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The U.S. Securities and Exchange Commission (SEC) may have just been gelded by the Supreme Court, but the agency is going down schwinging with a new civil suit against blockchain software firm Consensys.
On June 28, the SEC filed a civil complaint against Consensys Software Inc. for failing to register as a securities broker and for failing to register the offer and sale of certain ‘crypto’ securities. The SEC claims Consensys earned “over $250 million in fees” from these unregistered operations.
The first charge relates to the operation of Consensys’s MetaMask Swaps service, which is an exchange in all but name, with Consensys matching up buyers and sellers and charging a fee for processing ‘swaps’ of one type of token for another. The complaint claims Consensys has brokered over 36 million such transactions—including at least 5 million transactions involving “crypto asset securities”—since Swaps debuted in 2020.
The second charge relates to the MetaMask Staking program, which, since January 2023, has provided customers with access to ‘liquid staking’ programs offered by Lido and Rocket Pool. The tokens offered via these programs were stETH and rETH, versions of ‘staked’ ETH, the native token of the Ethereum blockchain.
Staking ETH is the method by which Ethereum validates network transactions following its September 2022 transition from a consensus mechanism based on proof-of-work to one based on proof-of-stake (PoS). Individuals wishing to become a validator must stake 32 ETH (current fiat value of ~US$109,000), a prohibitively high bar for most users.
Lido and Rocket Pool allow ETH minnows to ‘pool’ their meager resources with that of other small fry. The two companies use these pooled tokens to open numerous validator positions, with each contributor receiving a proportionate slice of the resulting block rewards (minus a fee).
The SEC says these staking programs “are each offered and sold as investment contracts and, therefore, securities. Specifically… investors make an investment of ETH in a common enterprise with a reasonable expectation of profits from the managerial efforts of Lido and Rocket Pool,” thereby ticking the necessary boxes of the Howey test for identifying securities that require registration with the SEC.
The complaint adds that “[b]y soliciting investors to participate in the Lido and Rocket Pool staking programs and by acting as an intermediary” between the two pools and individual stakers, “Consensys was an integral part of the distribution of these securities… MetaMask Staking investors never interact directly with Lido or Rocket Pool; all investor interactions are directly with Consensys’s platform.”
The SEC notes that Consensys “developed and deployed MetaMask Staking for the specific purpose of offering and selling the Lido and Rocket Pool staking program investment contracts.”
The SEC wants the Court to permanently enjoin Consensys from breaking the law in this fashion and to force Consensys to pay unspecified civil monetary penalties.
In a statement accompanying the complaint, SEC Division of Enforcement director Gurbir Grewal called Consensys a “noncompliant actor” that had “inserted itself squarely into the U.S. securities markets while depriving investors of the protections afforded by the federal securities laws.”
Up in toke(n)
The SEC cited several examples of the ‘crypto asset securities’ that Consensys offered its customers via MetaMask Swaps, including MATIC, MANA, CHZ, SAND, and LUNA. But the SEC notes that Consensys has also “brokered crypto assets that have been the subject of prior SEC enforcement actions based upon their status as crypto asset securities,” including AMP, AXS, BNB, COTI, DDX, FLOW, HEX, LCX, NEXO, OMG, POWR, RLY and XYO.
For each of the five security tokens specifically addressed in the complaint, the SEC claims they were “offered and sold, and continued to be offered and sold on Consensys’s platform, as an investment contract and thus a security.” Moreover, “statements by the crypto asset issuers and promoters have led investors reasonably to expect profits based on the managerial or entrepreneurial efforts of such issuers and promoters (and associated third persons).”
The SEC notably didn’t include ETH in their token hall of shame, but there’s little doubt that Ethereum’s founders understood that ETH was a security from its initial issuance via the controversial ‘crowdsale’ to insiders and became even more of a security following the network’s 2022 shift to PoS consensus. (Don’t take our word for it; do enjoy this lengthy thread of Ethereum principals freely admitting Howey test triggers.)
Then compare Ethereum’s dire straits with that of BSV, perhaps the only digital asset that—due to its locked protocol and the BSV Blockchain’s ability to trace its origins all the way back to Bitcoin’s Genesis block—is not considered a security by the SEC.
Here come da judge(s)
Consensys responded to the SEC’s filing with a statement calling the suit “a transparent attempt to redefine well-established legal standards and expand the SEC’s jurisdiction via lawsuit. We are confident in our position that the SEC has not been granted authority to regulate software interfaces like MetaMask. We will continue to vigorously pursue our case in Texas for ruling on these issues.”
‘Our case in Texas’ refers to the pre-emptive suit Consensys filed in April after abruptly relocating its ‘headquarters’ to Fort Worth to establish residency in the Northern District of Texas. The SEC’s complaint was filed in the Eastern District of New York, based on Consensys having long based its actual headquarters in that state. This sets up the likelihood of a jurisdictional dispute that will delay any proceedings on the relative suits’ legal merits.
