SEC CONTINUES PUSH AGAINST CRYPTOCURRENCY PLATFORMS’ “UNREGISTERED SECURITIES” DESPITE INDUSTRY PUSHBACK

 

 

Josh Sherman

The U.S. Securities and Exchange Commission continues to push forward in the face of industry resistance and legal uncertainty with enforcement actions against cryptocurrency exchange platforms for allegedly offering unregistered securities. Earlier this month, the SEC filed its opposition to Kraken’s motion to dismiss in one such action, while Coinbase moved to certify an interlocutory appeal of the court’s denial of its motion to dismiss in another. A common thread running through these cases is whether the purchase and sale of cryptocurrency assets counts as an “investment contract” under the Supreme Court’s 1946 decision in Howey. The Securities Exchange Act of 1934 says that “securities” under the SEC’s purview include “investment contracts,” which the Supreme Court in Howey defined as “contract[s], transaction[s], or scheme[s] whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” Applying the Howey test to cryptocurrency exchanges, courts have come up with different answers.

Kraken

On April 9, 2024, the SEC filed its response to Kraken’s February 22 motion to dismiss, in case number 3:23-cv-06003 in the Northern District of California, which the SEC initiated against Kraken in November of last year. In its motion, Kraken argues that the exchanges of certain cryptocurrency tokens on its platforms cannot constitute “investment contracts,” because the SEC has not plausibly alleged (1) the existence of any contracts, (2) post-sale obligations owed by digital asset issuers to Kraken customers, (3) investments in a common enterprise, (4) participation in a common enterprise, or (5) reasonable expectations of profits based solely on issuers’ efforts. In its response, the SEC argues that it has plausibly alleged the last three facts and that it need not allege the first two, calling Kraken’s contrary position a “perversion” of Howey. The motion is set to be heard on June 12.

Coinbase

On April 12, Coinbase moved to certify an interlocutory appeal of the denial of its motion to dismiss, in case number 1:23-cv-05738 in the Southern District of New York, which the SEC initiated against Coinbase in June of last year. The parties’ arguments at the motion to dismiss stage in the Coinbase action largely mirrored those in the Kraken one, and the court sided with the SEC.

Coinbase’s motion highlights that the Southern District itself has split over how Howey applies in the cryptocurrency context. In July 2023, in the SEC’s action against Ripple Labs in case number 1:20-cv-10832, the court issued a summary judgment ruling finding that Ripple’s token was not a security itself; that it was a security when it was sold directly to institutional investors; and that it was not a security when it was sold on public exchanges, used as payment for services, or used to compensate employees. But later that month, another court in the Southern District denied Terraform Labs’ motion to dismiss the SEC’s case against it, in case number 1:23-cv-01346, finding that the SEC had plausibly alleged Terraform offered “unregistered investment-contract securities” under Howey.

Coinbase’s motion also points out that in the SEC’s failed attempt to appeal the summary judgment ruling in its case against Ripple, the SEC argued that the “investment contract” question was purely legal, as Coinbase does in its motion.

The SEC has not yet responded to Coinbase’s motion. But last month, it offered as supplemental authority the court’s decision in SEC v. Wahi et al., case number 2:22-cv-01009 in the Western District of Washington, where the court entered a default judgment against Sameer Ramani, an associate of a former Coinbase manager. In its ruling, the court found that Ramani engaged in insider trading of securities based on the purchase and sale of cryptocurrency assets. Coinbase responded with its own letter to the court the next day—pointing out, among other issues, that the court in Wahi concluded that the cryptocurrency assets themselves constituted “investment contracts,” despite the SEC’s position in its action against Coinbase that the assets themselves are not securities.

Meanwhile, Coinbase reinvigorated its efforts to force the SEC to engage in rulemaking to support its cryptocurrency-related enforcement actions in case number 23-3202 in the Third Circuit. Coinbase’s previous such attempt—which it initiated in July 2022 prior to the SEC’s enforcement action against it—languished in December of last year, after the SEC responded with a two-page letter disagreeing with Coinbase’s position that the existing legal landscape of federal securities laws is “unworkable” as applied to cryptocurrency exchanges. Coinbase filed its brief in support of its new petition on March 11, and the SEC’s response is due May 10.

Takeaways

Since June 2023, the SEC has anchored down in its position that it has regulatory and enforcement authority over cryptocurrency exchanges, predominantly under the theory that buying and selling certain cryptocurrency assets constitutes “investment contracts” as defined by the Supreme Court in Howey. While industry stakeholders seek more clarity, the SEC seems reluctant to formally engage in rulemaking that would further solidify its stances. Decisions in the SEC’s actions against Kraken and Coinbase, among others, may shed more light on the legal landscape.