Crypto Cos. Add New Play In Their Offense Against SEC

Published in Law360 Expert Analysis.

The crypto industry continues to break new ground by upending the traditional legal response to a Wells notice from the U.S. Securities and Exchange Commission.

Instead of taking the long-followed deferential approach to SEC enforcement attorneys — undertaken in the hopes of persuading SEC staff to retreat from an enforcement action or negotiate a lenient settlement — crypto industry players have taken the fight into their own hands, issuing combative statements to the press and via social media, as well as adopting a novel strategy of preempting SEC enforcement actions by filing declaratory actions challenging the SEC's jurisdiction to regulate crypto-assets.

This year saw crypto actors Consensys Software Inc. and Crypto.com put a new twist on that strategy: relocating their headquarters to Texas shortly before suing the SEC in an attempt to launch their suits in a friendlier jurisdiction.

The Crypto Industry's Offensive Tack Against the SEC

There has been a recent trend among players in the crypto marketplace to meet threats of SEC enforcement head-on by being the first to file suit, thereby preempting enforcement claims with their own declaratory actions against the commission, all of which challenge the SEC's jurisdiction to regulate digital assets.

This year saw an influx of such suits: a March suit brought by apparel company Beba LLC and the DeFi Education Fund in the U.S. District Court for the Western District of Texas,[1] an April suit by the Crypto Freedom Alliance of Texas and the Blockchain Association in the U.S. District Court for the Northern District of Texas,[2] a July suit filed by two NFT artists in the U.S. District Court for the Eastern District of Louisiana,[3] and an October suit filed by Bitnomial Exchange LLC in the U.S. District Court for the Northern District of Illinois.[4]

The Consensys and Crypto.com actions filed this year not only follow that playbook, but they also seem to reflect a preference for launching this strategy within Texas.

Consensys Takes SEC Fight to Texas

According to court filings, on April 4, 2022, the Brooklyn-based Consensys received a letter from the SEC's Division of Enforcement advising the company that the commission was conducting an investigation of its MetaMask offerings.[5] The company relocated to Fort Worth, Texas, in or around February 2024,[6] just weeks before the SEC issued an April 10 Wells notice indicating its intent to bring an enforcement action based on the MetaMask offerings, which the SEC contends violate federal securities laws.

On April 25, Consensys filed a complaint in the Northern District of Texas. The company's complaint listed the Wells notice, the SEC's June 2023 action against fellow cryptocurrency exchange Coinbase Inc. in the U.S. District Court for the Southern District of New York,[7] and the SEC's prior enforcement actions against Consensys as the rationale prompting the suit.

Consensys' claims focused on the SEC's investigations into the company's transactions involving the digital asset Ethereum and its MetaMask offerings, and sought, among other things, declarations that ether is not a security and that its MetaMask offerings are not offerings of securities in violation of the federal securities laws. Consensys also sought to enjoin the SEC from pursuing any investigation or enforcement action regarding ether transactions as securities transactions.[8]

The SEC successfully sought an extension of time to answer Consensys' complaint to July 29.[9] In the intervening weeks, the SEC notified Consensys that it had terminated the ether investigation and was pursuing an enforcement action related to MetaMask. The SEC then filed its own pleadings in the U.S. District Court for the Eastern District of New York, focused on the MetaMask offerings, on June 28.

The SEC referenced its pending New York action in its July 24 motion to dismiss Consensys' Texas action, which was ultimately granted on Sept. 19.[10] That decision, issued by U.S. District Judge Reed O'Connor, determined that the SEC's withdrawal of the ether investigation rendered those claims moot and deemed the MetaMask claims unripe, dismissing them for lack of subject matter jurisdiction.[11]

Judge O'Connor's ripeness determination on the MetaMask claims involved considering whether any of the SEC's actions — including the Wells notice — were final, as would be required to render Consensys' claims fit for judicial review. In doing so, he expressly determined that the Wells notice was not final, but merely "the SEC staff's 'preliminary determination to recommend' the SEC pursue an enforcement action against Plaintiff."

Crypto.com Doubles Down on Texas Offensive Strategy

On October 8,[12] Crypto.com filed a complaint against the SEC in the Eastern District of Texas. Like the Consensys action, the Crypto.com filing followed the SEC's issuance of a Wells notice, which the SEC sent to Crypto.com in August. As with the Consensys Wells notice, the letter issued to Crypto.com warned that the SEC was contemplating bringing an enforcement action against the exchange for the issuance of unregistered securities.

