Court says SEC correct in arguing Coinbase sold unregistered securities

Getting your Trinity Audio player ready...

Crypto Open Patent Alliance (COPA) members are celebrating their victory over Craig Wright even as U.S. authorities continue poking holes in their claims that ‘crypto’ deserves special treatment.

On March 27, Judge Katherine Polk Failla of the U.S. District Court for the Southern District of New York issued a ruling rejecting the bid by Coinbase (NASDAQ: COIN) to dismiss the complaint filed against the digital asset exchange by the U.S. Securities and Exchange Commission (SEC) last June. The SEC accused Coinbase of operating as an unregistered securities exchange, broker, and clearing agency.

Last August, Coinbase asked Failla to dismiss the case based on its argument that none of the 12 tokens cited in the SEC’s complaint are unregistered securities. Coinbase went further during oral arguments in January, claiming the four Coinbase services cited in the SEC’s complaint—general token sales, Coinbase Prime for institutional customers, the Coinbase Wallet, and the exchange’s staking service—were all outside the SEC’s purview.

Failla’s ruling utterly rejected Coinbase’s argument that ‘crypto’ is so revolutionary that it can’t be contained within existing securities laws. According to Failla, the SEC’s “well-pleaded allegations … plausibly support the SEC’s claim that Coinbase operated as an unregistered intermediary of securities.”

Failla went on to say that “the ‘crypto’ nomenclature may be of recent vintage, but the challenged transactions fall comfortably within the framework that courts have used to identify securities for nearly eighty years. Further, the Court finds that the SEC adequately alleges that Coinbase, through its Staking Program, engaged in the unregistered offer and sale of securities.”

Failla also rejected Coinbase’s longstanding argument that the SEC has violated the Administrative Procedures Act (APA), which governs how agencies craft regulations. Coinbase based this argument on the fact that the SEC has repeatedly rejected the exchange’s demands for crypto-specific regulations. The SEC maintains that existing securities laws are sufficiently elastic to apply to digital assets.

Failla ruled that the SEC hadn’t violated Coinbase’s rights by failing to provide ‘fair notice’ that tokens are indeed securities.

“The SEC is not announcing a new regulatory policy, but rather is simply engaging in a fact-intensive application of an existing standard—an application that Coinbase also conducted—to determine whether certain transactions involving crypto-assets meet the characteristics of an ‘investment contract.’”

Failla’s ruling is by no means the end of this story, as her ruling only confirms that the suit will proceed to trial. But her utter rejection of Coinbase’s securities arguments—after seeming to be on the fence during oral arguments—doesn’t bode well for the eventual outcome of this affair. And that could have ripple effects for a great number of ‘crypto bros’ who continue to conduct themselves as if no rules apply.

Failla did toss Coinbase a consolation prize by granting its request for dismissal of the SEC’s claim that Coinbase acts as an unregistered broker by making its Wallet application available to customers.

“The factual allegations concerning Wallet are insufficient to support the plausible inference that Coinbase ‘engaged in the business of effecting transactions in securities for the account of others’ through its Wallet application.”

The Wallet ruling was celebrated not just by Coinbase execs but by the broader
decentralized finance (DeFi) community, who claim that DeFi app developers now have a potent legal ruling to use against future regulatory suits of this kind.

When life hands you lemons

Coinbase’s chief legal officer, Paul Grewal, put a brave face on Failla’s ruling, saying, “we were prepared for this,” adding that everyone at Coinbase understood that motions of this type “are almost always denied.” And yet, at the time of that January oral argument, Grewal said Coinbase remained “confident in our legal arguments.”

Failla’s ruling comes shortly after a different federal judge ruled that tokens traded on Coinbase are securities transactions. That ruling, which came in the case of a former Coinbase staffer who illegally traded on inside knowledge of new token listings, found that the tokens involved met the criteria of the Howey test for identifying securities that require registering with the SEC.

These back-to-back legal brushback pitches don’t bode well for Coinbase’s appeal of the SEC’s refusal to implement the “new regulatory framework” for digital assets that Coinbase claims to want so badly. On March 11, Coinbase filed a petition with the U.S. Court of Appeals for the Third Circuit seeking a review of the SEC’s latest rejection of the exchange’s plea for ‘regulatory clarity.’

Coinbase asked the Third Circuit to vacate the SEC’s December order and “direct the agency to begin a long-overdue rulemaking process.” Coinbase takes issue with the SEC’s “terse” rejection letter and the regulator’s “inapplicable, inapt, and still-evolving securities-law requirements.”

Following Coinbase’s filing, Grewal tweeted his thoughts on the matter. Grewal claimed that the SEC had historically “acknowledged the limits of its authority over digital assets and asked Congress to give it additional authority … and then practically overnight the SEC decreed that it already had the authority” and started cracking crypto skulls.

Grewal leaves out the inconvenient truth that Congress hasn’t been a functioning body for years. Their abdication of responsibility obligated the SEC to step into this void because, as SEC chair Gary Gensler has noted, digital asset investors deserve the protections of U.S. securities laws. Coinbase appears only too eager to restore the absence of oversight/consequences by clipping the SEC’s wings.

One step forward, five steps back

Whatever spin Grewal wants to put on the latest legal developments, the courts have clearly had enough of ‘crypto’ lawlessness and are letting their feelings known in no uncertain terms.

That was all too evident in the 25-year sentence imposed on FTX founder Sam Bankman-Fried on March 28 and will likely be present when SBF’s former rival Changpeng ‘CZ’ Zhao is sentenced on April 30 for his criminal antics at the Binance exchange. Other cases, including Alex ‘Celsius’ Mashinsky, Richard ‘Hex’ Heart, and (eventually) Tether and Digital Currency Group (DCG) boss Barry Silbert, will accelerate this forced march to compliance.

Crypto does have one notable victory under its belt. Coinbase is a ‘platinum’ member of the COPA, the cabal of crypto luminaries and Silicon Valley giants that recently celebrated a victory over Craig Wright in a U.K. court. The justice overseeing that case ruled that Wright had failed to prove that he was the real-world figure behind the Satoshi Nakamoto pseudonym credited with authoring the 2008 Bitcoin white paper.

While COPA may be celebrating its victory over Wright, we’ll make the fearless prediction that their attacks on the BSV Blockchain that Wright supported will continue. Wright always seemed a proxy for COPA’s wider fight against BSV’s belief that (a) what Satoshi created is more than a lumpen, utility-free ‘digital gold’ and (b) the data-processing technology at BSV’s core is infinitely more valuable to enterprises and governments than the blinkered belief that ‘number go up.’

COPA’s victory over Wright was a personal victory over a man. But BSV was never about any single individual. Wright may have lost, but BSV the technology will endure, preserving Satoshi’s original vision for Bitcoin—the vision COPA and their ilk seem determined to erase from public consciousness.

Watch: Digital currency regulation and the role of BSV blockchain