SEC Is Alleging Legal Violations ‘On the Fly,' Coinbase Says

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The U.S. Securities and Exchange Commission (SEC) is making decisions about alleged legal violations “on the fly,” crypto exchange Coinbase (COIN) said Thursday.

The San Francisco-headquartered platform pushed back against the SEC in a document this month, made public for the first time on Thursday, in responding to a Wells Notice – a formal warning from the SEC that the Enforcement Division found sufficient proof of lawbreaking that it may recommend a lawsuit against the exchange.

Much of Coinbase’s arguments rest on the idea that cryptocurrencies listed on the exchange are not securities – a sharp contrast to claims by SEC Chair Gary Gensler, who has repeatedly stated that, in his view, the majority of digital assets do indeed meet the standards of a security under federal law. Other arguments outlined in the document say that even if certain digital assets listed on the exchange are securities, Coinbase’s own products don’t meet the standards for securities law violations.

The SEC warned Coinbase last month it could sue when it filed the notice. The SEC claims Coinbase’s staking service, Prime and Wallet products, along with its general listing process, may all violate federal securities law.

In a video shared earlier on Thursday, Gensler reiterated his view that crypto intermediaries must register as regulated entities in the U.S. “Crypto markets suffer from a lack of regulatory compliance. It's not a lack of regulatory clarity,” he said.

“An investment contract exists when you invest money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. Intermediaries for investment contracts, whether they're exchanges, brokers, dealers, clearinghouses, they need to comply with the securities laws and register with the Securities and Exchange Commission,” he said. “Instead, many crypto platforms are just pretending that these investment contracts that they offer are more like goldfish,” using an analogy about pets.

In its response, which was filed on April 19 to the regulator, Coinbase said it had “repeatedly” answered SEC staff questions about how it determined whether listed assets were securities or not. The exchange also pushed back against SEC allegations that it was simultaneously operating a national securities exchange, brokerage and clearinghouse.

“The threat of imminent litigation appears to be intended to pressure Coinbase to accept demands that the Commission simply does not have the authority to order; namely, that Coinbase (i) agree that virtually all digital assets listed on Coinbase’s platform are securities; and (ii) overhaul its entire business model to register as an NSE [national securities exchange] and clearing agency, potentially requiring Coinbase to jettison its entire customer-facing business and overhaul its public company governance structure to conform to limits on concentrated voting control of NSEs and clearing agencies,” the exchange argued. “Neither of those objectives is supported by law or within the bounds of the Commission’s authority.”

As part of its response, Coinbase created a video featuring CEO Brian Armstrong and General Counsel Paul Grewal talking through the exchange’s history.

Grewal told CoinDesk that representatives from the exchange had met with officials from the SEC after filing the response. Any SEC enforcement action will need a majority of the five commissioners to vote in favor. The benefit of a Wells response is that these commissioners will have both the Enforcement Division’s argument and the company’s response when they decide how to vote, he said.

“Our sense is they remain unpersuaded at the staff level,” he said. “We're fully preparing for litigation, just to be very clear, and have been doing so for some time. I always remain optimistic that cooler heads will prevail but you should not be under any illusion that we are holding out any hope that somehow the SEC will change its mind.”

Operating licenses
Coinbase already owns both a broker-dealer and alternative trading system (ATS), but needs SEC and Financial Industry Regulatory Authority (FINRA) approval to operate them, the company said. It also said it had 45 money transmitter licenses, a New York BitLicense and a designated contract market.

The exchange has also asked a number of questions of the SEC, including about its asset listing process, the Wallet product and its staking services. The SEC has now alleged that all three of these types of products may be in violation of securities laws, the exchange said.

“A chronology of just some of Coinbase’s efforts to engage with the Commission over four years spans eight pages and is attached as Appendix A. This list includes dozens of instances in which Coinbase sought clarity from the Commission on when registration might be required for digital asset companies and, if so, how to effect such registration, including with respect to its dormant broker-dealer and ATS,” the filing said.

According to the filing, Coinbase provided information in response to SEC staff questions about all three of these types of products, but “the staff raised no concerns during” meetings about the products.

The exchange also argued it did not receive “fair notice” from the regulator about the enforcement action, arguing repeatedly in the document that “one media statement by a member of the Commission is not policy guidance.”

“We’ve seen the SEC shift its position on what assets qualify as securities. You have statements from the chair himself dating back to his time at MIT where he states that 75% of assets was not a security. Even after he became chair he said he believed there was no registration framework in place and was willing to work with Congress,” Grewal said.

Coinbase’s filing argued that the SEC could provide further rulemaking to clarify how it sees digital assets as securities.

“If the Commission wants to consider how issuer disclosure, brokerage, custody, clearing, and related issues can work in the digital asset securities markets, Coinbase remains available to discuss these issues – and is keen to do so – at any time,” the filing said. “These issues need not, and should not, be addressed before a court."