Crypto.com and Bitnomial Sued the SEC
If they win, it could stop Chair Gensler in his tracks
I started Brogan Law to provide top quality legal services to individuals and entities with legal questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their startup mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz.
This week, crypto projects began suing the SEC. If that seems a bit odd, it is. A “declaratory judgment” action is a lawsuit in which one party asks a court to define their legal rights. In this way, this form of action is forward looking, describing future entitlements and obligation, rather than remedial, as in a case seeking damages. This form of action was formally codified by the Declaratory Judgment Act of 1934 and allows courts to “terminate controversies” concerning the “existence or nonexistence of any right, duty, power, liability, privilege, disability, or immunity or of any fact upon which such legal relations depend, or of a status.”
Two entities, Foris DAX, Inc., which does business as Crypto.com, and Bitnomial Exchange, LLC (“Bitnomial”) brought such declaratory judgment actions in an aggressive attempt to affirmatively define their rights.
Crypto.com
Crypto.com’s action, filed on Oct. 8 in the United States District Court for the Eastern District of Texas, Tyler Division is apparently a response to a Wells notice the entity received recently from the SEC accusing it of “operating as an unregistered broker-dealer and securities clearing agency.”
We addressed Wells notices a few weeks ago when talking about OpenSea, but they’re basically letters from the SEC saying they’re going to sue you. Instead of waiting, Crypto.com filed this to head the SEC off. The court they chose, E.D. Tex., Tyler, has been a popular “forum shopping”[1] venue among conservative plaintiffs for its perceived leanings.[2] More importantly, cases appealed from Texas district courts go to the Fifth Circuit Court of Appeals, which is the most favorable appeals court in the country for those skeptical administrative state and the SEC.[3]
It seems that Crypto.com’s strategy here is to try to box the SEC into a corner—forcing it into an unfavorable jurisdiction facing a question that could undermine much of its enforcement program. It might just work.
The thrust of their argument is that the SEC’s crypto policy is without legal merit, and so the set of what Crypto.com calls “Network Tokens”[4] are not securities. Crypto.com admits that in the course of its business “[it] buys and sells a variety of network tokens, including bitcoin, ether, and the Targeted Network Tokens.” If these tokens were securities, this would be exactly the broker activity that requires SEC licensure. If they are not securities, then the SEC has no oversight authority. In this way, the security classification is the core issue of the case.
Crypto.com contends that the Network Tokens are not investment contracts because “every transaction involving [them] that occurs on the Platform is merely the sale of a digital product and is not coupled with additional commitments, promises, or expectations“ and “[i]t is only when those underlying assets are sold together with promises or commitments by the seller that the overall transaction constitutes an investment contract.“
They argue that in order to regulate the cryptocurrency industry without promulgating formal rulemaking, the SEC has created an artificial category “crypto asset security” out of “whole cloth.” This, they say, is a violation of the Administrative Procedures Act (“APA”). In support of this, they point to numerous public statements by the SEC referencing a rule to cover “crypto asset securities”, and argue that this “rule” illegitimately forces them to “come into compliance.”
Crypto.com goes on to cite rulings in SEC v. Binance Holdings Ltd., No. 23-1599, (D.D.C. June 28, 2024) and a 2023 Ripple order that was considered highly controversial at the time it was issued. In those cases, two influential courts, D.D.C. and S.D.N.Y., found that secondary market sales of certain cryptocurrencies were not “investment contracts.” In Ripple, Judge Annalisa Torres held that “programmatic sales” facilitated by exchanges did not constitute investment contracts because “Ripple did not make any promises or offers because Ripple did not know who was buying the XRP, and the purchasers did not know who was selling it.” In Binance, Judge Amy Berman Jackson found “it necessary to distinguish between the digital coins themselves and the offers to sell them” but caveated that “no one should read this case as deciding that crypto assets themselves are or are not ‘securities.’”
E.D. Tex. is fairly characterized as one of the most skeptical in the country of agency authority, and so these arguments have a reasonable chance of prevailing on the merits. First, though, they have to traverse a procedural hurdle we’ll discuss in a moment.
Bitnomial
Before we get to the procedural issue, let’s look at the parallel action commenced by Bitnomial this week in N.D. Ill. Bitnomial is a CFTC registered Designated Contract Market (“DCM”), which operates legally as an exchange for cryptocurrency derivatives and futures.
According to the complaint, Bitnomial sought to list a futures contract based upon the price of the Ripple token XRP. Apparently, shortly thereafter they received a call from the SEC[5]:
After filing its self-certification with the CFTC, but before Bitnomial listed XRP Futures for trading, the SEC contacted Bitnomial to discuss the contemplated listing. In discussions with Bitnomial, the SEC asserted that Bitnomial would violate the federal securities laws if Bitnomial proceeded with its contemplated listing of XRP Futures pursuant to its CFTC self certification. The SEC asserted that XRP Futures are security futures, which are subject to joint SEC and CFTC jurisdiction (unlike non-security futures which are subject only to the CFTC’s exclusive jurisdiction). The SEC further asserted that Bitnomial is required to comply with a host of additional SEC requirements before listing XRP Futures, including the significant task of registering as a national securities exchange (“NSE”) and submitting to the SEC’s jurisdiction.
