In every major litigation, there comes a time when you realize it’s time to settle it. Judgment didn’t go your way, a jury gives your legal team a side view, the judge explains it’s time for a settlement conference. Following Judge Analysis Torres’ decision in SEC v. Ripple, the time has come for the United States Securities and Exchange Commission to settle the rest of its case against Ripple Labs — as well as its case against Coinbase.
The SEC’s attacks on crypto have used a flexible legal definition of what constitutes a security that must be registered with the SEC under a legal test established by the Supreme Court in the 1946 SEC v. Howey. Throughout most of its history, the SEC used this tool to pursue fraud and outright fraud with little economic reality behind it. You can understand why judges tend to give the SEC the benefit of the doubt and make tests more flexible over a series of historical fraud cases. Using this flexible test to attach legitimate crypto projects is different and, in the end, leaves crypto projects with no way to register.
Torres decided that the sale of XRP tokens (XRP) to retail investors should not be linked to Ripple’s entrepreneurial endeavors as a company and, as such, failed one element of Howey’s test. This is a unique crypto twist on the Howey test. Linking investment to the entrepreneurial endeavors of anyone selling interest is more difficult in crypto because tokens do not represent an equity interest in the issuer. As such, buyers of crypto tokens are not as closely tied to the endeavors of new blockchain founders as equity investors are in traditional companies.
Related: Supreme Court may stop SEC’s war on crypto
This turned the SEC’s case against Coinbase — and Coinbase knows it. That sent a strong message to the SEC when Coinbase re-listed XRP tokens within hours of Torres’ decision. This victory was only a partial victory, but it made it very difficult for the SEC to target secondary markets in crypto securities such as secondary trading on the Coinbase platform.
All of this analysis doesn’t even begin to explore the challenges the SEC will face with a Supreme Court looking to rule in an administrative body with an evolving key question doctrine that could dramatically limit the SEC’s war on crypto.
People are speculating what would happen if the SEC appealed the Ripple case to the 2nd Circuit. Don’t forget, Ripple may still win it all on SCOTUS. https://t.co/MaWU940Ms1
— BlockProf (@JWVerret) July 14, 2023
The SEC’s best move now is to settle and make a deal with Coinbase. Coinbase had extended its olive branch to the SEC a year ago by filing a rulemaking request to create a customized listing process for crypto assets. I suggested the same thing about six months earlier after a meeting of the SEC’s investor advisory committee — which I chaired. The committee found that crypto tokens could not be properly registered with the SEC without adaptation of the listing process.
There is no shortage of crypto attorneys ready to work with the SEC to figure out adaptive regulatory regimes for crypto tokens. There are hundreds of securities attorneys who are SEC alumni or major legal alumni working in crypto today who can help the SEC adapt their rules the same way the SEC adapted its rules in the past for asset-backed securities, limited partnership masters, real estate investment trusts. and dozens of hybrid assets and other asset vehicles.
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Many of the disclosure requirements in the SEC’s disclosure rules regarding boards of directors, executive compensation, shareholder proposals, and financial reports are inconsistent with crypto projects. Who will “register” Ethereum today? It has no board and no CEO.
What assets and liabilities will be on the balance sheet of the entity that files documents on Ethereum, given that no single entity actually controls the properly decentralized Ethereum blockchain? Nothing is clear.
And things crypto asset buyers want to know, like tokenomics or blockchain security audits or the smart contracts underlying decentralized financial exchanges (DeFi), are not mentioned in SEC disclosure regulations.
The game of chicken the SEC has been playing with Coinbase and Ripple must end as the SEC is about to go off the rails. There is a better path that is consistent with the rule of law. It’s time for the SEC to work with crypto lawyers to develop a workable crypto asset listing and disclosure regime and move away from the “go in and register it” talking point. This alternative approach will better protect crypto asset buyers.
JW Verret is an associate professor at George Mason University’s Antonin Scalia School of Law. He is a practicing crypto forensic accountant and also practices securities law at Lawrence Law LLC. He is a member of the Advisory Board of the Financial Accounting Standards Board and a former member of the SEC’s Investor Advisory Committee. He also chairs Crypto Freedom Lab, a think tank that advocates for policy changes to preserve freedom and privacy for crypto developers and users.
This article is for general informational purposes and is not intended to and should not be construed as legal or investment advice. The views, thoughts and opinions expressed here are those of the authors themselves and do not necessarily reflect or represent the views and opinions of Cointelegraph.