SEC Alleges Violation ‘On the Fly,’ Crypto Exchange Coinbase Says

The US Securities and Exchange Commission (SEC) is making decisions on alleged legal violations “on the fly,” crypto exchange Coinbase ( COIN ) said Thursday.

The San Francisco-headquartered platform pushed back against the SEC in a filing this month, made public for the first time Thursday, in response to a Wells notice — a formal warning from the SEC that the enforcement division found sufficient evidence of wrongdoing that it can recommend a case against the stock exchange.

Much of Coinbase’s argument rests on the idea that publicly traded cryptocurrencies are not securities — a stark contrast to claims made by SEC Chairman Gary Gensler, who has repeatedly stated that, in his view, the majority of digital assets actually meet the standards of a security under federal law. Other arguments outlined in the document say that while certain digital assets listed on the exchange are securities, Coinbase’s own products do not meet the standards for violating securities laws.

The SEC warned Coinbase that it could sue last month when it filed the notice. The SEC said that in its view, Coinbase’s staking service, Prime and Wallet products, along with the general listing process, may all violate federal securities law.

In a video shared earlier on Thursday, Gensler reiterated his view that crypto intermediaries must register as regulated entities in the US, saying: “Crypto markets suffer from a lack of regulatory compliance. It’s not a lack of regulatory clarity.”

“An investment contract exists when you invest money in a joint venture with a reasonable expectation of profit from the efforts of others. Intermediaries of investment contracts, whether exchanges, brokers, dealers, clearing houses, must comply with securities laws and register with the Securities and Exchange Commission, » he said. “Instead, many crypto platforms just pretend that these investment contracts they offer are more like goldfish,” using a pet analogy.

In its response, which was filed April 19 with the regulator, Coinbase said it had “repeatedly” answered questions from SEC staff about how it determined whether listed assets were securities or not. The exchange also pushed back against SEC claims that it simultaneously operated a national securities exchange, brokerage and clearinghouse.

“The threat of pending litigation appears intended to pressure Coinbase into accepting demands that the commission simply does not have the authority to order; namely, that Coinbase (i) agrees that virtually all digital assets listed on Coinbase’s platform are securities; and (ii) revise the entire business model for registering as an NSE [national securities exchange] and clearing agency, potentially requiring Coinbase to divest its entire client-facing business and overhaul its public company governance structure to comply with the limits of concentrated voting control by NSEs and clearing agencies,” the exchange claimed. “None of these goals are supported by law or within the limits of the commission’s authority.”

As part of the response, Coinbase created a video with CEO Brian Armstrong and General Counsel Paul Grewal talking through the history of the exchange.

Grewal told CoinDesk that representatives from the exchange had met with officials from the SEC after filing the response. Any SEC enforcement would need a majority of the five commissioners to vote in favor. The advantage of a Wells response is that those commissioners will have both the Enforcement Division’s argument and the company’s response when deciding how to vote, he said.

“Our sense is that they remain unconvinced at the staff level,” he said. “We are fully preparing for litigation, just to be very clear, and have been for some time. I always remain optimistic that cooler heads will prevail, but you shouldn’t be under any illusion that we have any hope that the SEC will somehow change its mind.”

Coinbase already owns both a broker-dealer and an alternative trading system, but needs approval from the SEC and the Financial Industry Regulatory Authority (FINRA) to operate them, the company said. It also said it had 45 money transmitter licenses, a New York BitLicense and a designated contract market.

The exchange has also asked the SEC a number of questions, including about the asset listing process, the Wallet product and betting services. The SEC has now alleged that all three of these types of products may violate securities laws, the exchange said.

“A chronology of just some of Coinbase’s efforts to engage with the Commission over four years spans eight pages and is attached as Appendix A. This list includes dozens of instances in which Coinbase sought clarity from the Commission on when registration might be required for digital assets companies, and if so how to conduct such registration, including with respect to its dormant broker-dealer and ATS, the filing said.

According to the filing, Coinbase provided information in response to questions from SEC staff about all three of these types of products, but “staff did not raise any concerns during” meetings about the products.

The exchange also argued that it did not receive “fair notice” from the regulator of enforcement action, and repeatedly argued in the document that “one media statement by a member of the commission is not policy guidelines.”

“We’ve seen the SEC change its position on what assets qualify as securities. You have statements from the chairman himself dating back to his time at MIT where he states that 75% of the assets were not a security. Even after he became chairman he said he that he believed there was no registration framework in place and was willing to cooperate with Congress, Grewal said.

Coinbase’s filing argued that the SEC could issue additional regulations to clarify how it views digital assets as securities.

“If the Commission wishes to consider how issuer disclosure, brokerage, custody, clearing and related issues may operate in the digital asset securities markets, Coinbase remains available to discuss these issues — and is committed to doing so — at any time,” the filing said . “These issues need not, and should not, be dealt with in a court of law.”