By Sarah Wynn, CQ Appeal (TNS)
The Securities and Exchange Commission (SEC) fired a warning shot at the cryptocurrency industry when it filed an insider trading case classifying several digital assets as securities, according to those closest to the agency.
The SEC last month indicted a former Coinbase Global Inc. executive for letting others know which tokens should be listed for trading on the exchange so they could benefit when the listing drove prices higher. However, what caught the attention of many stakeholders was the agency’s finding that nine of the 25 cryptocurrencies involved were securities and therefore under its jurisdiction.
It seems inevitable that the issuers of these tokens will soon be victims of a civil lawsuit from the SEC, Lee Reiners, executive director of the Global Financial Markets Center at Duke University, said in an interview. An unknown number of the estimated 19,000 types of cryptocurrencies currently in circulation could also be involved.
The immediate consequences for crypto exchanges are less certain, said Reiners. He said it’s likely exchanges are nervously reading through the SEC’s complaint, looking at what’s currently listed on their platforms, and comparing that to how the SEC views the nine digital assets in question.
Reiners said he doesn’t see the SEC filing complaints against exchanges until a court weighs whether the tokens in question are actually securities.
“They will wait and then, if the court agrees with them, at that point exchanges will of course be forced to register themselves,” Reiners said. “To me, it may be a longer process to get to a desired outcome, but I think in the case of the SEC, it’s a surefire way to get to the desired outcome, which is to bring crypto exchanges into the realm of securities regulation .”
In the insider trading case, the agency accused 32-year-old Seattle resident Ishan Wahi of giving his brother and a friend clues as to which cryptocurrencies to trade on the platform to allow them to benefit from a price jump, according to a complaint to the Filed in US District Court for the Western District of Washington. The Justice Department also filed charges against all three for wire fraud.
Crypto supporters have criticized the SEC’s approach, calling it regulation through enforcement. Critics have warned that crypto is riddled with scams and is hurting retail investors. Last year, SEC Chairman Gary Gensler said that most cryptocurrencies are investment contracts and therefore securities. Crypto exchanges also likely trade securities and should be regulated, Gensler said.
Reiners said the SEC’s move finally corroborates what Gensler has been saying for some time.
“So that’s kind of like the SEC doing the talking,” he said.
Teresa Goody Guillén, a partner at BakerHostetler and a former SEC litigator, agreed that the agency appears to be bearing Gensler’s words.
“Through this case, the SEC has shown its willingness to venture into uncharted waters — it’s unclear whether these cryptoassets are even securities, and they’ll also have to extend an insider trading theory to the facts,” Guillén said in one E-mail. The agency’s approach to enforcing crypto assets is becoming more aggressive, she added.
If the case goes to court, the SEC will need to prove that at least one of those underlying assets is a security, and precedent from this portion of the litigation could provide more certainty about when digital assets are securities, Guillén said.
“The shockwaves this case has created and the attention it is receiving could lead Congress and other regulators to take action to make the crypto space more secure,” she said.
The agency has declared crypto to be securities in the past. In 2020, the SEC alleged that Ripple Labs Inc., a San Francisco-based technology company, and two of its executives raised over $1.3 billion through an unregistered securities offering of digital assets known as XRP.
But this case is on a different basis than the Coinbase insider trading lawsuit, said Christopher LaVigne, a partner on the litigation team at the law firm Withers.
“The SEC may have marginalized the issuers of these digital assets, and the SEC obtained a strategic advantage to secure a potential backdoor ruling that numerous digital assets listed on the Coinbase exchange are securities ‘ La Vigne said.
He did not want to predict how the lawsuit will end. It is possible that the SEC will prevail and obtain a federal court ruling that the underlying assets are securities.
“If they do that, they can then use that as a premise to, say, sue the issuers of the underlying assets directly…they already have a head start on this hypothetical potential future lawsuit because they already have the judgment in their hands,” he said he.
Backers of some of the cryptocurrencies flagged as securities in the SEC’s insider trading complaint have already responded. Monty Metzger, founder of crypto token LCX, said on Twitter that regulation is good for the crypto industry, although doing it through enforcement is not the right strategy. He argued that LCX is a utility token that can be used to pay fees related to the services offered by the company.
The SEC declined to comment beyond previously released documents. When called with reporters, officials said the agency would not confirm any further investigations or whether it is pursuing proceedings against the operators of the nine tokens or Coinbase.
However, Bloomberg News reported on July 25 that Coinbase is facing an SEC investigation into whether it unlawfully allowed people to trade digital assets that should have been registered as securities, citing three people familiar with the matter.
Coinbase declined to comment, but the company’s chief legal officer, Paul Grewal, said the exchange has confidence in its process.
“We are confident that our rigorous due diligence process — a process that the SEC has already reviewed — keeps securities off our platform, and we look forward to working with the SEC on this matter,” Grewal said in an email Explanation.
Shortly after the SEC’s indictments, Grewal said in a statement that Coinbase “disagreed 100 percent” with the SEC’s decision to pursue securities fraud charges, stressing that none of the cryptocurrencies in question were securities.
Coinbase also announced that it has filed a petition asking the SEC to start regulating digital assets.
“Crypto assets, which are securities, need an updated rulebook to guide safe and efficient practices,” said Faryar Shirzad, the company’s chief policy officer, in a post on Coinbase’s website. “Crypto assets that are not securities need reassurance that they are outside of these rules.”
The industry has some regulators on its side. Caroline Pham, Commissioner of the Commodity Futures Trading Commission, in a rare cross-agency commentary, called the SEC’s enforcement action a “striking example of ‘regulation through enforcement'” and said it could have far-reaching implications.
The CFTC declined to comment on whether it plans to take enforcement action of its own against the three defendants in the Coinbase case.
Bartlett Naylor, a fiscal policy advocate at consumer advocacy organization Public Citizen, supported the SEC’s move.
“Ideally, Washington regulators will continue to track down and locate any bad guys, which unfortunately can be a significant percentage of the people who work in this industry,” Naylor said.
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