SEC v Coinbase Lawsuit (What it Means for Crypto Exchanges)

SEC vs. Coinbase Lawsuit 

In 2023, the Security and Exchange Commission seeks to drop the hammer on Coinbase after years of pursuing them, alleging securities law violations. Coinbase is one of the largest trading platforms, in which Taxpayers across the globe — especially those in the United States — can purchase, trade, sell, or store virtual currency assets. As with any crypto exchange, the key concern for the US government is that because cryptocurrency platforms are not regulated similar to how other securities platforms are regulated (such as acquiring assets through Vanguard or Schwab for example), it is ripe for fraud. And, since Coinbase is the largest exchange and generates the most income, it is the platform that the US government wants to go after specifically with regard to disclosures they believe Coinbase did not make and to ensure investors are protected. Let’s take a look at the case of the SEC vs Coinbase.

What is the SEC (Securities and Exchange Commission)?

The SEC describes itself as:

• • • The Securities and Exchange Commission oversees securities exchanges, securities brokers and dealers, investment advisors, and mutual funds in an effort to promote fair dealing, the disclosure of important market information, and to prevent fraud.

Why does the Government Dislike Crypto?

From a baseline perspective, some regulation is generally welcome – even by the most pessimistic investors. That is because investors want to at least have basic protections and transparency available to them about their investment. Crypto started out primarily on the dark web on websites such as Silk Road. And, while cryptocurrency had made its way out from the dark web and into mainstream society in the past several years, it is still ripe for fraud. That is because anyone can essentially claim anything about the investment that they are promoting to taxpayers — and since there are no protections for the taxpayer, it can make it very dangerous for investors who may not have a deep understanding of how crypto works. Let’s take a walk through some of the key provisions of the over 100-page complaint lodged by the Securities and Exchange Commission.

What is the Securities and Exchange Act of 1934?

• • • “Congress enacted the Securities Exchange Act of 1934 (the “Exchange Act”) in part to provide for the regulation of the national securities markets.  And Congress charged the SEC with protecting investors, preserving fair and orderly markets, and facilitating capital formation, in part through a series of registration, disclosure, recordkeeping, inspection, and anti-conflict-of-interest provisions.  These provisions have led to the separation of key functions in the securities markets— including those carried out by brokers, exchanges, and clearing agencies—in part to protect investors and their assets from the conflicts of interest that can arise when these functions merge.”

Unregistered Brokers

• • • “Since at least 2019, through the Coinbase Platform, Coinbase has operated as an unregistered broker, including by soliciting potential investors, handling customer funds and assets, and charging transaction-based fees; an unregistered exchange, including by providing a market place that, among other things, brings together orders of multiple buyers and sellers of crypto assets and matches and executes those orders; and an unregistered clearing agency, including by holding its customers’ assets in Coinbase-controlled wallets and settling its customers’ transactions by debiting and crediting the relevant accounts.  By collapsing these functions into a single platform and failing to register with the SEC as to any of the three functions, and not having qualified for any applicable exemptions from registration, Coinbase has for years defied the regulatory structures and evaded the disclosure requirements that Congress and the SEC have constructed for the protection of the national securities markets and investors. 

    • In addition, during the same period, Coinbase has operated as an unregistered broker through two other services it has offered to investors: Coinbase Prime (“Prime”), which Coinbase markets as a “prime broker for digital assets” that routes orders for crypto assets to the Coinbase Platform or to third-party platforms; and Coinbase Wallet (“Wallet”), which routes orders through third-party crypto asset trading platforms to access liquidity outside the Coinbase Platform.

    • Coinbase has carried out these functions despite the fact that the crypto assets it has made available for trading on the Coinbase Platform, Prime, and Wallet have included crypto asset securities, thus bringing Coinbase’s operations squarely within the purview of the securities laws.  CGI—Coinbase’s parent company to which Coinbase’s revenues flow—is a control person of Coinbase and thus violated the same Exchange Act provisions as Coinbase.”

SEC vs W.J. Howey

• • • For years, Coinbase has made calculated business decisions to make crypto assets available for trading in order to increase its own revenues, which are primarily based on trading fees from customers, even where those assets, as offered and sold, had the characteristics of securities.  Since at least 2016, Coinbase has understood that the Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) and its progeny set forth the relevant test for determining whether a crypto asset is part of an investment contract that is subject to regulation under the securities laws.  And, as part of its public marketing campaign to position itself as a “compliant” actor in the crypto asset space, Coinbase has for years touted its efforts to analyze crypto assets under the standards set forth in Howey before making them available for trading.  But while paying lip service to its desire to comply with applicable laws, Coinbase has for years made available for trading crypto assets that are investment contracts under the Howey test and well-established principles of the federal securities laws.  As such, Coinbase has elevated its interest in increasing its profits over investors’ interests, and over compliance with the law and the regulatory framework that governs the securities markets and was created to protect investors and the U.S. capital markets.  

Alleged Act 34′ Violations

• • • By engaging in the conduct set forth in this Complaint, Coinbase has acted as an exchange, a broker, and a clearing agency, without registering as an exchange, broker, or clearing agency, in violation of Sections 5, 15(a), and 17A(b) of the Exchange Act [15 U.S.C. §§ 78e, 78o(a), and 78q-1(b)(1)], and for purposes of Coinbase’s violations of the Exchange Act, CGI was a control person of Coinbase under Exchange Act Section 20(a) [15 U.S.C. § 78t(a)].  In addition, through its Staking Program, Coinbase has offered and sold securities without registering its offers and sales, in violation of Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. §§ 77e(a) and 77e(c)]. 9. Unless Defendants are permanently restrained and enjoined, there is a reasonable likelihood that they will continue to engage in the acts, practices, transactions, and courses of business set forth in this Complaint and in acts, practices, transactions, and courses of business of similar type and object in violation of the federal securities laws.

Relief Sought

WHEREFORE, the Commission respectfully requests that the Court enter a Final Judgment:

• • • Permanently enjoining Defendants, and each of their respective agents, servants, employees, attorneys and other persons in active concert or participation with any of them, from violating, directly or indirectly, Sections 5, 15(a), and 17A(b) of the Exchange Act [15 U.S.C. §§ 78e, 78o(a), and 78q-1(b)];

    • Permanently enjoining Coinbase and each of its respective agents, servants, employees, attorneys and other persons in active concert or participation with any of them, from violating, directly or indirectly, Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. §§ 77e(a) and (c)];

    • Ordering Defendants to disgorge on a joint and several basis all ill-gotten gains resulting from their Exchange Act violations, and ordering Coinbase to disgorge all ill-gotten gains resulting from its Securities Act violations, with prejudgment interest thereon, pursuant to Sections 20(a), 21(d)(3), 21(d)(5) and 21(d)(7) of the Exchange Act [15 U.S.C. §§ 78u(a) and 78u(d)(3), (5) and (7)]; 

    • Ordering Defendants to pay civil money penalties pursuant to Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u(d)(3)], and ordering Coinbase to pay civil money penalties pursuant to Section 20(d) of the Securities Act [15 U.S.C § 77t(d)]; and

    • Granting any other and further relief this Court may deem appropriate or necessary for the benefit of investors pursuant to Section 21(d)(5) of the Exchange Act [15 U.S.C. § 78u(d)(5)].

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