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It was inevitable: the U.S. Securities and Exchange Commission (SEC) has just announced charges against Coinbase (NASDAQ: COIN) over its listing of digital asset securities.
Today we charged Coinbase, Inc. with operating its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency and for failing to register the offer and sale of its crypto asset staking-as-a-service program.https://t.co/XPG2gDkxtV pic.twitter.com/hCdVMw8B2v
— U.S. Securities and Exchange Commission (@SECGov) June 6, 2023
The charges are similar to those announced against Binance on Monday. They accuse Coinbase of operating as an unregistered securities exchange, broker, and clearing agency in violation of the Exchange Act and the Securities Act.
“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,” reads the filing.
The suit outlines that Coinbase has had a long-standing mechanism for assessing coins that were candidates for listing, including collecting information that seemed to concern the Howey test for determining if a given asset offering is an investment contract and, therefore, a security. It also points out that Coinbase proceeded to list assets that it had identified as high-risk.
“In other words, to realize exponential growth of the Coinbase Platform and boost its own trading profits, Coinbase made the strategic business decision to add crypto assets to the Coinbase Platform, even where it recognized the crypto assets had the characteristics of securities.”
Additionally, the charges point to Coinbase’s staking program, which allows investors to earn returns from digital assets pledged to Coinbase “through Coinbase’s managerial efforts with respect to certain blockchain protocols.”
“The Staking Program includes five stakeable crypto assets, and the Staking Program as it applies to each of these five assets is an investment contract, and therefore a security. Yet, Coinbase has never filed a registration statement filed or in effect with the SEC for its offers and sales of its Staking program, thereby depriving investors of material information about the program, undermining investors’ interests, and violating the registration provisions of the Securities Act of 1933.”
Birds of a feather flock together
The most notable difference between yesterday’s Binance charges and those brought today against Coinbase is that the latter’s executive team is largely left out of the SEC’s gripes.
For Binance, founder Changpeng Zhao was a named defendant in the SEC charges. The legal basis for this exists in the Securities Exchange Act, which imposes liability upon any person who controls a person or entity liable under the Act. Changpeng Zhao was considered the control person over the Binance group and is thus personally liable for their violations.
In Coinbase’s case, the SEC considers the “person in control” as Coinbase Global, the exchange’s global entity. The suit notes that executive Brian Armstrong is CEO of the local Coinbase entity and Coinbase Global but stops short of naming him as a defendant.
Part of the reason for this discrepancy may arise out of the sheer volume of evidence demonstrating Changpeng Zhao’s wilful non-compliance with U.S. laws, as hinted at by the SEC in their tweet announcing those charges:
Today we charged Binance Holdings Ltd. (Binance); U.S.-based affiliate, BAM Trading Services Inc., which, together with Binance, operates https://t.co/swcxioZKVP; and their founder, Changpeng Zhao, with a variety of securities law violations.https://t.co/H1wgGgR5ir pic.twitter.com/IWTb7Et86H
— U.S. Securities and Exchange Commission (@SECGov) June 5, 2023
The Binance charges outline—at length—the ‘calculated evasion’ of U.S. securities laws by Binance, including the establishment of ‘sham controls’ and a Potemkin-like U.S. entity to draw regulatory heat away from Binance’s primary entities.
Though the SEC charges attack Coinbase for listing assets it knew had a high risk of amounting to securities under U.S. law, they are not quite as damning as the allegations made against Binance—although spectators will no doubt be salivating at what internal communications might similarly spill out of Coinbase in discovery.
There are other differences between the two sets of charges. Coinbase is a publicly traded company, meaning the SEC had a little more to say about the group’s liability over its listing of digital asset securities.
“As part of its effort to become a public company, CGI publicly filed with the SEC Form S-1…. In its form S-1, CGI acknowledged the risks that the crypto assets Coinbase makes available for trading could be deemed securities and thus that Coinbase could be found to be engaging in unregistered brokerage, exchange, and/or clearing-agency activity.”
