In June alone, two of the largest cryptocurrency platforms were sued by the Securities and Exchange Commission (SEC). Binance, the world’s biggest exchange, and Coinbase, the only publicly listed exchange in the U.S. were booked for violating securities laws, and accused of operating securities exchanges and selling digital assets that it says should have been registered. The recent cases brought up the question on everyone’s mind yet again: Are digital assets securities or not?
The crackdown could dramatically transform a market that has largely operated outside of regulation. If successful, the lawsuits could transform the crypto market by asserting the SEC’s jurisdiction over the industry, which for years has argued that tokens do not constitute securities and should not be regulated by the SEC.
In a recent webinar hosted by Berkeley Law Executive Education, Assistant Dean Adam Sterling was joined by Emily Flitter of The New York Times to discuss the SEC’s lawsuits. A brief panel discussion followed with Berkeley Law Professors Robert Bartlett, Stavros Gadinis and Jai Massari.
In its suit against Binance, the SEC also accuses its chief executive, Changpeng Zhao, of civil fraud, while its case against Coinbase does not claim fraud or name the company’s chief executive, Brian Armstrong, as a defendant.
“The difference between the Binance case and Coinbase case is that this can be taken as an SEC attempt to bring Coinbase into a regulatory regime,” said Flitter. “It doesn’t label Coinbase as a bad actor through the details of the complaint in the same way that it labels Binance as a bad actor in summation in the details of the complaint.”
“We are now in a world where thousands of coins are sort of out there; the horses have been out of the barn,” said Bartlett. “And the SEC is asking, how do you get them back into the barn? And the solution is to go after the exchanges.”
“At its core, the lawsuit hinges on whether any one of these tokens are a security,” said Massari. “Really simply put, if there aren’t any securities here, the SEC just doesn’t have jurisdiction and that will be the core of all the legal arguments involved.”
Dean Sterling asked Stavros if he were a judge in the Southern District of New York, what would be top of mind for him. “Something that’s fascinating to me is the emphasis that the SEC puts on semantics and how Coinbase actually looks like an exchange and expects the same kind of service, the same type of safeguards to apply, and yet it isn’t an exchange,” Stavros said. “So, there’s an element of smokescreen that the SEC is trying to create. I would be very concerned about the possibility of people losing a lot of money. If I were the judge on this case, I would be very concerned. Do I approve it and then it collapses on my hands? I wouldn’t want to be in that position.”
The SEC’s decision on the matter may come down to the Howey Test, which is used to determine whether an asset is a security or not. The test refers to the U.S. Supreme Court case for determining whether a transaction qualifies as an “investment contract,” and therefore would be considered a security and subject to disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934. The test consists of four elements often referred to as prongs. According to the test, a transaction is a security if it is:
- An investment of money,
- In a common enterprise,
- With the expectation of profit, or
- To be derived from the efforts of others.
Stavros continued, “What I believe we’re seeing is that the SEC has a strong hand and they’re playing it because if they are able to mark a win, they will have a much stronger position in how to design the regulatory regime that’s going to follow.”
“The inevitable outcome here would be that Congress would have to come up with some regime that strikes a compromise where you have sufficient investor protections in place but also permitting innovation with regard to digital assets,” added Bartlett.
After the charges were filed, Coinbase’s CEO Armstrong responded on Twitter, pointing out that the SEC reviewed and permitted Coinbase to become a publicly traded company in 2021, thus rejecting the idea that the company was operating without oversight.
“This is a little bit of a funny policy position,” added Massari. “It’s a bit strange for the agency to let through the IPO of a company where it then later views its entire business illegal.”
Why is this story relevant now? The general consensus was that the crypto market has shrunk since the implosion of FTX and it’s meaningful now because this is the SEC’s opportunity to draw a line between the past when crypto was a Wild West kind of space and the future which Chairman Gary Gensler and the SEC enforcement division see as a place where crypto is regulated like any other financial industry area.
