Crypto.com (CDC) sued the US SEC on 9th October after receiving a Wells Notice, A full copy of their filing can be found here. 

The Best Defense is a Good Offense

The suit is unique because crypto companies (Binance, Coinbase, Ripple) generally take a defensive approach when litigating against the SEC. In these cases, the SEC generally launches a lawsuit against the defendant companies who then proceed to defend themselves. It is also notable that the SEC has a record of losing when bringing crypto companies to court. CDC's approach was radically different in that they took the initiative to launch a suit against the SEC, preferring to go on the offensive rather than taking a more passive approach. Because of the uniqueness of the approach as well as my own CRO token holdings, i was intrigued on how CDC planned to take the fight to the SEC. 

I wrote this article to share my layman's interpretation CDC's suit. However it must be noted that im neither a lawyer and nor trained in law. I try to read the documents and understand them at face value. Because of this, there may be gaps in my understanding - i will leave the comments open in the hopes that professionals with more training can contribute your insights.

Because of the length and complexity of the document (there are 48 pages!), I plan to write my interpretation in parts. If there response for part 1 is good, i will continue to write more parts. Part 1 focuses on how CDC attacks the SECs definition of what a security is.

The SEC's Stance (according to CDC)

According to CDC, SEC shows inconsistency and vagueness in 3 main points

1. The SEC doesnt tell CDC what they are being sued for

According to Para 90 of the complaint "The SEC has refused to provide Crypto.com a complete list of network tokens sold on the Platform that it plans to allege are Crypto Asset Securities. Instead, it has referred Crypto.com to other enforcement actions in which the SEC has asserted claims based on secondary-market sales of various network tokens, including the Targeted Network Tokens." 

This continues in Para 91: "Because the SEC has refused to reveal the full list of tokens traded on the Platform that it will assert are Crypto Asset Securities, Crypto.com is focusing this complaint initially on the Targeted Network Tokens."

My interpretation: 

The SEC are suing CDC for selling unregistered securities, but are unwilling/unable to define WHAT these securities are. CDC is forced to refer to other court cases to guess what tokens they are being sued for selling. As a layman looking in, this is strange at best and preposterous at worst - if im being sued for a crime, at least tell me what im being sued for! 

Based on referencing previous court cases, CDC has ASSUMED that they are being sued for the following tokens: : SOL, ADA, BNB, FIL, FLOW,
ICP, ATOM, ALGO, NEAR, and DASH (Para 74, page 12). This leads to the next problem 

2. The SEC doesnt tell CDC what is the definition of a security in the context of a crypto asset 

From Para 43 to 68 of the complaint, CDC outlines the brief history of Bitcoin and Ether and how they work. They then go on to state in para 69 that "the SEC’s position is that bitcoin and ether themselves are not securities and secondary-market sales of bitcoin and ether are not securities transactions."

In para 70 to 81, CDC then lists the similarities between BTC/ETH and the tokens that they are being sued for (remember that at this point we dont even conclusively know WHAT tokens they are being sued for). 

My interpretation: 

CDC's stance here is basically "the SEC says BTC and ETH are not securities, but these tokens operate in the same way, so why are we being sued for selling securities?". The point is straightforward and aims to showcase the inconsistency of SEC's stance. 

3. The SEC's use of the Howey test is problematic 

This is where things get SUPER complicated, because CDC really gets into the law and fights on technicalities. First of all, it is important to know what the Howey Test is. In short: 

• The Howey test is a framework used by the US Supreme court to define what a security is
• 4 Criteria are used to define a security:
  • An investment of money --> very straightforward
  • In a common enterprise --> The investors and the enterprise behind the asset are bound by a financial relationship, and the fortunes of the investors are tied to the enterprise’s success
  • With the expectation of profit --> Buyer needs to expect profit
  • To be derived from the efforts of others --> The success of the investment depends predominantly on the efforts of individuals other than the investor

CDCs offensive approach in the filing aimed to explain why the sales of crypto failed the Howey Test (which mean the assets cannot be defined as securities and therefore are outside the jurisdiction of the SEC). 

The first part is quite easy to understand:

In para 97 to 99, CDC states that not everything that can be sold can be defined as a security (Gold and silver are commodities, baseball cards are not securities). 

The Setup for the Attack

In para 101 to 111, CDC contextualizes Howey with the key part of the argument being

"In Howey, the transaction was for the sale of orange groves. However, those groves alone (and the oranges they produced) were not alleged to be the investment contract itself. The investment contract was the sale of the orange groves coupled with a commitment by the seller to cultivate the groves, sell the oranges, and distribute profits to the owners. It was the coupling of the land-sale contract with post-sale efforts from the seller that brought the transaction within the SEC’s jurisdiction."

