempted to regulate by enforcement through the courts, and now that the agency has received a ruling it deems incorrect, the SEC will spitball separate arguments from ongoing cases into its appeal process—delaying litigation across the board. These are the desperate tactics of a regulator who lost the case.

When tackling crypto, the SEC should be wary of overreach

Posted on

By Brooke Masters. (Financial Times). August 15, 2023.

For more than a century now, US watchdogs have policed the financial landscape, seeking to protect investors from potential fraud and the consequences of their own blind optimism.

Most of their efforts to ensure that investors get accurate information about what is happening to their money are focused on familiar products, such as stocks and bonds. But every so often an explosion of interest in new investments forces a debate about the regulatory perimeter and whether to expand it. This is one of those moments.

Right now, the US Securities and Exchange is fighting on multiple fronts to bring enforcement cases involving cryptocurrencies, while a completely separate lawsuit is seeking to upend more than 30 years of practice in the leveraged loan market.

The laudable goal is investor protection. The volatility of bitcoin and other tokens and the implosion of the FTX crypto exchange have cost investors billions; and a bankruptcy trustee is seeking to recover money for loan investors left holding the bag when a drug testing firm went belly up after being investigated for fraud.

Read the full article here.

SEC Crypto Litigation Ventures Into Dangerous Legal Territory

Posted on

By John E. Deaton.

The US Supreme Court issued the landmark SEC V. Howey decision in 1946, laying out a specific definition of what constitutes a security. Those justices couldn’t have guessed how complex digital commerce over encrypted lines of computer code would fit in almost a century later.

The Securities and Exchange Commission under Chairman Gary Gensler has its own idea of how cryptocurrencies should be regulated today, but bears little resemblance to that decision—and it’s straying into dangerous legal territory in court.

The Howey case involved orange groves sold by a Florida resort to tourists in a scheme where the investors earned passive income from the resort’s management and commercialization of the oranges. The so-called Howey test says a transaction is a security if it is an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others. All three prongs of the test must be met.

Hundreds of federal cases that followed found unregistered securities in the packaging and sales of whiskey, condos, chinchillas, oil and gas, and beavers. A scheme to sell any asset, including cryptocurrencies, could easily fit into this test. All modern securities law is built on it.

Ripple and XRP

But this isn’t what the SEC has been arguing for two years in the biggest unregistered securities enforcement action to date against a crypto company. The suit was filed against US software company Ripple Labs, which sells a digital payment solution for banks, and includes cryptocurrency XRP as a bridge asset to settle cross-border payments in seconds for almost no cost.

Since 2013, the company has also sold billions of XRP tokens it holds to various crypto exchanges who resold them on the secondary markets to millions of retail holders.

Over the last decade, the XRP ledger grew as a decentralized permissionless distributed ledger with a variety of uses by other companies and individuals. The XRP token eventually rose to having the third-highest market cap for any cryptocurrency in the world.

I am an XRP holder and trial lawyer, so I read the SEC’s complaint as soon as I heard about it. I expected to see the SEC pointing to a scheme of specific early sales by Ripple of XRP, which met the Howey test. That would’ve made sense. But I was shocked to read that the SEC was arguing that all sales of XRP have always been and would always be securities, because “the very nature” of the digital asset is to be a security and nothing else. The token itself is “the embodiment” of an investment contract in Ripple, they argue, even on the secondary markets with no involvement of the company, including mine.

This goes beyond anything the 1933 Securities Act and over 250 federal appellate and Supreme Court decisions about securities law ever imagined. The SEC’s argument is the equivalent of the oranges in Howey being “the embodiment” of the scheme to sell the groves. If that’s the case, how does a corner grocer register an orange with the SEC?

All US exchanges immediately suspended XRP trading in fear of SEC reprisal, locking up the tokens of innocent retail holders as the value plummeted by $15 billion. The collateral damage done to these holders that the SEC claimed to be defending was staggering.

I organized a class of over 75,000 retail XRP holders and gained amicus curiae status in the case. Our reasons are pretty logical. The vast majority attest they’d never heard of Ripple Labs when they acquired the token for their own purposes.

These lines of computer code they obtained can’t be an investment contract or a common enterprise with a company they’d never heard of, and nothing in the law—before or after Howey—supports that idea.

Judge Analisa Torres in the Southern District of New York is taking her time with a ruling in the Ripple case because she must understand the stakes, particularly on appeal. The questions to be decided go to the foundations of modern securities law, and what assets can and can’t be included in it. Torres also knows the current US Supreme Court has been knocking down regulators that overreach the powers Congress specifically granted them.

Similar Suits Follow

Other crypto companies from Coinbase to LBRY started facing similar SEC lawsuits. Gensler’s public statements on crypto grew sharper. The larger objectives became clear. He inherited the Ripple case from his predecessor, but he’s made its legal theory the centerpiece of an expansion of regulatory power in court, not through rulemaking or legislation. That has drawn Congress’ ire.

I’m all for clear rules and regulations to protect people. But the SEC is exploiting legal uncertainty about crypto to radically redefine what constitutes an investment contract and a common enterprise in the US. The legal and economic consequences could be enormous and that will only harm people.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

John Deaton is an American attorney acting as amicus counsel for retail digital asset holders in a number of high-profile federal SEC enforcement cases on crypto, most notably SEC v. Ripple (SDNY) and SEC v. LBRY (DNH).

Reproduced with permission. Published May 2, 2023. Copyright 2023 Bloomberg Industry Group 800-372-1033. For further use please visit https://www.bloombergindustry.com/copyright-and-usage-guidelines-copyright/  

Gary Gensler’s gross SEC overreach

Posted on

By John Deaton. August 21, 2022. (FOX Business).

The Supreme Court may have recently struck down overreach by the Environmental Protection Agency, but at the Securities and Exchange Commission, chairman Gary Gensler remains undeterred in expanding the agency’s power beyond its constitutional boundaries.

For proof, you need no better example than his all-out assault on the cryptocurrency space.

It doesn’t take a constitutional law expert to understand that the SEC has limited jurisdiction over the crypto industry; barring congressional action, front line regulation of digital assets belongs with the Commodity Futures Trading Commission – the main regulator of investments that are not deemed traditional securities.

Read the full article here.

For Clarity on Cryptocurrency, Look to Congress or the Supreme Court

Posted on

By Curt Levey. August 1, 2022. (The Federalist Society)

With the rapid growth of cryptocurrencies have come increasing calls for its regulation and both uncertainty and overreach concerning the applicability of existing rules. If Congress doesn’t address the regulatory confusion, that job may fall to the Supreme Court.

Most of the attention has focused on the Securities and Exchange Commission, which has sued a number of companies in the cryptocurrency field, citing its authority to regulate securities under the 1933 Securities Act and the 1934 Securities Exchange Act. But that’s quite a stretch. Unsurprisingly, those 90-year-old statutes did not include anything like crypto—that is, digital assets existing only on a decentralized ledger (the “blockchain”) that’s distributed across disparate computers—in their definition of a security.

Instead, the Acts defined a “security” by listing well-understood examples, such as “stock” and “bond,” then adding a catch-all term, “investment contract.” Because cryptocurrency is not among the examples, the SEC argues that crypto is sometimes an investment contract.

Read the full article here.