The SEC vs. the CFTC: Who Regulates Crypto and Why It Matters
The SEC and CFTC Want to Regulate Crypto. Their Turf War Is Playing Out in Federal Court
Regulators in the U.S. have made it clear that they want a bigger role to play in the cryptocurrency space. However, that desire has become complicated by the fact that there is no clear regulatory leader. The U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have both taken substantial leads in the effort to regulate crypto. However, the legal framework for determining which agency should regulate which aspects of the crypto landscape is lacking.
The SEC and the CFTC have filled that void by taking on their own cases, often against the same actors and for the same conduct.
This has created a turf war between these two federal agencies as they jockey for position to regulate the crypto world.
It has also put legal professionals in a difficult position – particularly those who have never represented crypto companies, exchanges, or developers. This is virgin territory for everyone; even federal judges are not sure how to resolve the disputes.
The cryptocurrency defense and compliance lawyers at the national law firm Spodek Law Group know that the SEC and CFTC are making it up as they go along, and are doing so with an eye towards expanding their regulatory reach as far as possible. This puts crypto companies and their executives in a dangerous place.
The Problem: What is Cryptocurrency?
The core of the problem is that there is not much federal law on cryptocurrency. The technology and the unique nature of it has forced the SEC and the CFTC to decide whether to shoehorn cryptocurrency into their purview, and then to try to convince judges that their interpretation of the law is the correct one.
The SEC’s jurisdiction lies over securities, while the CFTC has control over commodities.
Which begs the question: What is cryptocurrency? Is it a security or is it a commodity?
To figure out if it is a security, the SEC has turned to the Howey Test.
This test comes from the Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). That case involved a Florida citrus farm that sold plots of land from its orchards, but then leased the land back from the buyer. The landowners and Howey Co. shared the profits from the harvest. When the SEC called the transaction an unregistered security, Howey Co. argued that the arrangement was just a land lease.
The Supreme Court sided with the SEC, and established that an investment contract – which is one type of security under federal law – is an investment of money in a common enterprise with the expectation that profit will come solely from the efforts of others.
The Howey Test has remained the law of the land for over three quarters of a century, now. Under it, the SEC claims that many cryptocurrencies are securities, because they are an investment in a common enterprise, and because its value comes from the efforts of the network’s founders.
Meanwhile, the CFTC claims that cryptocurrency is a commodity, and therefore under its jurisdiction.
The SEC and the CFTC Both Want to Control Crypto
The SEC and the CFTC have both claimed that cryptocurrency falls within their purview, and have both made arguments that have some merit. This has led both agencies to regulate the crypto space, and that has led to a handful of lawsuits in which the SEC and CFTC have sued the same crypto company for the same conduct.
In the end, these cases have to be resolved by the federal courts. The SEC and CFTC make their arguments, and the court decides which view is more likely to be correct. The result is that the precedent that is set is done by the judiciary, not by the legislature. This is unfortunate because, while the legislature is not as good at interpreting the law as courts are, it is far better at writing it.
How the SEC and CFTC’s Turf War Hurts the Crypto Space
The turf war between the SEC and the CFTC has a negative impact on the crypto space in a few ways.
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First, it has led to inconsistent results.
In Ripple Labs, the SEC sued the developer of Ripple’s XRP tokens, claiming that they were unregistered securities. After denying the company’s motion to dismiss the case, the court ruled that the XRP tokens were not securities when they were sold on a crypto exchange, but were securities when sold to institutional investors.
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Second, it has led to inconsistent punishments.
When a crypto company is sued by the SEC and the CFTC for the same conduct, it will quickly become apparent that the SEC has much more draconian penalties at its disposal, including the ability to ban executives from the industry.
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Third, it creates uncertainty in the crypto space.
When there is no clear guidance about how to operate within the law, investors and developers will be wary to get involved in the industry. This can stifle growth and innovation.
Frequently Asked Questions About the SEC, the CFTC, and Cryptocurrency
What is the Howey Test?
The Howey Test is a legal test that was created by the Supreme Court in a landmark case that it heard way back in 1946. The case, SEC v. W.J. Howey Co., was about whether a novel financial product was a security or not. In making its decision, the Court created the Howey Test to apply to future financial products that may or may not be securities.
The test asks whether the financial product involves:
- An investment contract
- In a common enterprise
- With the expectation that the profits come from the work of others
If so, then the product is a security and falls under the jurisdiction of the SEC.
Cryptocurrency tokens are the type of financial product that were probably unimaginable back in 1946. In fact, that is exactly why the Howey Test was created – to provide the legal criteria against which the courts could compare the new financial products of the future. Whether cryptocurrencies fall under the Howey Test is a pertinent question, and has far more to do with how they are sold than what they are.
Why is it Important That the SEC and CFTC Both Want to Regulate Crypto?
In many instances, when two federal agencies both want to regulate the same thing, nothing happens. They negotiate and work things out amongst themselves, sometimes with Congress stepping in to clarify its legislative intent.
The turf war between the SEC and CFTC, however, has not been resolved like this. Instead, both agencies have taken concrete steps to regulate the crypto space. This has meant that crypto companies have been sued by both federal agencies for the same conduct. It has also meant that crypto companies have had to interact with two different federal agencies, with different reporting requirements, different procedural formalities, and different expectations. Handling just one of these agencies is difficult and time-consuming. Having to deal with both at once is an immense challenge, and one that cannot be ignored.
What is the Difference Between a Security and a Commodity?
A security is a financial instrument that represents ownership in something. Common examples are stocks and bonds. If you buy a share of stock, you own a piece of the company and its success or failure.
A commodity, on the other hand, is not a financial instrument. Instead, it is the good that is used to create the financial instrument. For example, if you buy shares of stock in a mining company, you have a security. If the company mines gold, then that is the commodity. The price of the stock fluctuates in response to how much gold the company is able to mine.
Cryptocurrency Defense and Compliance Lawyers at Spodek Law Group
The turf war between the SEC and CFTC has created a legal mess for crypto companies to navigate. The blockchain lawyers at Spodek Law Group have handled these disputes before. Contact them online or call their national law office at 212-300-5196 so they can help you and your company.
