Interview With Justin Wales, Head of Legal for the Americas at Crypto.com
Interview With Justin Wales, Head of Legal for the Americas at Crypto.com
Crypto.com sued the SEC, so I talked to one of the lawyers behind the case.
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.
Crypto.com is Fighting the SEC
By now you all know about Crypto.com’s action against the SEC in the United States District Court for the Eastern District of Texas, Tyler Division. In a post here a few weeks ago, and a CoinDesk op-ed, I laid out my perspective that this matter has the potential to be transformative to the regulation of cryptocurrency in the United States.
The story, in brief, is this. Crypto.com received a Wells notice from the SEC on August 22 of this year, “threatening to bring an enforcement action against Crypto.com for operating as an unregistered broker-dealer and securities clearing agency under the federal securities law.” A Wells notice is a final announcement from the SEC to a target that enforcement is imminent. Typically, at this stage, targets would entreat the SEC not to bring the threatened action, but Crypto.com chose, instead, to file a four-count complaint.
This is atypical for a few reasons. If you politely ask the SEC to please not bring an enforcement action, they might not. By some estimates, around 20% of Wells notices do not lead to enforcement. As a company, there are real advantages to waiting and hoping to be a part of that lucky 20%. Some entieis reach favorable settlements with the SEC, resulting in a limited fine, low litigation costs, and preservation of your ability to operate in the United States.
Bringing an action instead involves a lot of risk. You are committing to spending with no guarantee of a favorable outcome. You are also, possibly, foreclosing some settlement avenues by positioning the SEC for a fight.
There are also procedural challenges. Declaratory actions, and really any offensive litigation against the United States government, are difficult to prosecute. Courts here just tend to favor the government. Sure it is possible you gain some advantage from going on the offensive, but that could be lost if the SEC brings an enforcement action anyway, and a court finds that such enforcement moots your action.
So what Crypto.com did was bold, with high risk. It also has a potentially high reward. On the offensive, they were able to choose the frame for their case, and their arguments cut across the entirety of the SEC’s enforcement authority in cryptocurrency. If they do win, it could stop the SEC in its tracks.
There is no-one better to talk about this case and the Crypto.com litigation strategy than the lawyers who conceived it. And with that, today I am extremely honored to speak with Justin Wales, Head of Legal for the Americas at Crypto.com.
In addition to his important work at Crypto.com, Mr. Wales is an OG crypto attorney and author of The Crypto Legal Handbook, so he is certain to be a fascinating interview!
AJB: Thank you very much for coming on, I know that my readership has been intently interested in the Crypto.com case since it was filed and will be just as intently interested in your perspective on it. To start, let’s go a little bit further into the background of this complaint. I believe Crypto.com began operating in the United States sometime around 2021—the SEC issued a formal Order of Investigation on March 28, 2023, and then a Wells notice on August 22 of this year. How long have you been contemplating this litigation strategy? What was the lead up to this action from your perspective?
JW: No company wants to file a lawsuit against the government for overstepping its authority, and in an ideal political environment, it wouldn't be necessary. Like many in the industry, we engaged extensively with the SEC on these matters, but when it became evident they were solely focused on litigation aimed at halting crypto in the United States, we began considering our options.
AJB: A crucial piece of the complaint is something that you call “the Rule.” This is, broadly, the position that cryptocurrency tokens (or at least a large subset of them) are a new class of asset that the SEC has called “crypto asset securities”, and that these assets are subject to SEC oversight regardless of the circumstances of purchase or sale. Can you talk a little bit about “the Rule”, the legal problems it raises, and when you first perceived it?
JW: The SEC’s authority to create new rules is constrained by the Administrative Procedure Act (APA), which generally mandates that any new government rules go through a formal process, allowing the public to be notified of proposed regulations and to provide feedback on their potential impact. Our position, as detailed in our complaint, is that the SEC has implemented a de facto rule, evidenced through numerous actions, proposals, and public statements that collectively demonstrate the SEC will treat all digital assets, except arbitrarily bitcoin and ether, as securities to be regulated. The SEC invented the term "Crypto Asset Security" as a mechanism to enforce this rule, but regardless of terminology, the SEC's broad classification of all digital assets—except bitcoin and ether—as securities is a rule under federal law and subject to the APA’s rulemaking requirements.
AJB: Obviously it’s one thing to look at the SEC’s enforcement and say “hey, that isn’t right” and quite another to place your company at the center of a fight against it. Can you talk about the choice to make this aggressive maneuver and bring the Dec. J. and APA case to the SEC in Texas? What was your strategic thinking there? What did you see as the benefits of fighting this case affirmatively versus waiting and seeing if the SEC pursued action against you?
JW: Our lawsuit goes beyond any potential claims the SEC may bring against us; it addresses a broader question of whether the SEC can unilaterally expand its own authority. Federal law provides a process for addressing these challenges outside of an individualized enforcement action, and we are utilizing that procedure. Regarding the location of our suit, our U.S. headquarters are in Texas.
AJB: Another pertinent issue this strategy raises is the free rider problem. We recently saw this with Kalshi. They took the risk—and paid the attorneys’ fees—to fight the CFTC over election-based event contracts. When they finally won, however, their competitor IBKR immediately began listing the same contracts. On some level, there is nothing to be done about this, and there may be advantages that come with fighting the case, but in terms of pure economics, there are obvious efficiencies to turtling and letting other exchanges take on the expensive fights. How do you think about this?
