In a significant legal development, eighteen states have taken a stand against the U.S. Securities and Exchange Commission (SEC) and the Biden administration. This lawsuit, filed in the U.S. District Court for the Eastern District of Kentucky Frankfort Division, names the SEC, its chair, and four commissioners as defendants. The Commonwealth of Kentucky led the charge, with the attorney generals of Nebraska, Tennessee, West Virginia, Iowa, Texas, Mississippi, Montana, Arkansas, Ohio, Kansas, Missouri, Indiana, Utah, Louisiana, South Carolina, Oklahoma, Florida, and the DeFi Education Fund joining forces.

Background and Context

With the emergence of new blockchain technology, states have recognized the need to oversee the digital asset industry. Some states have enacted specific regulatory regimes for financial institutions focused on digital assets. Others have required digital asset platforms to obtain money-transmitter licenses and security bonds to ensure liquidity. Additionally, some states have embraced digital assets more generally, allowing citizens to use them for tax payments and fee settlements and amending unclaimed-property laws to include digital assets.In Kentucky, the General Assembly passed a law granting the commonwealth the authority to take control of abandoned property, including virtual currency. However, the SEC's actions have hindered Kentucky's ability to enforce its laws as a sovereign state. Kentucky has the second-highest collective computing power in the U.S. dedicated to crypto mining and offers tax incentives to digital asset miners to stimulate investment and job creation. Roughly one in five Americans, more than 50 million people, have acquired a digital asset, and American businesses are increasingly accepting Bitcoin and other digital assets as payment methods.Under the leadership of SEC Chair Gary Gensler, the SEC has launched a regulatory offensive against crypto companies. By labeling cryptocurrencies as investment contracts similar to stocks or bonds, the SEC has brought these assets under its regulatory purview. While states have implemented their own regulatory measures, Congress has repeatedly rejected proposals to grant federal agencies broad regulatory power over digital assets. The SEC has not respected state authority and has attempted to assert regulatory control over the digital asset industry through a series of enforcement actions without congressional authorization.In the lawsuit brief, examples of the SEC's aggressive and unorthodox enforcement actions are highlighted. In 2022, the SEC sued a Coinbase employee and his brother, claiming they were not registered with the SEC. However, the SEC did not sue Coinbase, a licensed digital asset platform operating as a money transmitter in several states. The SEC also took action against other individuals but did not allege that the digital assets were securities. In June 2023, the SEC took enforcement action against Coinbase and Binance, arguing that their transactions were securities transactions and that they were using unregistered securities exchanges, brokers, and clearing agencies.The AGs argue that instead of issuing regulations or seeking congressional authorization, the SEC has continued to sue participants in the digital asset industry, faulting them for not complying with requirements that the agency had previously indicated did not apply. While the SEC claims that its actions are justified under the Securities Act of 1933 and the Exchange Act of 1934, these laws do not apply to digital assets like cryptocurrencies, which did not exist 90 years ago.The lawsuit contends that the SEC has engaged in unlawful actions and violated the Administrative Procedure Act. It seeks a court declaration that a digital asset transaction is not an investment contract under the 1933 and 1934 laws. It also asks the court to declare that digital asset platforms facilitating secondary transactions do not need to register as securities exchanges, dealers, brokers, or clearing agencies. Additionally, the lawsuit aims to prohibit the SEC from taking similar enforcement actions and rules that the SEC violated the APA.Texas Attorney General Ken Paxton emphasized that federal bureaucrats in Washington have no authority to dictate to states how they should interact with cryptocurrency and should not crush this new field with a regulatory framework that Congress did not intend. The AGs argue that the SEC's assertion of sweeping jurisdiction without congressional authorization deprives states of their proper sovereign role and stifles the development of innovative regulatory frameworks for the digital asset industry. By attempting to fit digital assets into ill-fitting federal securities laws and disclosure regimes, the SEC is harming the very citizens it is supposed to protect by displacing more suitable state laws designed to ensure consumer protection in the digital asset industry.