From Wells Notice to Lawsuit: The U.S. SEC Pursues Consensys

Author: 0xjs, Golden Finance

It seems that the U.S. SEC is not ready to let ConsenSys off the hook.

On April 26, 2024, the U.S. SEC issued a "Wells Notice" to ConsenSys, accusing its product MetaMask of violating securities laws by not registering as a broker and participating in the issuance and sale of certain unregistered securities. ConsenSys subsequently sued the U.S. SEC.

After the U.S. SEC passed the spot ETH ETF 19b-4 filing under political pressure, the market briefly thought that the U.S. SEC would let ConsenSys off the hook. On June 18, 2024, the U.S. SEC wrote to ConsenSys' lawyers stating, "We write to inform you that we have completed our investigation into [the Ethereum 2.0 issue]… Based on the information we currently have, we do not intend to recommend that the SEC take enforcement action against your client ConsenSys Software Inc. regarding this investigation."

Two months after the Wells Notice was issued, the U.S. SEC decided to continue its pursuit of ConsenSys. On June 28, 2024, the U.S. SEC officially sued ConsenSys.

U.S. SEC Sues ConsenSys: MetaMask Unregistered

1. Since 2016, ConsenSys has developed and operated a series of crypto asset-related services branded under "MetaMask." ConsenSys positions itself as a leader and innovator in the crypto asset industry, but certain products it offers to customers perform traditional functions: (1) broker securities transactions for retail investors and (2) participate in the issuance and sale of securities.

2. ConsenSys violated federal securities laws by not registering as a broker and participating in the issuance and sale of certain unregistered securities, thereby depriving investors of the important protections afforded by these laws. Since October 2020, ConsenSys has acted as an unregistered crypto asset securities broker through its MetaMask Swaps service. Since January 2023, ConsenSys has participated in the issuance and sale of unregistered securities in the form of a crypto asset staking program through its MetaMask Staking service, acting as an unregistered broker. Through its actions as an unregistered broker, ConsenSys has collected over $250 million in fees.

3. MetaMask Swaps is a digital platform that brokers crypto asset securities transactions for MetaMask Swaps users (including retail investors in crypto asset securities). As its name suggests, through "MetaMask Swaps," ConsenSys exchanges one crypto asset for another on behalf of investors. ConsenSys solicits potential crypto asset securities investors, positions itself as a venue for buying and selling crypto assets (including crypto asset securities), recommends trades (as ConsenSys itself states, with "best" value), accepts investor orders, transmits investor orders, handles customer assets, trades according to customer parameters and instructions, and charges transaction-based fees.

4. The operation of MetaMask Swaps works as follows. Investors input the name and amount of the crypto asset they wish to sell, as well as the name and amount of the crypto asset they wish to receive. MetaMask Swaps then pulls available exchange rates from a curated set of execution venues and other third-party liquidity providers (referred to in this document as "third-party liquidity providers") and displays these rates to investors, highlighting the option that ConsenSys considers "best." With one more click, MetaMask Swaps executes the necessary functions to complete the transaction, trading on behalf of the investor with third-party liquidity providers. As further described below, ConsenSys' software transmits the investor's orders via smart contracts on the blockchain, interacting with third-party liquidity providers on behalf of the investor. As is typically the case in traditional securities markets, investors never interact directly with third parties; all investor interactions occur directly through ConsenSys' platform. ConsenSys charges fees on most transactions.

5. Since 2020, through MetaMask Swaps, ConsenSys has facilitated over 36 million crypto asset transactions, of which at least 5 million are crypto asset securities transactions, with one side being investors and the other side being third-party liquidity providers (such as so-called "decentralized" crypto asset trading platforms and market makers).

6. In addition to acting as an unregistered broker in MetaMask Swaps, ConsenSys has also performed another traditional function of the securities market: the issuance and sale of securities. Specifically, ConsenSys has issued and sold tens of thousands of securities for two issuers (Lido and Rocket Pool). Through this conduct, ConsenSys acted as an underwriter for these securities and participated in key points of their issuance.

7. Lido and Rocket Pool each offer a program known as "liquid staking." "Staking" in blockchain networks refers to the commitment of the native crypto assets of the blockchain (such as Ether or "ETH" in the Ethereum blockchain) to act as "validators" on the network. Blockchain validators perform certain functions to earn rewards in the form of additional tokens and propose new blocks to the blockchain when selected. Lido and Rocket Pool provide Ethereum blockchain-centered investment programs, known as "staking programs." These staking programs essentially pool the ETH contributed by investors and stake it on the blockchain, leveraging their technical expertise to earn returns that ordinary investors cannot achieve on their own. Upon receiving investors' ETH, Lido and Rocket Pool issue a new crypto asset—stETH or rETH—to investors, representing their proportional interest in the staking pool and its returns. Lido and Rocket Pool refer to their staking programs as "liquid" because the interests of investors in these programs (represented by stETH and rETH tokens) can be traded on secondary markets, providing investors with a mechanism to exit their investment positions, whereas tokens staked directly on the blockchain are not easily accessible during the staking period.

