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Inside the crypto industry’s plan to vanquish the SEC at the Supreme Court

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A coalition of crypto entrepreneurs filed a lawsuit in Texas this week that could force the Supreme Court to take up the all-important question of whether the Securities and Exchange Commission has the authority to regulate most digital assets.

The outcome of the fight could determine the future for companies like crypto exchanges Coinbase Global Inc.
COIN,
-2.88%
,
Binance and Kraken, as well as variety of up-and-coming crypto projects like Solana
SOLUSD,
-0.90%
,
Cardano
ADAUSD,
-0.66%

and Polygon
MATICUSD,
-0.67%

— all of whom the SEC has accused of violating federal securities law by failing to register with the agency.

The Crypto Freedom Alliance of Texas, a nonprofit trade group, and Lejilex, yet-to-be-launched crypto exchange, filed a complaint in federal court Wednesday seeking a judicial declaration that sales of digital assets are not securities transactions, as the SEC has alleged in its lawsuits against Coinbase, Binance and Kraken.

Read more: SEC charges Coinbase for illegally operating an unregistered securities exchange

“We wish we were launching our business instead of filing a lawsuit, but here we are,” said Mike Wawszczak, Co-Founder of Lejilex, in a statement. “The SEC’s rogue enforcement actions targeting our industry have paralyzed those of us who just want to build lawful businesses and technologies.”

The SEC declined to comment.

The industry hired the law firm of Clement & Murphy — led by former Solicitor General Paul Clement and litigator Erin Murphy — which specializes in “strategic litigation,” or court cases that are motivated by a desire to bring about broader policy change, often through rulings at the Supreme Court.

The lawsuit was filed in district court in the federal judiciary’s Fifth Circuit, known for its conservative-leaning judges, and was assigned to Judge Reed O’Conner, a George W. Bush appointee famous for his rulings that have undermined the Obamacare law and other liberal causes.

“The crypto industry needed to find a way for these very conservative courts to hear these cases, because there’s no way they’re going to rule for the SEC,” said Todd Phillips, an administrative-law expert who teaches at Georgia State University.

The Crypto Freedom Alliance of Texas and Lejilex want Judge O’Connor to issue a declaratory judgement saying that the exchange doesn’t have to register with the SEC as a securities exchange, so that it can avoid getting sued by the agency under the same theories that it used to accuse Coinbase of violating the law.

If they succeed, the crypto industry can seize the initiative from the SEC, which up to this point has been able to choose the times and places it has battled digital-asset companies in court, according to a source familiar with the plaintiffs’ strategy.

Even if the SEC is successful in convincing other district courts in New York, Washington, D.C., and California that crypto exchanges have been violating securities laws, a favorable ruling in the Fifth Circuit would create a situation where the Supreme Court would likely have to take up the case.

The Supreme Court is dominated by a 6-3 conservative majority that has been eager to issue rulings that have weakened the regulatory state in recent years, including a ruling that blocked the Environmental Protection Agency’s ability to fight climate change by regulating power companies, and another which said that the leadership structure of the Consumer Financial Protection Bureau is unconstitutional.

“The crypto industry is trying to manufacture a circuit split so that the Supreme Court will basically have to take the case,” Phillips said.

The lawsuit’s central argument is that the SEC is misinterpreting the case law on the question of what constitutes an “investment contract.”

Investment contracts are securities under federal law, and those who issue securities or operate exchanges that sell securities must register with the SEC and submit to its regulatory regime.

See also: Blockchain firm LBRY tries to rally sector against SEC; critics allege a ‘cryptocurrency suppression program’

The SEC has argued that digital assets like Solana or Cardano are securities because investors buy these tokens and expect to profit based on the efforts of the entrepreneurs behind these projects.

The Lejilex lawsuit argues the SEC is ignoring the fact that, for a digital asset to qualify as investment contract, it would have to confer on the buyer of that asset some sort of contractual claim on proceeds earned by the issuers of the asset — which is not the case for Solana, Cardano or any of the other tokens the SEC has characterized as securities in its cases against crypto exchanges.

Under the SEC’s view of the law, the plaintiffs argue, the agency would be allowed to regulate collectibles like limited-run sneakers or baseball cards as securities, because investors often buy those products with the expectation that they’ll increase in value based on the promotional efforts of the collectibles’ manufacturers.

The SEC will get a chance to respond to Lejilex’s claims in a filing of its own, which can be expected in the coming months, and the court will likely rule on the issue later this year.

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