The Breakdown - Lawyers See Weakness in SEC's Response to Coinbase

Episode Date: July 11, 2023

Late on Friday, the SEC responded to Coinbase's motion to dismiss the SEC's lawsuit against them. In many ways it's just a rehashing of arguments they've previously made, but the crypto legal core doesn't seem impressed with the SEC's arguments (or caselaw precedent).  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Monday, July 10th, and today we are talking about the SEC's latest response to Coinbase. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Well, friends, today we pick up right where we left off at the end of last week, because on Friday afternoon, fairly late, we got this thread dropped from Paul Grewell, the chief legal officer

at Coinbase. He wrote, after Coinbase gave notice of its intent to move to throw out their case, we consented to a few extra days for the SEC to explain why it intends to oppose. They've now filed, and sadly, it's more of the same. They ignore the plain requirement in the Supreme Court's holding in Howie decades ago that an investment contract first and foremost requires enforceable rights against an issuer. It requires more than just an investment of money, et cetera. They ignore their obligation to give due regard to the public interest and investor protection when they allowed us to list publicly over two years ago.

They ignore the statements of their own chair a month later in testimony before Congress that there are no regulatory authorities applicable to cryptocurrency exchanges like us. They ignore the clear and unmistakable warnings of the Supreme Court just last week, against regulatory overreach and major questions reserved to Congress. And on and on it goes ignoring these dispositive points. But apparently, we agree on one thing. Many of these issues can and should be decided promptly as matters of law. So that is what we're going to focus on today, and let's dig into what all is going on here.

So, as you've heard on Friday, the SEC filed a response letter in its lawsuit against Coinbase for violations of securities law. In late June, Coinbase submitted its answer to the complaint, along with a letter seeking permission from the court to file for a motion for judgment on the pleading, essentially that the court should decide the lawsuit on the available material without proceeding further. Coinbase argued that the SEC lacked the jurisdiction to bring the lawsuit, in part because the question of how to regulate crypto is currently under consideration by Congress and should not be preemptively decided by the regulator.

The SEC's letter claimed that the regulator not only has the jurisdiction to bring this enforcement action, but that Coinbase knew it might have been violating securities law. The regulator wrote, Coinbase, a multi-billion-dollar entity advised by a sophisticated legal counsel, argues it was unaware that its conduct risked violating the federal securities laws and suggest that by approving Coinbase's registration statement in 2021, the SEC confirmed the legality of Coinbase's underlying business activities at that time and for all time. End quote. Rejecting Coinbase's argument that the SEC had allowed them to go public without objection, the SEC noted that since becoming a public company, Coinbase has, quote, repeatedly

informed its shareholders of the risk that the crypto assets traded on its platform could be deemed securities and therefore that its conduct could violate the federal securities law. The regulator also points out that Coinbase follows an asset listing procedure, which utilizes the Supreme Court's how we test to ensure the crypto tokens at lists are not securities. They state that Coinbase uses the quote, very legal framework as a basis for making listing decisions that it now claims have no applicability to its activities. According to the SEC, this asset listing process is an implicit acknowledgement that securities law, and therefore the regulator's jurisdiction, could apply to crypto assets. In addition, the regulator draws attention to the fact that Coinbase, quote,

explicitly discourage crypto asset issuers from using problematic statements in their marketing materials that are traditionally associated with securities. Summing up, the SEC states that, quote, these actions clearly show that Coinbase understood that the securities laws could apply to its conduct and knew which rules to consider in evaluating the legality of its conduct, but nevertheless made the calculated decision to take on this risk in the name of growing its business. From there, the SEC moved onto its argument that certain crypto tokens are securities. It claims that Coinbase has put forward to, quote, related and equally flawed arguments. Firstly, that to be considered an investment contract, token offerings must include the formal elements of a contract. And secondly,

that secondary sales of tokens that were issued as investment contract securities could successfully shed that classification if the token issuer plays no part in the transaction. The SEC cites extensive legal precedent to dispute these arguments, pointing out that the court has often applied the howie test in a, quote, flexible and adaptive manner to capture and quote, unconventional scheme or contract. It argues that the court has often found an investment contract under securities law can be missing key elements of a formal contract and that the law's focus is on economic reality. Regarding secondary sales, the SEC references its success in the lawsuit against LBRY Library in November, where the judge found that secondary sales of tokens could be considered in an identical manner to direct sales from the issuer.

