Extraterritorial Reach of U.S. Crypto Regulation by the SEC

In 2008, the world ushered in the blockchain era[1] with a whitepaper posted pseudonymously in an online discussion of cryptography under the name “Satoshi Nakamoto.”[2] That paper formed the foundation for Bitcoin, the first blockchain-hosted cryptoasset,[3] a new substitute for conventional government-backed currency that was designed to be “secure, international and fungible,” and free from the control of any government or other central authority.[4] Today, there are more than 9,000 different cryptoassets with a total market capitalization that has exceeded $2 trillion,[5] and we are long past the wild, wild west of unregulated crypto activity. Governments around the world have sought to regulate this new asset class, with the U.S. Securities and Exchange Commission (SEC) being by far the most active regulator.[6]

In one of its most significant enforcement actions, in 2019 the SEC initiated a complaint against Telegram Group Inc. and Ton Issuer Inc.,[7] referred to in this post simply as Telegram. Telegram, a popular global, cloud-based instant messaging, videotelephone, and voice over service company, had planned to raise capital in two stages. The first stage, lasting from January to March of 2018, involved the sale of contractual rights to acquire cryptoassets to be developed to 171 initial purchasers, including 39 U.S. investors, for $1.7 billion. These sales were designed to be exempt from the U.S. securities registration requirements pursuant to the terms of Rule 506(c) of Regulation D.[8]

The second stage called for Telegram to issue the new cryptoasset, called Grams, both to the original purchasers and to members of the public worldwide. This phase was scheduled to occur no later than October 31, 2019, approximately 18 months after the end of the first phase. Because the plan was to have a fully functional blockchain and tokens before this occurred, the position taken by Telegram was that at that point, the Grams would not be securities and instead would be a currency or commodity.[9]

The SEC’s enforcement action was initiated shortly before the Grams were to be delivered in October 2019, and on March 24, 2020, the court granted the SEC’s request for a preliminary injunction, halting the proposed sale of Grams on the grounds that Telegram sought to introduce a security into the public market without registration.[10] There were no allegations of fraud or other wrongdoing aside from the failure to register the offering, and the fact that wealthy, sophisticated investors had been willing to back the development of Grams to the tune of $1.7 billion. Telegram promptly asked for the trial judge to limit the scope of the order to U.S. purchasers, but on April 1, 2020, U.S. District Judge P. Kevin Castel, after castigating Telegram for failing to raise the issue earlier, refused to limit his ruling, deciding instead that there was a substantial risk of resales to U.S. citizens.[11] Telegram thereafter abandoned its plans and any right to appeal, agreeing to return $1.2 billion to investors worldwide and to pay a fine of $18.5 million to the SEC.[12]

The global reach of the Telegram opinion may surprise some, but the SEC’s mandate to protect U.S. markets and investors is broad. While there is a presumption against extraterritorial application of U.S. laws such as the registration requirement of the federal securities laws, Congress can mandate a broader response. As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”),[13] Congress gave federal courts “jurisdiction” over claims by the SEC or the United States involving “(1) conduct within the United States that constitutes significant steps in furtherance of [a] violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”[14]

It is not clear, however, if this language was intended to expand the reach of the federal securities laws or merely to give the federal courts jurisdiction when such claims were brought. A U.S. Supreme Court case decided just before Dodd-Frank was enacted held that the anti-fraud provisions of federal securities laws should apply only if the claimed violation is within the “focus” of the “objects of the statute’s solicitude.”[15] There are plenty of valid reasons for this limitation on the extraterritorial application of U.S. law.

First, application of U.S. law in other nations creates a significant risk of redundancy and over-regulation.  Many other countries have their own regulatory regime, and adding U.S. rules on top of that could be redundant, costly, and confusing, impeding the free flow of capital and stifling innovation. Similarly, U.S. law would almost certainly be unevenly applied to foreign transactions, creating additional inconsistency and uncertainty. It is also true that the policy objectives valued and emphasized in the U.S. are not the same in every other country. In addition, a major risk associated with efforts to enforce U.S. laws in other countries is increased international resentment. This is a pattern that has been observed before, leading to complaints that such efforts by the U.S. are intrusive and arrogant.[16]  Not surprisingly, this creates the impetus for pushback where other nations seek to impose their laws and vision on U.S. businesses. Finally, a system of international regulation where individual nations seek to have their own viewpoint applied globally is inconsistent with the goal of harmonization. Extraterritorial application of U.S. domestic law therefore diminishes the role of traditional international law, which is contrary to our interests and the interests of entrepreneurs everywhere.

