Tuesday (June 6, 2023) morning, the Securities and Exchange Commission filed a lawsuit against cryptocurrency exchange Coinbase in federal court in New York, stating that it was operating as an unregistered broker and exchange and requesting that it be “permanently restrained and enjoined” from doing so.
Shares closed down 12% Tuesday. Coinbase stock had already fallen 9% on Monday, after the SEC unveiled charges against rival crypto exchange Binance and its founder Changpeng Zhao.
“These trading platforms, they call themselves exchanges, are commingling a number of functions,” SEC chair Gary Gensler said on CNBC Tuesday. “We don’t see the New York Stock Exchange operating a hedge fund,” Gensler continued.
The agency said in its lawsuit that Coinbase’s flagship prime brokerage, exchange, and staking operations break securities rules. The company “has for years defied the regulatory structures and evaded the disclosure requirements” of U.S. securities law.
The SEC has alleged that at least 13 crypto assets available to Coinbase customers were considered “crypto asset securities” by the regulator. Those assets include Solana’s SOL token, Cardano’s token and Protocol Labs’ Filecoin token.
The SEC’s reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America’s economic competitiveness and companies like Coinbase that have a demonstrated commitment to compliance.
Paul Grewal
“We allege that Coinbase, despite being subject to the securities laws, commingled and unlawfully offered exchange, broker-dealer, and clearinghouse functions,” Gensler said in a statement.
“The SEC’s reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America’s economic competitiveness and companies like Coinbase that have a demonstrated commitment to compliance,” Coinbase chief legal officer Paul Grewal told CNBC in a statement.
“The solution is legislation that allows fair rules for the road to be developed transparently and applied equally, not litigation. In the meantime, we’ll continue to operate our business as usual.”
Coinbase’s institutional service, Prime, its retail exchange product, and its self-custody Wallet service all offered one or more crypto asset security, the SEC said in its complaint.
Coinbase’s staking program was also identified as a investment contract and as an unregistered security: The SEC had already taken similar action to force the closure of crypto exchange Kraken’s staking service.
The SEC described the staking program as a way for “investors to earn financial returns through Coinbase’s managerial efforts.” The SEC says the five “stakeable crypto assets” are considered securities under its interpretation of the law, an assessment that will no doubt be disputed by Coinbase.
The exchange had already received a Wells notice from the regulator earlier this year, a letter notifying a company when SEC action is pending. Coinbase had mounted a vigorous defense of its offerings, publicly litigating with the regulator and preparing for potential action with advertising campaigns and publicity.
The business has been named by many in the cryptocurrency sector as the only one having the financial and institutional resources to square off against the SEC and Gensler. The business has a polished image and has long promoted itself as a safer, more regulated alternative to other exchanges.
But that same advertising has formed part of the SEC’s arguments against the exchange. Regulators alleged that the exchange actively solicits new clients, noting that “Coinbase expends hundreds of millions of dollars a year on marketing and sales to maintain and recruit new investors.”
Solicitation is one of the aspects the SEC uses to determine whether a company is operating as a broker or an exchange.
Another test that the SEC relies upon is the Howey test, which is used to determine whether an asset is an investment contract and therefore, a security. An asset is considered a security if it involves a three things: investment in a common enterprise, with the reasonable expectation of returns, through the work of others.
