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On February 21, 2024, LEJILEX and the Crypto Freedom Alliance of Texas (“CFAT”) announced that they brought a pre-enforcement challenge against SEC.
In this blog post, we explore what a pre-enforcement challenge is and why LEJILEX and CFAT went down this road, the details of the suit, what success for LEJILEX and CFAT looks like, and the implications of this action for the digital asset industry in the United States.
Let’s dive in.
What is a Pre-Enforcement Challenge?
A pre-enforcement challenge is a legal action that entities or individuals can pursue to challenge agency action before the agency enforces against that entity or individual. This allows a pre-enforcement plaintiff to seek clarity from a court on the legality of agency rules before the agency pursues an enforcement action against the plaintiff or other third parties. Pre-enforcement challenges are brought because the plaintiff has a credible fear of enforcement, meaning it is likely the agency would bring an enforcement action against them at some point in the future.
The Benefits of a Pre-Enforcement Challenge in the Digital Asset Space
LEJILEX and CFAT are attempting to force the SEC to provide clarity to the digital asset ecosystem in the near future, and they hired experienced and talented counsel at Clement Murphy to represent them.
For those following the digital asset sector’s development in the United States, it's been clear as day that over the last several years, without explicit authority from Congress and in an effort to claim jurisdiction over this sector, the SEC has been on a crusade of regulation by enforcement. The SEC has not proposed written rulemaking despite numerous calls for clarity by those in the industry, and the SEC has failed to provide any clear path to operating in a compliant manner. Instead, the SEC has chosen to sue market participants for violating decades-old laws, punishing U.S. businesses and entrepreneurs for simply operating in this novel space. This casts a looming shadow for those law-abiding individuals working in the digital asset sector, who operate in a constant state of uncertainty and fear of an upcoming enforcement action.
If they are successful in their pre-enforcement challenge, LEJILEX and CFAT could benefit from being able to obtain clarity from the court and protect themselves from the talons of the SEC.
We applaud LEJILEX and CFAT for stepping into the ring and challenging the SEC.
What’s in the Complaint?
At a high-level, the complaint seeks a declaration from the court confirming that transactions on LEJILEX’s exchange are not securities transactions and therefore, LEJILEX is not required to register with the SEC.
The complaint outlines how the SEC has assumed total control over the digital asset industry, despite SEC Commissioners themselves acknowledging that Congress has never granted their agency authority to do so. Specifically, the complaint argues that secondary sales of the digital assets at issue are not investment contracts as they “do not involve any kind of ongoing commitment on the part of the asset seller or developer to manage any common venture for the asset buyer’s benefit.”
Furthermore, the complaint alleges that the SEC’s attempt to seize jurisdiction over the digital asset sector “runs head-on into the major questions doctrine,” and that in attempting “to regulate the sale of nearly all digital assets on secondary markets, the SEC purports to locate newly discovered power in the words “investment contract,” even though that term has never been understood to cover asset sales that do not involve any continuing obligations on the part of the asset creator or seller toward the purchaser.”
To read the full complaint, click here.
What Does Success for the Plaintiffs Look Like?
It is relatively simple, LEJILEX and CFAT are asking the court to provide declaratory and injunctive relief to prevent the SEC from subjecting them to unlawful enforcement actions. Winning this action means that the court would rule that secondary-market sales of the digital assets that LEJILEX plans to list on their exchange are not sales of securities as laid out by the Securities Acts of 1933 and 1934, and LEJILEX’s exchange is not an unregistered securities exchange, broker or clearing agency.
The Significance of this Lawsuit
First things first, as stated above, DEF applauds the efforts of both LEJILEX and CFAT in their efforts to obtain regulatory clarity for the digital asset industry in the United States. Embarking on a pre-enforcement challenge is no small feat. It takes courage, and a deep commitment to ensuring that the United States remains a global hub for innovation.
If successful, this case could represent a real barrier to the SEC’s campaign of regulatory overreach. While one ruling from one federal judge does not set law for the entire country, it would provide some precedent to other courts and be a critical first step to achieving full clarity for the sector. Already, the mere existence of this case sends a message to the SEC that their current approach will not go unchallenged and will be analyzed by a court. If the plaintiffs win, the SEC may think twice before bringing more enforcement actions in this space.
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