A new SEC proposal has a serious change hidden within its complex language.

Coin Center files a comment explaining why it is unconstitutional.

Today Coin Center filed a comment letter with the Securities and Exchange Commission on its proposed rulemaking regarding the definition of ‘exchange’ and Alternative Trading Systems. Bottom line: The Commission’s proposed redefinition of “exchange” violates the First Amendment by requiring a license to speak–even of open source developers. It’s unconstitutional and they should change it. Our comment explains why the First Amendment arguments against the proposed rule are strong and why the Supreme Court is poised to rule against the SEC should it finalize this new rule as drafted. The proposed rule alters the definition of “exchange” (and therefore who must register) but it never mentions crypto or defi once in its 200 pages.

The effect of the definition on open source software developers is nonetheless clear: anyone writing or distributing DEX software would be violating the law if they don’t register. The current definition regulated conduct: “bringing together orders” and “using methods” to effectuate trades. The new proposed definition would regulate speech as speech: “bringing together buyers and sellers” and “making available” “communications protocols”

Prior restraints on expressive conduct (flag burning) or professional conduct that includes speech (licensing lawyers) are sometimes constitutional, restraints on speech as speech (mere publication or communication) are always unconstitutional. Indeed, this has all happened before. In 1985 the SEC tried to ban folks from publishing stock tip newsletters. The Court said that the ban violated the plaintiff’s First Amendment rights. The majority interpreted the statute as not including mere publication and found that SEC’s interpretation inappropriately broad.

A concurrence from Justice White found that the statute had intended to limit and ban mere publications and was, therefore, unconstitutional as applied. Justice White created a test for when legitimate professional conduct regulation strays into the illegitimate territory of speech censorship. Justice White’s test demanded that securities regulation be focused narrowly on persons who “take the affairs of a client personally in hand and purport to exercise judgment on behalf of the client in the light of the client’s individual needs and circumstances.” And he cited a boatload of similar cases, for example Thomas v. Collins: Speaking about labor rights and worker organization? Speech, the state can’t require registration. But personally collecting union dues and offering union benefits? That’s conduct and can be subject to registration.

As we describe in detail, today’s Supreme Court is even more likely to protect speech rights than the Court in 1985. We believe they would adopt Justice White’s “take the affairs of a client personally in hand” standard wholesale and invalidate any attempt to apply exchange registration requirements to persons who merely publish or republish software on open blockchain networks. You can get a sense of their position from Sorrell v IMS Health, a case in which Vermont laws banning the sale and distribution of prescription information (which doctor prescribed which drugs) by pharmaceutical companies was found unconstitutional.

That case (which we wrote about in our 2019 paper on DEX and the Constitution) both (1) reaffirms that mere data (let alone software) is protected speech and (2) commercial speech gets no lesser protection than regular speech if there is content-based and viewpoint discrimination. Just like the Vermont law in Sorrell, the SEC’s proposed rule is entirely content-based: is the content you are making available a “communications protocol” or not? And it is viewpoint discrimination: general purpose communications protocols are exempt, but those that might allow people to freely trade securities peer-to-peer are not. As we know, people have very strong views about disintermediation and financial freedom.

Finally, another recent change in the Court’s jurisprudence means it will be even easier to challenge this rule should it become final. In Americans for Prosperity v. Bonta, the Court made clear that pre-enforcement facial challenges can be brought to protect speech rights. That is, we don’t need to wait to sue the SEC, it can happen as soon as the rule is final.

But we would rather not have anyone have to sue the SEC. As we conclude, former Commissioner Roberta Karmel gave a stirring speech about the intersection of our speech rights and securities regulations, and recounted how a proposed rule about advertisements was narrowed to protect speech. And current Commissioner Hester Peirce has been a true champion of these rights, dissenting from this rulemaking and sounding the alarm for civil liberties groups. The chairman and the other commissioners should learn from these wise perspectives spanning half a century.

The SEC should narrow the definition of “exchange” to true professional conduct (following Justice White’s standard) before finalizing the rule. Otherwise they will chill substantial protected speech, quash innovation on our shores, and face an unfriendly Court that’s primed to vindicate our First Amendment freedoms.