BLOCKCHAIN—S.D. Cal.: SEC escapes lawsuit seeking clarification on crypto assets but court urges ‘definitive guidance’ - 02 August 2023

Although the SEC prevailed, the court chided that conflicting SEC positions “demonstrate the need for the SEC to issue definitive guidance rather than approaching the issue in piecemeal litigation.”

The SEC won dismissal of a lawsuit by Hodl Law, a small crypto-focused law firm that sought declaratory relief on the status of the Ether crypto asset (ETH) under the federal securities laws. The federal district court dismissed on jurisdictional grounds, finding the law firm failed to show standing, there was no “case or controversy” for purposes of ripeness, and the SEC’s actions were not “final agency actions” under the Administrative Procedure Act (Hodl Law, PLLC v. SEC, July 28, 2023, M. Lorenz).

Hodl Law said it was disappointed the court dismissed the action but appreciated that the opinion provided judicial clarity on several issues.

Declaratory relief sought. Hodl Law filed a lawsuit last November seeking declaratory relief, arguing it is at risk of imminent harm because the SEC may exert jurisdiction over Ethereum and Ether and bring enforcement actions relating to lack of securities registration. The firm is concerned it might have legal liability because it transacts on the Ethereum Network and uses the Ether digital currency unit (DCU) for various purposes.

The SEC sought to dismiss, arguing the court lacked jurisdiction because:

There was no case or controversy between Hodl Law and the SEC;

Hodl Law had no standing;

Hodl Law did not plead a ripe dispute; and

The Administrative Procedure Act did not provide authority to bring the case.

No injury or standing. First, the court found that Hodl Law lacked standing because it had not shown an injury caused by the SEC’s actions. Standing requires that: (1) plaintiff suffered an injury in fact; (2) plaintiff can show the defendant's causal connection to the injury; and (3) plaintiff can demonstrate that the injury would be redressed by a favorable decision.

Here, the court found no injury in fact in Hodl Law’s allegation that the SEC might sue it for its activity on the Ethereum Network. The court noted there was no allegation the SEC has investigated or prosecuted the firm.

The court was not persuaded by Hodl Law’s argument that the SEC has pursued civil enforcement action against a defendant for trading in crypto assets, alluding that the Ethereum Network is a security in SEC v. Wahi. The court in Wahi did not determine whether the crypto assets at issue were securities, the court said.

The court was also not swayed by Hodl Law’s argument that the SEC has failed to announce rules regarding the classification of digital currency units (DCUs) as securities despite the law firm’s request for guidance.

“Plaintiff does not identify any authority compelling Defendant to engage in specific rulemaking, pursue specific regulatory approaches, or respond to private parties’ requests for guidance,” wrote the court.

Not ripe. Next, the court found the claim was not ripe.

It was not ripe under the “constitutional ripeness” doctrine because the SEC’s lack of a decision on the status of Ether and Ethereum Network under the federal securities laws did not constitute a substantial controversy between Hodl Law and the SEC to warrant issuance of a declaratory judgment. Here, the court touched again on the lack of investigation or lawsuit, as well as lack of a controversy with immediacy and reality.

The claim was also not ripe under the “prudential ripeness” doctrine. The court found the matter wanting on the first prong” whether the matter was “fit for review.”

“Whether the Ethereum Network and Ether DCU’s are securities is a purely legal question not fit for review ‘until the scope of the controversy has been reduced to more manageable proportions, and its factual components fleshed out, by concrete action applying the regulation to the claimant's situation in a fashion that harms or threatens to harm him,’” wrote the court.

The court also found the finality prong wanting. Cited developments including the so-called “Hinman emails” appearing to indicate internal disagreement on the SEC’s position on Ether were not “final agency action,” the court said. The argument of “firm prediction” was unavailing.

“Instead, they are commentary that illustrate the ongoing confusion surrounding the status of cryptocurrencies as securities and demonstrate the need for the SEC to issue definitive guidance rather than approaching the issue in piecemeal litigation,” the court wrote.

The court continued, “The other element for consideration is hardship, but that does not mean just anything that makes life harder; it means hardship of a legal kind, or something that imposes a significant practical harm upon the plaintiff.”

No support in APA. Finally, the court found that Hodl law could not bring its claims pursuant to the APA.

The court found the firm had not identified any statute that governs review of the SEC’s action, or inaction, regarding the Ethereum Network or Ether DCU’s.

“Although Plaintiff alternatively claims that the SEC’s actions permit judicial review under the APA, the SEC’s actions do not constitute ‘final agency action’ because there is no ‘definitive statement of the agency's position,’ the SEC’s actions do not have a ‘direct and immediate effect on the day-to-day operations’ of Plaintiff, and no action by the SEC requires ‘immediate compliance with the terms,” the court wrote.

Case dismissed. Finding no possibility of curing the jurisdictional deficiency, the court dismissed the complaint without leave to amend.

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