Coinbase protests as judge declares token trades are securities transactions

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Coinbase (NASDAQ: COIN) took a major legal hit last week as a federal judge confirmed that trades of some digital assets on the exchange are indeed securities transactions.

On March 1, U.S. District Judge Tana Lin in the Western District of Washington at Seattle issued a ruling in the case of Sameer Ramani, one of three individuals charged with insider trading in July 2022. Ramani, former Coinbase product manager Ishan Wahi, and Wahi’s brother Nikhil Wahi were accused of using Ishan’s advance knowledge of token listings on Coinbase to conduct trades that generated over $1.1 million in illegal profits.

Hit with charges both criminal (U.S. Attorney’s Office for the Southern District of New York) and civil (U.S. Securities and Exchange Commission), the Wahi brothers eventually pleaded guilty to wire fraud conspiracy, resulting in Ishan getting two years in prison in May 2023 while Nikhil was sentenced to 10 months that January.

But Ramani managed to flee the U.S. before the authorities could detain him, prompting the SEC to seek a default judgment against the absent defendant. Judge Lin ruled Friday that the SEC had met the necessary standards for default judgment against Ramani, but another aspect of Lin’s ruling is making headlines.

The SEC sought Lin’s agreement that Ramani’s misconduct was in connection with the purchase or sale of a security. The SEC’s case against the insider trio listed nine digital assets—AMP, RLY, DDX, XYO, RGT, LCX, POWR, DFX, and KROM—that the regulator insisted were securities that were never registered with the SEC, making Coinbase’s offering of them to the public a violations of securities law.

The legal standard for identifying a security is the Howey Test, which involves four planks; the product involves an investment of money, in a common enterprise, with an expectation of profits, predominantly from the efforts of others.

Lin found that the tokens traded by Ramani met all the Howey criteria. Moreover, “the Court’s analysis remains the same even to the extent Ramani traded tokens on the secondary market.”

Citing the ruling in SEC V NAC Foundation (the company behind the initial coin offering of the ABTC token), Lin found that the “promotional statements and managerial promises” made by the token issuers in the Ramani case “apply equally to tokens that an investor may have bought from the issuer directly or from another investor, including on a crypto asset trading platform.” As such, “Ramani’s illicit trading was accordingly in connection with the purchase or sale of a security.”

Ripple effect

The SEC wasted little time in leveraging its victory, writing a letter to New York District Judge Katherine Polk Failla—who is hearing the SEC’s complaint against Coinbase for failing to register as an exchange, broker-dealer, and clearing agency—alerting her to Lin’s ruling.

The SEC added that “[n]otably, in briefs supporting the Wahis’ motion to dismiss, certain defendants and Coinbase as amicus curiae argued that secondary market trades in crypto assets cannot involve investment contracts because there needs to be an asset sale ‘coupled with legally binding promises by the seller.'”

There have been two previous digital asset rulings by federal judges regarding the security issue over the past nine months. Last July, U.S. District Judge Analisa Torres said Ripple’s
so-called ‘programmatic’ aka secondary sales of its XRP token on exchanges to retail customers didn’t violate securities laws. However, this view was rubbished shortly thereafter by U.S. District Judge Jed Rakoff ahead of his ruling in the SEC’s suit v. Terraform Labs and its former CEO, Do Kwon.

Coinbase’s chief legal officer Paul Grewal tweeted on March 3 that he didn’t “think much of” Lin’s ruling, noting that “[d]efault judgments aren’t contested … [s]o the judge literally has the SEC on one side and no one on the other.” Grewal claimed that “the SEC was pushing against a completely open door” and default judgments “are not worth anything as precedent or persuasion.”

Grewal’s reaction was understandable, given how greatly Coinbase’s business model relies on tokens similar to those in the SEC’s complaint against Ramani. Alt-coins accounted for 42% of Coinbase’s transaction volume and 57% of transaction revenue in Q4 2023, up from 28% and 44%, respectively, in Q3. Recall that Q4 was Coinbase’s first profitable quarter in two years, so the idea that Coinbase’s future is utterly dependent on shitcoin hype is undeniable.

Coinbase filed its own notice to Judge Polk Failla on March 5, largely repeating Grewal’s tweets in more legalistic phrasing. The notice said Lin’s ruling “was procured against an empty chair and its reasoning reflects as much. Coinbase respectfully submits that the default judgment against Mr. Ramani should be afforded no weight.”

Former SEC enforcement director John Reed Stark said that he expected Coinbase’s dismissive reaction but rejected the view that Judge Lin’s decision was “an outlier.” Stark called Lin’s decision “an extraordinarily thorough, thoughtful, meticulous and well-written decision” that “absolutely considered all relevant legal arguments, whether stated or not.”

Stark added that Lin’s decision is “a mammoth loss not only for Coinbase because of its obvious ramifications but also for the cryptoverse because Judge Lin’s decision was a harbinger of the kind of future rulings that lie ahead.” Lin’s decision was “also a tremendous victory for [digital asset] investors,” who have for too long been denied the protections offered by traditional brokerage firms.

The SEC also alerted the U.S. District Court for the District of Columbia, which is handling the regulator’s complaint against Coinbase rival Binance, which is facing similar civil charges of peddling securities without authority. The SEC could well add this info to its case against Kraken, its appeal of last summer’s Ripple ruling, as well as in all other cases of this nature, both existing and prospective.

Courts can’t be bought, politicians…?

