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SEC Commissioners’ Raging Dissent on Enforcement Action
What happened?
On March 5th, the Securities and Exchange Commission (SEC) issued a cease-and-desist Order settling allegations that ShapeShift AG (ShapeShift) acted as an unregistered securities “dealer” in connection with its digital asset trading platform. According to the Order, from 2014 to 2021, ShapeShift operated an online platform where it acted as a market maker, buying and selling digital assets from and to users. The SEC claimed that ShapeShift “effected exchanges from its own inventory, serving as the customer’s counterparty in every transaction,” and gained revenue from the spread charged on each transaction. The Order concludes without explanation that the “crypto assets offered by ShapeShift included those that were offered and sold as investment contracts, and, therefore, securities.” Therefore, according to the SEC, ShapeShift’s activities met the definition of a dealer under Section 3(a)(5)(A) of the Exchange Act, and it was required to register with the SEC. ShapeShift agreed to pay a $275,000 penalty for the registration violation.
SEC Commissioners Hester Peirce and Mark Uyeda wrote a scathing dissent, “On Today’s Episode of As the Crypto World Turns: Statement on ShapeShift AG.” The Commissioners said that the ShapeShift Order underscored the “adverse consequences of the Commission’s approach to regulation in the crypto space and adds to the ambiguity that hangs over the crypto world.” The dissent also included a dramatized conversation between a potential “broker” and the SEC regarding the SEC’s ambiguous registration requirements. In the dialogue, the would-be broker asks for guidance from the SEC, but ultimately is left with no guidance, and more questions than answers. The Commissioners said that the dialogue was “by no means hypothetical. Industry participants have consistently expressed concern that they need clarity on which crypto assets are securities,” and the agency has failed to provide it.
What does this mean?
The dissent highlights the disjointed approach the SEC has taken towards regulating digital assets and the lack of guidance given to the digital asset industry. The SEC’s perfunctory orders settling charges against protocols, token issuers, and crypto users provide no forward-looking guidance whatsoever, and the dissenting commissioners confirm that there is no guidance in SEC meetings either.
Coinbase Challenges the SEC’s Denial of its Request for Rulemaking
What happened?
Last Monday, Coinbase filed its opening brief in the Third Circuit challenging the Securities and Exchange Commission's (SEC) denial of Coinbase’s petition for rulemaking. In July 2022, Coinbase filed a petition asking the SEC to engage in formal rulemaking regarding digital assets to provide the industry and investors with much needed clarity. The SEC did not answer Coinbase’s petition for several months, so Coinbase filed a mandamus action in the Third Circuit to compel the SEC to respond. In December 2023, “anticipating imminent action by the Court in the mandamus proceeding,” the SEC formally denied Coinbase’s petition for rulemaking, stating that “existing laws and regulations apply to the crypto securities markets…[and] it is important to maintain Commission discretion in setting its own rulemaking priorities.”
Coinbase argues that the SEC’s denial of the rulemaking petition violates the Administrative Procedure Act (APA) and is an abuse of agency discretion. Paul Grewal, Chief Legal Officer of Coinbase, stated that “Even if the SEC believes it can lawfully assert new authority over digital assets today (it can’t), it must explain why in a rulemaking process and give the public a chance to understand and challenge that view. That hasn’t happened here, and yet it’s what the law requires.”
What does this mean?
There are several ways the Third Circuit may decide the case:
The Court rules in favor of Coinbase: the Court orders the SEC to engage in a formal rulemaking per Coinbase’s petition.
A middle-ground ruling: the Court orders the SEC to provide more concrete reasons as to why the agency denied Coinbase’s petition. Coinbase would get greater clarity from the SEC on why it has not done rulemaking, but no rulemaking would be required.
The Court rules in favor of the SEC: the Court decides that the SEC’s denial of Coinbase’s petition was not arbitrary and capricious, and vacates Coinbase’s petition.
It is likely the Third Circuit will take into account the terseness of the SEC’s denial of Coinbase’s petition – which was only two pages long and barely explained its reasoning. Coinbase lays out the SEC’s inconsistent approach to regulating digital assets in a helpful chart that shows the distinctly different positions the SEC has held over time. It is likely that the SEC is reluctant to engage in rulemaking regarding digital assets because marrying itself to a rule would sunset the agency’s incoherent regulation by enforcement strategy against the industry and reign in its self-proclaimed jurisdiction. DEF will continue monitoring this case and provide updates.
DUNA: A New Frontier for Legal Recognition of Decentralized Entities
What happened?
On March 7th, Governor Mark Gordon of Wyoming signed into law the Wyoming Decentralized Unincorporated Nonprofit Association (DUNA) Act. This act allows for legal recognition of decentralized autonomous organizations operating for non-profit purposes within the state of Wyoming. In the United States, corporations are under the purview of the states, not the federal government.
