The Major Questions Doctrine

The SEC Exceeds Its Authority When It Rules Digital Assets Sold on the Secondary Market Are Securities

Jun 13, 2023

INTRODUCTION

West New York, N.J. - The U.S. Supreme Court has declared that if an agency seeks to decide an issue of major national significance, its action must be supported by clear congressional authorization. Courts and commentators have referred to this doctrine as the major questions doctrine. Agencies often interpret statutes that grant them regulatory authority. If challenged, courts need to review such interpretations to determine if an agency has exceeded its authority.

The U.S. Supreme Court has explained that, in general, courts interpret statutory language “in its context and with a view to its place in the overall statutory scheme.” In cases where there is something extraordinary about the “history and breadth of the authority” an agency asserts or the “economic and political significance” of that assertion, however, the U.S. Supreme Court indicated courts should “hesitate before concluding that Congress meant to confer such authority.” West Virginia v. EPA, 142 S. Ct. 2587, 2607–2608 (2022).

Under the major questions doctrine, the U.S. Supreme Court has rejected agency claims of regulatory authority when (1) the underlying claim of authority concerns an issue of “vast economic and political significance,” and (2) Congress has not clearly empowered the agency with authority over the issue. Util. Air Regul. Grp. (UARG) v. EPA, 573 U.S. 302, 324 (2014). In requiring agencies to point to clear congressional authorization for their actions in major questions cases, the U.S. Supreme Court has further explained that Congress rarely provides an extraordinary grant of regulatory authority through language that is modest, vague, subtle, or ambiguous.

The major questions doctrine is an independent principle of statutory interpretation focused on ensuring Congress bears the responsibility for confronting questions of major national significance. The U.S. Supreme Court’s jurisprudence leaves open the question of how, or even whether, Congress may grant agencies the authority to act to address major issues in the future that Congress did not anticipate when it enacted a statute. (CRS IF12077, The Major Questions Doctrine (Updated November 2, 2022), by Kate R. Bowers).

Under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act), the U.S. Securities and Exchange Commission (SEC) has full authority over the offer, sale, and the trading of securities, including investment contracts, and the derivatives trading of securities. Under the federal securities laws, every offer and sale of securities must be either registered with the SEC or conducted under an exemption.

The central question of whether the SEC has jurisdiction over a digital asset is whether it falls within the definition of a security. For a detailed analysis, see “The Howey Test.”

The Commodities Future and Trading Commission (CFTC) is the primary market regulator for derivatives in the United States. It is the sister agency to the SEC. A derivative is a financial contract whose value depends on an underlying asset, group of assets, or benchmark. While not regulated by the CFTC, perhaps the most widely known derivative is a stock option on a single stock. The CFTC regulates futures, options, and swaps, which reference commodities.

When a digital asset is considered a commodity, it is subject to the same jurisdiction of the Commission as any other commodity. In 2015, the CFTC established that virtual currencies are commodities for purposes of the CEA section 1a(9). (In re Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Docket No. 15-29, 2015 WL 5535736, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 33,538 (CFTC Sept. 17, 2015) (consent order); In re TeraExchange LLC, CFTC Docket No. 15-33, 2015 WL 5658082, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 33,546 (CFTC Sept. 24, 2015) (consent order)).

The CFTC’s regulatory authority is limited to transactions, participants, and intermediaries in the commodity derivatives markets. Regulated intermediaries include designated contract markets, swap execution facilities, clearinghouses, futures commission merchants, introducing brokers, commodity trading advisors, and others. The Commission currently does not have regulatory authority over spot market transactions, unless the transaction is a margin, leveraged, or financed retail commodity transaction or retail foreign exchange transaction. As such, the CFTC currently does not have regulatory authority over spot market transactions or intermediaries in the digital commodity spot markets.

Generally, the SEC and CFTC have attempted to resolve the legal question of whether a digital asset is a security or a commodity through enforcement actions. However, the agencies have not always agreed on which digital assets are considered securities and which digital assets are considered commodities.

SEC Chair Gary Gensler has stated that he considers all digital assets other than bitcoin to be securities. CFTC Chairman Behnam has expressed his view that a number of digital assets are considered commodities including bitcoin and ether, among others. These conflicting positions demonstrate the necessity and urgency of congressional action.

In sum, determining whether a digital asset is offered as part of an investment contract (i.e., meeting the definition of a security) or falling under the definition of commodity in the CEA has proven difficult in the United States. Until there is a consistent, clear framework in place, market participants, consumers, and investors will continue to seek regulatory clarity given the requirements that stem from the classification of a particular digital asset.

In SEC v. Wahi, et al., Defendants Ishan and Nikhil Wahi’s motion to dismiss is superbly drafted and raises many of the issues that must be addressed in order to provide regulation clarity to the U.S.-based digital asset markets and protect crypto investors. The following, in part, is a brief analysis of this motion to dismiss.

