DeFi Triumphs: Court Strikes Down SEC’s Overreaching Dealer Rule

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KEY TAKEAWAYS

• A United States’ federal court vacated the SEC’s controversial expanded ‘dealer rule,’ marking a significant victory for the DeFi industry.
• The federal court’s ruling prevents the SEC from imposing stringent registration and compliance requirements on DeFi participants.
• This decision underscores the need for regulators to balance innovation in decentralised systems with investor protection and market stability.

INTRODUCTION: COURT DECISION PROTECTS DEFI INNOVATION

The decentralised finance (“DeFi“) sector has achieved a major legal triumph in its ongoing battle against regulatory overreach. On 21 November 2024, a federal court (“Court“) in the case National Association of Private Fund Managers; Alternative Investment Management Association Limited; and Managed Funds Association v. Securities and Exchange Commission[1] invalidated the United States Securities and Exchange Commission’s (“SEC“) expanded definition of a securities “dealer.” This decision is a milestone for the crypto industry, which has been grappling with regulatory uncertainty, as it reinforces the boundaries of the SEC’s authority and grants DeFi participants much-needed clarity and relief.

In our previous article, we explored how the new Trump administration is expected to bring significant changes to the United States cryptocurrency framework, marking a key step toward establishing a more crypto-friendly regulatory environment.[2]

BACKGROUND OF THE SEC’S EXPANDED DEALER RULE

In February 2024, the SEC introduced new rules redefining “dealers” under the Securities Exchange Act.[3] This expanded definition aimed to include:

1. Traders consistently expressing interest in buying or selling at market-best prices.
2. Entities earning revenue from bid-ask spreads or incentives for providing liquidity on trading platforms.

The rule was seen as a move to subject DeFi participants—such as traders and liquidity providers—to traditional registration and compliance requirements.

However, these rules sparked backlash, with critics arguing that they:

1. Exceed SEC Authority: Critics alleged the rules went beyond the SEC’s statutory powers.
2. Target DeFi Unfairly: The amendments could inadvertently impose dealer requirements on decentralised protocols that operate without intermediaries.
3. Create Uncertainty: The SEC provided no clear guidance on how these rules apply to specific DeFi activities.
4. Impose Undue Burden: Decentralised networks often lack centralised authority to implement conventional compliance measures, making adherence to such regulations impractical.

COURT RULING: SEC’S OVERREACH STRUCK DOWN

On 21 November 2024, the Court ruled against the SEC, stating: “The Court concludes that the SEC exceeded its statutory authority by enacting such a broad definition of dealer untethered from the text, history, and structure of the Securities Exchange Act.”

This landmark decision invalidates the SEC’s expanded definition and prevents the immediate application of stringent regulations to DeFi participants.

IMPLICATIONS FOR THE DEFI INDUSTRY

The Court’s ruling has profound implications for the decentralised finance space:

1. Regulatory Relief: DeFi participants can continue operating without fear of burdensome registration requirements.
2. Preservation of Innovation: By removing regulatory barriers, the decision safeguards DeFi’s ability to innovate and offer decentralised solutions.
3. Defining Limits of Authority: The ruling reinforces the boundaries of SEC oversight, setting a legal precedent for future regulatory disputes.
4. Ongoing Debate: While a win for DeFi, this decision signals the beginning of a larger discussion about crafting appropriate regulatory frameworks for decentralised systems.

FUTURE OUTLOOK: NAVIGATING THE REGULATORY LANDSCAPE

This Court decision highlights the complexities of regulating decentralised financial ecosystems. Moving forward, collaboration between regulators and the crypto industry will be critical to striking a balance between fostering innovation and ensuring investor protection.

The DeFi industry must also proactively address legitimate concerns, such as anti-money laundering and fraud prevention, to build trust and credibility with regulators and the public.

CONCLUSION: A WIN FOR INNOVATION, A CHALLENGE FOR REGULATION

The Court’s invalidation of the SEC’s expanded dealer rule represents a significant victory for the DeFi industry. It affirms the sector’s ability to operate and innovate without facing regulatory measures that may not align with its decentralised nature.

However, this ruling is unlikely to mark the end of regulatory scrutiny. As DeFi continues to grow and disrupt traditional financial systems, the need for well-defined, balanced regulations will remain a pressing issue. For now, the industry can celebrate this hard-earned victory as it works toward building a sustainable and compliant future.

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TLP Advisors is a dynamic and forward-thinking consulting, strategy and law firm specialising in providing cutting-edge solutions to our diverse clientele. With our roots deeply embedded in financial services, gaming, web3, and emerging tech, we offer unparalleled knowledge and support tailored to these rapidly evolving sectors’ unique challenges and opportunities.

TLP Advisors has consistently been the firm of choice for L1 chains, DeFi protocols, gaming companies, fintech and payment companies, foundations, funds, and investors. We have built a reputation for excellence through frequent collaborations with regulators, funds, and technology incubators. Our deep understanding of the intricate regulatory landscapes and industry dynamics allows us to provide strategic guidance and innovative solutions that empower our clients to navigate complex challenges and seize emerging opportunities.

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[1] National Association of Private Fund managers; Alternative Investment Management Association Limited; and Managed Funds Association v. Securities and Exchange Commission, United States District Court, Northern District of Texas Fort Worth Division, Case No. 4:24-cv-00250-O, https://assets.bwbx.io/documents/users/iqjWHBFdfxIU/rr6hc21ox2Lc/v0.

[2] Soham Jethani, et. al, Trumping the Crypto Landscape: Could a Second Term Reshape the Future of Crypto in the US?, TLP Advisors (7 November 2024), https://techlawpolicy.com/2024/11/trumping-the-crypto-scene-could-a-second-term-reshape-the-future-of-crypto-in-the-us/.

[3] Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer in Connection With Certain Liquidity Providers, 89 Fed. Reg., 14938, 29 February 2024, https://www.sec.gov/files/rules/final/2024/34-99477.pdf; See also, Press Release, SEC Adopts Rules to Include Certain Significant Market Participants as “Dealers” or “Government Securities Dealers”, 06 February 2024, https://www.sec.gov/newsroom/press-releases/2024-14.