Law360 Op-Ed: Crypto Is a Major Question Only Appellate Courts Can Answer

My latest op-ed in Law 360 is available here and pasted below.

Crypto Is 'Major Question' Only Appellate Courts Can Answer

By J.W. Verret (March 6, 2023), Law360

Crypto enthusiasts and securities lawyers alike are awaiting the resolution of the U.S. Securities and Exchange Commission's case against Ripple Labs Inc. and its founders over their distribution of the cryptocurrency XRP.

The SEC alleges that there was an unregistered sale of securities when XRP was first distributed, as well as unregistered subsequent distributions. Under former SEC Chair Jay Clayton, the Ethereum network was appropriately blessed in guidance from the SEC's Division of Corporation Finance director as not meeting the Howey test for what is considered a security, but the distribution of XRP instead was met with a midnight enforcement action approved in Clayton's last days in the role.

The deck is usually stacked against defendants in cases of this type, as existing interpretations of what must register with the SEC are fairly flexible, but Ripple has argued strenuously that there are limits to that flexibility when it comes to this new asset class. Yet no matter how SEC v. Ripple Labs Inc. is resolved at the U.S. District Court for the Southern District of New York, conventional wisdom is that the losing side will appeal. When it does, this case may become the vehicle by which administrative law itself is transformed by the U.S. Court of Appeals for the Second Circuit and the U.S. Supreme Court.

The SEC has recently brought a series of cases against other cryptocurrency operators, including stablecoins and staking services, with more expected imminently. Meanwhile, the commission has proposed rules to require decentralized finance protocols in crypto — which are essentially just computer code written onto a blockchain like Ethereum to autonomously settle financial transactions — to register as licensed exchanges, which is impossible.

The Supreme Court has long held that when federal agencies seek to determine a matter of national significance, they must do so using clear authorization from Congress. This has been described as the "major questions doctrine" by lower appellate courts. In essence, for a federal agency to regulate a major question, the statute must clearly state that the agency shall regulate this issue.

The phrase "major questions doctrine" was used for the first time by the Supreme Court in 2022 in West Virginia v. U.S. Environmental Protection Agency, a landmark opinion that overturned one of the EPA's signature rules from the Obama administration. The major question in the case was whether the agency had the authority to regulate greenhouse gas emissions from power plants under the Clean Air Act.

Specifically, the EPA had issued a rule, known as the Clean Power Plan, that set carbon dioxide emissions limits on power plants and required states to develop plans to meet them, but there was no clear authority in the act for the EPA to do so. The agency tried to thread together a number of vague statutory references to justify a congressional grant of authority, but the Supreme Court was not convinced.

The Supreme Court has previously used the doctrine in a number of opinions limiting agency discretion, from stopping the U.S. Food and Drug Administration's attempt to regulate cigarettes using its authority over drugs in its 2000 decision in FDA v. Brown & Williamson Tobacco Corp. to similarly blocking the U.S. attorney general's regulation of assisted suicide using his authority over controlled substances in 2006's Gonzales v. Oregon.

The appellate courts invoke this doctrine when faced with something unique about the history and breadth of the authority asserted, or when dealing with a matter of distinct national political or economic importance that an agency is attempting to regulate using vague or outdated statutory authorization. Conservative lawyers are excited that the Supreme Court's renewed focus on the major questions doctrine may constrain agency discretion, and they are increasingly talking about how efforts to defend against the SEC's crypto enforcement cases are a prime vehicle toward that end.

One irony appreciated by, and sometimes embarrassing to, conservative constitutional and administrative lawyers is that the Supreme Court opinion most deferential to executive agencies, 1984's Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc., was endorsed by Justice Antonin Scalia in a speech early in his tenure.

Times change, and so goes both law and politics. The progressives who once vigorously defended free speech against the overreach of conservative politicians are now fighting conservatives over the same principle. Those fights bleed into the political and legal realms. Similarly, Justice Scalia's deference for administrative agencies in a time that predated the exponential growth in the sheer size of the Code of Federal Regulations now gives way to a renewed push among conservative lawyers and judges to constrain the beast.

The SEC is using its authority to regulate traditional securities and stock exchanges to here regulate the transfer of value as computer code. This is different from the commission's transition to regulating online stock transfers in the 1990s, where the transfer may have taken place online but the assets transferred themselves were little different from what stocks and bonds were in the 1930s. With crypto, the asset only exists as numbers and letters in a blockchain computer code.

This is a revolution in finance that hopes to replace traditional banks and stock exchanges, as well as the existing system of property ownership fiat money itself. Whether this revolution in finance succeeds or not, it has surely reached the point where the major questions doctrine applies.

The SEC's reliance on a 1946 opinion in SEC v. W.J. Howey Co., which gave the SEC authority to regulate a contract to sell an interest in an orange grove, is an odd fit for crypto-assets and well ripe for the application of the major questions doctrine.

And to make matters worse, the Wall Street Journal and Bloomberg recently reported that these actions by the SEC appear to be part of an administration wide effort to simply freeze crypto-assets out of the traditional financial system rather than regulate them. That's one more unique fact that heightens the odds that appellate judges will apply the major questions doctrine to the Ripple case.

If the U.S. Postal Service had sought to regulate email using its authority over P.O. boxes and required that only certified postmen were allowed to deliver this new "email," courts would have rightly overturned it with the major questions doctrine.

The SEC's assertion over jurisdiction of what is now a trillion-dollar asset market — and has been as large as $3 trillion — is surely a matter of such significance that the vague language contained in the securities laws granting the SEC authority over investment contracts implicates the major questions doctrine.

Rather than predict the outcome of the Ripple lower court opinion, it would be safer to predict that litigation over the Ripple case and the SEC's other crypto regulations will continue for years, as the legal questions are far too big to settle at the district court level.

Eventually, the SEC's discretion to regulate crypto may well be substantially constrained by the major questions doctrine. Until then, this hope will prove little solace to crypto entrepreneurs seeking to come into compliance and those who just want to understand the rules of the road.

J.W. Verret is an associate professor of law at George Mason University's Antonin Scalia Law School. He is a former member of the SEC's Investor Advisory Committee.