Punishment as discovery

ASIC is acting in bad faith as it "tests the regulatory perimeter" for crypto assets

Darcy Allen and I have a new submission to an inquiry by the Australian Securities and Investment Commission into how crypto and other digital assets are regulated:

Today we are living through a deep shift in our digital economic institutions. Crypto and digital assets might look like an isolated example, but they underpin a broader stack of innovations and technological trajectories. We have written widely about the opportunities from artificial intelligence, advanced cryptography and the low earth orbit economy. Each of these technologies are reshaping markets and spawning new industries. A diversity of digital assets will play an important role in accelerating, funding and governing their development.

In the absence of legislative clarity — or even non-binding guidance clarity — Australians will not capture these opportunities. We are not raising some hypothetical concern. While Australia debates how a regulator might interpret traditional financial law for crypto assets, other nations are establishing clear, forward-looking regulatory frameworks. The risk is not just that Australia will fall behind — we have already done that — it is that our approach is destined to become obsolete in real time.

The submission responds to an inquiry into a proposed update (CP 381) of an information sheet (INFO 225). Simple, yes?

The main point that Darcy and I make is that changes to an ASIC information sheet are no substitute for legislative clarity. The regulator should spend its energy asking parliament to provide that clarity rather than, well, whatever this is.

I’ve been writing submissions to government inquiries for more than two decades. The reasons to do so vary. One is to provide information to policymakers that they might need. The second is to register objections with the goal of persuading the general public, or other political interested parties, that the agency to which you are submitting has gone off the rails.

Either way, it is rarely productive to accuse the agency or authority that is seeking submissions of acting in bad faith (although I have sometimes had to point out that the very existence of an inquiry can be its own threat to liberty).

In this case, though, I have very serious problems with ASIC’s strategic approach to crypto and digital asset enforcement. It is saying one thing in public. It is acting in a very different way in court.

Let’s start with what it says in public. Last year, ASIC Chair Joe Longo went on Sky News and was pretty concrete about how regulator thinks about the legal status of crypto. For Longo and ASIC, some crypto related products are clearly financial products under Australian law. But there is a great deal of uncertainty at the margin, and there is a need for regulatory reform:

So the key point is, it's not entirely unregulated at the moment. If it's a financial product or service, we will be there.

However, this activity is new and unusual. The Corporations Act doesn't really easily talk about digital assets and crypto, so there needs to be some reform to get a grip on what we're dealing with here.

How should a regulator act in such uncertainty? Longo argued that the uncertainty is not a reason to be shy about enforcement. Instead, ASIC should pursue products and firms that it believes have arguably violated the law and get the courts to decide where the line is to be drawn:

in the meantime, we will take action, we will test the regulatory perimeter … [and] we'll work with government for a more bespoke, if you like, regulatory regime.

“Test the regulatory perimeter” is an artful phrase. For ASIC, regulatory ambiguity should not be interpreted as regulatory absence, and ASIC can discover how the law applies to whole sectors of the economy by experimenting how it applies to specific facts in specific cases. Bad news if it is your part of the fence that gets tested - but you shouldn't have stood so close.

This is a facially reasonable position.¹ But it does not describe what ASIC is actually doing. In its litigation strategy, ASIC is operating as if the regulatory framework is clear, that it does not need to be discovered through legal contest, and, accordingly, violations of this unambiguous law are willful and knowing and worthy of the harshest blow available to Australian law.

This is most obvious in the Block Earner case.

In late 2022 ASIC sued Block Earner for offering two products that they believed required a license because they were managed investment schemes. The first product, “Earner” allowed customers to loan their cryptocurrencies to Block Earner in exchange for interest. The second, “Access”, served as a gateway for customers to access to decentralised protocols that offered yield.

In February 2024 the Federal Court found that the Earner product was a managed investment scheme, and therefore required a licence. Access, by contrast, was a hands-off product that didn’t involve Block Earner providing yield directly to consumers, so ASIC’s claims were rejected.

So far so good, regulatory perimeter tested. Now we know.

It’s in the question of penalties that everything goes off the rails.

In a separate ruling on penalties, the Federal Court concluded that Block Earner should not have to pay any penalties for the adverse finding against the Earner product.

The judge concluded that Block Earner acted honestly and had relied on legal advice to make its decisions. But more importantly from a policy perspective, the judge concluded that the regulatory framework lacked clarity and Block Earner’s good faith attempts (engaging expensive lawyers and participating in the public policy process directly with ASIC) to determine whether their products were legally compliant in an uncertain environment should be seen as a mitigating factor for penalties:

a person who perceives there to be legal uncertainty in a proposed course of conduct, who then obtains legal advice from a person who is qualified to give it competently, and who then genuinely concludes that there is no identified risk of breaching the law, ought fairly to be excused from liability for a civil pecuniary penalty for later engaging in that conduct and thereby breaching the law, at least in circumstances where the person does not thereby derive a substantial profit or cause substantial harm.

Not even ASIC knows what the law is here (after all, its action against the Access product failed!). In court ASIC agreed that the law is unclear. As the Federal Court justice wrote,

ASIC accepts that there was a degree of uncertainty in the application of the regulatory framework to crypto asset-related products generally, and submits that that uncertainty, once it was appreciated, was a reason for taking particular care in relation to compliance

Yet, ASIC is appealing the court’s decision to waive penalties to Block Earner. And on frankly disingenuous grounds. According to its appeal, the Federal Court erred by:

holding that the regulatory complexity was a relevant consideration in circumstances in which the respondent perceived significant uncertainty but deliberately engaged in conduct in the field of endeavour for a profit-making purpose

For ASIC, legal uncertainty is not a mitigating factor - in fact, the clear message for this is that wherever there is uncertainty about whether law applies, firms should simply not operate.

(Note that there was not just “perceived” uncertainty, as ASIC’s filing claims, there is uncertainty. The ASIC chair agreed on Sky when he said that “the Corporations Act doesn't really easily talk about digital assets and crypto, so there needs to be some reform to get a grip on what we're dealing with here.”)

If that is one of our most powerful regulator’s position, then that would leave vast fields of entrepreneurial endeavour completely untilled until parliament decides to pro-actively make law changes to clear up uncertainty - which, we should note, has not happened in the 16 years since Satoshi Nakamoto released Bitcoin.

This attitude in the back and forth of a legal case goes a lot further than Longo’s academic interested in law as a discovery process - it is strikingly anti-innovation, and will virtually guarantee that Australia remains at the back of the pack in the global technology race.

Not to put too fine a point on it but:

in circumstances … of significant uncertainty [Block Earner was] … deliberately engaged in … profit-making

… is exactly what we want to see in a dynamic economy.

The grounds for appeal are absurd. But the fact of the appeal itself is the real worry. ASIC is broadcasting a hell of a mixed message: there is enough uncertainty to require legal exploration and reform, but simultaneously there should be zero-tolerance for anyone who tries to operate in that uncertainty.

In the United States, the new SEC leadership has been fast walking back the regulatory aggression of past chair Gary Gensler and the Biden administration. It has dropped the lawsuit against the centralised exchange Coinbase, put its case against Binance on hold, and this week closed off its potential action against Uniswap. It is doing so because it 1) explicitly wants to support new technologies and industries and 2) wants to defer to the legislature which has the authority to make rules about new industries.

If there is a change of government at the next Australian federal election, we can only hope for a similar change in attitude.

1. It’s not what I would be doing, but I’m not the ASIC chair