18 US states jointly sued the SEC. What are the chances of success for both parties? (Part 1)

Another attempt by the US crypto industry to challenge the current strict regulatory model in the US through legal means.

Author:TaxDAO

On November 14th local time in the US, 18 states led by Kentucky filed a lawsuit against the US Securities and Exchange Commission (SEC) and its five commissioners in the Kentucky District Court, alleging that they have been over-regulating cryptocurrencies for a long time, imposing unfair persecution on the crypto industry, and violating the US Constitution. This is another attempt by the US crypto industry to challenge the current strict regulatory model in the US through legal means. If successful, according to the tradition of US case law, this will profoundly change the regulatory model of the US crypto industry, and may also affect the global direction of the crypto industry. This article will sort out the dynamics of US crypto industry regulation around this case, analyze the specific allegations made by the 18 states against the SEC's regulation, and compare two typical cases between crypto companies and the SEC, and on this basis, discuss the future direction and impact of this case.

1. Dynamics of US Crypto Industry Regulation

The scale and influence of the US crypto market are far ahead of the rest of the world. This prominent position is largely due to the US's strong economic foundation, large population base, active and highly liquid capital market, and leading technological innovation capabilities. At the same time, the relatively stable and standardized market environment and the status of the US dollar as the main reserve currency in the international financial system have also provided a solid support for the continuous development of the US crypto asset market. According to research data published by Statista in July 2024, the global cryptocurrency market revenue is expected to reach $56.7 billion in 2024, with the US revenue being the highest, estimated at $9.788 billion.

1.1 Current Regulatory Policies of the US Crypto Industry

At the federal level in the US, the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) play a key role in regulating the crypto market. In the US regulatory framework, the classification of crypto assets as "securities" or "commodities" is of great significance. If crypto assets are classified as "securities", like stocks and bonds, they should be included in the regulatory scope of the SEC. Issuers of securities and platforms and brokers that facilitate securities trading need to comply with the Securities Act of 1933 and the Securities Exchange Act of 1934. If crypto assets are identified as commodities or their derivatives, such as gold, oil, and grains, crypto asset-related transactions are regulated by the Commodity Exchange Act (CEA) and supervised by the CFTC.

Should crypto assets be classified as securities or commodities? This is the focus of the dispute between the crypto industry and the regulatory authorities. Regulatory authorities have different views on the classification of crypto assets, leading to multi-headed regulation of the crypto market, and there is a long-standing overlap in the jurisdiction over cryptocurrencies between the SEC and the CFTC.

Under the SEC's regulatory framework, the SEC uses the Howey Test to determine whether a crypto asset is a security. In an April 2022 speech, SEC Chair Gary Gensler stated: "In a non-biased way, most crypto tokens are investment contracts (securities) under the Howey Test...Crypto tokens that are securities must be registered with the SEC, and issuers of such tokens must register the trading activity of these assets with the SEC and comply with relevant disclosure requirements." From the SEC's enforcement actions, since 2013, the SEC has fined crypto companies and individuals over $7.42 billion, with 63% (or $4.68 billion) of the fines occurring in 2024. The majority of the 2024 fines came from the SEC's enforcement action against Terraform Labs PTE,Ltd. and its co-founder Do Kwon, which was the largest fine to date, setting a precedent in crypto regulation.

Under the CFTC's regulatory framework, crypto assets like and are defined as "commodities". The CFTC's jurisdiction covers the spot crypto market and the derivatives market, but with different emphases. The CFTC has comprehensive regulatory authority over the derivatives market, focusing on trading activities of crypto assets in the futures and swaps markets. For the spot market, the CFTC's authority is limited, but it has the power to combat fraud and market manipulation within it.

Overall, the SEC is core-focused on investor protection and tends to be more risk-averse, but this regulatory stance has drawn criticism from some in the industry, as overly strict regulation will saddle crypto projects with high legal and compliance costs, hindering industry innovation. The CFTC, on the other hand, is more focused on market efficiency, supporting industry self-regulation and technological innovation. Regarding jurisdictional disputes, the U.S. Congress proposed the Financial Innovation and Technology for the 21st Century Act (FIT21) in 2023, hinting at delegating more regulatory power to the CFTC, which has a more crypto-friendly attitude. In May 2024, the U.S. House of Representatives passed the FIT21 Act by an overwhelming majority, but the plan was shelved by the Senate.