Now, taking a slight detour for a moment, at the time when that decision came out, many recognized that the library decision could have dramatic consequences as precedent in other crypto legislation. The concern was so great, in fact, that lawyer Johnny Deaton subsequently appeared before the court to make the point that some secondary market token purchasers obtained token. purely for their utility, with no regard for their value as an investment. The judge accepted this point, telling Deaton that, quote, I'm going to make it clear that my order does not apply to secondary market sales. However, we're still waiting a written order in the library case to see how the judge's decision addresses this point. The SEC argues that the court should recognize, quote,

the economic reality for those who invest in the secondary market is the same as for those investors who bought crypto assets directly from the issuers. The representations made by crypto asset issuers and promoters and investors' reasonable profit expectations do not disappear merely because an asset can be resold or purchased on a trading platform. Now, the linchpin of Coinbase's anticipated motion for early judgment is that crypto policy should be written by Congress and not developed via regulatory enforcement. This is, as we've heard before, the so-called major questions doctrine. To that, the SEC simply argues that, quote, this case, by contrast, involves the SEC's exercise of its longstanding authority to enforce statutory

requirements. In 1934, Congress authorized the SEC to enforce the federal securities laws through civil law enforcement actions. Now, this matter is currently scheduled to return to court on Thursday for a pre-motion conference. The SEC said they take no position on whether Coinbase should be granted permission to file the motion, but noted they will oppose the motion if it moves forward. The regulator also foreshadowed their intention to file a motion to strike some of Coinbase's defenses related to the major questions doctrine and lack of prior notice. Now, let's dig into commentary and start with some summarizations from Crypto-Legal Minds, starting with James Murphy at Matt a Lawman who wrote, The SEC submitted a letter to the judge yesterday, responding to

Coinbase's request for permission to file a motion for judgment on the pleadings. Here's what you should know. One, the SEC will not object to Coinbase moving forward on the motion. This is important. While the SEC will oppose the motion, it will not try to delay consideration of the issues raised by Coinbase. This means there is at least some hope of a prompt resolution of the case. Two, the SEC's letter previews the arguments it will make against Coinbase.

Those arguments are not particularly strong. The SEC suggests that the library case somehow helps them, even though the judge there did not hold that tokens traded on the secondary markets are securities. Number three, the SEC relies on an inapplicable case out of Connecticut that was brought against the issuer of a token, not against a secondary trading platform. Maybe the SEC will come up with some better case law when their full briefing occurs, but this is not signaling strength. Number four, the SEC offers no response at all to the damaging,

Gensler testimony cited in Coinbase's letter. To recap, Gensler testified in May 2021 that the SEC did not have legal authority over crypto exchanges, and there was no regulatory framework at the SEC for crypto exchanges. Number five, the SEC says it will move to strike Coinbase's defense under the major questions doctrine. That motion is very unlikely to succeed. It is likely, in my view, that Coinbase will eventually prevail on the MQD argument, either at the district court level or on an appeal. Bottom line, so far, Coinbase's strategy to accelerate the case appears to be working. Now, another aspect of this that's worth taking note of is the race aspect of these legal proceedings. Bill Hughes, a lawyer at Consensus, says, it's a race to the Second Circuit. The stage

after that is likely a cert petition to the Supreme Court, which we presume will be necessary. These issues aren't going to be resolved at the district court level, and Coinbase wants to take the first crack on appeal. Can't have BitTrecs or Binance go first. Basically, the point here is that with this big aspect of major questions doctrine underpinning this case, Coinbase doesn't want to have precedent set by the Bittrex case or by Binance first. They want to be the ones to make these arguments and eventually set that precedent. Now, Bill actually wrote a longer threat about the major questions doctrine that I think is worth understanding as well. Connecting it to the recent decision about student loan forgiveness, Bill writes, if Coinbase follows the Barrett reasoning for applying

the major questions doctrine in the case, the pillars of its argument might look something like this. One, crypto is a quote-unquote important subject, not a detail. And that's because it's a new internet, new invention, huge part of the economy and dollar terms, etc. Important subjects are for Congress, and that is confirmed by some degree by legislation in the space being frequently debated in both House and Senate. Two, the SEC bases its entire authority on a steadily more expansive and tortured definition of investment contract, which is nonsensical and without obvious limit. That delegation of power in 1933 over investment contracts is too narrow for such a broad invocation of power by the SEC. Number three, the SEC regulates investments of all shapes and sizes, but crypto is not

entirely in this wheelhouse. Yes, people use blockchain to create investment products and actually buy tokens for investment, but these are also purpose agnostic global computer networks, where data can be stored and changed according to commonly followed rules that might not be meaningfully controlled by anyone. Regulating computer networks, particularly new, revolutionary ones, is not the SEC's competency. The SEC seemingly ignores this aspect of the subject matter as if they don't know what to do with it, and think it's better to pretend it doesn't exist or matter. Number four, the SEC's conduct and statements over past years that it needs more authority, or it has imperfect authority over crypto, provides some clue that the power to regulate it

as broadly as they say they currently can, was never conferred by Congress. Newfound expansive conceptions of investment contract, exchange, and broker-dealer, which paper over these conceded gaps, should not be accepted. I'm sure Coinbase's lawyers can and will do better than this, but you get some compelling arguments after thinking about it for about only 30 minutes. I should add that the unmistakable pattern of this SEC trying to derail the legislative process by engaging in enforcement actions to distract or undermine the legislative discussion is probably a very useful fact that speaks to, one, the SEC's awareness and tacit admission that crypto is an important

