In charging a former Coinbase employee with insider trading, the SEC fired what appeared to be the opening salvo in a bigger legal brawl with the crypto powerhouse over a crucial question: Are crypto tokens securities?
In fact, the fight was already brewing. Before the insider case arose, the SEC was reportedly already probing Coinbase itself for alleged securities laws violations, setting the stage for a confrontation that could define not just the company’s future but that of the entire crypto industry.
Coinbase quickly signaled plans to fight back. The day the SEC announced its charges, which leaned heavily on the notion that the tokens involved were securities, Chief Legal Officer Paul Grewal flatly declared that “Coinbase does not list securities. End of story.” He also accused the SEC of having “little interest in this most fundamental role of regulators.”
Coinbase executives have been known for unleashing strong, even fiery public statements against the SEC. But Grewal and Chief Policy Officer Faryar Shirzad, Coinbase’s generals in the battle with the SEC, also highlighted key arguments for the company’s legal counteroffensive.
Of the nine digital assets the SEC insider trading complaint said were securities, seven are traded on Coinbase. Grewal said the company has “a rigorous process to analyze and review each digital asset before making it available on our exchange — a process that the SEC itself has reviewed.”
That was a reference to the SEC review of Coinbase’s IPO filing last year, according to a company representative. The SEC declined to comment.
It’s far from clear that the issues the SEC would consider in vetting a company’s financial reporting ahead of an initial public offering have much to do with the question of whether digital assets are securities, even if the same agency happens to have oversight in both cases.
John Reed Stark, former chief of the SEC’s Office of Internet Enforcement, said Grewal’s statement was misleading. “What they’re saying implies some sort of approval,” he told Protocol.
Marc Fagel, the SEC’s former San Francisco regional director, agreed that the company statement is “obviously a little self-serving.”
“Whether the SEC did or didn’t review Coinbase’s listing process has no bearing on whether a particular coin offering required registration under the federal securities laws,” he said.
As SEC chair, Gary Gensler has made his view clear that most cryptocurrencies are securities. But that stance predates his arrival — under Jay Clayton, the agency sued Ripple on the premise that XRP was an unregistered security. The long-standing judicial standard used by the agency, that it’s now applying to crypto, is called the Howey Test, which looks at whether people are investing money in something with an expectation of profits from others’ efforts.
“What the SEC will say is, ‘These are the rules. They've always been the rules. It's technology agnostic, and we will use the test to decide something as a security,’” Alma Angotti, a partner at Guidehouse and a former SEC senior counsel, told Protocol.
Coinbase has argued that current rules are outdated and don’t make sense. “Securities law is … not well-suited to govern digital assets,” wrote Shirzad, the company’s chief policy officer, in a proposal for a separate federal regulator in charge of crypto. That proposal didn’t gain much traction; the leading bill for crypto regulation from Sens. Cynthia Lummis and Kirsten Gillibrand would divvy up crypto regulation among existing agencies, including the SEC.
The day the SEC announced the insider trading complaint, Shirzad announced that Coinbase had filed a petition “asking the SEC to begin rule-making on digital asset securities.” He said Coinbase is asking the regulator to “start a process where the public and key stakeholders can transparently provide input into the agency’s work on crypto.”
The SEC has a rule-making process to make or update rules for laws passed by Congress that is “designed to give members of the public an opportunity to provide their opinions.”
But it’s unusual for a single company to request that the SEC begin a rule-making process, experts say. Trade associations or Congress itself are known to make such requests. “I've never heard of anybody doing that before,” Angotti said.
Stark said there’s “absolutely nothing wrong with asking the SEC to come out with guidelines, but the reality is in the area of crypto [it] brought over 100 cases” and has come out with “every conceivable form of guidance already.”
The SEC has issued some rules that led Coinbase to make changes in its business. For example, the SEC announced early this year that companies holding cryptocurrencies on behalf of customers must record those assets as a liability on their balance sheets and disclose potential risks to investors. That prompted Coinbase to disclose in a regulatory filing that customers could lose their crypto assets if the company went bankrupt.
And Coinbase has argued that it has gone to great lengths to comply with the existing rules. Testifying before a House subcommittee on intelligence and counterterrorism in January, John Kothanek, Coinbase’s vice president for global intelligence, noted that the company is a licensed money transmitter in more than three dozen states and is a federally registered money services business with FinCEN.
Grewal said the company “cooperated” with the SEC’s investigation of the former Coinbase employee. But he complained that “instead of having a dialogue with us, the SEC jumped directly to litigation.”
Omid Malekan, who teaches blockchain and cryptocurrencies at Columbia Business School, said there’s been a debate in crypto on “whether Coinbase’s mistake was trying to play with the rules because at every turn, it seems to result in more crackdowns, more blowback and you don't see a regulatory agency like the SEC praising them for at least trying, for going to them, for communicating with them.”
If there’s anything to take away from Coinbase’s freshly combative stance, it’s that the company may think it has little to lose from confrontation.