On the statutory level, DUNA establishes a new corporate type “decentralized unincorporated nonprofit associations.” These entities allow for “governance and operation using algorithmic means,” which can include governance decisions made on a blockchain. To incorporate under this act, a DAO must have at least one hundred members and obtain mutual consent from potential members. Notably, the act allows DAOs to function as they typically would.
Importantly, in order to register under DUNA, a DAO must be formed for a “common nonprofit purpose,” following the rules of nonprofit organizations in the state of Wyoming — as is implied in the name. In Wyoming, this typically means that the DAO must champion charitable, religious, scientific, among other public interest causes. However, the law does allow the DAO to “engage in profit-making activities” so long as the profits go back to the DAO’s common nonprofit purpose.
What does this mean?
Experimentation with opt-in corporate forms viable for DAOs is a good thing. Wyoming has long been a national leader in developing and implementing policies that are supportive of innovations based on blockchains. Enacting DUNA continues that tradition, as most DAOs that seek to operate within a legal entity structure do not currently have any viable options to do so in the United States. Wyoming’s old law that sought to create a pathway for such DAOs has proven unworkable in practice. The state’s new DUNA law offers a promising alternative to the existing model and, importantly, includes important protections for DUNA members’ privacy. While not all DAOs will pursue this path, this new registration type will be useful for DAOs that do.
HFSC Hearing on the CFPB’s Digital Payment Apps Rulemaking
What happened?
Last Wednesday, the U.S. House Financial Services Subcommittee on Digital Assets, Financial Technology and Inclusion conducted a hearing, titled “Bureaucratic Overreach or Consumer Protection? Examining the CFPB’s Latest Action to Restrict Competition in Payments.”
The hearing examined the Consumer Financial Protection Bureau’s (CFPB) “Larger Participant Rulemaking,” a proposal that seeks to delineate a market for general-use digital consumer payment applications. The CFPB states that this proposal is designed to establish supervisory authority over “large providers of funds transfer and wallet functionalities through digital applications intended for consumers’ general use in conducting payments to others for personal, family, or household reasons.”
In his initial remarks, Chair French Hill (R-AR), criticized the ambiguity in the rulemaking and failure to accurately define the market. “Many companies are utterly confused, wondering not only how the rule will be implemented, but whether they're even covered by it. I would argue that this confusion is by no means an accident. The CFPB is trying to cast as wide a net as possible and become a Technology Regulator,” stated Chair Hill. He also criticized the inclusion of digital assets within the definition of funds without proper justification, as it sparked bipartisan concerns about its broad implications. "Calls from both sides of the aisle urge the CFPB to fine-tune its strategy, ensuring consumer safety while supporting technological progress," Chairman Hill added.
In his testimony, Carl Holshouser of TechNet criticized the CFPB's proposed rule for its "stark and troubling" lack of empirical analysis, creating an arbitrary market detached from the digital payment ecosystem's realities. He highlighted the rule's failure to identify consumer harms or address the supervisory costs to companies, concluding these shortcomings make the rule "defective."
Brian Johnson, the Managing Director of Patomak Global Partners, who previously served as a Deputy Director of the CFPB, criticized the rulemaking and called for the CFPB to withdraw and re-propose its rule, and “engage in a more thoughtful, deliberative rulemaking process.” He also criticized the broad definition of a “market” as it amalgamates diverse functions rather than outlining a clear market for interchangeable financial products and services.
Additionally, Jack Solowey of the Cato Institute testified about concerns related to the CFPB's approach to crypto, noting that the proposed rule's lack of clarity could lead to inappropriate comparisons between crypto tools and FinTech tools, such as treating self-hosted or non-custodial crypto wallets as if they were digital payment apps. He emphasized a fundamental difference in two, that self-hosted wallets allow users to manage their crypto keys independently without the involvement of service providers. He further highlighted that self-custody could mitigate the systematic risks outlined in the proposed rule's objectives. However, the regulatory ambiguity over the coverage of these technologies only complicates their deployment by developers and users, exacerbated by the prevailing regulatory uncertainty.
What does this mean?
The hearing highlights the procedural shortcomings in the proposed rule-making process for defining a significant market, emphasizing its potential critical impact on consumers and the whole payment industry. Notably, in January, several Congressmembers of the HFSC petitioned CFPB Director Rohit Chopra by letter for a 60-day extension on the comment period regarding the proposed rulemaking. They highlight the significance of hearing more insights from market participants, noting the proposed rulemaking in its current language lacks clarity—a concern reinforced by multiple witness testimonies.
DEF has shared similar concerns, detailed in our comment letter, submitted in January 2024.
We demonstrated inadequate engagement by the CFPB in a comprehensive cost-benefit analysis, highlighting a significant oversight in considering the digital asset market's complexities and potential regulatory impacts.