I. BOTH HOWEY AND THE MAJOR QUESTIONS DOCTRINE FORECLOSE THE SEC’S ATTEMPT TO SCRAP THE TRADITIONAL DEFINITION OF AN “INVESTMENT CONTRACT.”

Precedent confirms what text and history already make clear: The federal securities laws use the traditional definition of “investment contract.” Indeed, the Supreme Court held as much in Howey, stating in quite plain terms that, “by including an investment contract within the scope of….the Securities Act, Congress was using a term the meaning of which had been crystallized by this prior judicial interpretation in state blue sky cases.” 328 U.S. at 298. Despite this straightforward sentiment, the SEC appears to contend the Howey Court actually replaced the traditional definition of “investment contract” with something else - a malleable standard that does not require any “contract,” much less the specific sort of contract uniformly required under the blue sky laws. The SEC is wrong. Neither the U.S. Supreme Court nor the Ninth Circuit has ever found an “investment contract” where the instrument does not satisfy that term’s traditional definition. See generally Lewis Rinaudo Cohen et al., The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securities 36-72 (Nov. 10, 2022) (exhaustively surveying federal appellate cases applying Howey).

The “Major Questions Doctrine” dispels any doubts. The U.S. Supreme Court has explained that an “extraordinary grant of regulatory authority” - a term that plainly captures a broad power over the new, trillion-dollar digital asset industry - requires “clear congressional authorization.” West Virginia v. EPA, 142 S. Ct. 2587, 2614-16 (2022). The SEC’s attempt to wring broad jurisdiction over digital assets from the text of the Depression-era securities laws or the spirit of Justice Murphy’s 1946 Howey opinion fits that doctrine to a tee. The SEC needs “clear” statutory authority to regulate digital assets. It does not have it.

A. The Major Questions Doctrine Confirms the SEC May Not Jettison the Traditional Definition of “Investment Contract.”

Even if the SEC were able to conjure some ambiguity about the scope of its authority - whether from Howey or the federal securities laws themselves - the Major Questions Doctrine would foreclose exploiting that ambiguity. That is, even if the SEC’s competing understanding of the law were “colorable” or “plausible,” that is not enough. West Virginia, 142 S. Ct. at 2609. As between two possible interpretations of the law - one that confers vast power on federal agencies to resolve substantial policy questions, and one that ensures Congress makes major policy choices - the Major Questions Doctrine requires the federal courts to opt for the latter reading.

It is hard to fathom a more archetypal violation of the Major Questions Doctrine than the SEC’s assertion of authority over digital assets. That doctrine holds, at heart, that an agency may not bring about a major policy without clear statutory authorization. Id. The SEC is pressing a novel construction of an isolated term from a Depression-era law to assert regulatory authority over a trillion-dollar industry built upon revolutionary technology poised to define the next generation of the internet - all as Congress is actively debating the issue, considering zero proposals that bless the SEC’s view of its own authority. Time and again, the U.S. Supreme Court has rejected this sort of expansionism by federal agencies.

1. The SEC lacks clear congressional authorization to deem digital assets sold on the secondary market to be “securities.”

The SEC does not have clear congressional authorization for its assertion of regulatory power broadly over the digital asset space. Five independent points show why.

First, far from clearly authorizing the SEC’s assertion of regulatory power, the term “investment contract” affirmatively forecloses it. As explained above, “investment contract” is a term of art that Congress incorporated into the federal securities laws - a term of art that necessarily excludes digital assets sold on the secondary market. This is thus far simpler than those in which courts have had to grapple with vague terms that lacked established definitions. See, e.g., Brown & Williamson, 529 U.S. at 126-27 (“drugs” and “devices”); Utility Air, 573 U.S. at 310 (“air pollutant”); West Virginia, 142 S. Ct. at 2610 (“system”). At minimum, the SEC cannot divine a clear statement of existing authority by recasting a term of art in an entirely novel way.

Second, the SEC’s position would massively expand its own power. Congress included the phrase “investment contract” in the securities laws to cover one-off business ventures where the investment interests had the basic attributes of a traditional security. See Edwards, 540 U.S. at 393-94. And that term has been applied consistently with its limited focus, covering investment schemes involving orange groves, beavers, and real estate. The SEC is now trying to dust off this obscure term to ensnare an entire industry worth around $1 trillion. The SEC has “never relied on this authority to regulate business….in such a remarkable manner.” West Virginia, 142 S. Ct. at 2609. And the Major Questions Doctrine forecloses its attempt to “discover” such an “unheralded power” in “a long-extant statute.” Utility Air, 573 U.S. at 324.

Third, the SEC’s sweeping view of an “investment contract” is in tension with the existing framework for securities regulation. Not only is the SEC’s view inconsistent with the basic function of securities regulation. It is also, as a practical matter, an exceedingly poor fit for the securities laws. And when an agency’s position is “inconsistent with the design and structure of the statute as a whole,” it flunks the Major Questions Doctrine. Id. at 321.

