The SEC has targeted its next crypto enforcement target — “governance tokens.”
The agency’s Jan. 20 lawsuit alleges a trader violated federal securities laws by manipulating the price of Mango Markets, MNGO’s governance token. Such tokens, which are becoming increasingly popular, give the holder the right to vote on changes to a blockchain organization that issued the token.
The case shows that governance tokens are not immune to the agency’s aggressive efforts to regulate crypto markets. It could also serve as a reference for other crypto projects on how to structure their governance models.
“This is the greatest amount of ink that has been spilled on governance and the application of the SEC’s views on governance to a specific set of facts,” said Willkie Farr & Gallagher LLP Partner Justin Browder.
The Securities and Exchange Commission claimed the MNGO token is a security. But which cryptocurrency is a security that would fall under the SEC’s enforcement jurisdiction is a heated, ongoing legal debate.
The complaint clarifies the agency’s view that governance rights do not carry much weight in their analysis when token holders are not actually involved in the group’s operations.
The SEC notes that “just because you call a governance token a governance token doesn’t mean it’s not a security,” said Nelson Mullins Riley & Scarborough LLP partner Arina Shulga.
The case also shows how crypto can become entangled in the web of federal oversight. The SEC’s complaint came less than two weeks after the defendant, Avraham Eisenberg, was sued by another regulator, the Commodity Futures Trading Commission (CFTC), over the same scheme.
“Efforts of Others”
Eisenberg allegedly used two Mango Markets accounts to artificially inflate the price of Mango Perpetual Swaps, which is a type of futures contract, and to prop up the price of MNGO tokens.
He used the swaps to borrow and then withdraw $116 million worth of crypto assets from Mango Markets, a crypto trading platform operated by Mango DAO, the SEC said. A DAO is a “decentralized autonomous organization” based on blockchain technology and designed to have no central governing body.
Eisenberg later negotiated a deal to return approximately $57 million worth of assets to the Mango DAO, according to the SEC. Eisenberg could not be reached for comment.
To determine whether a digital asset is a security, regulators use the Howey test, which dates back to a 1946 Supreme Court ruling. The test checks whether money has been invested in a common venture with the expectation of reaping profits from the efforts of others.
The last part – derived from the efforts of others – is typically a focus in crypto cases.
Crypto firms often argue that their tokens are decentralized and not dependent on the “efforts” of central leadership for decision-making. Some token issuers believe that attaching governance rights to tokens — and giving people a say in how a project is run — reinforces this argument.
However, the SEC argued that governance rights in MNGO tokens issued to thousands of people around the world are illusory.
Mango token holders must submit “executable code” to propose a governance proposal, and not all holders likely would have the technical skills to do so, the SEC said. The votes were also dominated by the creators of Mango Markets, the agency said.
This means that according to the SEC, people who held MNGO tokens relied on “others” — namely the creators of Mango — to add value.
The SEC suggests that “if you design a governance system that doesn’t allow for widespread governance — indeed, widespread governance by many different token holders — it’s kind of useless in terms of refuting the Howey analysis,” Browder said , who co-heads Willkie’s Digital Works practice.
Claiming that MNGO token holders expect profits from the efforts of others, the SEC also said people could earn the tokens as rewards for contributing to liquidity pools on the Mango Markets platform. MNGO token holders could also earn interest on their tokens, the SEC said.
Crypto monitoring
The lawsuit comes amid ongoing deliberations in Congress over which of the top market regulators, the SEC or the CFTC, should take the lead on crypto oversight.
SEC Chairman Gary Gensler has previously said that he believes most digital assets are securities that fall under the jurisdiction of his agency. However, some within the crypto industry are pushing to give the CFTC, which regulates the derivatives markets, more powers to regulate crypto assets. Rules for commodities and their financial derivatives are seen as less onerous.
“Both are clearly interested in regulating crypto,” said Tyler Cobb, attorney for Ballard Spahr LLP.
In the CFTC’s complaint, Eisenberg was accused of manipulating the price of swap contracts offered by Mango Markets. The US Attorney in Manhattan has also charged the 27-year-old dealer with fraud and manipulation of goods.
Although violations of various laws are alleged, the CFTC and SEC complaints do not directly contradict each other.
The SEC is focused on manipulating the MNGO token. The focus of the CFTC was on the barter relationship.
The CFTC claimed that USDC, a stablecoin whose value is pegged to the US dollar, and certain other digital assets involved in Eisenberg’s plan were commodities. The CFTC Complaint does not take an explicit position on whether MNGO is a security or a commodity. But the agency may need to comment before the case closes.
“We could get into a situation where we have the same pattern of facts, two agencies are vying for jurisdiction, and one agency can win over the other for jurisdiction,” said Willkie Farr partner and former CFTC attorney Neal Kumar.
The case “certainly demonstrates the need for greater clarity about what is and is not a security,” Kumar said.
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