Supreme Court Issues Landmark Decision on Digital Assets Regulation

08/05/2024

Summary of Key Points

The Supreme Court's conservative majority overturned a decades-old precedent instructing judges about when they could defer to federal agencies' interpretations of law in rulemaking.
The effects of the rulings will have broad impacts on highly regulated emerging technologies such as digital assets.
Historically, the ambiguity in legislative language allowed regulatory agencies considerable leeway in interpretation and enforcement. However, with the Chevron deference no longer in effect, there is an anticipated shift towards legislation that includes detailed, technical specifications to ensure clarity and limit the scope of regulatory interpretation.
Digital Asset companies, and other emerging technology companies in similar highly regulated industries must now adapt their business plans to a highly uncertain environment which requires a functional legislative branch to engage in highly specific law making or otherwise continue to exist in an uncertain regulatory environment subject to ongoing existential threats.

Landmark Ruling Issued

Two recent U.S. Supreme Court decisions to overturn the established legal doctrine of Chevron deference have significant prospective implications for the regulation of digital assets. In establishing the doctrine, the U.S. Supreme Court rendered its 1984 opinion in Chevron U.S.A. v. Natural Resources Defense Council, Inc. et. al. In that decision, the Supreme Court ruled that courts must defer to the expertise of regulatory agencies to interpret and apply federal law as long as the interpretation is reasonable. As a result of Chevron, agencies, such as the U.S. Securities and Exchange Commission (SEC), have undertaken the development of expansive regulatory frameworks to govern commercial sector companies. However, in both Loper Bright Enterprises v. Raimondo, and Relentless v. Department of Commerce, the Supreme Court has now rejected that approach, finding that Chevron has proved to be fundamentally misguided and unworkable.

This landmark ruling, which diminishes the weight of federal agencies' interpretations in rulemaking, is now poised to reshape the landscape of digital asset regulation. This means that regulatory clarity is dependent on a functional legislative branch engaging in highly specific and articulated law and thus possibly rendering some components of existing regulatory framework elements unenforceable to the extent that they previously relied upon agency interpretation of existing laws or agency-promulgated rulemaking relied upon Chevron authority.

Impact on Regulatory Flexibility

The ruling is now expected to constrain the flexibility of agencies like the U.S. Securities and Exchange Commission (SEC) in regulating certain aspects of industries like those involved in the digital assets sector. Agencies are now expected to face new challenges in enforcing rules that require interpretation of broad legislative language. This could result in a more cautious approach to rulemaking and existing enforcement activities by the SEC in context to digital asset regulation, with agencies possibly relying more on explicit statutory mandates rather than prior interpretative rulemaking.

Going forward, Agency actions are expected to also decline, as they will be required to seek input from Congress for more precise and detailed legislative directives to minimize ambiguities that could otherwise lead to adverse judicial rulings against the agencies. While this would ostensibly result in more detailed and prescriptive laws governing digital assets, that would require a functional legislative branch to engage in extensive legislative activities which is exceedingly unlikely. If the legislative branch does act, and to the extent that it does at all, those new laws will potentially reduce the scope for flexible regulatory responses to new technological developments and will potentially create new issues of precedence to be interpreted by the Court which will further increase regulatory environment uncertainty.

Additionally, Agencies will need to ensure their interpretations and rulemakings are well within the clear bounds of existing statutory language to withstand judicial scrutiny in context to these new decisions, and that is similarly expected to chill regulatory enforcement at scale as potentially agency-adverse decisions would further limit agency authority and oversight, requiring further legislative intervention by an already over-extended legislative branch now required to engage in new lawmaking across the totality of agency sectors.

Implications for Future Digital Asset Legislation

The Supreme Court decisions is likely to also influence the drafting of future digital asset regulations. Legislators might now be inclined to include granular details in laws to explicitly define the scope and authority of regulatory agencies, reducing the need for subsequent interpretation. This could lead to more precise definitions of digital assets, clearer guidelines on their classification as securities or commodities, and specific standards for anti-money laundering measures related to digital assets.

This issue has long been subject to ongoing confusion and uncertainty, for example, with respect to the definitions of utility and securities tokens which has been subject to an agency-derived multi-factorial characterization test. Additionally, this shift may prompt a functional legislature to also address emerging issues such as the governance of decentralized autonomous organizations (DAOs) and the regulatory treatment of non-fungible tokens (NFTs) with greater specificity. However, historically, the legislature has not engaged in the necessary lawmaking to establish workable regulatory frameworks that did not otherwise require SEC interpretation, and the lack of legislation addressing digital assets has precisely resulted in that creation of the SEC rulemaking which is now mooted by the Supreme Court decisions.

