Summary Overview of SEC’s Lawsuit Against Coinbase
Overview of SEC Lawsuit Against Coinbase
Source: US Securities and Exchange Commission Translation: Blocking
Summary
1. Coinbase provides buying and trading services for cryptocurrency assets to US customers through its trading platform (“Coinbase Platform”). Coinbase’s assets include cryptocurrency securities. Coinbase is the largest cryptocurrency asset trading platform in the United States and has provided services to more than 108 million customers. It trades billions of dollars of cryptocurrency assets every day among hundreds of cryptocurrencies. The Coinbase platform combines the three functions of brokers, exchanges, and clearing institutions, which are usually separated in traditional securities markets. However, Coinbase has never registered with the US Securities and Exchange Commission (SEC) as a broker, a national securities exchange, or a clearing institution, thus avoiding the disclosure system established by Congress for our securities markets. At the same time, Coinbase charges transaction fees from investors who have been deprived of registration, which brings disclosure and protection, and therefore earns billions of dollars in revenue.
2. The US Congress enacted the Securities Exchange Act of 1934 (“Exchange Act”), partly to regulate the national securities market. Congress authorized the SEC to protect investors, maintain fair and orderly markets, and promote capital formation through a series of registration, disclosure, recordkeeping, inspection, and anti-conflict of interest provisions. These provisions led to the separation of key functions in the securities market, including those performed by brokers, exchanges, and clearing institutions, partly to protect investors and their assets from the effects of conflicts of interest that may arise from the consolidation of these functions.
3. Since at least 2019, Coinbase has been operating in the following roles through the Coinbase platform: unregistered brokers, including soliciting potential investors, processing customer funds and assets, and charging transaction-based fees; unregistered exchanges, including providing a market venue, which includes aggregating and matching and executing cryptocurrency asset orders from multiple buyers and sellers; unregistered clearing institutions, including holding customer assets in wallets controlled by Coinbase and settling customer transactions through debits and credits to related accounts. By consolidating these functions into a single platform, and by not registering with the SEC for any of these three functions and not meeting any applicable registration exemption conditions, Coinbase has ignored regulatory structures for years and evaded the disclosure requirements established by Congress and the SEC to protect the national securities market and investors.
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4. In addition, during the same period, Coinbase also operated as an unregistered broker through two other services it offered to investors, Coinbase Prime (“Prime”) and Coinbase Wallet (“Wallet”). Coinbase positioned the Prime market as the “chief broker of digital assets,” routing cryptocurrency asset orders to the Coinbase platform or third-party platforms; Wallet routed orders through third-party cryptocurrency asset trading platforms to obtain liquidity outside of the Coinbase platform.
5. Although the cryptographic asset securities that Coinbase provides for trading on Coinbase platforms, Prime, and Wallet place Coinbase’s operations squarely within the regulatory purview of the securities laws, Coinbase has never submitted a registration application to the SEC as a broker-dealer, exchange, or clearing agency. Coinbase’s parent company, CGI, as Coinbase’s controller, has also violated the same trading regulations as Coinbase.
6. Over the years, Coinbase has made deliberate business decisions to enable the trading of cryptographic assets to increase its own revenue, primarily from customer trading fees, even though these assets had characteristics of securities when offered and sold. Since 2016, Coinbase has understood the relevant tests for determining whether cryptographic assets are investment contracts subject to securities law regulation, as explicated by the Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and subsequent cases. As part of its public marketing efforts, Coinbase has for years touted its efforts to analyze cryptographic assets under the Howey test before offering trading according to standards. However, despite verbal representations of a desire to comply with applicable law, Coinbase has for years offered cryptographic assets for trading that constitute investment contracts under established principles of Howey tests and federal securities law, and Coinbase has subordinated its interest in increasing profits to the interests of investors, legal and regulatory frameworks designed to protect investors and the U.S. capital markets.
7. Further, since 2019, Coinbase has engaged in the unregistered offer and sale of securities through its cryptographic asset staking program (“Staking Program”). The program allows investors to earn financial returns through Coinbase’s management efforts for certain blockchain protocols. Through the Staking Program, investors’ cryptographic assets are transferred and pooled (separated by asset), and Coinbase then “stakes” (or commits) them for rewards, distributing the rewards to investors proportionally after paying itself 25-35% commission. Investors understand that Coinbase will make efforts and use its expertise and professionalism to generate returns. Staking Program includes five cryptographic assets that can be staked, and the application of Staking Program to each asset is an investment contract and therefore a security. However, Coinbase has never submitted a registration statement to the SEC regarding the issuance and sale of its Staking Program, depriving investors of their right to obtain important information about the program, harming investors’ interests, and violating registration provisions of the 1933 Securities Act.
What laws did Coinbase violate?
8. By engaging in the conduct described in this litigation, Coinbase operated as an exchange, broker, and clearing agency without being registered as an exchange, broker, or clearing agency, in violation of Sections 5, 15(a), and 17A(b)(1) of the Exchange Act [15 U.S.C. §§ 78e, 78o(a), and 78q-1(b)(1)]. With respect to Coinbase’s violations of the Exchange Act, CGI violated Section 20(a) of the Exchange Act [15 U.S.C. § 78t(a)] as Coinbase’s controlling person. Additionally, Coinbase offered and sold securities through its Staking Program without registering the offers and sales of such securities, in violation of Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. §§ 77e(a) and 77e(c)].
9. Defendants are reasonably likely to continue to engage in the conduct, practices, transactions, and business activities described in this litigation, as well as similar types and purposes of conduct, practices, transactions, and business activities, in violation of the federal securities laws unless permanently enjoined.
