SEC Charges Crypto Exchange Coinbase with Registration Failures | Practical Law

SEC Charges Crypto Exchange Coinbase with Registration Failures | Practical Law

The SEC filed a complaint in the US District Court for the Southern District of New York (SDNY) charging major crypto exchange Coinbase with operating an unregistered national securities exchange, broker-dealer, and clearing agency. The SEC also charged Coinbase with failing to register the offer and sale of its crypto-asset staking-as-a-service program.

SEC Charges Crypto Exchange Coinbase with Registration Failures

Practical Law Legal Update w-039-7204 (Approx. 9 pages)

SEC Charges Crypto Exchange Coinbase with Registration Failures

by Practical Law Finance
Published on 07 Jun 2023 • USA (National/Federal)
The SEC filed a complaint in the US District Court for the Southern District of New York (SDNY) charging major crypto exchange Coinbase with operating an unregistered national securities exchange, broker-dealer, and clearing agency. The SEC also charged Coinbase with failing to register the offer and sale of its crypto-asset staking-as-a-service program.
On June 6, 2023, the SEC filed a complaint in the US District Court for the Southern District of New York (SDNY) charging crypto exchange Coinbase, Inc. (Coinbase) and Coinbase Global, Inc. (CGI and, collectively with Coinbase, defendants) with operating the Coinbase crypto-asset trading platform (Coinbase platform) as an unregistered national securities exchange, broker-dealer, and clearing agency. The SEC also charged Coinbase with failing to register the offer and sale of its crypto asset staking-as-a-service program called Coinbase Earn.
The Coinbase lawsuit is the SEC's second action initiated in two days against a major crypto exchange, following its June 5, 2023 action filed against Binance, the world's largest cryptocurrency exchange, and its founder Changpeng Zhao (see Legal Update, SEC Charges Crypto Trading Platform Binance and Its CEO with Violation of US Securities Laws).
The SEC's Coinbase complaint alleges that defendants violated certain registration provisions of the Securities Exchange Act of 1934 (Exchange Act) and that Coinbase violated the securities offering registration provisions of the Securities Act of 1933 (Securities Act) by:
According to the complaint, since at least 2019, Coinbase has unlawfully facilitated the buying and selling of crypto-asset securities by operating as a middleman on crypto transactions, while evading disclosure requirements meant to protect investors.
The SEC seeks injunctive relief, disgorgement of ill-gotten gains plus interest, penalties, and other equitable relief.

Registration Failures

The SEC alleges that Coinbase, through the Coinbase platform, intertwines the traditional functions and services of an exchange, broker-dealer, and clearing agency without registering in any such capacity with the SEC as required under US securities laws. According to the complaint, through the Coinbase platform, Coinbase has operated in those three functions as an unregistered:
  • Broker, by soliciting potential investors, handling customer funds and assets, and charging transaction-based fees, as well as effecting securities transactions for the accounts of Coinbase customers in violation of Exchange Act Section 15(a) (15 U.S.C. § 78o(a)).
  • Exchange, by providing a marketplace that, among other things, brings together orders of multiple buyers and sellers of crypto assets and matches and executes those orders through established, non-discretionary methods under which such orders interact, without registering as a national securities exchange in violation of Exchange Act Section 6 (15 U.S.C. § 78f) absent an applicable exemption.
  • Clearing agency, by holding customer assets in Coinbase-controlled wallets and settling its customers’ transactions by debiting and crediting the relevant accounts in violation of Section 17A(b) of the Exchange Act and:
    • providing facilities for comparison of data on the terms of settlement of crypto-asset securities transactions;
    • serving as an intermediary in settling transactions in crypto-asset securities by Coinbase customers; and
    • acting as a securities depository.
    (15 U.S.C. § 78q-1(b)).
In addition, the SEC complaint alleges that since 2019, Coinbase has operated as an unregistered broker through two other services it has offered to investors:
  • Coinbase Prime, which Coinbase markets as a "prime broker for digital assets" that routes orders for crypto assets to the Coinbase platform or to third-party platforms.
  • Coinbase Wallet, which routes orders through third-party crypto asset trading platforms to access liquidity outside the Coinbase platform.
  • For purposes of prevailing on the Exchange Act claims, the SEC alleges that it need only establish that Coinbase has engaged in activities relating to a single crypto-asset security during since 2019. Nevertheless, the SEC sets out additional details regarding what it characterizes as a non-exhaustive list of the following 13 crypto-asset securities available through Coinbase:
    • The native token of the Solana blockchain created by Solana Labs, Inc. (SOL).
    • The native token of the Cardano blockchain (ADA).
    • The native token of the Polygon blockchain, originally called the Matic Network (MATIC).
    • The native crypto asset of the Filecoin network created by Protocol Labs, Inc. (FIL).
    • The native token of the Sandbox platform created by Pixowl, Inc. on the Ethereum blockchain (SAND).
    • The Ethereum blockchain tokens that are native to the Axie Infinity (Axie) game as Axie Infinity Shards (AXS).
    • The Ethereum blockchain tokens for the Chiliz sports & entertainment ecosystem built on the Chiliz blockchain (CHZ).
    • The native token for the Flow blockchain developed and eventually launched by Dapper Labs (FLOW).
    • The native token of the Internet Computer Protocol, a blockchain-based protocol conceived by Swiss not-for-profit DFINITY Foundation (ICP).
    • The native token of the NEAR blockchain protocol, a proof-of-stake blockchain conceived by Near, Inc. (NEAR).
    • The native token of the crypto-asset platform Voyager owned and operated by Voyager Digital, LLC (VGX).
    • The native token of the Dash blockchain used for financial transactions on the Dash platform (DASH).
    • The native or “exchange” token for the Nexo platform, a crypto-asset trading and lending platform created by Nexo Capital, Inc. (NEXO).
The SEC alleges that 12 of these are available on the Coinbase platform (and through Prime and Wallet) and one available only via Wallet (NEXO). This list has already begun to function as a guideline for other crypto-asset platforms, certain of which have begun to de-list certain of these tokens in the context of the SEC assertion in the Coinbase complaint that they are crypto-asset securities under the US securities laws.
Through these services, the SEC alleges that Coinbase acts as an unregistered exchange, broker or clearing agency in violation of Sections 5, 15(a), and 17A(b) of the Exchange Act (15 U.S.C. §§ 78e, 78o(a), and 78q-1(b)(1)).
As alleged in the SEC’s complaint, Coinbase’s failure to register with the SEC for these services has deprived investors of significant protections, including inspection by the SEC, recordkeeping requirements, and safeguards against conflicts of interest, among other compliance deficiencies. The SEC’s complaint also alleges that Coinbase’s holding company, CGI, is a control person of Coinbase under Exchange Act Section 20(a) (15 U.S.C. § 78t(a)) and is therefore also liable for certain of Coinbase’s securities law violations.