While U.S. regulators might like the power to impose their views on a global scale, the numerous arguments against such a broad reach suggest that decisions like SEC v. Telegram should not be followed at least insofar as the rules announced apply to transactions taking place outside the U.S., involving persons who are neither citizens nor residents here. Unfortunately, we are in a time of uncertainty as courts struggle with how to interpret the mandate of Dodd-Frank in view of the general presumption against extraterritorial application of U.S. law.

We are likely to have our next glimpse into how the U.S. securities laws will apply in extraterritorial cryptotransactions as we watch SEC v. Ripple[17] play out in the courts. Filed on the last day of former SEC Chairman Jay Clayton’s tenure in office and involving an international company with a cryptoasset (the XRP token) that has been sold worldwide for years,[18] the outcome of this decision is likely to further shape the discussion on extraterritorial application of U.S. law to crypto.

ENDNOTES

[1]  See, i.e, Yoav Vilner, The Basics of Security Needs in the Blockchain Era, Forbes (June 22, 2018) (archived at https://perma.cc/BCT7-MHY3).

[2]  Satoshi Yakamoto, Bitcoin—A Peer-to-Peer Electronic Cash System, available online at https://bitcoin.org/bitcoin.pdf.2008. The person or persons who used the pseudonym “Satoshi Nakamoto” wrote in this document about the potential to create blockchains for digital assets using new consensus protocols.

[3]  Cryptoassets have variously been called cryptocurrencies, cryptocurrencies, cryptotokens, cyber cash, decentralized money, digital currency, virtual assets, and simply crypto. This post uses “cryptoasset” to describe this new class of assets.

[4]  Coryanne Hicks, The History of Bitcoin, U.S. News & World Rpt (Sept. 1, 2020) (available online at https://money.usnews.com/investing/articles/the-history-of-bitcoin).

[5]  As of mid-April 2021, CoinMarketCap reported 9,203 different cryptoassets with a total market capitalization of $2,171,657,237,9142. CoinMarketCap.com (archived at https://perma.cc/D9AE-5FWS on Ap. 13, 2021).

[6]  Douglas S. Eakely & Yuliya Guseva, Crypto-Enforcement Around the World, S. Cal. L. Rev. Postscript (forthcoming) available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3713198.

[7]  Complaint, SEC v. Telegram Group, Inc., No. 19 Civ. 9439 (PKC), at p. 5, ¶ 16.  (S.D.N.Y. filed Oct. 11, 2019) (https://www.sec.gov/litigation/complaints/2019/comp-pr2019-212.pdf) (hereinafter Telegram Complaint).

[8]  Regulation D appears at 17 C.F.R. §§ 230.501 to .508. Rule 506(c) refers to § 506(c) of those provisions.

[9]  Defendants’ Answer …, SEC v. Telegram Group, 19 Civ. 9439 (PKC) (S.D.N.Y. 2019) (filed November 12, 2019) ¶ 3 at p. 2 (archived at https://perma.cc/N9XW-UTTP).

[10] SEC v. Telegram Group, Inc., No. 19 Civ. 9439 (PKC) (S.D.N.Y., order of March 24, 2020) (https://perma.cc/4WWK-LKBX).

[11] See SEC v. Telegram Group Inc, No. 1:2019cv09439 – Opinion and Order (S.D.N.Y. Ap. 1, 2020) (https://law.justia.com/cases/federal/district-courts/new-york/nysdce/1:2019cv09439/524448/234/).

[12] SEC Press release, Telegram to Return $1.2 Billion to Investors and Pay $18.5 Million Penalty to Settle SEC Charges, Rel. 2020-146 (June 26, 2020) (https://www.sec.gov/news/press-release/2020-146).

[13] Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong (2nd Session 2010).

[14] Id. at § 929P(b).

[15] Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010).

[16] Scott M. Himes, The Supreme Court Limits Transnational Securities Fraud Cases, 79 U.S.L.W. 1090 (July 7, 2010).

[17] SEC v. Ripple Labs, Inc., 20 Civ. 10832 (Complaint, SDNY, filed Dec. 22, 2020) (archived at  https://perma.cc/L5YL-N25Y).

[18] Roslyn Layton, SEC v. Ripple: The Cryptocurrency Trial of the Century, Forbes (Dec. 29, 2020) (archived at https://perma.cc/BKP9-KY6X).

This post comes to us from Carol Goforth, University Professor and Clayton N. Little Professor of Law at the University of Arkansas School of Law. It is based on her recent article, “SEC v. Telegram: A Global Message,” available here

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