subject, and two, it evidences an effort to fabricate a regulatory perimeter in the attempt to thwart earnest, bipartisan attempts to regulate this important subject for the very first time, which speaks to the fact that they are attempting to wield authority that they haven't been granted. The SEC shenanigans over the last several years give you lots of interesting arguments to make. So the interesting thing here, as this continues to proceed, because this is obviously going to be a major, major landmark fight over the following few months, what's important to note is that we're not just anymore dealing with whether tokens are securities. Instead, what Coinbase is trying to reorganize the argument around is whether or not the SEC should have jurisdiction here at all, or if not at all, at least in full as they are trying to claim.

Now, the other piece of this is the political dimension of it. There is a widely held sense in the crypto industry that this particular composition of the Supreme Court is likely to be highly favorable to its arguments around the major questions doctrine, and part of the reason that everyone is pushing so hard to get their cases heard, is likely because of the anticipation that appeals are going to take it all the way up to the Supreme Court. It seems very clear from their actions that Coinbase wants to be the crypto case to tackle this major questions doctrine. And so far, it seems like that quest is on track. All right, just a couple more quick things before we get out of here. One is not really related,

but gives a good indication of why Coinbase wants it to be heard first, not Binance. And that is Bitcoin was on sale this weekend for about 8.5% off, but despite that, there were few takers. That's because the discount was only on Binance US and only applied to US dollar fiat transactions. Now, in early June, as the SEC lawsuit heated up, Binance US announced that US dollar deposits would no longer be accepted. More recently, remaining users were notified that Fiat withdrawals would be halted on the 20th of July. So with Fiat-on-Ramps closed and the exchanges held a major question mark, depegged assets appeared to present little interest to arbitragesers. Alongside Bitcoin trading at 27,500, Ethereum was available at a $200 discount, while both Tetherin USDC traded at 10%

discounts. Because stable coins were trading at a discount, the arbitrage opportunities could only be captured using Fiat currency balances that were still on the exchange. Anyways, a small thing ultimately in the scope of things, but a weird, wonky little dislocation nonetheless. Lastly, a more positive note, an interesting thing happening, the BlackRock effect. Remember, when BlackRock CEO Larry Fink went on Fox business last week to talk Bitcoin, it seemed at least in part like a signal for Wall Street to get with a program. In the following days, it appears that some mainstream financial publications have taken that message and ran with it. Numerous commentators have noted in the past few days, Forbes has published

not one but four positive articles on Bitcoin. Now, these are pieces that could have been at home at any Bitcoin native news service and touched on some relatively nuanced and well-made points, implying more than a surface-level understanding. The articles cover topics including how Bitcoin could be a net positive for the environment, dealing directly with emissions reductions use cases already in action, how refugees are using Bitcoin to flee war-torn countries, with more than just the clothes on their back, and even how North Korean hackers have moved on from using the heavily surveilled Bitcoin network, with more than 80% of illicit crypto transactions now occurring on other chains. Alessandro Otaviani said the BlackRock effect

in Bitcoin has already started. Lex Moskovsky says, post-Black Rock Forbes, Bitcoin suddenly has become greener, helps third world countries, and is not being used by the baddies anymore. You love to see it. Now, I do think that there is likely to be a shifting narrative to the extent that Bitcoin becomes safe and no longer persona non-grado when it comes to mainstream investors. However, we have to temper our enthusiasm in this particular case, given that the publication in question is Forbes. I don't know how it's possible that Forbes has retained its brand for so long, despite the fact that the vast, vast majority of content that one sees from Forbes is written by outside

contributors. In many ways, I think it's a convenient delusion that we don't call out because it's useful for us to say, hey, look, here's a Forbes article that supports my priors or whatever thing I'm interested in, despite the fact that we all know that it's just outside contributors with basically no editorial oversight. Now, this isn't ragging on Forbes actual editorial, which has often been quite good. Frankly, Forbes has for a long time had some of the best crypto writers that are actually on staff as their journalists. But any time you see a quote-unquote narrative shift coming from Forbes specifically, ask a few more questions about who's writing the actual articles.

I do think that we're going to see some big shifts when it comes to what people think about Bitcoin, but I'm not ready to say that these four pieces are exemplary of that exactly just yet. Still, pretty cool to see, and I'd much rather have these headlines than the ones we've had in the past. That's going to do it for today. I appreciate you guys listening as always. As I mentioned in a previous episode, we are back open for sponsorship. I'll have some announcements on that front soon, so if you are interested, feel free to reach out at sponsors at Breakdown.network. And until tomorrow, be safe and take care of each other. Peace.