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  • J Huang and M Bacina

SEC sought to squash US crypto with Coinbase delisting "request"

Coinbase CEO Brian Armstrong has said the US Securities and Exchange Commission (SEC) asked Coinbase to stop trading all cryptocurrencies except Bitcoin, just before the SEC commenced legal proceedings against the cryptocurrency exchange in June.

Mr Armstrong reportedly told the Financial Times that the SEC made the "recommendation" before launching sweeping legal action against the Nasdaq-listed Coinbase in June for breaching US securities law, including failure to register as a broker and as a national securities exchange. Coinbase responded to the SEC's complaints by pointing out that it has long sought regulatory clarify from the SEC and that it had formally lodged a request for rule-making.

The SEC’s case specifically identified a dozen, mostly lightly traded, crypto-assets traded on Coinbase’s platform, calling them securities under US law and asserting that by offering them to customers the exchange fell under the regulator’s jurisdiction.

But the prior "request" for Coinbase to delist every one of the more than 200 tokens on the exchange - with the exception of Bitcoin - indicates that the SEC's chair Gary Gensler, has pushed for even wider authority over the industry, and the position aligns with Mr Gensler's prior comments that he believes all crypto-assets are securities under US law.

Armstrong told the Financial Times:

They came back to us, and they said . . . we believe every asset other than bitcoin is a security...And, we said, well how are you coming to that conclusion, because that’s not our interpretation of the law. And they said, we’re not going to explain it to you, you need to delist every asset other than bitcoin.

This request by the SEC would have set a chilling precedent and essentially shuttered Coinbase's business, as well as sending a message to the vast majority of US cryptocurrency exchanges that the SEC considered they were operating illegally unless they have registered with the SEC. This could be a "catch-22", because even if the exchanges want to register with the SEC, there is no clear guidance as to how, and no exchange (other than Prometheum, which has no trading or assets live) has been able to register to date.

Mr. Armstrong said delisting all cryptocurrency except Bitcoin would have sounded the death knell for the industry in the US:

We really didn’t have a choice at that point, delisting every asset other than bitcoin, which by the way is not what the law says, would have essentially meant the end of the crypto industry in the US

And that the SEC left Coinbase with no options but to go to court:

It kind of made it an easy choice . . . let’s go to court and find out what the court says.

So far, the SEC and the US Commodity Futures Trading Commission (CFTC) are jostling for jurisdiction over the crypto industry. The CFTC sued Binance - the world's largest crypto exchange - and its founder CZ early this year. Three months later, the SEC launched its own legal action against Binance. Gensler has previously said he believes most cryptocurrencies, with the exception of Bitcoin, are securities under US law.

This arises from the so-called "embodiment theory" under which, if an "investment contract" is offered in connection with the sale of tokens, most often seen by the issue of a Simple Agreement for Future Tokens, the SEC considers those "Future Tokens" to be securities, whereas the entire crypto industry considers the "Future Tokens" to be a property delivered to the investor who entered into the SAFT, and the SAFT itself is the only securities offering which has been made. Put another way, in the famous Howey decision, investing in orange groves via contract was found to be a kind of securities transaction under US law, but of course the oranges grown in the orange groves were not securities, because they were just oranges. Similarly Courts around the world have been recognising crypto-assets as a kind of property and not in and of themselves (but of course depending on individual facts and circumstances) to be securities, most recently in the Ripple decision.

Coinbase and the SEC have been entangled in a series of legal disputes including:

  • In July 2022, Coinbase applied for clarity and rulemaking to the SEC;

  • The same month the SEC issued Coinbase a Wells Notice indicating that it is considering enforcement action against the exchange;

  • In May 2023, the SEC was ordered by the court to explain its failure to respond to a 2022 petition for rulemaking by Coinbase;

  • In June 2023, the SEC filed sweeping legal actions against Coinbase for alleged breaches of securities law;

  • Following the SEC's complaint, the court made a rare decision urgently ordering the SEC to respond to Coinbase's previous petition; and

  • On 13 June 2023, the SEC responded to the order saying that it was considering the petition and needed 120 days to reply.

The SEC's request to Coinbase signals that the SEC has long positioned itself as giving a very broad interpretation of the definition of "securities" under US law as it pursues a regulation by enforcement campaign.

However, the SEC said its enforcement division did not make formal requests for:

companies to delist crypto assets

and added

In the course of an investigation, the staff may share its own view as to what conduct may raise questions for the commission under the securities laws

This latest instalment of the SEC vs Coinbase (and the whole crypto industry) again highlights the importance of swift and clear regulatory clarity with meaningful and achieveable pathways to compliance which can only be provided by the legislature. While Australia has largely avoided a broad regulation-by-enforcement, there has been ongoing delays in legislation for even basic custody and licensing rules to apply to digital currency exchanges.

Without clarity, users are exposed to the risks of exchanges which don't properly segregate assets or meet a minimum required standard, increasing the likelihood of further losses in avoidable collapses in future.


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