A complaint was recently filed by 18 state attorneys general and the DeFi Education Fund against the US Securities and Exchange Commission (SEC), alleging that the agency is exceeding its authority by attempting to regulate the digital asset industry under existing federal securities laws. The attorneys general argue in the Complaint that the SEC’s approach not only harms states’ sovereignty but also stifles innovation and jeopardizes states’ economic interests.
The attorneys general[1] assert three main arguments as to why the SEC’s enforcement actions against digital assets constitute regulatory overreach: (1) most digital assets are not “investment contracts” that are subject to the federal securities laws; (2) the SEC’s regulation by enforcement exceeds its regulatory authority; and (3) the SEC’s conduct has caused sovereign and pecuniary injury to the states.
This is not the first time that the SEC’s regulatory authority over digital assets has come into question, for example, in July 2023 a federal court ruled on the SEC’s lawsuit against a digital asset issuer, granting the SEC authority over sales of digital assets to institutions while also finding that digital asset transactions on exchanges are not securities transactions.
The crux of the attorneys general’s argument rests on the definition of an “investment contract.” The Complaint alleges that the SEC finds most digital asset transactions, particularly those on secondary markets, are investment contracts because buyers anticipate profits based on the creators’ efforts.
According to the Complaint, the SEC’s view brings these transactions under its purview as outlined in the Securities Act of 1933 and the Securities Exchange Act of 1934. The attorneys general counter that this interpretation drastically broadens the SEC’s regulatory scope and contradicts established legal precedent.
The heart of the disagreement lies in the nature of digital assets themselves. The attorneys general maintain that digital assets are more akin to commodities and should not be subject to federal securities regulations. The value of digital assets might fluctuate due to market dynamics and the efforts of their creators, but this alone does not automatically make them “investment contracts” under the Howey test.
The attorneys general state that the long-held legal understanding of “investment contract,” as defined in SEC v. W.J. Howey Co., requires a contractual agreement between the buyer and seller where the seller has an ongoing obligation to manage the investment and share profits with the buyer. This kind of relationship, they argue, is absent from exchange and secondary market transactions when the original issuer or creator is not a party.
The attorneys general further accuse the SEC of “regulation by enforcement,” citing the agency’s refusal to clarify its stance through formal rulemaking and its reliance on aggressive enforcement actions against digital asset platforms. They highlight that the SEC, despite previously acknowledging its limited authority over digital assets, is now pursuing an aggressive enforcement strategy, demanding platforms register with them without providing clear guidelines on how to do so.
This “regulation by enforcement” approach, the attorneys general argue, runs afoul of the Major Questions Doctrine and the Administrative Procedure Act (APA).
The Complaint alleges the SEC’s regulation of digital asset transactions violates the Major Questions Doctrine, a legal principle that requires an administrative agency to have clear congressional authorization to act on a matter of significant political or economic importance. The attorneys general claim the SEC’s regulation has a dramatic impact on the digital asset industry, which represents a significant portion of the American economy, and therefore requires explicit congressional authority to regulate.
Additionally, the attorneys general claim that the SEC has violated the APA because its stance on treating secondary transactions in common digital assets as uniformly “investment contracts” constitutes a final agency action requiring a notice and comment process, which the SEC has not followed. The attorneys general assert the SEC’s overreach hinders innovation in the digital asset industry.
The attorneys general also raise concerns about the SEC’s actions infringing on their sovereign rights and negatively impacting their economies. They argue that the SEC’s stance undermines carefully crafted state-level regulations for digital assets, particularly money transmitter laws, which many states (including those involved in the lawsuit) have implemented.
The attorneys general also point to the potential conflict with their unclaimed property laws, which require the liquidation of abandoned digital assets, a process that could be deemed illegal if the SEC classifies those assets as securities. Furthermore, they contend that the SEC’s regulatory uncertainty regarding the classification of digital assets under Howey is driving digital asset businesses away from the United States, harming state economies and hindering technological advancement.
The lawsuit represents a significant challenge to the SEC’s authority in the burgeoning digital asset space and raises fundamental questions about the nature of digital assets, the scope of the SEC’s regulatory powers, and the balance of power between federal and state authorities in this rapidly evolving industry. The outcome of this legal battle could have far-reaching implications for the future of digital asset regulation in the United States, but it may also be resolved by the next administration’s SEC, which is expected to be more friendly toward digital assets.
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[1] The 18 state plaintiffs are Kentucky, Nebraska, Tennessee, West Virginia, Iowa, Texas, Mississippi, Montana, Arkansas, Ohio, Kansas, Missouri, Indiana, Utah, Louisiana, South Carolina, Oklahoma, and Florida, all of which have a Republican attorney general.