JW: Everyone benefits from a government that creates fair rules and follows a proper process in developing those rules. We are bringing this suit to protect everyone's access to crypto in the United States, not just for Crypto.com’s benefit.
AJB: Something that you’ve brought up to me since my original piece is that I didn’t focus enough on your APA claims. What do you see as the core strength of these claims? To play devil’s advocate here, the SEC is going to argue that the whole point of the Howey test is that it doesn’t need a new rule to evaluate each investment scheme, that a court may or may not decide that sales of certain “Network Tokens” are investment contracts, but that that doesn’t suggest that there is an unarticulated standard. For example, Judge Analisa Torres, in a Ripple opinion you cite, says that:
“[T]he case law articulates sufficiently clear standards to eliminate the risk of arbitrary enforcement. Howey is an objective test that provides the flexibility necessary for the assessment of a wide range of contracts, transactions, and schemes… the SEC’s approach to enforcement, at least as to the Institutional Sales, is consistent with the enforcement actions that the agency has brought relating to the sale of other digital assets to buyers pursuant to written contracts and for the purpose of fundraising”
What do you think this devil’s advocate view is missing about the SEC’s “rulemaking by enforcement” program over the last few years?
JW: Our case addresses the limits of the SEC's jurisdiction and the authority granted to it by Congress, as well as how the Commission has unilaterally and unlawfully created and enforced a rule that all digital assets–except bitcoin and ether– are securities regardless of how they are sold. This issue extends beyond whether a specific asset is sold as part of an investment contract in a specific transaction to the broader rule the SEC has created and enforced that digital assets are securities regardless of their method of sale.
AJB: Something I talk about here from time to time is what an appropriate regulatory regime should look like for cryptocurrency in the United States. There’s a story you can tell about cryptocurrency as a type of “regulatory arbitrage.” In much the same way as Uber upended sclerotic taxi medallion monopolies, and Airbnb defied ancient hoteling norms, cryptocurrency and DeFi broke through an, arguably, over-intrusive regime of securities and derivative laws that have operated in the United States since the 1930s. This allowed cryptocurrency projects to quickly provide massive new liquidity to an energetic community of builders in a way that a lot of people found inspiring. On the other hand, when the crash came, some of those entities were caught without adequate internal controls, resulting in spectacular flameouts like Three Arrows Capital and FTX/Alameda. For you, what should United States regulation of cryptocurrency and DeFi look like?
JW: The details of what a regulatory framework looks like are too complicated to answer here, but we support the on-going good faith, bipartisan efforts in Congress to build consensus on a framework that creates a clear and fair path for consumers, businesses, and developers to engage with digital assets and distributed ledger technology.
AJB: This is a good opportunity to cover the lesser discussed aspect of your case against the SEC. Your affiliate CDNA brought a second action requesting the CFTC and SEC to clarify the regulatory treatment of certain swaps under 17 CFR § 1.8 of the Commodities Exchange Act (CEA). This was particularly interesting because it came in the same week that Bitnomial brought its own Dec. J. action in N.D.Ill. after the SEC apparently asserted regulatory authority over XRP futures products as security futures, implicating the same issue. With sincere apologies to my Leg. Reg. professor Susan Davies, I had no idea this provision of the CEA existed. Can you walk me through the thinking behind this two-pronged approach?
JW: The Dodd-Frank Act establishes a process allowing the SEC and CFTC to issue a joint interpretation to determine whether certain products are securities-based swaps (and thus fall under the SEC's jurisdiction) or non-securities-based swaps (and under the CFTC’s jurisdiction). This process enables both agencies to discuss the matter internally and issue a public interpretation on whether the digital assets underlying these derivative contracts are securities or not. This collaborative approach offers an excellent opportunity for both agencies to provide clarity to the public in a way that is far more efficient than the SEC's current enforcement-first approach.
AJB: One motif I’ve observed over the years is a preference among cryptocurrency professionals for CFTC rather than SEC oversight. Obviously, Rostin Benham has not been quite as hard as Gary Gensler on the industry these past few years, but from your perspective, are there any other reasons to inherently prefer the CFTC’s oversight to the SEC’s?
JW: Administrations change, so preference for one regulator over another should not be based on current personnel. The underlying issue with granting the SEC broad jurisdiction over the digital asset industry is that Congress has not provided the SEC with the authority needed to regulate secondary market sales of digital assets comprehensively. Fundamentally, any legislation enacted by Congress should be clear on the rules of the road and on the remit of the regulator(s) (whichever regulator(s) they choose).
AJB: A couple months ago I talked to Eric Wessan, the Solicitor General of Iowa. He wrote at length about the applicability of the Major Questions Doctrine to SEC enforcement in cryptocurrency. It strikes me that those arguments would feel at home in your complaint, and yet you didn’t choose to invoke the doctrine here. What was your thinking in excluding it?
JW: Many have noted that the SEC’s approach raises issues under the major questions doctrine, and we agree. We cite West Virginia v. EPA in a footnote, and it’s possible that a major questions analysis could become more relevant if this case reaches the Supreme Court. However, our claims do not rely on the court conducting that analysis.
AJB: Thank you for your time talking through this fascinating complaint! I’ve been deeply impressed by your litigation strategy thus far, and really enjoyed thinking about these issues. I hate to heap Jones Day with praise, but credit where credits due, you all did a good job here. Before you go, is there anything you’d like to add? Could be something I forgot, something about Texas, whatever you want.
JW: We’re excited to see how the case progresses. Thanks for your time.
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