I personally think it is very funny to imagine Gary Gensler calling up a random DCM and threatening them against listing a futures product. Scorsese-esqu.
Apparently the SEC feels that XRP is a security. However, Bitnomial astutely notes in their complaint that, as mentioned above, S.D.N.Y. has already ruled that secondary market transactions in XRP are not securities. While the SEC is appealing that ruling, as of writing it has not been stayed, calling into question the SEC’s argument here.
Bitnomial goes on that even if it were an NSE, it couldn’t list a security future on XRP because XRP is not registered with the SEC, and that it has no power to register XRP since it was not the issuer. That means that, in effect, the SEC is attempting to issue a blanket ban on the trade of XRP futures under the guise of “procedural compliance.” Bitnomial also notes that, despite the SEC’s protestations, the CFTC has not stayed the proposed contract, and so the only thing preventing it from listing it is the SEC’s threatened enforcement.
When Bitnomial asked the SEC for some justification for its argument, apparently the SEC sent the briefs it submitted in the Ripple case, without mentioning that it had lost the crucial issues in that case.
Ultimately, the merits of this case will depend on whether N.D. Ill. buys Judge Torres’ reasoning in Ripple. It is not bound to do so, and indeed courts frequently split on issues of legal applicability. Before it gets there though, there is an aforementioned gating issue.
Ripeness, Justiciability, and Declaratory Judgments
The problem with both Crypto.com and Bitnomial’s cases here is that their posited harms are fairly attenuated. Not in an everyday sense, of course—every one of us understands intuitively that the SEC conduct, refusing to promulgate formal rules and instead sending threatening letters and emails, is thuggish and destructive to these businesses' prospects. Legally, though, declaratory judgments are disfavored[6], and so it is hard to get a court to agree to hear them.
You see, courts hate deciding things that they don’t have to. Federal judges have busy dockets, and not much time to consider each case, so any time a case might shake out on its own, without court intervention, they want to get rid of it. Declaratory judgments, being preemptive, are fundamentally in tension with this disinclination. To deal with this, courts have developed concepts of “justiciability” and “ripeness” to avoid “entangling themselves in abstract disputes.” These are a little complicated, but here's the takeaway—declaratory judgments usually don’t work, and especially don’t work where the harm is speculative or not imminent, and where there isn’t a concrete, live controversy between the parties.
In these cases, the harms at issue may or may not rise to this standard. In Crypto.com, the company argues that “[a]bsent judicial review by this Court, Crypto.com will continue to operate its business with the ongoing threat of the SEC enforcing the Rule hanging over it.” Similarly, Bitnomial argues that it “has no other redress, absent relief from this Court”, that “[t]here is no process for [it] to appeal the SEC’s position”, and that “[w]ithout a ruling from this Court, [it] must either abandon its plans or list XRP Futures and face potential enforcement from the SEC.”
As far as I know, no court has ever held that a Wells notice was a sufficiently final agency action to support a declaratory judgment. However, recent jurisprudence has suggested that such a notice may well be sufficient. In 2016, for instance, the D.C. Circuit found in Rhea Lana, Inc. v. DOL, No. 15-5014 (D.C. Cir. 2016) that a letter from the Department of Labor identifying alleged violations was enough to permit a declaratory judgment action to go forward. That letter was probably more final than a Wells notice, making it distinguishable, but that may not matter, as the late Justice Antonin Scalia wrote in MedImmune, Inc. v. Genentech, Inc., 549 U.S. 118 (2007):
[W]here threatened action by government is concerned, we do not require a plaintiff to expose himself to liability before bringing suit to challenge the basis for the threat—for example, the constitutionality of a law threatened to be enforced. The plaintiff’s own action (or inaction) in failing to violate the law eliminates the imminent threat of prosecution, but nonetheless does not eliminate Article III jurisdiction. For example, in Terrace v. Thompson, 263 U. S. 197 (1923), the State threatened the plaintiff with forfeiture of his farm, fines, and penalties if he entered into a lease with an alien in violation of the State’s anti-alien land law. Given this genuine threat of enforcement, we did not require, as a prerequisite to testing the validity of the law in a suit for injunction, that the plaintiff bet the farm, so to speak, by taking the violative action. Likewise, in Steffel v. Thompson, 415 U. S. 452 (1974), we did not require the plaintiff to proceed to distribute handbills and risk actual prosecution before he could seek a declaratory judgment regarding the constitutionality of a state statute prohibiting such distribution. As then-Justice Rehnquist put it in his concurrence, “the declaratory judgment procedure is an alternative to pursuit of the arguably illegal activity.” In each of these cases, the plaintiff had eliminated the imminent threat of harm by simply not doing what he claimed the right to do (enter into a lease, or distribute handbills at the shopping center). That did not preclude subject-matter jurisdiction because the threat-eliminating behavior was effectively coerced. The dilemma posed by that coercion—putting the challenger to the choice between abandoning his rights or risking prosecution—is “a dilemma that it was the very purpose of the Declaratory Judgment Act to ameliorate.” (internal citations omitted)
Collectively, this case law may suggest that one or both courts petitioned this week could take up these cases and reach the merits of Crypto.com and Bitnomial’s arguments. That could be a big deal.
