The tension between the crypto industry and the United States Securities and Exchange  Commission over the issue of which tokens qualify as securities has been well documented.  SEC Chair Gary Gensler is on record as saying almost all crypto products are securities.  On April 23, 2024, two crypto industry groups, the Blockchain Association and the Crypto Freedom Alliance of Texas sued the SEC in federal court in Texas, challenging the SEC’s rule expanding the definition of a “dealer” to capture digital assets (the “Dealer Rule”).

In February 2024, the SEC adopted the Dealer Rule, on a 3-2 vote, requiring proprietary traders and other firms that routinely deal in government bonds and other securities to register as broker-dealers.  The Dealer Rule expanded the SEC’s interpretation of the statutory term “dealer” in the Securities Exchange Act of 1934 in a way that identified dealers based on whether a person’s trading activity had the effect of providing market liquidity.  The Complaint alleges that the Dealer Rule, “while nominally aimed at participants in traditional financial markets, threatens to bulldoze [cryptocurrency] innovations and potentially much of the burgeoning digital assets industry.”  In other words, the concern is that the expanded definition of a dealer is going to capture persons who are just trading in digital assets.

According to the Complaint, the Dealer Rule exceeds the SEC’s authority and amounts to arbitrary and capricious rulemaking because the SEC “refused to exempt the digital assets industry or to coherently explain how and when the rule would apply to those novel markets.”  More specifically, the Complaint alleges:

At the outset, digital assets industry members objected that the single mention of digital assets in a footnote provided clearly insufficient notice of how and why the Commission intended to apply the rule to the digital asset markets. See, e.g., DEF Comment at 11; Chamber of Digital Commerce Comment at 4 (June 13, 2022) (“[I]t is completely unclear whether the Commission proposes that the term ‘dealer’ now include digital asset or cryptocurrency market participants since there is no reference to digital asset market intermediaries anywhere in almost 200 pages of regulatory discussion and not one request for comment relates to the impact of the Proposal[] on the digital asset industry.”). The single footnote was particularly lacking because the Commission, consistent with its longstanding, unlawful approach to the industry more generally, had provided no clarity as to which transactions in which digital assets constitute securities transactions. See, e.g., a16z Comment at 10 (“[T]he Commission should not compound the costs of uncertainty over the status of digital assets through a single sentence in a footnote of the Proposal.”); BA Comment at 1 (May 27, 2022) (“[T]he Proposal exacerbates the harmful impact of existing regulatory uncertainty caused by the SEC’s failure to provide adequate guidance regarding the classification of digital assets as securities.”).

The industry groups behind the lawsuit said in a statement that “this is the latest example of the SEC’s blatant attempts to unlawfully regulate outside its authority, skirting legal obligations to address the numerous concerns received during its compressed comment period. The Dealer Rule advances the SEC’s anti-digital asset crusade and unlawfully redefines the boundaries of its statutory authority granted to it by Congress, threatening to drive U.S. companies offshore and incite fear in American innovators.”

Included in the relief requested is a declaratory judgment that the Dealer Rule is arbitrary, capricious, or otherwise contrary to law within the meaning of the Administrative Procedure Act and an order vacating and setting aside the Dealer Rule in its entirety pursuant to the APA.

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