Consider, for instance, how digital assets may interact with the many disclosure rules in the securities laws. To take one example, before a security is sold to the public, an “issuer” usually needs to file a registration statement with the SEC detailing information about the issuer’s business. The Securities Act defines “issuer” as “every person who issues or proposes to issue any securities.” 15 U.S.C. § 77b(a)(4). But what does that mean for digital assets? Is the issuer the computer software that creates and distributes tokens? Is it the person who originally wrote that program, even if he no longer has anything to do with the platform? Is it each validator on the platform who gets tokens by verifying transactions? Each user who earns new tokens as rewards? Other examples abound. But the basic point is that there is a mismatch between the securities laws’ focus on centralized companies (e.g., General Motors) and digital assets’ decentralized networks. A legal regime designed around singular companies and business ventures - with clear point people and leaders - does not map cleanly onto a set of products defined by their diffuse nature.

Fourth, Congress is actively considering how to best regulate digital assets. The reality is that digital assets do not fit cleanly into any existing federal regulatory regime - they blur the lines across money, commodities, and securities. That has led to confusion among regulators.

The Commodity Futures Trading Commission (“CFTC”), for example, has taken the view that some digital assets are commodities. See, e.g., Commodity Futures Trading Comm’n, Digital Assets Primer 23 (2020); Amended Complaint ¶ 1, Commodity Futures Trading Comm’n v. Bankman-Fried, No. 22-cv-10502 (S.D.N.Y. Dec. 13, 2022). One CFTC Commissioner even criticized the SEC’s decision to allege here “that dozens of digital assets,” including utility tokens and governance tokens, “are securities.” Statement, Commodity Futures Trading Comm’n, Statement of Commissioner Caroline D. Pham on SEC v. Wahi (July 21, 2022).

Meanwhile, one SEC Commissioner has conceded that, if the SEC “seriously grappled with the legal analysis and its statutory authority,” it “would have to admit that it likely needs more, or at least more clearly delineated, statutory authority to regulate certain crypto tokens and to require crypto trading platforms to register with us.” Hester M. Peirce, Comm’r, Secs. & Exch. Comm’n, Outdated: Remarks Before the Digital Assets at Duke Conference (Jan. 20, 2023).

That same Commissioner added: “Congress can figure out whether and how to fill the regulatory gaps.” Id. And given this novel terrain and the jurisdictional questions digital asset regulation presents, Congress appears to have taken on that task and begun to “debate the matter frequently.” West Virginia, 142 S. Ct. at 2621 (Gorsuch, J., concurring); see also, e.g., S. 4760 (Aug. 3, 2022) (“Digital Commodities Consumer Protection Act”); S. 4356 (June 7, 2022) (“Lummis-Gillibrand Responsible Financial Innovation Act”); H. 4741 (July 2021) (“Digital Asset Market Structure and Investor Protection Act”).

Congress is not now actively debating a question it has already answered. And the Congress that passed the federal securities laws did not make the policy choice about how to regulate something like crypto. If anything, the current congressional debates strongly suggest that the SEC should not be in charge of digital assets. None of the current proposals in Congress assigns primary regulatory authority to the SEC. Indeed, a wide number of proposals have been introduced specifically to clarify the SEC currently lacks regulatory jurisdiction over broad swaths of digital assets. See, e.g., H.R. 1628, §§ 2-5 (Mar. 8, 2021) (“Token Taxonomy Act”); H.R. 4451 §§ 2(a)(2)-(5), 3 (July 16, 2021) (“Securities Clarity Act”). Congress has thus “conspicuously and repeatedly declined” to accede to the SEC’s broad view of its own authority. West Virginia, 142 S. Ct. at 2610; see also id. at 2620-21 (Gorsuch, J., concurring) (“This Court has found it telling when Congress has considered and rejected bills authorizing something akin to the agency’s proposed course of action.”).

Finally, practical consequences weigh heavily against the SEC’s position. See id. at 2608. Given the unprecedented nature of the SEC’s interpretation of “investment contract,” there are minimal real-world consequences to rejecting it; we are aware of no case in which the U.S. Supreme Court has ever countenanced an “investment contract” that departs from the term’s traditional definition. The repercussions of adopting the Commission’s broad view would, by contrast, be momentous, and would expand far beyond digital assets. In its plainest form, it is hard to see how the SEC’s view - unburdened by the traditional definition of “investment contract” - would not extend to baseball cards, beanie babies, designer sneakers, commemorative coins, initial sales of concert tickets (often bought to flip for a profit), and much more besides. With that interpretation, as SEC Commissioner Peirce has noted, “functionally the ‘most important’ factor of the Howey Test is an SEC-invented ‘fifth shadow factor’: whether the SEC wants to regulate the asset.” But Congress likely did not delegate the question whether to regulate any asset - and thereby an entire industry - to an agency to decide on a whim. Thus, even if the SEC’s interpretation were potentially plausible, “the sheer scope of its claimed authority….would counsel against its interpretation.” Alabama Ass’n of Realtors v. Dep’t of Health & Hum. Servs., 141 S. Ct. 2485, 2489 (2021) (per curiam).

CONCLUSION

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