SEC’s Coinbase Insider Trading Charges Resurrects Crypto Securities Specter in “Regulation by Enforcement”

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Overview

The Securities and Exchange Commission (SEC), the US federal securities regulator charged a former product manager for Coinbase, his brother, and a friend with insider trading of 9 alleged crypto securities last week. 

In the case SEC vs Wahi, the three men Ishan Wahi, Nikhil Wahi, and Ramani are accused of breaking the securities laws’ anti-fraud provisions in the SEC’s complaint, which was submitted to the federal district court in Seattle, Washington. The defendants have since plt guilty to the charges.

The trio allegedly orchestrated an illegal scheme to trade ahead of several crypto announcements and listings that would be made available for trading on the Coinbase platform, netting them over $1 million in the process. 

The charges sent shockwaves through the crypto industry, not only for the tarnishing it brings to the reputation of Coinbase, but also for the revelation that the SEC still considers certain cryptocurrencies to be securities and therefore subject to securities law, yet are not actively engaging the crypto industry on their selection process. It is currently rumored that the SEC is planning to charge Coinbase for the listing of these deemed crypto securities as well. 

Coinbase bounced back this week with a big announcement of a well-received strategic partnership with investment giant Blackrock, the world’s largest asset manager with nearly $10 trillion in assets under its control.

Coinbase insider trading: what happened?

Who Is Ishan Wahi Coinbase Manager? Arrest And Charges
Former Coinbase manager Ishan Wahi (pimico.com)

According to the SEC’s complaint, Ishan Wahi assisted in organizing Coinbase’s public listing announcements, which contained insider information about the crypto assets or tokens that would be made available for trading. 

The SEC’s complaint claims that Coinbase considered such information as secret and issued warnings to its staff members not to use it as the basis for trading or to tip off third parties. Ishan frequently revealed to his brother Nikhil Wahi and his friend Sameer Ramani the timing and details of impending listing announcements, however, in violation of his obligations, from at least June 2021 to April 2022. 

The brothers allegedly bought at least 25 crypto assets, nine of which were securities according to the SEC, ahead of those disclosures, which frequently led to a spike in the assets’ prices, and typically sold them for a profit immediately after the announcements. The extensive insider trading scheme resulted in ill-gotten gains of more than $1.1 million.

According to Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, “We are not concerned with labels; rather, the economic reality of an offering.” 

SEC considers 9 Coinbase-listed crypto assets to be securities

These facts, in this case, confirm that some of the in question crypto assets were securities and that, as alleged, the defendants engaged in conventional insider trading prior to the crypto assets’ publication on Coinbase. 

The nine assets in question are AMP (AMP), Rally (RLY), DerivaDEX (DDX), XYO (XYO), Rari Governance Token (RGT), LCX (LCX), Powerledger (POWR), DFX Finance (DFX), and Kromatika (KROM). Coinbase competitor Binance.US, no stranger to the whims of the SEC, subsequently delisted some of the assets on this list.

Carolyn M. Welshhans, acting chief of the Enforcement Division’s Crypto Assets and Cyber Unit, stated the following: 

“In almost a year, the defendants collectively earned over $1.1 million in illegal profits by engaging in an alleged insider trading scheme that repeatedly used material, nonpublic information to trade ahead of Coinbase listing announcements.” 

“As today’s case indicates, we will uphold our mandate by identifying and combating insider trading in securities wherever we see it, whether in shares, options, crypto assets, or other securities,” the statement reads.

Coinbase response asks for improved rulemaking on crypto securities

Coinbase CEO Brian Armstrong tweeted soon after the charges that the company had in fact identified the criminal activity themselves and reported the culprits to authorities.

Coinbase has since responded with a blog post which revealed the company had lodged a petition with the SEC to improve “rulemaking on digital asset securities and included the following statement:

“Our petition calls on the SEC to develop a workable regulatory framework for digital asset securities guided by formal procedures and a public notice-and-comment process, rather than through arbitrary enforcement or guidance developed behind closed doors.”

When does the SEC deem certain cryptocurrencies a security?

The SEC defines a security according to the Howey Test which stems from the Securities Act of 1933 and provided the following motivation in their statement:

“A digital token or crypto asset is a crypto asset security if it meets the definition of a security, which the Securities Act defines to include ‘investment contract,’ i.e., if it constitutes an investment of money in a common enterprise, with a reasonable expectation of profit derived from the efforts of others.”

Essentially, a security is created under US law when a person invests in an asset with the expectation that they’ll generate a profit based on the work of the founders. This outdated interpretation can reasonably be applied to a large number of crypto asset projects, where the founders and developers play an integral part in getting the project off the ground before it eventually matures enough to be handed over to a decentralized autonomous organization (DAO) for governance.

In practice, however, as we’ve seen with projects like UniSwap during its V3 release, founding teams continue to wield a lot of influence and dictate decisions often as they see fit.

Is SEC Chairman Gensler going after crypto securities?

The SEC in previous years has maintained that neither Bitcoin nor Ethereum are securities, however, with Biden’s regime-changing administration, this has become a new point of concern under incumbent chairman Gary Gensler’s tenure. Gensler currently believes that only Bitcoin is definitely not a security, and is not forthcoming with a clear answer when asked about Ethereum

Gensler last month delivered an ominous speech that alluded to the fact that DeFi platforms might in fact be trading securities. This spells future troubles for crypto trading platforms:

Furthermore, these platforms likely are trading securities. A typical trading platform has dozens of tokens on it, at least. In fact, many have well in excess of 100 tokens. As I’ll address later, many of the tokens trading on these platforms may well meet the definition of “securities.” While each token’s legal status depends on its own facts and circumstances, given the Commission’s experience with various tokens that are securities, and with so many tokens trading, the probability is quite remote that any given platform has zero securities.

SEC securities charges puts it once again at odds with CFTC

The SEC’s securities claims once again put it in the crosshairs of the much-smaller Commodities and Futures Trading Commission (CFTC), seen by many as the only rightful crypto regulator of crypto assets in the US. The stakes are incredibly high for both agencies to stay involved in crypto regulation, in order to remain relevant and get the necessary funding.

CFTC commissioner calls SEC case “regulation by enforcement”

CFTC commissioner Caroline Pham soon expressed her concerns in a statement on Twitter, lamenting the case as “regulation by enforcement”, its negative fallout, and asking for better cooperation between the two federal agencies.

Conclusion

The SEC’s charges against insider trading at Coinbase should certainly be welcomed by both crypto regulation advocates and opponents, as insider trading is an insidious form of market manipulation that is certainly not victim-free. However, the problem arises with its increasing efforts to wrest regulatory oversight away from other more suitable federal agencies such as the CFTC.

It does this by flip-flopping over the status of certain crypto assets and whether they are in fact not commodities but rather securities. Yes, there are in fact thousands of fledgling Ponzi-esque cryptocurrencies operating as securities if we use the Howey Test’s definition as a yardstick, and many of them should be regulated as well as possible. However, not delivering clear legislation on this continues to put the US crypto industry in a regulatory no-mans land.

This regulatory limbo has been criticized by the likes of the Wall Street Journal and certainly seems to stifle crypto asset innovation in the US, a country that should rightfully remain at the forefront of the blockchain revolution and reap the rewards of it. As long as this indecision remains and threatens the long-term legal status of crypto projects, expect projects to continue to seek greener pastures across the pond in friendlier jurisdictions such as Singapore and Dubai. 

This article was written by Werner Vermaak for educational purposes only, and shouldn’t be deemed financial advice in any form.

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