Coinbase (NASDAQ: COIN) took a major legal hit last week as a federal judge confirmed that trades of some digital assets on the exchange are indeed securities transactions.
On March 1, U.S. District Judge Tana Lin in the Western District of Washington at Seattle issued a ruling in the case of Sameer Ramani, one of three individuals charged with insider trading in July 2022. Ramani, former Coinbase product manager Ishan Wahi, and Wahi’s brother Nikhil Wahi were accused of using Ishan’s advance knowledge of token listings on Coinbase to conduct trades that generated over $1.1 million in illegal profits.
Hit with charges both criminal (U.S. Attorney’s Office for the Southern District of New York) and civil (U.S. Securities and Exchange Commission), the Wahi brothers eventually pleaded guilty to wire fraud conspiracy, resulting in Ishan getting two years in prison in May 2023 while Nikhil was sentenced to 10 months that January.
But Ramani managed to flee the U.S. before the authorities could detain him, prompting the SEC to seek a default judgment against the absent defendant. Judge Lin ruled Friday that the SEC had met the necessary standards for default judgment against Ramani, but another aspect of Lin’s ruling is making headlines.
The SEC sought Lin’s agreement that Ramani’s misconduct was in connection with the purchase or sale of a security. The SEC’s case against the insider trio listed nine digital assets—AMP, RLY, DDX, XYO, RGT, LCX, POWR, DFX, and KROM—that the regulator insisted were securities that were never registered with the SEC, making Coinbase’s offering of them to the public a violations of securities law.
The legal standard for identifying a security is the Howey Test, which involves four planks; the product involves an investment of money, in a common enterprise, with an expectation of profits, predominantly from the efforts of others.
Lin found that the tokens traded by Ramani met all the Howey criteria. Moreover, “the Court’s analysis remains the same even to the extent Ramani traded tokens on the secondary market.”
Citing the ruling in SEC V NAC Foundation (the company behind the initial coin offering of the ABTC token), Lin found that the “promotional statements and managerial promises” made by the token issuers in the Ramani case “apply equally to tokens that an investor may have bought from the issuer directly or from another investor, including on a crypto asset trading platform.” As such, “Ramani’s illicit trading was accordingly in connection with the purchase or sale of a security.”
Ripple effect
The SEC wasted little time in leveraging its victory, writing a letter to New York District Judge Katherine Polk Failla—who is hearing the SEC’s complaint against Coinbase for failing to register as an exchange, broker-dealer, and clearing agency—alerting her to Lin’s ruling.
The SEC added that “[n]otably, in briefs supporting the Wahis’ motion to dismiss, certain defendants and Coinbase as amicus curiae argued that secondary market trades in crypto assets cannot involve investment contracts because there needs to be an asset sale ‘coupled with legally binding promises by the seller.’”
There have been two previous digital asset rulings by federal judges regarding the security issue over the past nine months. Last July, U.S. District Judge Analisa Torres said Ripple’s
so-called ‘programmatic’ aka secondary sales of its XRP token on exchanges to retail customers didn’t violate securities laws. However, this view was rubbished shortly thereafter by U.S. District Judge Jed Rakoff ahead of his ruling in the SEC’s suit v. Terraform Labs and its former CEO, Do Kwon.
Coinbase’s chief legal officer Paul Grewal tweeted on March 3 that he didn’t “think much of” Lin’s ruling, noting that “[d]efault judgments aren’t contested … [s]o the judge literally has the SEC on one side and no one on the other.” Grewal claimed that “the SEC was pushing against a completely open door” and default judgments “are not worth anything as precedent or persuasion.”
Grewal’s reaction was understandable, given how greatly Coinbase’s business model relies on tokens similar to those in the SEC’s complaint against Ramani. Alt-coins accounted for 42% of Coinbase’s transaction volume and 57% of transaction revenue in Q4 2023, up from 28% and 44%, respectively, in Q3. Recall that Q4 was Coinbase’s first profitable quarter in two years, so the idea that Coinbase’s future is utterly dependent on shitcoin hype is undeniable.
Coinbase filed its own notice to Judge Polk Failla on March 5, largely repeating Grewal’s tweets in more legalistic phrasing. The notice said Lin’s ruling “was procured against an empty…
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