Additionally, though there’s a lot of overlap, the “non-exhaustive” list of securities provided in the SEC charges against Coinbase is slightly different and more expansive than the one included in its charges against Binance. In the Coinbase suit, they are SOL, ADA, MATIC, FIL, SAND, AXS, CHZ, FLOW, ICP, NEAR, VGX, DASH, and NEXO. The Binance charges also included SOL, ADA, MATIC, FIL, and AXS, but not the other coins, despite all also being listed on Binance.
Why the SEC cites a different (though largely the same) set of coins in both sets of charges isn’t obvious, it emphasizes in both filings that the list of securities being traded by the defendants are not exhaustive. The message from the SEC seems to be that you could pick out any 10 assets listed by these exchanges and be nearly-guaranteed to come back with a list of 10 securities.
They can’t say they weren’t warned
The charges are hardly a surprise, especially for Coinbase. Coinbase was the target of a SEC Wells Notice back in March, which warned the exchange of imminent legal action over its violation of federal securities laws in connection with “aspects of the Company’s spot market, staking service Coinbase Earn, Coinbase Prime and Coinbase Wallet” products.
Coinbase’s response was to pen a blog post decrying the SEC’s action, insisting that “the bottom line remains: Coinbase does not list securities or offer products to our customers that are securities” and claiming that the company has “a rigorous process to analyze and review each digital asset before making it available on our exchange.”
Given that the SEC’s charges highlight that Coinbase listed digital assets regardless of their ‘high risk’ designation, it seems the Commission was unimpressed by Coinbase’s excuses.
As for the likely consequences of the SEC’s charges for Coinbase, these are two-fold.
First are the direct remedies being sought by the SEC in court. The SEC is asking that the court restricts the defendants and all of their employees from further violations of the Securities Act or the Exchange Act, as well as full disgorgement of all ill-gotten gains arising from their violations of both acts.
The SEC also asks for civil penalties under both the Exchange Act and the Securities Act. These penalties are fixed amounts of up to $500,000 for each violation but can be set to the amount of financial gain resulting from each violation in cases of fraud, manipulation, or ‘deliberate or reckless disregard of a regulatory requirement.’
However, beyond the direct penalties likely to be levied as a part of this action, success by the SEC here means eradicating Coinbase’s most significant revenue streams. After the Binance charges were announced, Berenberg analyst Mark Palmer wrote that a similar action against Coinbase would put ‘at least’ 37% of their net revenue at risk.
In a statement released alongside the charges, Gurbir S. Grewal, director of the SEC’s division of enforcement, said: “You simply can’t ignore the rules because you don’t like them or because you’d prefer different ones: the consequences for the investing public are far too great.”
“As alleged in our complaint, Coinbase was fully aware of the applicability of the federal securities laws to its business activities but deliberately refused to follow them. While Coinbase’s calculated decisions may have allowed it to earn billions, it’s done so at the expense of investors by depriving them of the protections to which they are entitled.”
Coinbase receives show-cause order from ten state regulators
The SEC charges are substantial in and of themselves, but they might ultimately be most notable for the parallel enforcement actions they enable.
This has already started: simultaneously with the SEC’s filing of charges, 10 state securities regulators issued Coinbase with Show Cause orders, demanding that the company show cause why they should not be required to cease and desist from selling unregistered securities (in the form of Coinbase’s staking program) in those states. The states, according to an announcement by the Alabama Securities Commission, are Alabama, California, Illinois, Kentucky, Maryland, New Jersey, South Carolina, Vermont, Washington, and Wisconsin.
“The ASC is committed to protecting Alabama consumers and investors, including those who choose to invest in the decentralized finance space. This action is another step toward ensuring that investors in crypto asset products are offered the same protections under our laws and are fully aware of the risks involved in these investments,” said ASC director Amanda Senn.
Indeed, we’re less than two days into the week, and the two largest exchanges by market cap have been hit with existential charges by the SEC. Who knows what else is around the corner?
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