By Matthew Goldstein, Ephrat Livni and Emily Flitter
In an intensifying effort to end what the authorities see as the era of lawlessness in the cryptocurrency market, the Securities and Exchange Commission earlier this week sued Coinbase, the largest crypto trading platform in the United States, claiming that the company broke the law by not registering as a broker.
The SEC, the nation’s top securities regulator, filed the lawsuit a day after it accused Binance, the world’s biggest cryptocurrency trading exchange, of mishandling customer funds and lying to American regulators and investors about its operations.
With these federal actions against major crypto companies, along with other lawsuits at the state level, regulators have sought to reshape the crypto sector by treating digital asset exchanges like more traditional financial firms, while pushing out individuals and companies that they view as bad actors.
In its filing on Tuesday, the SEC detailed the ways in which Coinbase’s leaders had demonstrated that they knew how the marketing and sale of digital assets should be governed under U.S. laws, even while failing to follow them.
“Coinbase has elevated its interest in increasing its profits over investors’ interests, and over compliance with the law and the regulatory framework that governs the securities markets and was created to protect investors and the U.S. capital markets,” the filing said.
Coinbase went public in April 2021, an event seen as a milestone in crypto’s march into the mainstream. The company handled $830 billion worth of trades last year, with nearly 9 million users making at least one trade per month.
The SEC said Coinbase had made billions easing the sale of crypto assets but deprived investors of significant protections. Its complaint, filed in federal court in Manhattan, claims that the company operated as an unregistered exchange even though it told investors in going public that regulators might deem some of the products traded on its platform to be securities.
Coinbase has argued that its business model got tacit approval from the SEC when the agency approved its initial public offering. The company has said it is willing to work with the SEC but does not agree with its position that all digital assets offered on its trading platform must be registered securities, which require more strict oversight.
The action is consistent with the SEC’s long-held view that most crypto products are no different from stocks, bonds and other securities. That means the firms that operate as exchanges and provide a platform for trading and selling crypto products must be registered like any exchange or brokerage that facilitates stock or bond trading.
“You simply can’t ignore the rules because you don’t like them or because you’d prefer different ones: the consequences for the investing public are far too great,” Gurbir S. Grewal, the director of the SEC’s enforcement division, said in a statement.
Executives in the crypto industry, which has reveled in challenging the rules and operating outside the heavily regulated confines of the mainstream finance industry, have often argued that digital assets are different and that many of the rules for stocks should not apply.
“The SEC’s reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America’s economic competitiveness,” Coinbase’s chief legal officer, Paul Grewal, said in a statement about the suit.
“The solution is legislation that allows fair rules for the road to be developed transparently and applied equally, not litigation,” added Grewal, who is not related to the SEC enforcement officer.
“The message here is that regulatory clarity already exists when it comes to exchanges and broker dealers,” said John Reed Stark, a former SEC enforcement lawyer and regulatory consultant.
Adding to Coinbase’s legal troubles, securities regulators in 10 states, including Alabama, California, Illinois and New Jersey, filed their own actions on Tuesday seeking to stop the company from selling unregistered securities to investors in their states.
The state regulators said Coinbase must first register to offer those products in their states. Some states, like New Jersey, imposed fines on the company.
The SEC suit and the actions by state regulators against Coinbase touched on a crucial issue that many in the crypto industry have said Congress must address: whether digital asset products are securities or something totally different.
The SEC has said the test to determine whether a crypto product should be treated like a security is derived from a 1946 Supreme Court case that led to what is known as the Howey test. The SEC chair, Gary Gensler, has often said that this standard is clear and that no new laws are needed to determine whether a digital asset is a security. The industry, however, has begged to differ.
The suit, long anticipated by Coinbase, comes as its executives and others in the crypto industry hope to shift the narrative about digital assets. Grewal of Coinbase testified before a House committee on Tuesday about a draft bill regulating crypto. Coinbase has said it welcomes regulation, and wants to cooperate with the SEC.
The SEC lawsuit is the latest enforcement in a multiyear crackdown on the crypto market by the regulator, which has picked up steam after the collapse of the FTX cryptocurrency exchange in November and criminal charges against its founder, Sam Bankman-Fried.
The lawsuit against Coinbase notably did not include an allegation of fraud, like the complaint against Binance, or a request for a preliminary injunction against the company. The SEC on Monday also sued Binance’s founder and CEO, Changpeng Zhao. On Tuesday, it did not similarly sue Coinbase’s CEO, Brian Armstrong.
The SEC took another step on Tuesday that differentiated its cases against Binance from the one against Coinbase. In a new filing, the agency asked the court to freeze assets related to U.S.-based customers of Binance, whose headquarters are outside the United States, and move any such assets back to the United States, arguing that a quick freeze was necessary “given the defendants’ years of violative conduct, disregard of the laws of the United States, evasion of regulatory oversight, and open questions about various financial transfers and the custody and control of customer assets.”
In the filing, the SEC also asked the court to cut off any access Binance and its senior leaders might have to assets of its U.S. customers. The filing contained a summary of bank account information related to Binance’s U.S. business, which showed that the company had multiple accounts at Axos Bank, a San Diego-based lender, along with an account at the shuttered bank Silvergate.
Coinbase, unlike Binance, does not issue its own crypto tokens, and the company has argued that its status as a publicly listed company ensured that it followed strict rules about its operations.