For those reading the tea leaves, Lin’s ruling cited Rakoff’s Terraform ruling as a precedent while ignoring Torres’ Ripple ruling. We should expect other judges to adopt similar positions, dismissing crypto bros’ desperate insistence that tokens are somehow an entirely new classification of asset that should be exempt from existing securities law.

For years, Coinbase and other unauthorized peddlers of unregistered securities have declared that Congress must approve bespoke legislation recognizing digital tokens’ unique status. They’ve adopted this mantra because they know the current Congress can’t achieve consensus on what day of the week it is, let alone anything as complex as approving a new asset class.

This inertia has served both exchanges and token issuers well, and they’re only too eager to preserve this ambiguous status quo. They decry ‘regulation by enforcement,’ ignoring the fact that enforcement is an integral part of regulation. Fueled by Silicon Valley’s endemic cocktail of entitlement, hubris, and (probably) ketamine, they believe the correct formula is regulation without enforcement.

But their threadbare legal defenses are being shredded by the courts. So, booting the current regulatory cops and installing individuals who will drop these lawsuits is their only hope. This explains why Coinbase and other crypto-focused entities are spending millions looking to change who gets to pick the next heads of the SEC, the Commodity Futures Trading Commission, and even the Department of Justice.

The Super Tuesday primary vote in California will offer some hint of how Coinbase-funded political influence groups are faring. Its Stand With Crypto group held a rally in Los Angeles on October 4 ahead of the Super Tuesday vote to determine November’s candidates for the U.S. Senate seat formerly held by the late Dianne Feinstein.

The Fairshake super PAC—to which Coinbase is the largest contributor—will also be watching Tuesday’s vote carefully. As of February 27, Fairshake had spent just $292,206 supporting digital currency-friendly candidates in the 2024 election cycle while spending $10.3 million opposing candidates. And nearly all of that $10 million was spent trying to prevent Rep. Katie Porter (D-CA) from being on November’s ballot.

Whether or not Fairshake’s “mostly false” anti-Porter ads doomed her chances will be hard to measure. Porter’s Democratic rival, Rep. Adam Schiff, spent $11 million trying to boost Republican candidate (and former baseball great) Steve Garvey in the state’s ‘jungle’ primary, in which the top two candidates get to face off in the general election, regardless of party affiliation. (Garvey is a political novice Schiff believes he can crush in the general.)

Regardless, Coinbase/Fairshake will undoubtedly claim that their actions were the key to victory, er, defeat. And they’ll continue to roll out campaigns attacking any politician who doesn’t think meme coins are as important as manufacturing or health care.

As for the candidates Fairshake does support, one of the names that leaps out is Rep. Wiley Nickel (D-NC). Nickel recently made headlines for publicly supporting the suggestion by Circle, Coinbase’s partner on the USDC stablecoin and another Fairshake contributor, that rival stablecoin Tether (USDT) should be targeted for destruction. Will Coinbase get what it paid for?

Executives get cash, infrastructure gets rubber bands

Coinbase’s share price briefly hit a two-year high on March 5, coming within a whisker of $240 before tumbling back to close under $217. That’s more than 4x the price it carried one year ago, reflecting the wider digital asset sector’s rebound from the depths of ‘crypto winter.’

Last month, Coinbase announced that it would boost stock-based compensation for its execs in 2024 (after doling out $865 million in 2023). That could explain why senior management continues to dump their shares to take advantage of the temporary price bubble.

Since mid-February, CEO Brian Armstrong has sold $51.3 million, Co-founder Fred Ehrsam III dumped another $44.1 million (pushing his three-month total close to $200 million), Chief People Officer Lawrence Brock sold $24 million, President/COO Emilie Choi unloaded $20.7 million, Grewal added $13 million to his total and Chief Accounting Officer Jennifer Jones is $5.7 million richer.

The sales have provided sufficiently bad optics that Chief Financial Officer Alesia Haas used a portion of Coinbase’s Q4 analyst call to insist that none of these execs are selling based on day-to-day share price fluctuations and that the sales are all planned well in advance.

Still, you’d think maybe they’d take some of the millions they spent last year keeping their execs fat and happy and use it to build up their shoddy infrastructure. Coinbase’s systems crashed again on March 4, the third such outage in a week. While some customers experienced “errors in buying or selling,” other customers reported seeing their account balances zeroed out.

Cynics have long noted that such outages almost always occur during periods of plummeting token prices, but these recent cases appear to have happened during
rising token prices. We suppose the result is the same, preventing customers from withdrawing, which can either stabilize a falling token or ensure a rally continues due to nobody being able to take profits.

Armstrong tweeted that the surge in traffic during the first outage had exceeded the exchange’s modeling. Armstrong also moaned about how it’s “expensive to keep services over-provisioned,” which suggests that outages are just something users must get used to. (Stock-based compensation isn’t free, you know.)

Meanwhile, Binance suffered a comparatively minor outage on March 5 that was largely limited to specific trading pairs. In general, Binance manages to keep its operations afloat far better than its smaller U.S.-based rival, despite the fact that Coinbase had a five-year head start on Binance. You’d think that gap would have put Coinbase similarly ahead in terms of robust infrastructure, but it turns out that’s not the case. Unless, of course, that’s by design.

Follow CoinGeek’s Crypto Crime Cartel series, which delves into the stream of groups—from BitMEX to Binance, Bitcoin.com, Blockstream, ShapeShift, Coinbase, Ripple, Ethereum,
FTX and Tether—who have co-opted the digital asset revolution and turned the industry into a minefield for naïve (and even experienced) players in the market.