Pre-enforcement review is one way to combat regulatory uncertainty.

The digital asset industry has now met the regulatory state. Those interested in building digital asset businesses that operate in the United States thus need to be aware of a vital tool for resisting regulatory overreach by the federal government—the pre-enforcement challenge.

One of the biggest issues facing digital asset firms today is a lack of clarity about what laws apply to them (and, if so, how). The financial services laws (many of which were drafted before the creation of the internet) turn on notoriously ambiguous terms like "security," "financial institution," "broker," etc. What’s more, federal regulators charged with implementing those laws often adopt similarly opaque regulations that minimize clarity and maximize the regulator’s flexibility. Worst of all, federal enforcement agencies have increasingly focused negative attention on cryptocurrency. For instance, senior officials in the Securities and Exchange Commission and the Commodity Futures Trading Commission—and other agencies, too—have begun to single out digital assets as targets for increased scrutiny under these uncertain laws and regulations.

For digital asset firms who face increasingly aggressive regulators wielding ambiguous federal laws, pre-enforcement challenges are worth considering as a way to obtain regulatory clarity.

The Supreme Court has made clear that a person or business usually does not need to break the law in order to challenge that law. Rather, one can often pursue a pre-enforcement action against the government on the ground that (i) the law at issue is itself unlawful (say, because it violates the Constitution), or (ii) the law does not in fact apply to the challenger (say, because the challenger falls outside its scope).

So who could pursue these sorts of challenges? And what do they entail? Boiled down, the most important thing is that a person or business seeking to pursue a pre-enforcement challenge must show a "credible threat" of enforcement. In other words, someone seeking pre-enforcement relief must show that (i) they plan to engage in conduct that arguably may fall within the scope of a given law, and (ii) there is a good chance that the government will enforce that law against them if they go forward with their planned conduct. At that point, a person should be able to go to federal court to seek a declaratory judgment that the government may not enforce the law or regulation at issue against the person’s intended conduct.

Of course, there are exceptions and the details matter. Some statutes preclude pre-enforcement review or channel it in specified ways. For instance, challenges to certain Securities and Exchange Commission orders and rules need to follow certain procedures. And pre-enforcement challenges must be "ripe" for a court to be able to hear them. That is, a challenge needs to be sufficiently factually developed before you can bring it to court.

Today, many digital asset firms are subject to unclear laws and regulations and are, in turn, put to the unpleasant choice of excessive caution or excessive risk. Pre-enforcement challenges are a potential path out of that dilemma. Digital asset entrepreneurs should consider taking it.

Harry Graver, in the Washington Office, assisted in the preparation of this Alert.