1.2 The Future Regulatory Reform Direction of the Trump Administration

Prior to the 2024 U.S. presidential election, Trump had repeatedly positioned himself as a supporter of cryptocurrencies in his campaign activities, and made several promises to the crypto industry represented by : First, to establish a strategic reserve and incorporate into the national financial strategy. Trump stated at the Nashville Conference in July 2024 that if he returned to the White House, he would launch a strategic national crypto reserve and pursue crypto-friendly policies. Second, to reduce regulatory intensity and promote industry innovation. Trump promised that after being elected, he would dismiss SEC Chair Gary Gensler, who had taken a strict regulatory stance towards the crypto industry, and create a crypto-centric crypto advisory council, which could be composed of major domestic industry stakeholders and participants to help guide policy and regulations. Third, to support crypto mining and make the U.S. an industry leader. In June 2024, Trump stated in a private meeting that "if crypto is to define the future, I want it mined, minted and made in America." In September 2024, Trump gave a speech at the New York Economic Club and emphasized plans to make the U.S. the "global capital of crypto and ". Additionally, as a symbol of embracing the crypto industry, Trump also promised to release Silk Road founder Ross Ulbricht.

In November 2024, Trump was successfully elected as the next U.S. President, and the Republican Party represented by Trump is gradually fulfilling its promises to the crypto industry. First, he nominated a crypto-friendly SEC Chair. On November 21, 2024, the SEC announced that current Chair Gary Gensler would resign on January 20, 2025. On December 5, Trump nominated Paul Atkins as the future SEC Chair, and if Atkins takes office, he may create a more inclusive environment for the crypto industry. Second, he nominated a crypto-friendly government team. On November 23, all cabinet members of Trump's new administration were confirmed, and more than 5 officials nominated by Trump are crypto-friendly and have previously disclosed their crypto holdings. In addition, according to Fox News, the Trump administration also hopes to expand the CFTC's power, granting it a large part of the regulatory authority over the digital asset market, reducing the overlap and conflict between the SEC and CFTC, and providing a clearer and more stable regulatory framework for the crypto market. The crypto market reacted strongly to this, with price surging after Trump's landslide victory in the November election, reaching a new high of $100,000 on December 5, up 4% intraday.

Despite past regulatory challenges, the U.S. crypto industry still dominates globally. In the future, under Trump's leadership, the regulatory landscape of the U.S. crypto market may undergo major changes, and supportive regulatory measures will further unleash the potential of the crypto industry. The U.S. is likely to continue to strengthen its leading position in the crypto industry and become a pillar of the global decentralized finance.

2. The Specific Content of the Lawsuit Filed by 18 States Against the SEC

In the second week after Trump's election, 18 U.S. states filed a related lawsuit, which seems to be a carefully chosen timing. Some commentators believe that although the President-elect Trump has promised to fully support the digital asset industry and nominate a crypto-friendly new SEC Chair, this lawsuit appears to be aimed not only at conveying a message to the outgoing administration, but also at preventing the future SEC Chair from implementing strict regulation on the industry like Gary Gensler.

2.1 Summary of the 18 States' Lawsuit

In the lawsuit, the 18 states first mentioned the development of the digital asset industry and the basic regulatory model of state governments, emphasizing the positive effects of the digital asset industry and state government regulation. The digital asset industry has grown rapidly in the past decade, attracting many entrepreneurs and developers, with a value exceeding $3 trillion and daily trading volume reaching hundreds of billions of dollars, providing financial services to unbanked Americans and also driving cross-border payments and charitable donations. States have used their autonomous regulatory powers to support innovation and development of the digital asset industry through flexible regulatory frameworks, which has also driven local economic growth.