Consensys’s choice of Texas is based on the anti-‘gubmint’ sentiments of federal courts in the Lone Star State. That sentiment led to the local filing of several civil suits aimed at defanging government agencies like the SEC, the results of which were on full display in a flurry of monumental U.S. Supreme Court rulings over the past week or so.
On June 27, the Supreme Court issued a ruling that gutted the SEC’s ability to use in-house administrative courts to determine whether a party has violated securities regulations. The Court ruled that imposing civil penalties without allowing a defendant the right to a jury trial violated the U.S. Constitution’s seventh amendment.
The ruling—which will also impact dozens of other federal agencies—specifically addressed civil penalty suits alleging fraud. However, the three justices who dissented from the majority said this distinction wouldn’t prevent the ruling from being applied more broadly.
In other words, the ruling is expected to result in a tsunami of legal challenges to SEC-issued administrative penalties, putting defendants’ fates in the hands of juries that lack the technical understanding of the rules the SEC claims the defendants have violated. It raises the specter of juries rendering verdicts based more on emotion than fact, which is all but certain in the current political climate.
Chevron begone
An even stronger blow was struck against federal agencies’ ability to police their respective sectors on June 29, when the Supreme Court struck down the ‘Chevron deference.’ This doctrine, which has been the rule for four decades, held that judges should defer to agencies when a legal issue affecting their sector isn’t explicitly covered by the legislation defining the scope of those agencies.
As a result, federal judges are now empowered to issue rulings on what they believe Congress intended when authorizing agencies to act. This virtually guarantees that the practice of ‘forum shopping’ will accelerate as defendants seek out judges known more for their individual policy preferences than any profound understanding of the industries in question.
In both of the above cases, the rulings were decided along partisan lines, and Justice Elena Kagan’s dissent underscored the serious ramifications of abandoning Chevron. “In one fell swoop, the majority today gives itself exclusive power over every open issue—no matter how expertise-driven or policy-laden—involving the meaning of regulatory law. As if it did not have enough on its plate, the majority turns itself into the country’s administrative czar.”
A third ruling on July 1 overturned the six-year statute of limitations that the Federal Reserve imposed in a 2011 decision involving interchange fees charged by credit card companies. A retailer challenged the decision because the company didn’t start operations until 2017, and the court ruled that this unfairly restricted the company’s ability to challenge the ‘injury’ done to it by this 2011 decision.
The ruling is expected to produce a flurry of lawsuits challenging federal statutes regarding their age, further hobbling the ability of the federal government to administer, well, anything. Take, for example, the Howey test for identifying a security, which was decided way back in 1946.
‘Crypto bros’ (and gals) reacted to the rulings with undisguised glee, celebrating the systematic dismantling of the few regulatory policies currently constraining their activities. Throw in the Supreme Courts’ July 1 ruling that U.S. presidents are basically immune from prosecution and their ruling last week that effectively legalized bribery of government officials, and any ‘crypto bros’ convicted under the current regime should be able to buy their pardons with a suitable donation to the appropriate slush fund.
Vitalik has some thoughts
As luck would have it, Ethereum co-founder Vitalik Buterin has waded into this newly hobbled regulatory environment with helpful suggestions for how to remedy the alleged ‘regulatory uncertainty’ that crypto bros have so long lamented.
Last week, Buterin contributed to a Warpcast conversation on regulatory issues, saying the “main challenge with ‘crypto’ regulation (esp in the U.S.) has always been this phenomenon where if you do something useless, or something where you’re asking people to give you money in exchange for vague references to potential returns at best, you are free and clear, but if you try to give your customers a clear story of where returns come from, and promises about what rights they have, then you’re screwed because you’re ‘a security.'”
Buterin suggested policy-makers “move to the opposite situation, where issuing a token _without_ giving a clear long-term story for why it will maintain or increase in economic value is the riskier thing, and if you _do_ give such a long-term story and follow basic best practices then you’re safe. Actually getting to this will require good-faith engagement, both from regulators and from industry.”
It’s a bit rich for Buterin to be presiding over an empire built on unregistered securities while simultaneously pleading for ‘good-faith engagement’ on his self-interested policy proposals. And frankly, Buterin’s suggestion that token issuers who freely volunteer that they plan to violate securities regulations should be left alone speaks volumes about the collective myopia plaguing this sector.
Mind you. This is the same Buterin who recently endorsed Railgun, one of North Korea’s favorite Ethereum-based ‘coin mixing’ services. The same Buterin who previously defended Ethereum developer Virgil Griffith for traveling to North Korea to educate the regime on how ‘crypto’ could help them evade U.S. economic sanctions. The same Buterin, whose ties to China have raised concerns about the independence of Ethereum’s governance.
But hey, since North Korea is one of the rogue states—along with China and Russia—that Donald Trump wants to make ‘great’ again, we suspect an appropriately generous ‘campaign’ contribution of ETH could help eliminate those economic sanctions and retroactively wash clean Griffith’s legal sins. It’s the (new) American way.
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