What a Judge Said About the SEC’s Suit Against Coinbase

Between Coinbase, Custodia, Roman Storm and Sam Bankman-Fried, there was a lot of news last week. Let’s get to it.

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Coinbase and Custodia both lost early and preliminary court fights. The Coinbase loss was more or less expected – companies rarely win much on a motion for judgment at such an early stage – but still pretty enlightening.

At some point the cases involving the U.S. Securities and Exchange Commission are going to move to appeals courts and maybe even the U.S. Supreme Court, if they’re not settled first. Until that point, these decisions in the district court are shedding light on how judges view the crypto industry.

Judge Katherine Polk Failla ruled mostly against Coinbase after an initial motion for judgment, dismissing the SEC’s claims about Coinbase Wallet but leaving a substantial part of the complaint intact.

The usual disclaimers apply: This is an initial motion and the judge was bound to accept the SEC’s complaint’s facts as alleged. We also don’t usually see cases fully dismissed at this stage anyway, so the chances of Coinbase succeeding were also pretty slim.

That said, the judge drew a pretty clear roadmap in her 84-page ruling, taking on common industry arguments about whether crypto meets the standards for the major questions doctrine (no), what a cryptocurrency ecosystem means in terms of this kind of litigation (more on this later), whether there needs to be a written contract to satisfy the terms of an “investment contract” as defined in SEC v. Howey (no) and whether some of the assets the SEC named in its complaint are securities (it’s plausible). In her ruling, the judge rejected some of Coinbase’s arguments about how cryptos could be treated in the U.S.

As far as the major questions doctrine goes, Judge Failla agreed with Judge Jed Rakoff, who’s in the same district, in ruling that the crypto industry does not meet the Supreme Court’s standards for what might be a major industry. In doing so, she became the latest judge to say that the SEC is well within its bounds to pursue enforcement actions and regulate crypto, and does not need a Congressional mandate. Failla agreed with Rakoff in other parts of her order as well.

“Contrary to Defendants’ assertions, neither Howey nor its progeny have held that profits to be expected in a common enterprise are limited just to shares in income, profits, or assets of a business,” the judge wrote, also pointing to another Supreme Court decision.

Again citing Rakoff, Failla said a common enterprise would exist if a token issuer used proceeds from a token sale “to further develop the tokens’ broader ‘ecosystem.'”

Judge Failla explicitly rejected an argument that there needs to be a formal contract for an “investment contract” to exist, pushing back against another fairly common argument in these kinds of cases.

“To begin, there need not be a formal contract between transacting parties for an investment contract to exist under Howey,” she wrote. “Indeed, courts in this Circuit have consistently declined invitations by defendants in the cryptocurrency industry to insert a ‘contractually-grounded’ requirement into the Howey analysis.”

Arguments that cryptocurrencies are akin to Beanie Babies or baseball cards fell flat before the judge, as did the suggestion that the SEC could take over jurisdiction on “essentially all investment activity” if a formal contract isn’t needed.

The judge seemed to suggest that any crypto is part of a common enterprise because a token does not exist as an individual product.

“Unlike in the transaction of commodities or collectibles (including the Beanie Babies discussed during the oral argument…), which may be independently consumed or used, a crypto-asset is necessarily intermingled with its digital network – a network without which no token can exist,” she wrote.

The judge also looked at the question of whether Coinbase listed securities, finding that the regulator did plausibly allege that with at least two of them, solana (SOL) and chiliz (CHZ), holders could “reasonably … expect to profit” from Solana Labs or the Chiliz team’s efforts around their respective tokens.

“The parties do not dispute that, to prevail on its claims, the SEC need only establish that at least one of these 13 Crypto-Assets is being offered and sold as a security, and that Coinbase has intermediated transactions relating therewith, such that transacting in that Crypto-Asset would amount to operating an unregistered exchange, broker or clearing agency,” the order said.

The case will now move into the discovery phase, with both parties facing an April deadline to work together on a case management plan. Presumably the case will heat up after that, as the parties argue over who gets what and exchange documents.

This week

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