Ex-Coinbase Manager Tests Whether SEC Crypto Reach Is a ‘Big’ Question

The Securities and Exchange Commission will grapple with the question of whether regulation of a crypto-token is a “major” problem, seeking an answer that could help define how the controversial products are controlled.

The agency has sued Ishan Wahi, a former Coinbase manager, and his brother for alleged insider trading involving tokens listed on Coinbase’s platform.

The SEC says it has jurisdiction because several tokens are securities. But the defendants argue that regulating digital tokens is a big problem. The SEC’s power grab violates the “big questions doctrine” that says an agency can’t make a major policy without clear statutory authorization, they say.

Last week, the Wahi brothers asked a judge in the US District Court for the Western District of Washington to dismiss the SEC’s suit.

SEC v. Wahi promises to be closely watched, as it is the first case to directly ask a judge to weigh the main issue doctrine in a crypto case. If Wahis’ arguments were to gain traction in the courts, the extent of the SEC’s existing ability to monitor the massive crypto markets could become clearer.

“If the court agrees with the defendants here and grants the motion to dismiss, this will be one of the first cases of this magnitude,” Rutgers Law School professor Yuliya Guseva said. “It will have broad implications in future cases.”

Ishan Wahi pleaded guilty last week to criminal fraud charges brought by the Department of Justice in connection with the scheme. His brother, Nikhil Wahi, was sentenced in January to 10 months in prison for his role.

The DOJ “did its job in holding this individual accountable,” Coinbase’s legal director, attorney Paul Grewal, wrote in a LinkedIn post following Ishan Wahi’s plea. Still, “egregious personal conduct should not result in egregious regulatory overreach that violates the law,” Grewal wrote.

Big problem

The “major issue doctrine” requires clear authorization from Congress if an agency wants to decide a matter of major importance. The Supreme Court agreed with the doctrine i West Virginia v. Environmental Protection Agencya decision from 2022 involving a regulation to curb emissions from power plants.

“The Supreme Court has made quite clear that it does not believe Congress is giving sweeping authority over big issues that hide in ambiguous text or a footnote,” said Jenner & Block LLP attorney Kayvan Sadeghi.

There are two branches to the main question doctrine. A court first considers whether the agency claims authority over a matter of “great economic and political importance.” It then considers whether Congress clearly authorized the agency’s action.

The question of how to regulate crypto tokens is arguably a “big” question, lawyers and academics say.

It is a $1 trillion industry that has attracted investment from millions of people. In March 2022, President Biden asked federal agencies to coordinate an approach to the crypto markets.

Congress has been considering crypto-related legislation, and lawmakers held hearings following the stunning collapse of bankrupt FTX Trading Ltd., the defunct cryptocurrency exchange and hedge fund.

“This is clearly an important issue of our time,” said Florida International University College of Law Professor Jerry Markham.

Power to act

The more difficult question for the Washington court may be whether Congress has already clearly authorized the SEC to regulate digital assets.

Securities laws give the SEC the power to regulate “investment contracts,” and the SEC has taken the position that most crypto tokens fall under that category.

The Wahi brothers argue that the agency is twisting the term and using it in a new way that “massively” expands the agency’s power.

“It is difficult to conceive of a more archetypal violation of the Major Questions Doctrine than the SEC’s assertion of authority over digital assets,” the brothers wrote as part of a motion to dismiss filed last week.

To determine whether something is an investment contract, courts and regulators use a test derived from a 1946 Supreme Court decision, SEC v. WJ Howey. While that is a flexible test, there is no indication that Congress intended “investment contract” to be a catch-all phrase, the nonprofit law firm Investor Choice Advocates Network said in an amicus brief filed Monday supporting Wahis.

“The SEC nonetheless claims — as the EPA impermissibly did — to have discovered ‘an unknown power’ that would transform and vastly expand its regulatory authority,” ICAN wrote.

Critics of the SEC’s approach say the agency is getting it wrong Howey test. That test is designed to look at transactions — not objects like crypto tokens, lawyers and academics have argued.

Howey involved land sales with promises to manage orange groves. Courts have also found investment contracts in cases where breeders sold beavers promising to raise them for fur, or when chinchillas were sold with an agreement to buy back the babies.

“But that doesn’t give you the right to control the entire secondary market for oranges and beavers and chinchillas and tokens,” Sadeghi said.

By jumping from an analysis of the transaction to a conclusion about the tokens, the SEC is overstepping the bounds of the law and triggering the principal issue doctrine, Sadeghi said.

Some of the crypto-related bills Congress has considered were aimed at clarifying that the SEC lacks jurisdiction over large swathes of digital assets, the Wahi brothers said. This underscores that the SEC is exceeding its authorization from Congress, they say.

A lawyer for Wahis declined to comment.

No change in the law

The SEC has stepped up enforcement efforts in the crypto space, and has already won a handful of court rulings.

The Wow The case is unique because it directly calls into question the distinction between transactions and tokens, lawyers said.

Republican SEC Commissioner Hester Peirce acknowledged the difference when she said in a speech last month that the SEC’s reference to crypto-tokens as securities involves an “imprecise application of the law.” The agency likely needs “more, or at least more clearly delineated, statutory authority to regulate certain crypto-tokens,” Peirce said.

Nevertheless, some legal scholars are skeptical that the “big questions doctrine” fits in this context.

West Virginia v. EPA involved a new rule limiting greenhouse gas emissions from power plants, which was estimated to have billions of dollars in compliance costs. Here, what is being challenged is the SEC’s application of long-standing Supreme Court precedent.

“The problem with applying that doctrine to the SEC is that they haven’t made any rules,” said University of Arkansas law professor Carol Goforth. “They didn’t change the law right away.”

The case is Securities and Exchange Commission v. Wahi et al, WD Wash., No. 22-cv-01009.