Secondly, the lawsuit analyzes the SEC's regulatory authority and regulatory stance. The Securities Act of 1933 and the Securities Exchange Act of 1934 grant the SEC regulatory authority over securities. If a class of assets is deemed an investment contract through the Howey Test, it will fall within the SEC's regulatory scope. Digital assets generally do not meet the standard of "investment contract" because their trading often lacks the ongoing obligation relationship between investors and issuers. In its early public statements on the digital asset industry, the SEC has repeatedly stated that digital assets themselves are usually not securities, and their secondary market trading is not securities trading. However, since Gary Gensler became SEC Chair, the SEC has shifted from limited regulation to large-scale enforcement against the digital asset industry, and has tried to expand its power in the digital asset field through expansive legal interpretation. This change not only threatens state regulatory authority, but also creates uncertainty for the industry and unfairly treats it legally.

At the same time, the lawsuit raises legal questions about the SEC's current crypto policy, arguing that the SEC's interpretation of securities laws violates the text, history, precedent and common sense, violates the Major Questions Doctrine, the SEC's enforcement actions violate the Administrative Procedure Act (APA), and the SEC's overall crypto policy infringes on state interests, seriously damages industry interests and hinders industry development.

Finally, two main claims for relief were submitted to the court: first, the SEC's crypto policy exceeds its authority and is an "illegal administrative act", and the court should issue an order declaring the policy illegal and prohibiting the SEC from enforcing it against digital asset platforms in the future. Second, the SEC's crypto policy violates administrative procedures. The SEC failed to follow the necessary procedures when adopting this policy, violating the Administrative Procedure Act, and the court should vacate the policy and declare it illegal.

2.2 Basis for the SEC's Unconstitutionality

Specifically, from the perspective of unconstitutionality, 18 states primarily rely on the First Amendment and the Tenth Amendment of the U.S. Constitution to argue that the SEC's regulation of the crypto industry violates the U.S. Constitution.

According to the First Amendment of the U.S. Constitution, the 18 states believe that the SEC's actions exceed its statutory authority and infringe on the legislative power, undermining the constitutional principle of separation of powers. The First Amendment of the U.S. Constitution states: "All legislative Powers herein granted shall be vested in a Congress of the United States." However, on the one hand, in formulating regulatory rules, the SEC has attempted to develop comprehensive digital asset regulatory rules through "enforcement rather than legislation", exercising the legislative power that belongs exclusively to Congress. The SEC has unilaterally expanded its power without Congressional authorization or rule-making procedures, undermining the constitutional principle of separation of powers. On the other hand, in enforcement practice, the SEC has brought a large number of digital assets (such as cryptocurrencies) under the regulatory scope defined by the Securities Act of 1933 and the Securities Exchange Act of 1934, but in fact these assets are not included in the existing legal framework established by Congress. The SEC's regulation of these assets lacks clear Congressional authorization and exceeds its statutory authority.

According to the Tenth Amendment of the U.S. Constitution, the 18 states believe that the SEC's actions have deprived the states of their power and autonomy over these digital assets, disrupting the division of power between the federal government and the states. The Tenth Amendment of the U.S. Constitution states: "The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people." Without Congressional authorization, the SEC, through rule interpretation and enforcement actions, has brought almost all digital asset transactions under the regulation of federal securities laws, directly undermining the states' autonomous regulatory power. At the same time, the SEC's unified regulation has suppressed the development of local regulations, limiting the space for states to explore digital asset regulation based on their own economic and social needs, which is contrary to the original intention of federalism. In addition, some states have used tax incentive policies to attract investment and develop the crypto industry, but the SEC's strong regulation has hindered the industry from taking root in these states, infringing on the states' economic interests.

2.3 Summary

The focus of this case is still the characterization and regulatory intensity of crypto assets. The 18 states believe that the SEC's uniform identification of the secondary trading of most digital assets as "investment contracts" under the Securities Act of 1933 and the Securities Exchange Act of 1934, treating digital assets as securities, and requiring platforms that facilitate such transactions to comply with securities regulations, exceeds the SEC's statutory authority, illegally deprives the states of their primary regulatory power, and has caused damage to the overall digital asset economy.

Disclaimer: As a blockchain information platform, the articles published on this site only represent the personal views of the authors and guests, and are not related to the position of Web3Caff. The information in the articles is for reference only and does not constitute any investment advice or offer, and please comply with the relevant laws and regulations of your country or region.