New court filings show SEC, Chair Gensler believed ethereum was a security for at least a year

EXCLUSIVE: The Securities and Exchange Commission and its chairman, Gary Gensler, appear to have believed for at least a year that the second largest cryptocurrency, ethereum, may be an unregistered security trading out of compliance with current federal regulations, FOX Business has learned.

The revelation comes following the filing of an unredacted complaint against the agency by ethereum software company Consensys. The company filed the redacted version of the lawsuit in a Texas federal court last Thursday in response to a so-called Wells notice it received detailing the SEC’s plans to sue the firm for failing to comply with federal securities laws.

The new documents, filed Monday morning, have yet to be reported. They provide insight into the timeline behind the SEC’s thinking regarding ethereum's alleged status as a security, and shed light on what has been perhaps the biggest question facing the $2 trillion digital asset industry about the regulatory status of a cryptocurrency that is held by millions of investors.

It should be noted that formal investigations are considered an early step in an SEC investigation and are not necessarily indicative of the wider views of the Commission. An SEC spokesman declined comment.

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Consensys made waves in the crypto world last week when it filed a lawsuit against the SEC claiming the agency is attempting an unlawful power grab by seeking to classify ethereum as a security.

According to the new filing, on March 28, 2023, the head of the SEC's Division of Enforcement, Gurbir Grewal, approved a formal order of investigation into ethereum’s status as a security, authorizing enforcement staff to investigate and subpoena individuals and entities involved in the buying and selling of the ethereum token.

Consensys, established by one of the ethereum blockchain founders, Joe Lubin, was among a handful of firms associated with ethereum to receive a subpoena from the SEC around this time, according to a source familiar with the matter.

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The filing says the "Ethereum 2.0" investigation, as it was called, was based on the SEC's belief that "possible offers and sales of certain securities, including, but not limited to ETH," had occurred since at least 2018. If the Gensler SEC finds ethereum to be a security, it would contradict prior SEC guidance under Chairman Jay Clayton; in June of that year, then-Director of Corporation Finance Bill Hinman stated in a speech the SEC's position that ethereum, alongside bitcoin, was not a security.

Hinman had no immediate comment.

The price of ethereum jumped 10% following Hinman’s speech, which he gave at the Yahoo Finance All Markets Summit, as the crypto industry understood the SEC would not be regulating ethereum or bitcoin because, according to Hinman, they were both "sufficiently decentralized." A year later, the Commodity Futures Trading Commission announced ether to be a commodity that falls under its jurisdiction.

Consensys stated in its lawsuit that it built its business against the backdrop of this regulatory unanimity.

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The new filings show that the five-member commission approved the Division of Enforcement's "Ethereum 2.0" investigation on April 13, 2023, just five days before Gensler appeared before the House Financial Services Committee, where he refused to answer repeated questions from committee Chairman Patrick McHenry, R-N.C., on whether the SEC believed ethereum to be a security.

In launching the investigation, enforcement staff moved with what securities lawyers say is unusual secrecy. Sources with direct knowledge of the matter tell FOX Business that subpoena recipients were instructed by the SEC to sign confidentiality agreements in order to receive information about the progress of the probes. A source who received a subpoena compared the interaction with the SEC to signing a non-disclosure agreement. 

It's unclear why the SEC sought to keep the unfolding inquiry under such tight wraps, but one motive could be the far-reaching implications for the crypto market if the number two cryptocurrency, with a market cap of nearly $400 billion, is deemed a security. 

Even before his testimony, Gensler's reluctance to give a definitive answer on ethereum’s regulatory status raised red flags for the crypto industry. Many speculated that ethereum's September 2022 merge to a so-called "proof-of-stake" consensus mechanism – where validators "stake" their ethereum holdings to secure the network and create new tokens – made the crypto more like a security than it did on the original "proof of work" consensus mechanism that bitcoin runs on.

Gensler made comments alluding to this notion shortly after ethereum’s merge, saying that the nature of proof-of-stake tokens could trigger the so-called Howey Test, a Supreme Court ruling courts use to determine whether an asset qualifies as an investment contract and thus a security.

Consensys' lawsuit reveals that the SEC made numerous document requests over the past year asking for more detailed information regarding the company’s role in the merge to proof-of-stake as well as its acquisitions, holdings and sales of ethereum. It also shows the SEC may believe that sales of ethereum pre-merger, as early as 2018, are securities.

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The investigation has escalated in recent weeks, with Consensys receiving its fourth document subpoena in March and a Wells notice on April 10, stating the agency’s intent to bring an enforcement action against the firm for allegedly acting as an unregistered broker-dealer offering unregistered securities, including ethereum, through its MetaMask wallet.

The complaint would mirror ones brought against exchanges Coinbase and Kraken and cross-border payments company Ripple.

Consensys hopes the court will ultimately settle the dispute over ethereum’s regulatory status.