Coinbase Custody partner previously fined $80,000 for clients’ assets misuse

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Coinbase (NASDAQ: COIN) is making a concerted effort to become a legitimate financial entity in the United States. It has purchased three separate traditional financial companies, each with its own pluses that could pave the way for the cryptocurrency exchange company to receive approval by the U.S. Securities and Exchange Commission (SEC). While it works with regulators to become “bona fide,” it still is pushing forward with several projects, including the recent release of its Coinbase Custody platform. To be able to offer the new custody service, Coinbase partnered with Electronic Transaction Clearing (ETC) and some are now wondering if that was a smart move given the company’s checkered past.

In announcing the official launch of Coinbase Custody, Coinbase boasted of the alliance, saying, “Coinbase Custody leverages the expertise and systems of our partner Electronic Transaction Clearing (ETC). ETC is a SEC-registered broker-dealer and FINRA [Financial Industry Regulatory Authority] member subject to regulated financial reporting and independent audits.”  Unfortunately for Coinbase, though, it has now been discovered that ETC hasn’t always played fairly with clients’ money.

Nathaniel Popper, a reporter with the New York Times, tweeted on Monday, “Coinbase is setting up a new service to help big investors comfortably hold cryptocurrencies. Might not help that their partner on this, Electronic Transaction Clearing, has been charged by the SEC ‘with repeatedly putting customer assets at risk.’”

Here is the Coinbase announcement: https://t.co/OwiLpU7RvM

And here is the 103p document listing all of Electronic Transaction Clearing's past infractions: https://t.co/O9XMZqZKu8

— Nathaniel Popper (@nathanielpopper) July 2, 2018

Coinbase first announced the creation of Coinbase Custody in December 2017. The plan was already well under way with ETC’s involvement when, in March, the SEC slapped ETC on the wrist for some irregular practices. An investigation led by the SEC determined that ETC had “illegally placed more than $25 million of customers’ securities at risk in order to fund its own operations.”

In one case, $8 million deposited by a client was used by the firm to cover the margin requirements of a loan it held. ETC was also found to have used another $17 million from deposits as collateral to cover other loans. The SEC determined that the company had repeated the action “numerous times” in 2015, as well.

The practices were in violation of the SEC’s Customer Protection Rule, which requires that currency custodians maintain physical possession of customers’ assets at all times. Fortunately, the outcome of the actions was positive and no clients lost money. However, things could have certainly gone the other way, as has been seen time and time again.

ETC was forced to pay an $80,000 fine, and did so without neither confirming nor denying any wrongdoing.

The concern now is how this could impact institutional investments through Coinbase Custody. Investors are already a little skittish due to the market volatility, and the misuse of their funds—or even the perception that it could happen—won’t sit well with them.