After months of bad news for cryptocurrency, the Securities and Exchange Commission’s latest moves could be apocalyptic for the industry.
We previously wrote about the SEC’s Wells Notice issued to Coinbase in March 2023. A Wells Notice is a written notice that SEC staff sends to a company or individual before the staff recommends to the commission pursuing an enforcement action. We described the news as “jaw dropping” and cautioned that, if the SEC moves forward with litigation against Coinbase, it could spell the end of crypto. At the very least, we projected that the impending complaint would shed light on the SEC’s future agenda on crypto and indicate how aggressive the SEC might be in this space moving forward.
We finally have our answer. On June 6, 2023, in a complaint spanning over 100 pages and filed in the Southern District of New York, the SEC alleges that Coinbase knowingly operated an unregistered securities exchange for a decade. This comes on the heels of the SEC’s filing against Binance, also on the basis of operating an unregistered securities exchange.
More specifically, the Complaint asserts four claims against Coinbase: (1) violation of Section 5 of the Securities Exchange Act of 1934 (“Exchange Act”) for failing to register as an exchange; (2) violation of Section 15(a) of the Exchange Act for acting as an unregistered broker, (3) violation of Section 17A(b) for failing to register as a clearing agency; and (4) violation of Sections 5(a) and 5(c) of the Securities Act of 1933 (“Securities Act”) by offering through its staking program an unregistered security. The complaint also alleges derivative “control person” claims against CGI, Coinbase’s parent entity, for the aforementioned claims.
Without a doubt, this development is bad news for Coinbase, whose shares fell precipitately in the day the SEC announced its decision. It is interesting to note that the SEC’s complaint mentions in passing that Coinbase filed an S-1, which the commission accepted in April 2021, so that it could trade its own stock on Nasdaq. Consider the irony that the commission approved of Coinbase’s S-1 just a few years ago, which essentially authorized its business plan—the same business plan that is now at the heart of the SEC’s complaint.
This fact further calls into question the sincerity of SEC Chair Gary Gensler’s comment in the press release announcing the Coinbase litigation stating that purported exchanges like Coinbase must be registered to “prevent fraud and manipulation, proper disclosure, safeguards against conflicts of interest, and routine inspection by the SEC.” In theory, the function of the S-1 itself is to do all those things.
It is notable the SEC filed in the Southern District of New York, a jurisdiction in which it has been successful in bringing previous crypto securities enforcement cases. See SEC enforcement action against Justin Sun and three of his wholly-owned companies, Tron Foundation Limited, BitTorrent Foundation Ltd., and Rainberry Inc.(Mar. 22, 2023, Case No. 1:23-cv-02433) and follow-on settlements with celebrities touting the Tron token including Lindsey Lohan; see also SEC v. Terraform Labs PTE Ltd., and Do Hyeong Kwon (Feb. 16, 2023, Case No. 1.23-cv-01346l) https://www.sec.gov/news/press-release/2023-59; SEC v. Genesis Global Capital, Inc. and Gemini Trust Company, LLC, (Jan. 12, 2023, Case No. 1:23-cv-00287).
The timing is also curious. Typically the commission votes on the staff’s recommendations on Thursdays during its closed commission meetings, or “CCMs.” Since the complaint was not filed until Tuesday, there is an open question of if and why the staff waited four days to file it. Were there last minute negotiations with Coinbase? Additional revisions to the complaint? Or was there a strategic effort to wait to file until after the Binance complaint was made public?
Questions about timing aside, there are at least three takeaways from the SEC’s complaint against Coinbase.
First, much of it focuses on how the Coinbase platform looks and feels much like a traditional equities platform. “[T]he design and functionality of the unregistered Coinbase Platform is similar to those of properly registered national securities exchanges, including its (i) display of orders, (ii) order book and order types, and (iii) order matching and trading rules.” Complaint ¶ 90. The complaint includes a screenshot of the Coinbase platform that shows the option to trade cryptocurrencies like Cardano, Solana and Polygon. These tokens are also available on other established platforms that are not crypto-specific, like Robinhood. The complaint suggests that exchanges such as Robinhood that facilitate trading of cryptocurrencies may be next.
Second, the discussion of the SAND token, which the SEC alleges is a security, is also noteworthy. The SAND token was originally developed by Pixowl, a gaming platform, acquired by the infamous Animoca Brands, Inc. Animoca is headquartered in Hong Kong and connected to other big-named venture capital firms and projects, including the Bored Ape Yacht Club NFT. SAND was sold to build out the gaming platform and marketed to investors in the form of a SAFE—or a Secured Agreement for Future Equity. The SAND tokens provided holders access to the sandbox website, e.g. the gaming network, and allowed holders to earn rewards and participate in the platform’s governance. All of these features are intended, in part, to avoid the allegation that SAND is a security. Complaint ¶¶ 190-202.
The complaint suggests that so-called “governance” tokens that provide users a utility and a function regarding the platform may not avoid a securities designation. It also suggests the SEC may be following on its investigation of other big name issuers, like Animoca, and other “SAFE” warrant tokens.
Last, the complaint previews future actions against other platforms and exchanges that provide staking awards. Coinbase offers holders to receive rewards from staking five crypto-assets on the platform. Staking is a mechanism used by proof-of-stake blockchains like Ethereum to validate required functions for the blockchain. The SEC alleges Coinbase marketed its staking program as an investment opportunity: “During the Relevant Period, Coinbase’s website ... stated that investors can “[e]arn up to 6.00% APY on your crypto.” Complaint ¶ 323. Based on these representations and others, the SEC alleges that Coinbase’s staking program is a security. This could portend future actions against staking offerings such as Ethereum, Tether and Cardano.
At the time of publication, Coinbase CEO Brian Armstrong had issued a short response to the SEC complaint, noting that the case is entirely focused on whether Coinbase has issued a security and remarking that “we are confident in our facts and the law.” He continued: “We’ll get the job done. In the meantime, let's all keep moving forward and building as an industry. America will get this right in the end.”
Coinbase’s best defense may be reserved for litigation, which we will closely monitor.
This document is intended to provide you with general information regarding the SEC's 2023 lawsuit against Coinbase. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions. The information in this article is accurate as of the publication date. Because the law in this area is changing rapidly, and insights are not automatically updated, continued accuracy cannot be guaranteed.