My interpretation: 

CDC highlights the 4th bullet point of the Howey test - where "The success of the investment depends predominantly on the efforts of individuals other than the investor". What they are saying here is essentially "the Howey test only works if there is a promise to the buyer that there will be a profit, via the work of other parties". This sentence is a crucial setup for their attack on the SEC (explained in the next part). 

The Attack:

CDC then goes on to explain why the crypto assets being sold should not be considered securities under the Howey Test: (Para 112 to 120) 

Para 114

"the Targeted Network Tokens are not sold on the Platform as part of an identifiable investment contract and are not offered as part of a transaction or scheme with their issuers (i.e., original sellers). Transactions in the Targeted Network Tokens on the Platform do not include the party that issued the Targeted Network Tokens into the primary market, nor do they include any representations or commitments made by the issuer or promoters"

My interpretation:

This point seems to counter point 2 of the Howey Test whereby "The investors and the enterprise behind the asset are bound by a financial relationship, and the fortunes of the investors are tied to the enterprise’s success". CDC is saying that customers who bought the tokens have not entered any form of contract or signed any agreement with the token issuers (eg Solana). Because the Issuer of the token (eg Solana) is not communicating with the buyer, there is no contract or financial relationship. 

Para 115

"there is no relationship between Crypto.com and the issuer of the Targeted Network Tokens. Crypto.com is itself a secondary-market purchaser and merely operates the Platform through which customers can purchase network tokens directly from Crypto.com. Crypto.com purchases the Targeted Network Tokens without any representations or commitments from the Targeted Network Token’s issuer, and the issuer receives no remuneration or fees from any secondary-market transactions in those assets on the Platform." 

My interpretation:

This point further builds on para 114 by saying that CDC themselves buy the tokens from other resellers and are not in contact with the issuer of the Token (eg BNB). It works similarly as para 114 by stating that CDC themselves dont have any agreements with the issuer of the tokens and therefore there is no financial relationship, and a financial relationship is CRUCIAL to define the Howey test. 

Para 116

"there are no representations or ongoing obligations to deliver future value or commitments to the buyer from Crypto.com, such as one would find in nearly every investment contract case since Howey. Crypto.com makes no promises and creates no expectation that it will expend any effort to generate profits or value for the buyers of the Targeted Network Tokens on the Platform. In fact, Crypto.com’s Terms and Conditions specifically state that Crypto.com takes no responsibility for, and has no control of, the value of any network token sold on the Platform" 

 

My interpretation:

To me, this is the clearest point out of all of them. CDC is saying "i didnt promise the customer that he can make a profit from this" (no common enterprise) and "in fact i take no responsibility for, and have no control of your profitability". (Expectation of profit). With this 1 point, CDC disproves 2 requirements of the Howey test. 

Para 117

"the buyer from Crypto.com does not invest any money in any common enterprise—a necessary element for an investment contract to exist—whether that be with the issuer of the Targeted Network Token or Crypto.com generally. Instead, the buyer simply pays Crypto.com for the Targeted Network Token and receives it outright. The monetary value exchanged for the Targeted Network Token is retained solely for Crypto.com’s benefit without
restriction, limitation, or other obligations."

My interpretation:

CDC's stance seems to be "i am not in a common enterprise with the customer because hes giving me money in exchange for a good. As a reseller of the token, i dont really care if it goes up or down". To me that is the shakiest point that CDC makes so far - in my uneducated opinion, if I buy a token from CDC and CDC replenishes their stock by buying more of the same token, we both have a share in the well-being of the token (because CDC will want the token to retain or even gain value in the long term, and our interests are therefore aligned) - therefore in my humble opinion, this argument is flawed. 

Para 118

"the Targeted Network Tokens are functionally similar to bitcoin and ether and sold in the exact same way that bitcoin and ether are sold on the Platform. The SEC has concluded secondary-market sales of bitcoin and ether are not securities transactions; treating secondary-market sales of the Targeted Network Tokens differently is arbitrary and capricious." 

My interpretation:

This point is straightforward and brings us back to one of the starting arguments that CDC made. "If BTC and ETH are not securities as defined by the SEC, when why are these tokens which are functionally similar considered as securities?" 

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Concluding Thoughts:

In part 1 we touched on CDCs arguments on why the tokens they are selling fail the Howey test and should not be defined as securities. In part 2, we will analyse CDCs efforts to kick SEC off the case by saying that since crypto are not securities, the jurisdiction should fall under the CFTC (Commodities) instead. 

I hope you liked reading this article, if you do like it and would like to read more, please consider liking the article and commenting below. Doing so would definitely motivate me to churn out part 2 of the analysis.

Disclaimer: i am not a lawyer, neither am i legally trained. The above article is my interpretation of the lawsuit between CDC and SEC and none of it is financial or legal advice.