Implications
I don’t want to oversell both of these cases, the Bitnomial suit will probably not be epoch-defining. The technical problem at issue really only applies to DCMs, of which there are only eighteen in the country. Sure, N.D.Ill. may end up coming to a ruling on whether XRP is or is not an “investment contract” or “security” in a new context, but that ruling will probably be overshadowed by whatever comes out of the Second Circuit in the Ripple appeal.
The Crypto.com case, on the other hand, could be a very big deal. The first time I read the complaint, I thought it might have been filed for purely signaling purposes—pushing back against the SEC in a doomed action meant to gain credibility among the cryptocurrency consumers. On second read, however, the arguments that Jones Day put together could be quite powerful.
In most cases involving cryptocurrency, the issue of classifying cryptocurrency tokens is either collateral to other legal questions or so fact specific that it is difficult to generalize. For example, in the controversial Ripple case, a complex fact pattern was fundamental to Judge Torres’ finding. Crypto advocates can attempt to generalize these rulings, but the SEC will always be able to evade them by distinguishing, and nobody can really say which way individual courts might determine new cases. Even if cryptocurrency businesses might win if they fought they SEC in court, they can’t be sure, and so the SEC can still coerce them into settlement agreements with threats of enforcement.
The issue in Crypto.com is framed differently. In order to determine the merits, E.D.Tex. will have to grapple with the collective status of an entire group of so-called “network tokens.” If Crypto.com wins, there is little room for factual differentiation, any trade in network tokens would likely be outside of the SEC’s authority, and thus the numerous secondary exchanges operating in the United States would finally gain an affirmatively legal posture.[7]
This wouldn’t make ICO’s legal, so primary issuance of cryptocurrency tokens may still be difficult in this scenario, but this could nonetheless lay groundwork for the distribution of similar “network” tokens in the future, potentially opening the whole business back up. I have made much hay here of the fact that only one of the twenty tokens on the CoinDesk 20 cryptocurrency index has been issued since Chair Gensler’s term began in 2021. This is the first case I have seen that has the direct potential to change that.
This relevance is compounded because Crypto.com has a real chance to win. The gating issues are thorny, but there is some good language on their side, and if they get to the merits, they are in the most sympathetic court possible. The SEC has built up some uncomfortable case law in Ripple and Binance, and it will have to wade through this to develop coherent arguments here. Nomatter who wins, moreover, this case is getting appealed to the Fifth Circuit, which has been the reaper lately for administrative agencies. From there, if the Second Circuit reverses Ripple, there will be a cognizable circuit split, and it will become likely that the Supreme Court grants certiorari to hear one or both of these cases. And while the Supreme Court has not weighed in on these issues yet, it, too, seems to disfavor administrative agencies.
In other words, all the dominoes are lined up. In ten years, we could look back at this case as the turning point. And, of course, you’ll be able to read all about it here! Until next week.
[1] Forum shopping is the practice of bringing cases in specific jurisdictions in order to be heard by specific judges who plaintiffs expect to be favorable to them. If you think judges hate declaratory judgements, they really hate forum shopping, because it pierces the aura of an impartial judiciary.
[2] Crypto.com is actually headquartered in Tyler, so maybe this isn’t an example of forum shopping. However, it is worth noting that Crypto.com moved in on October 3, 2024, just five days before filing the lawsuit. Their lawyers Jones Day would have been preparing this complaint for some time, so as strange as it seems, it is plausible that the headquarters move itself was at least partly motivated by access to this courtroom. I’m sure there are other reasons the company might want to be in Texas, but if they see this litigation as existential then maybe it played a role. [Note: after I published an article on this topic in CoinDesk, Crypto.com informed me that they signed the lease on their new headquarters in Texas in May 2024, before they recieved a Wells notice from the SEC]
[3] Unless you count the Supreme Court.
[4] These include “SOL, ADA, BNB, FIL, FLOW, ICP, ATOM, ALGO, NEAR, and DASH.”
[5] Or, probably, an email, but the Complaint doesn’t specify and it's funnier to imagine it as a call.
[6] If you look it up, you won’t find any court admitting that declaratory judgments are disfavored, but they are. Judges don’t want to deal with them.
[7] At least with respect to the pure secondary market trade in network tokens, the various other products that a cryptocurrency exchange might offer like rewards programs, staking, and derivatives would still be on regulatory thin ice.
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