State Regulators: Crypto Bill Threatens Fraud Prosecution

State-level regulatory authorities across the United States have voiced significant apprehensions regarding proposed federal legislation for cryptocurrency market structure. Their primary concern centers on the potential for the bill to impede their crucial ability to investigate and prosecute fraudulent activities within the rapidly evolving digital asset landscape.

Mounting Concerns from State Regulators

Officials from various states, including Alabama and Montana, are raising alarms over the anticipated crypto market structure bill. They contend that the legislation, in its current form, may significantly diminish their capacity to pursue wrongdoers involved in crypto-related scams and illicit activities. This development could leave a substantial gap in investor protection, particularly at a time when digital asset adoption is expanding.

Amanda Senn, Director of the Alabama Securities Commission, highlighted that the Senate's draft, known as the Responsible Financial Innovation Act, notably lacks explicit provisions granting state-level agencies the authority required to supervise digital asset companies effectively. This omission could have profound implications, potentially hindering states from initiating and successfully concluding fraud prosecutions. The concern is further amplified by a noticeable trend of decreasing federal enforcement actions against cryptocurrency firms over recent years.

The Federal Enforcement Landscape

The past few years have witnessed a reduction in federal enforcement efforts targeting crypto companies. Key federal regulatory bodies, such as the Securities and Exchange Commission (SEC), the Department of Justice (DOJ), and the Commodity Futures Trading Commission (CFTC), have reportedly scaled back or disbanded their specialized digital asset enforcement units. This shift has led to the dismissal of numerous cases and investigations against crypto firms, creating a vacuum in oversight.

Data compiled by Cornerstone Research, as cited by Bloomberg, illustrates this decline vividly. By the end of August, the SEC had initiated only nine crypto-related enforcement actions. This represents a stark decrease compared to 47 actions in 2023 and 33 in 2024. If this trajectory continues, 2025 could mark the lowest number of crypto enforcement actions since 2017. Amanda Senn critically remarked on this trend, stating, "The dam is going to break. If you don't have the states paying attention and prosecuting fraud, nobody is looking out."

Redefining "Investment Contract" and Its Implications

Another significant point of contention for state regulators is the bill's proposed alteration to the definition of an "investment contract." Montana State Auditor James Brown cautioned that modifying this established legal definition could allow criminals to "wiggle out of being prosecuted." He emphasized the dual factors contributing to easy fraud: the pervasive national discourse about the benefits of digital currencies and the speculative notion of getting rich quickly.

The proposed changes would introduce new conditions and elements to the federal definition, potentially complicating the application of existing securities laws to digital assets. This could create ambiguities that fraudsters might exploit, undermining decades of legal precedent in investment contract analysis and making it more challenging for regulators to determine whether a particular digital asset falls under securities laws.

Safeguarding State Anti-Fraud Protections

In response to these concerns, state regulators have put forward several recommendations for changes to the market structure bill, which is slated for markup post-October. State officials have pointed out that the current draft's language does not mandate crypto businesses to register with state authorities or to respond to their inquiries, effectively sidestepping existing state-level oversight mechanisms.

The North American Securities Administrators Association (NASAA), a prominent voice for state securities regulators, formally addressed these concerns in a September letter to multiple Senators. NASAA unequivocally urged Congress to ensure the preservation of state anti-fraud enforcement authorities within the forthcoming crypto bill. The association underscored the vital role of state-level protections in safeguarding investors and combating online scams, deeming them "essential in the ongoing fight against online scams."

NASAA's Key Recommendations

• Reject Redefining the Investment Contract Test: NASAA strongly advised against provisions that seek to redefine the investment contract test. They warned that "upending decades of securities law as contemplated in Section 105 will have devastating effects on anti-fraud efforts by adding so many elements and conditions to the investment contract analysis that form, not substance, will determine whether regulators can take action." This highlights the risk of creating loopholes based on technicalities rather than the actual nature of the financial instrument.
• Enact the Support Anti-Fraud Enforcement (SAFE) Act: The association recommended the enactment of the SAFE Act. This legislation would explicitly ensure that states possess the necessary anti-fraud authority to address and respond effectively to residents' complaints involving digital assets, thereby strengthening the regulatory framework at the local level.

Divergent Industry Perspectives

Despite the widespread concerns articulated by state regulators, some industry stakeholders hold a different view. They suggest that the market structure bill may not necessarily hinder state authorities' ability to prosecute malfeasant actors, arguing that regulators will retain the capacity to pursue criminals "in the name of consumer protection." Mauro Wolfe, a leading partner at Duane Morris’s Digital Assets and Blockchain Group, acknowledged the states' concerns, particularly given the perceived lack of federal enforcement. However, he also anticipated that the interpretation of the bill's impact would likely lead to litigation, with defense lawyers challenging states' authority.

The ongoing debate underscores the complex challenges involved in crafting comprehensive and effective regulation for the digital asset space. Balancing innovation with robust investor protection and ensuring clear jurisdictional lines between federal and state authorities remains a critical task for lawmakers.