On Friday, June 28, 2024, Judge Amy Berman Jackson of the U.S. District Court for the District of Columbia struck a serious blow to Securities and Exchange Commission ("SEC") Chair Gary Gensler's regulation-by-enforcement campaign against secondary crypto asset market exchanges. In SEC v. Binance, an SEC enforcement action seeking to impose federal securities regulations on a variety of transactions involving foreign (Binance.com) and domestic (Binance.us) digital asset trading platforms, Judge Jackson partially granted the Binance defendants' motions to dismiss the SEC's complaint.1 Among other things, Judge Jackson's decision reaffirmed that crypto assets themselves are not "securities" subject to SEC oversight, rejected the SEC's allegations that crypto tokens somehow "embody" investment contract securities, and dismissed the agency's claims relating to secondary market sales of crypto tokens and certain other crypto asset products and services.2 Judge Jackson's nearly 90-page Memorandum Opinion and Order disposing of the motions, perhaps the most thoughtful and detailed judicial reckoning yet to address a panoply of regulatory issues impacting the crypto asset sector, may have far-reaching consequences for all market participants. Most importantly, the Order casts doubt on the SEC's authority to regulate secondary spot market transactions on crypto exchanges.
In the Order, Judge Jackson granted the Binance defendants' motions to dismiss the SEC's claims relating to secondary sales of BNB tokens, offers and sales of the BUSD stablecoin, and offers and sales made in connection with the Simple Earn token lending program. Judge Jackson denied motions to dismiss the SEC's claims relating to alleged initial and ongoing offers and sales of BNB tokens; alleged offers and sales under the BNB Vault program and Binance.us' staking program; the alleged failure to register the Binance.com and Binance.us platforms as securities exchanges, broker-dealers, and clearing agencies; and Binance.us' alleged violations of the federal securities laws' anti-fraud provisions, among other claims.
Judge Jackson started her analysis by pointing out that the fundamental question underlying each of the claims at issue is whether the defendants' offers and sales of crypto assets constituted investment contract transactions under Howey3 and therefore were appropriately deemed "securities" transactions for the purposes of the Securities Act of 1933, as amended (the "Securities Act") and the Securities Exchange Act of 1934, as amended (the "Exchange Act"). After considering the Howey jurisprudence and its relatively limited application to date by courts to activity in the crypto sector, Judge Jackson concluded that Howey is inherently a facts-and-circumstances specific test that applies to each offering separately and requires an examination of the entirety of the circumstances surrounding each offering.4
Consistent with the approach advocated for in Ineluctable Modality, Judge Jackson distinguished between the digital assets themselves and the offers to sell them, and assessed each of the challenged offerings separately. Critically, similar to the position taken by the court in SEC v. Ripple Labs, Inc., 5 Judge Jackson expressly rejected the SEC's theory that a crypto asset can be "the embodiment of the investment contract" conveying the asset, instead assessing the various offerings identified by the SEC in their complaint individually, stating:
[T]he SEC's suggestion that the token is "the embodiment of the investment contract," as opposed to the subject of the investment contract, muddied the issues before the Court, [and] ignored the Supreme Court's directive that the analysis is supposed to be based on the entire set of understandings and expectations surrounding the offering[.]6
Similarly, citing various Howey precedents, including early cases in the crypto asset industry,7 Judge Jackson found that a contractual arrangement is unnecessary for a transaction or scheme to qualify as an "investment contract" under the federal securities laws.