Unregistered Offer and Sale of Crypto-Asset Securities

The SEC alleges that, since 2019, Coinbase has been engaging in unregistered securities offerings through its staking-as-a-service program called Coinbase Earn (Coinbase staking program), which allows customers to generate crypto profits from the proof-of-stake mechanisms of certain blockchains. The SEC alleges the Coinbase staking program pools customers’ stakeable crypto assets, stakes the pool to perform blockchain transaction validation services, and provides a portion of the rewards generated from this work to its customers whose assets were part of the pool.
The SEC alleges the Coinbase staking program currently enables investors to stake five different assets – XTZ (Tezos), ATOM (Cosmos), ETH (Ethereum), ADA (Cardano), and SOL (Solana). According to the complaint, Coinbase failed to register offers and sales of the Coinbase staking program as required under Sections 5(a) and 5(c) of the Securities Act (15 U.S.C. §§ 77e(a) and 77e(c)).

Related Actions

The SEC notes in connection with the Coinbase complaint that ten US states led by California have also accused Coinbase of state securities law violations concerning its staking rewards program. On June 6, 2023, the California Department Of Financial Protection And Innovation (DFPI) announced that it has issued an action against Coinbase Global, Inc. and Coinbase, Inc. for violations of state securities laws and corresponding state penalties in connection with Coinbase’s staking rewards program
On April 24, 2023 Coinbase filed a petition for writ of mandamus to the SEC in the US Court of Appeals for the Third Circuit in an effort to compel the SEC to act on Coinbase’s previous rulemaking petition filed on July 21, 2022 to create new rules for digital assets and provide clarity for the crypto industry. In that ongoing action, on May 15, 2023, the SEC filed a brief in opposition and on May 22, 2023Coinbase filed a reply (see Legal Update, Updated: Coinbase Files Mandamus Action to Compel SEC to Write Crypto Regulations).
Earlier this year, the SEC issued a Wells notice to Coinbase regarding Coinbase Earn as well as Coinbase Prime and Coinbase Wallet (see Legal Update, Coinbase Receives SEC Wells Notice for Crypto Products).
For further information on SEC regulation of crypto-asset securities, see Practice Note, SEC Regulation of Digital Assets: FinHub Framework for Analyzing Offer and Sale of Digital Assets.
Update: On August 4, 2023, defendants filed a memorandum of law in support of their motion to dismiss the SEC complaint. In the pleading, defendants assert that the SEC exceeded its delegated authority in regulating digital assets (major questions doctrine), violated due process, abused its discretion, and abandoned its earlier interpretations of the securities laws.
Defendants' position has been supported by amicus curiae briefs, filed on August 11, 2023, by:
  • US Senator Cynthia M. Lummis (R-WY). The Lummis brief indicates the SEC enforcement action against defendants is premature and the result of overreach, as regulation of the crypto industry is being considered by Congress.
  • Andreessen Horowitz and Paradigm Operations LP. Andreessen Horowitz, a venture capital firm, and Paradigm Operations LP, an investment firm, assert in their brief that the SEC's unjustified expansion of its authority and the arbitrariness of its actions threaten to disrupt markets and inhibit the development of the blockchain industry.
Note that, on August 16, 2023, Coinbase Global announced in a blog that its subsidiary Coinbase Financial Markets, Inc. received approval from the National Futures Association (NFA) to operate as a futures commission merchant (FCM) and offer eligible US customers access to crypto futures contracts (see Legal Update, Coinbase Receives Approval to Operate as Futures Commission Merchant (FCM)).