Rather than responding to the Wells notice via a traditional Wells submission, Crypto.com seemingly adopted Consensys' forum strategy by moving its headquarters from Miami to Tyler, Texas, making the announcement just days before filing its Texas complaint, although it signed its lease in May.[13]

That complaint seeks to prevent the SEC from unlawfully expanding its jurisdiction to cover the exchange of certain cryptocurrency tokens in the secondary market, including on Crypto.com's platform. Crypto.com objects to the SEC's regulation-by-enforcement strategy, seeking a declaration that the at-issue tokens are neither securities nor part of a securities transaction — and that Crypto.com does not operate as an unregistered securities broker-dealer or securities clearing agency with respect to those sales.

While Crypto.com's Texas action may follow in Consensys' footsteps all the way to a similar dismissal, the company may still benefit from pursuing this aggressive strategy. The proactive filing may add pressure on the SEC to expedite any pending investigations, perhaps resulting in a strategy shift similar to the SEC's abandonment of its ether claims in the Consensys matter.

It also compresses the time frame for the SEC to file competing pleadings in the state of Crypto.com's recent headquarters — Florida — should the SEC hope to follow the strategy used against Consensys of pointing to a later-filed, preanswer action in seeking dismissal of Crypto.com's Texas pleadings.

Texas Offers a Pro-Crypto Toehold

If its lawsuit remains under the Texas court's jurisdiction — and proceeds to the requested jury trial — Crypto.com may benefit from litigating in a cryptocurrency-friendly region. Crypto.com is just the latest major industry player to relocate to Texas, which has already attracted numerous commercial bitcoin mining operations with its relatively cheap energy and welcoming politicians, who seem optimistic about the industry's potential to benefit the Texas economy. And to date, the U.S. Court of Appeals for the Fifth Circuit has not issued a substantive ruling adverse to those controlling the cryptocurrency market.

In contrast, Crypto.com's original headquarters locale, Florida, could prove to be a less friendly jurisdiction. In June 2021, the U.S. Court of Appeals for the Eleventh Circuit upheld a securities fraud class action, including claims for the violation of the Securities Act and Exchange Act, against Centra Tech Inc., which had developed a digital wallet for storing cryptocurrencies.[14]

The Eleventh Circuit issued a February 2022 opinion reinstating a claim against promoters of the cryptocurrency BitConnect for violating Section 12 of the Securities Act of 1933 for soliciting the purchase of unregistered securities.[15]

In February 2024, the Eleventh Circuit also issued an opinion affirming the sentence of Ryan Felton, an individual charged with multiple counts, including two counts of securities fraud in violation of the Exchange Act, for two schemes involving the creation and false promotion of cryptocurrencies.[16]

Takeaways

Whether the SEC will pursue a lawsuit against Crypto.com in Florida remains to be seen, as does the impact of Crypto.com's attempt to end the commission's regulation-by-enforcement strategy.

In the meantime, it is clear that the crypto industry is seeking friendlier venues to challenge what it sees as the SEC's regulatory overreach over the industry. And, favorable decisions in the Fifth Circuit reigning in the SEC may lead to a split between the crypto-friendly Fifth Circuit and the regulatory-friendly Second and Eleventh Circuits on the issue of when, if ever, a digital asset is a security — priming that issue for a decision by the U.S. Supreme Court.

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Arthur G. Jakoby is a partner and co-chair of the securities litigation and enforcement group at Herrick Feinstein LLP. He previously served as special trial counsel in the SEC's Division of Enforcement and as a special assistant U.S. attorney to the Financial Crimes Unit for the District of New Jersey.

Silvia Stockman is an associate at Herrick Feinstein.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] DeFi Complaint.

[2] CFAT and BA Complaint.

[3] Frye Mann Complaint.

[4] Complaint.

[5] NDTX Complaint.

[6] See EDNY Complaint.

[7] SEC v. Coinbase Inc. , 2024 WL 1304037, at *35 (S.D.N.Y. Mar. 27, 2024).

[8] NDTX Complaint.

[9] 7/1/2024 Order.

[10] 9/19/2024 Decision.

[11] Id.

[12] Crypto.com Complaint.

[13] Id. at ¶ 36.

[14] Rensel v. Centra Tech Inc. , 2 F.4th 1359, 1370 (11th Cir. 2021).

[15] Wildes v. BitConnect International PLC , 25 F.4th 1341, 1347 (11th Cir. 2022).

[16] United States v. Felton , 2024 WL 853687, at *7 (11th Cir. 2024).

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