With respect to secondary market transactions involving crypto assets, Judge Jackson was troubled by the SEC's argument that if a crypto asset was initially sold as a part of an investment contract, then any secondary sale of the crypto asset itself must be a sale of security. As a policy matter, the Judge observed that:
The agency's decision to oversee this billion dollar industry through litigation – case by case, coin by coin, court after court – is probably not an efficient way to proceed, and it risks inconsistent results that may leave the relevant parties and their potential customers without clear guidance.8
Similar issues were also considered in 2023 by Judge Analisa Torres of the Southern District of New York in Ripple Labs9 and by Judge Jed Rakoff of the Southern District of New York in SEC v. Terraform Labs Pte Ltd., 10 where the two judges took different approaches when considering initial (rather than secondary) sales of crypto assets, arriving at different conclusions. Recognizing the different approaches taken by other courts, Judge Jackson agreed with the approach taken by the Ripple court and took the further step of criticizing the SEC's position, finding that it would leave the court, the industry, and market participants with no clear differentiating principle between crypto assets in the marketplace that are securities and those that are not.11 In addition, because Judge Jackson concluded the SEC's complaint plausibly alleged that at least one token, BNB, and certain investment programs were offered as investment contracts, the allegations that the defendants operated unregistered securities exchanges, broker-dealers, and clearing agencies had enough support to move forward into discovery. As a result, Judge Jackson chose not to address the merits of whether any of the ten other crypto assets12 identified by the SEC in its complaint as "crypto asset securities" being traded on the Binance.com and Binance.us exchanges qualified as securities.13
Footnotes
1. SEC v. Binance Holdings Ltd., et al., No. 23 Civ. 1599, ECF No. 248 (D.D.C. June 28, 2024) (the "Binance Order" or "Order").
2. Cahill represents Binance Holdings Limited in several ongoing matters.
3. SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
4. This is consistent with the position taken in November 2022 in "The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securities," a paper published by Cahill partners Lewis Cohen, Greg Strong, and Sarah Chen, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4282385 ("Ineluctable Modality"). The paper, which was based on a thorough review of all 266 relevant federal appellate and Supreme Court decisions applying Howey, considered whether a particular contract, transaction, or scheme involving crypto assets should be deemed to constitute an investment contract transaction in the context of secondary market activity. The paper argued that the Howey test must be applied on a transaction-by-transaction basis, and that non-financial "objects" of an investment contract transaction are not themselves "securities" (or the "embodiment" of an investment scheme) solely as a result of being sold as part of such a transaction. However, it is important to bear in mind that a given crypto asset could be used to represent an interest in an ongoing business and therefore be found to be a security.
5. SEC v. Ripple Labs, Inc., No. 20 Civ. 10832, ECF No. 874 (S.D.N.Y. July 13, 2023) ("Ripple Labs") (citation omitted; emphasis in original).
6. Binance Order at p. 20.
7. See, e.g., SEC v. Telegram Group Inc., 448 F. Supp. 3d 352 (S.D.N.Y. 2020); SEC v. Kik Interactive, Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020).
8. Binance Order at p. 21.
9. In ruling on competing motions for summary judgment made by both the SEC and the defendants in Ripple Labs, Judge Torres rejected the SEC's theory that a crypto asset initially sold in an investment contract transaction thereafter embodies the elements of that investment contract and instead recognized that Howey is a facts-and-circumstances specific test that must be applied to a given "contract, transaction or scheme." Accordingly, Judge Torres applied the Howey test to each identified category of XRP distribution at issue in the case (i.e., whether the XRP tokens were transferred in "face-to-face" negotiated sales made with promises of ongoing efforts, in blind bid/ask sales on a crypto asset marketplace into an existing highly liquid market in the relevant crypto asset, or when exchanged by the defendants for non-cash consideration, as with employees or service providers), reaching different outcomes depending on the facts surrounding the different circumstances of each type of transaction.
10. Judge Rakoff declined to analyze different types of sales of the relevant digital assets by the defendants or draw a distinction between the manner of sale of these assets. Of particular importance, in his decision denying the defendants' motion to dismiss, Judge Rakoff expressly rejected Judge Torres' approach as set out in the Ripple Labs. See SEC v. Terraform Labs Pte Ltd., No. 1:23 Civ. 01346 (JSR), ECF No. 51 (S.D.N.Y. July 31, 2023).
11. See Binance Order at p. 43.
12. These crypto assets are: SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS, and COTI.
13. See Binance Order at p. 57 ("it would be highly irregular to [address the merits of whether these tokens were securities], since the issuers are not parties to this action and have not had an opportunity to weigh in on the claims that the offerings satisfy the requirements of an 'investment contract' or security.")
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