8. The staking programs of Lido and Rocket Pool are offered and sold as investment contracts, and thus are securities. Specifically, investors invest ETH in a common enterprise and reasonably expect to earn profits from the respective managerial efforts of Lido and Rocket Pool. However, neither Lido nor Rocket Pool has submitted a registration statement to the SEC for the issuance and sale of these investment contracts.

9. ConsenSys brokers and offers for sale these securities through its "MetaMask Staking" platform, engaging in unregistered transactions. By attracting investors to participate in the staking programs of Lido and Rocket Pool and acting as an intermediary between Lido and Rocket Pool and their staking program investors, ConsenSys is an integral part of the issuance of these securities. In fact, ConsenSys developed and deployed MetaMask Staking specifically to provide and sell Lido and Rocket Pool's staking program investment contracts. ConsenSys solicits investments in Lido and Rocket Pool's staking programs through "MetaMask Staking." When investors request to invest in Lido or Rocket Pool through MetaMask Staking, ConsenSys transfers ETH to Lido or Rocket Pool on behalf of the investors and transfers the newly issued stETH or rETH from Lido or Rocket Pool to the investors' MetaMask Wallet (a software application developed by ConsenSys for storing investors' crypto assets, as described below). Investors using MetaMask Staking never interact directly with Lido or Rocket Pool; all investor interactions occur directly through ConsenSys' platform.

10. Despite performing brokerage functions, ConsenSys has not registered with the Commission as a broker, violating federal securities laws. These federal securities laws require transparency, including the disclosure of conflicts of interest, so that investors can obtain the necessary information to make informed investment decisions. Registration also requires brokers to comply with applicable financial responsibility requirements to protect customers and other market participants.

11. ConsenSys has not registered to offer and sell Lido and Rocket Pool securities, and it has also acted as an unregistered broker in these activities, violating federal securities laws. It has deprived investors of the protections afforded by federal securities laws. In fact, registration statements provide investors with important information about the issuance of securities and the business and financial condition of the issuers, enabling investors to make informed investment decisions.

12. Through MetaMask Swaps and MetaMask Staking, ConsenSys has entered the U.S. securities market but has failed to act in accordance with the applicable federal securities laws, which exist to protect investors.

13. By engaging in the conduct described in this complaint, including operating its MetaMask Swaps and MetaMask Staking platforms, ConsenSys has acted as a broker without registration, in violation of Section 15(a) of the Securities Exchange Act of 1934 [15 U.S.C. § 78o].

14. Furthermore, through the MetaMask Staking program, ConsenSys has engaged in the unregistered issuance and sale of securities, in violation of Sections 5(a) and (c) of the Securities Act of 1933 [15 U.S.C. §§ 77e(a) and 77e(c)].

15. Unless the defendant is restrained and enjoined, it will continue to engage in the conduct, practices, transactions, and business described in this complaint, or engage in similar types and purposes of conduct, practices, transactions, and business.

ConsenSys Strikes Back: U.S. SEC Has No Authority to Regulate MetaMask

Consensys issued a statement regarding the lawsuit taken by the U.S. SEC against ConsenSys:

Consensys fully anticipated that the SEC would follow through on its threats, requiring our MetaMask software interface to register as a securities broker. The SEC has been pursuing an anti-cryptocurrency agenda dominated by temporary enforcement actions. This is just the latest example of its overreach—an obvious attempt to redefine established legal standards and expand the SEC's jurisdiction through litigation. ConsenSys firmly believes that the SEC has not been granted the authority to regulate software interfaces like MetaMask. We will continue to vigorously seek a ruling on these issues in Texas, as it is important not only for our company but also for the future success of web3.

In the lawsuit against the SEC, ConsenSys rebuts three key points made by the U.S. SEC:

• Ethereum is a global computing platform, not an investment scheme. ETH is not a security but a commodity, as repeatedly confirmed by the U.S. Commodity Futures Trading Commission (CFTC).
• Applications that allow people to trade on Ethereum themselves are not securities brokers and therefore cannot be regulated by the U.S. SEC.
• The SEC's illegal power grab could undermine the U.S.'s position as a leader in the next generation of the internet.