Red States Challenge SEC Authority to Police Digital Assets (1)

Kentucky and 17 other states are challenging the Securities and Exchange Commission’s authority to regulate digital assets such as cryptocurrency.

The SEC unilaterally asserted regulatory control over digital assets by classifying them as investment contracts and treating them like stocks and bonds, according to the complaint filed Thursday in the US District Court for the Eastern District of Kentucky.

The SEC maintains that the agency therefore has the power “to regulate secondary-market sales of digital assets as securities transactions, and to require digital asset platforms both to register with the SEC as securities exchanges, dealers, brokers, and clearing agencies and to comply with all manner of requirements under the federal securities laws,” the complaint says.

But the SEC’s regulation of digital assets “preempts some state laws, pressures States to change others, and subjects the entire digital asset industry to a single ill-fitting regime that Congress enacted for an entirely different kind of financial instrument,” the lawsuit says.

Digital assets “are just that—assets, not investment contracts covered by federal securities laws,” the complaint says. They should therefore be regulated by the states, it says. To hold otherwise will allow the SEC “to regulate (and displace State regulation of) not only all transactions in digital assets but also a boundless array of other assets as well, from collectibles to luxury goods and beyond,” it says.

The states seek a declaration that digital assets aren’t investment contracts and an injunction preventing the SEC from taking enforcement action against digital platforms that don’t register as securities dealers.

They also seek a declaration that the SEC violated the Administrative Procedure Act by not subjecting its regulation of digital asset platforms to notice and comment rulemaking, damages, costs, and fees.

“While we don’t comment on litigation, state securities regulators have been strong partners in efforts to uncover and prosecute misconduct in the crypto markets,” an SEC spokesperson told Bloomberg Law on Friday.

Several cases challenging alleged SEC overreach into the realm of crypto regulation have been brought in Texas district court, including suits filed by industry players Crypto.com, Lejilex, and Beba. In September, a Texas federal judge dismissed a case filed by crypto company Consensys Software Inc., finding it had been brought prematurely.

The latest challenge in Kentucky district court has the potential to reach the Sixth Circuit on appeal, which could coincide with any appeals in the Texas crypto-related SEC challenges and create a possible split with the Fifth Circuit. In that scenario, the issue of SEC crypto regulation could then land in the Supreme Court, where the justices would decide whether to curtail the agency’s enforcement.

Meanwhile, President-elect Donald Trump has pledged to fire SEC Chair Gary Gensler and roll back the agency’s efforts to police crypto trading.

The Kentucky Attorney General’s Office filed the complaint.

The case is Kentucky v. SEC, E.D. Ky., No. 3:24-cv-00069, complaint filed 11/14/24.