SEC v. Wahi could boost class action lawsuits for crypto shareholders

In late July, the US Securities and Exchange Commission filed charges against a former executive at Coinbase – the largest trading platform for cryptoassets in the US. The charges are the latest move in the agency’s efforts to regulate cryptocurrency, and could spur a surge in cryptocurrency-related securities litigation.

IN SEC v. Wahi, et. eel, the SEC alleged that the former manager, Ishan Wahi, improperly provided, or “tipped off,” material non-public information about the timing and content of Coinbase’s “listing announcements” to his brother and a close friend. These individuals allegedly used the information to trade ahead of several listing announcements and make at least $1.1 million.

According to the SEC, the insider trading scheme involved at least 25 different types of crypto assets. But because insider trading charges under Section 10(b) and Rule 10b-5 can only be brought “in connection with the purchase or sale of securities,” the SEC specifically alleged that nine of the cryptoassets traded were securities. Its claims track guidance in the SEC’s 2019 release, “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which stated that to determine whether a digital asset is a security, it must be analyzed under the test first laid out in SEC v. WJ Howey Co .328 US 293 (1946). Under Howey test, an “investment contract” exists when there is an investment of money, in a joint venture, with a reasonable expectation of profit to be derived from the efforts of others. Since the first two prongs are usually satisfied in an offer and sale of a digital asset because the asset is purchased or otherwise acquired in exchange for value as part of a “joint venture”, the main question in analyzing a digital asset is whether a buyer has a reasonable expectation of profit (or other financial return) arising from the efforts of others. Thus, i Wow Complaint, used SEC Howey test for each of the nine cryptoassets – focusing much of the analysis on whether investors had a reasonable expectation of profit based on the efforts of others.

The SEC’s decision to file this complaint brings uncertainty to Coinbase and other crypto-asset trading platforms. Although the complaint indicates that the SEC considers some, but not all, cryptoassets to be securities, the agency has not laid out a clear set of rules aside from the use of Howey test. The 2019 guidance provided some information, but it specifically noted that it represented only the views of the SEC Strategic Hub for Innovation and Financial Technology, and was not an official rule, regulation, or statement of the Commission. And Coinbase itself is reportedly facing its own SEC investigation into whether it listed digital assets that should have been registered as securities.

In response to Wow charges, Coinbase published a blog post arguing that none of the assets on its platform are securities and that it “filed a rulemaking petition with the SEC asking for actual rulemaking so that the crypto-securities market has a chance to develop.” Ishan Wahi’s lawyer also released a statement rejecting the SEC’s allegations, saying that “prosecutors are trying to criminalize innocent behavior because they are looking for a scapegoat because so many people have lost money in Cryptocurrency recently.”

Other regulators have responded to the SEC’s action in kind. In a public statement issued the same day Wow charges were announced, a commissioner of the Commodity Futures Trading Commission issued a statement criticizing Wow as a “striking example of ‘regulation by enforcement'” and argues that big questions like whether cryptoassets are subject to the securities laws should instead be addressed through the public notice and comment rulemaking process. And in the Justice Department’s parallel criminal action against the same three people, it brought wire fraud, but not securities fraud, charges — perhaps sidestepping any legal question about whether the assets are securities. After Wahi’s brother, Nikhil, pleaded guilty on September 12, Assistant US Attorney Noah Solowiejczyk stated that whether cryptocurrency is a security is not relevant to the wire fraud charges: “It is not part of the offense to which the defendant pleads guilty . . , and for that reason, Defendants’ decision to settle this case with a claim of wire fraud should not be construed as a statement as to whether these cryptoassets at issue were in fact securities or whether Defendants needed to know that they were securities.”

Even absent further guidance, however, the SEC’s efforts to regulate certain cryptoassets as securities will likely encourage private plaintiffs. According to a recent report, the number of cryptocurrency-related securities class action filings in 2022 so far is on pace to exceed the totals for 2021. Three of those filings specifically include allegations related to cryptocurrency securitization. In one example earlier this month, a plaintiff shareholder filed a securities class action lawsuit against Coinbase, alleging, among other things, that the company allowed individuals to trade digital assets that should have been registered with the SEC as securities. How this and other actions against cryptocurrency providers proceed will likely be affected by the outcome of Wow Procedure, litigation.