The need for detailed legislative language could now also extend to the rules governing the interoperability of different blockchain platforms and the privacy concerns associated with digital asset transactions. This legislative precision is intended to provide clearer compliance pathways for industry participants and reduce the ambiguity that often leads to costly litigation. However, as previously stated, this is contingent on a functional legislature that can engage in the quantity of lawmaking now necessary to replace the body of rulemaking created by agencies like the SEC to govern highly complex markets such as digital assets.

Challenges and Opportunities Await Digital Assets

For emerging technology companies which are often engaged in highly-regulated markets, in particular, the removal of Chevron deference introduces both challenges and opportunities. On one hand, it increases the burden on Congress to provide clear, detailed legislative frameworks, which could slow down the legislative process and complicate the introduction of new regulations for emerging technologies. On the other hand, it offers an opportunity for more transparent and predictable regulatory processes, potentially leading to greater stability and clearer compliance requirements for the digital assets industry.

This enhanced transparency could possibly attract more institutional investors who have been cautious due to the regulatory uncertainties surrounding digital assets. Furthermore, clearer regulations could foster innovation by defining legal boundaries more precisely, which can encourage developers and businesses to explore new products and services within a secure legal framework. However, the increased demand for detailed legislation could also lead to more intense lobbying efforts by industry stakeholders, potentially resulting in regulations that favor established players over new entrants.

Industry and Legislative Response

The industry is likely to respond with increased lobbying efforts to influence the precise crafting of digital asset regulations to influence the legislature in the direction of regulatory activities now necessary for a functional market. The need for clear legislative directives may also lead to enhanced collaboration between lawmakers and industry stakeholders to ensure that new regulations are both practical and effective.

As regulatory frameworks become more detailed and specific, industry players will now be motivated to shape these frameworks to align with their operational realities and strategic interests. This could result in a more dynamic legislative process, where real-time industry insights play a crucial role in shaping policy through legislative lawmaking.

Additionally, the shift towards more detailed legislation might encourage the formation of new industry alliances and think tanks aimed at providing continuous feedback and proposing updates to keep regulations in sync with technological advancements. This collaborative approach could help in mitigating the risks of overly restrictive or outdated regulations that could stifle innovation in the rapidly evolving digital assets market.

Recommendations for Emerging Technology Companies

As the regulatory landscape for digital assets undergoes significant changes, it is crucial for companies in this sector to proactively engage in shaping these new frameworks. First, digital asset companies should consider increasing their investment in regulatory and governmental affairs. This would enable them to have a sustained presence in legislative discussions, ensuring that their perspectives and needs are adequately represented.

Second, companies should prioritize forming or joining industry alliances and think tanks. These groups can serve as powerful platforms for collective advocacy, providing a unified voice on critical issues affecting the industry. By participating in these groups, companies can help drive the development of balanced regulations that foster innovation while ensuring consumer protection and market integrity.

Third, emerging technology companies, and especially those engaged in high-regulated markets such as digital asset or commercial space enterprises or biomedical markets should focus on enhancing their compliance infrastructure. As regulations become more detailed, the complexity of compliance will likely increase. Investing in robust compliance systems and teams will be essential to navigate this evolving regulatory environment successfully.

Additionally, companies should actively participate in educational initiatives for lawmakers and regulators. By providing expert insights and data, companies can aid in the creation of informed, effective legislation that reflects the realities of modern digital asset technologies.

Lastly, it is advisable for digital asset companies to maintain agility in their operational and strategic planning. The ability to quickly adapt to new regulations and market conditions will be a key competitive advantage in the rapidly changing landscape of digital assets.

In conclusion, the Supreme Court's decision to overturn Chevron deference marks a pivotal change in the regulatory landscape for digital assets. It emphasizes the need for precise legislative language and could lead to more stringent and clearly defined regulatory frameworks for emerging technologies. This shift is expected to have profound implications for how digital assets are regulated, requiring both lawmakers and industry participants to adapt to a new era of regulatory clarity and specificity.

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If you have any questions regarding matters involving emerging technologies law, or corporate practice law in general, please contact James A. Wolff, at jwolff@wbny.com, 212-984-7795, or any of the undersigned, or your regular Warshaw Burstein attorney.