SEC Threatens Crypto Exchange Coinbase With Legal Action
Coinbase, which by trading volume is the largest cryptocurrency exchange in the US, announced yesterday that it had been hit by the Securities and Exchange Commission (SEC) with threats of legal action.
As a public Form 8-K filed by Coinbase with the SEC explained, “On March 22, 2023, Coinbase … received a ‘Wells Notice’ from the staff … of the Securities and Exchange Commission … that the staff has informed the company that it made a “preliminary decision” to recommend that the SEC file an enforcement action against the company alleging violations of the federal securities laws.”
In the 8-K filing, which is required to inform the public of important events that may affect shareholders, Coinbase explained that based on what the SEC staff has communicated to them, “these potential enforcement actions will be related to aspects of the company’s spot market, betting service Coinbase Earn, Coinbase Prime and Coinbase Wallet. The potential civil action may seek injunctive relief, injunctive relief and civil penalties.” (The news is actually affecting shareholders, with Coinbase’s stock down about 13 percent today as of this article’s publication.)
Coinbase Chief Legal Officer Paul Grewal went public with much of the frustration that has plagued crypto market participants (and even federal bankruptcy judges) as they try to navigate the SEC’s approach to virtual currencies. Grewal explained how the SEC under Chairman Gary Gensler has reshaped regulatory law and policy via enforcement (and the occasional vague public threat).
Grewal echoed the complaints many have had while trying to understand exactly why and when the SEC believes that a cryptocurrency is a security and can be regulated as such, and thus that companies that facilitate trading in them face certain registration requirements. “We asked the SEC to specifically identify which assets on our platforms they believe may be securities, and they refused to do so,” Grewal wrote.
“We continue to believe that regulations and legislation are better tools for defining the law for our industry than enforcement actions,” Grewal said. He again reiterated a long-term frustration with the SEC’s apparent desire to disclose what it believes the law requires, not through strict and understandable written notice — something more like actual law or rulemaking — but by simply slamming certain crypto market players against the wall, apparently. random.
Grewal defended Coinbase’s efforts to try to understand the law and follow it. In the course of the investigation leading to this week’s notice, “the SEC asked us if we would be interested in discussing a potential settlement that would include filing a portion of our business with the SEC. We absolutely said yes. Specifically, the SEC asked us to give our views on what a registration path for Coinbase could look like – because there is no existing way for a crypto exchange to register.”
Grewal said that after trying to get the SEC to provide feedback on various registration models Coinbase proposed, the agency generally shut down, didn’t respond, and finally in January “told us they would go back to an enforcement investigation.” Coinbase insisted that “our staking and exchange services are largely unchanged since 2021, when the SEC reviewed our S-1 and allowed us to become a public company,” he wrote. “Our core business model remains the same.”
Grewal noted that different federal agencies have given conflicting reports on how to legally categorize certain virtual currencies: “The place for the CFTC [Commodity Futures Trading Commission] recently testified before Congress about it Ethereum is a commodity, which the public has long understood to be the case. Then-CFTC Commissioner Quintenz has so it’tThe SEC has no authority over pure commodities or their trading venues, whether those commodities are wheat, gold, oil…or crypto assets.’ Current SEC chairman recently opined that perhaps BTC [bitcoin] is the sole commodity for digital assets, which is completely contrary to the CFTC’s position.”
“If our regulators can’t agree on who regulates which aspects of crypto, the industry has no fair notice of how to proceed,” Grewal concluded. “Against this backdrop, it makes no sense to threaten enforcement action against trusted public companies like Coinbase that are committed to playing by the rules.”
Whether a financial instrument, contract or coin in the virtual currency space constitutes a “security” under the governing “Howey test,” based on the 1946 Supreme Court case SEC v. WJ Howey Co, continues to be a matter that the courts appear to have to sort out on a case-by-case basis. While complex, as most legal definitional principles are, a central element of Howey is that the buyer and seller of the product are involved in a joint venture involving a monetary investment where a reasonable expectation of profit is derived from the efforts of others. Most argue that most virtual currencies are more like commodities whose values fluctuate based on mass market demand, not based on any effort by the original issuer. As Coin Center research director Peter Van Valkenburgh explained in an interesting article considering whether ether (the virtual currency with the second highest market value) should legally be categorized as a security, there is a meaningful distinction between a virtual object that can in any way time has been part of an arrangement or offer which can reasonably be regarded as a security and a virtual object which itself is always a security.
Grewal insisted that nothing at his exchange should qualify as a security, including the betting services that he said the SEC has known about since 2019. “Prior to this investigation, we had not heard any concerns at all from the SEC about” them, he explained .
Grewal, like many in the crypto space who have watched in horror as the SEC’s wrecking ball swings unpredictably, believes that SEC actions like this “will only drive innovation, jobs and the entire industry overseas.”
